Fractional Shares: Are They Worth It?

Fractional shares are partial shares of a company's stock. Instead of owning one or more full shares of the stock, you own a portion, or fraction, of one. 

In the past, investors generally would end up with fractional shares only after a stock split since brokers allowed the purchase of full shares only. But that's changing now, with big-name brokers making it possible to purchase fractional shares directly.

Thanks to this shift, you can specify how much money you want to invest in a particular company (rather than how many shares you want to buy) and purchase a small portion of a share if your cash investment isn't enough for a full one.

Understanding fractional shares

Fractional shares are simply portions of a whole share of stock.

When a company issues stock shares, every investor owns a fraction of the total shares outstanding. Imagine a simple example of a company that issues 100 shares. If you purchase one, you own 1/100th of all outstanding shares. But with fractional shares, you don't have to buy a full share. You could purchase half a share, or a fifth of a share, and own .5/100th or .2/100th of all outstanding shares.

You purchase fractional shares through a process called dollar-based investing. You specify the amount of money you went to invest in a company -- such as $20 -- and buy the number of shares that your spending power allows. Most brokerages that offer fractional shares also offer commission-free trading, which means you will not pay transaction fees associated with the purchase or sale of your partial shares. Having to pay a commission to buy partial shares usually means the transaction isn't worth it since you'd have to earn a substantial rate of return on your partial share to cover trading costs.

Are fractional shares worth it?

Fractional shares have some advantages and some potential disadvantages. Nonetheless, it's an opportunity that's often not considered when investors first learn about investing in stocks and exchange-traded funds (ETFs).

Pros of fractional shares

1. You're treated the same as any investor with a full share. When you buy a fraction of a share, you make the same percentage gains and get the same benefits of stock ownership.
2. It enables you to invest in companies you might otherwise not be able to invest in. In some situations, a stock's price may be so high that investors may not have enough capital to afford a single share. Before fractional shares were a thing, investors in these situations were precluded from investing in certain companies.
3. You're still rewarded with dividends. If you purchase fractional shares of a stock that pays dividends, you will receive a payment based on how many shares you own, just as any other investor would. If shareholders receive a $1 dividend for each share they own and you own a half share, you receive $0.50.

Cons of fractional shares

1. It's no safer than owning full shares. Just like you receive the same benefits as those investors who own full shares, when you own fractional shares, you also take on the same risk of loss.
2. Options may be limited. While many brokerages offer fractional shares, they're not available from every brokerage. Similarly, some brokerages may limit the stocks for which you can buy fractional shares. Charles Schwab, for example, only provides fractional shares for stocks found in the S&P 500.
3. It may contribute to bad habits. With the ability to buy fractional shares instead of committing to full shares, investors may feel like they have less on the line, leading them to perform a lesser degree of due diligence with their potential investments. When investing $1 or $1,000, it's essential to dig deep into potential investments and not be capricious with investment decisions.

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The bottom line on fractional shares

Building a diversified portfolio reduces the risk of investing since you don't bet most or all of your money on a single company or industry. Thanks to fractional shares, diversification can be less expensive since you don't need as much money to make an investment. If you have just $25 to invest, you can spend $5 to buy a partial share of companies in five different industries instead of being forced into spending your entire $25 to buy a single share of one company. 

However, this does not mean that trading fractional shares is risk-free. The low cost of entry can result in some investors doing less research than is necessary to make fully informed purchases. And if you are buying partial shares of stock in individual companies, this is inherently riskier than buying mutual funds or index funds (although it also provides you with a chance of beating the stock market). 

In fact, if you have a sound -- and Foolish -- investment strategy, are willing to put in the time necessary to select individual investments, and are prepared to do the work to build a diversified portfolio, the ability to buy fractional shares actually gives you a better chance of selecting investments that outperform the market than if you were restricted to purchasing only full shares. That's because fractional shares make it possible to invest in whatever companies you believe are likely to perform best without worrying about per-share price. 

Every investor should weigh the benefits and risks before purchasing any assets, but many will find that fractional shares are a good addition to their portfolio.