Fractional shares are similar to pizza slices. Have you ever tried to order only one pizza slice? Most of the sellers won’t accept your order. You will arrive at the same situation if you try to buy or sell fractional shares. So, What Are Fractional Shares? How were they created? In this article, we will cover everything about fractional shares.
What Are Fractional Shares?
A fractional share is nothing but a part/fraction of a share. It is just like a slice of full pizza. All investors can’t buy shares of companies like MRF. They are too costly. Currently, MRF stock is trading around Rs.81850/share. But with fractional shares, small investors can also buy such stocks.
The concept of fractional shares is also applicable to cryptocurrencies. For example, the current price of 1 bitcoin is Rs.22,27,257. At this price, small investors can’t afford it. This problem can be solved by fractional shares. Using fractional shares, investors can start investing in costly bitcoins or shares with smaller amounts.
Currently, US investors can invest in huge tech giants like Google, Amazon, Facebook etc, using fractional shares. Even if you are an Indian, using some stockbrokers you can invest in American stocks using fractional shares up to some limit. The fractional shares concept has already existed for quite a while.
How Fractional Shares Work?
Like normal stocks, investors can buy and sell fractional shares of any company using their stockbrokers. When you buy fractional shares of a company, you will also be treated as an investor. That means, you are a partial owner of that company and will be entitled to profits, losses, risks associated with that business.
Just like normal shares/stocks, you can trade fractional shares. But the issue is not all brokers allow the trading of fractional shares. You need to spend some time finding one.
How Fractional Shares Created?
Mostly fractional shares are created because of corporate actions. Corporate actions like offering dividends to investors, stock splits and mergers and acquisitions.
1. Dividend Reinvestment Plan (DRIP)
Most of the fractional shares are created by dividend reinvestment plans. If investors opt for DRIP, what it will do is that whenever a company issues a dividend DRIP uses that dividend amount for reinvesting. In most cases, the dividend amount is not enough to buy the stock of that particular company. In such a case, it ends up buying fractional shares of that stock. Not only that reinvesting capital gains, but dollar-cost averaging can also end up buying fractional shares.
2. Stock Splits
Let us assume that an investor holds 213 shares of XYZ company. If that company decides to create a 3 for 2 splits, the above investor ends up with fractional shares. But how? 3 for 2 split means, for 2 shares the investor is holding, he will get an extra 3 shares. In our case, the investor is holding 213 shares. After a 3 for 2 splits, the total number of shares our investors have is (2131.5) = 319.5. If we observe, our investor ends up with a 0.5 share of XYZ company, which is nothing but a fractional share.
3. Mergers and Acquisitions
Mergers and acquisitions can also create fractional shares. During the process of mergers and acquisitions, companies use predetermined ratios to combine new stocks. This ratio often results in creating fractional shares. In some cases, brokerage firms purposely split the stocks to sell them to their clients. This is especially common with high-priced stocks.
For example, a young investor with little funds wanted to buy Google shares. With only $1,000 to invest, he/she can’t buy Google shares. But the investor may be able to find a brokerage company prepared to offer a fractional share. Using fractional shares, now the investor can buy a fraction of Google shares.
Fractional Shares Advantages
- Fractional shares can help small investors with little funds to invest in high-priced stocks or cryptocurrencies.
- Monthly investor/SIP investors can enjoy dollar-cost averaging.
- Using fractional shares, even small retail investors can do better portfolio diversification.
- With fractional shares, there is no need to divide the available funds with the stock price to find out the number of shares the investor can buy.
Fractional Shares Disadvantages
- Fractional shares trading and investment are not possible with all the brokers. Only big investments first offer fractional share investing and trading.
- In the process of diversification, investors may end up buying many stocks. Due to over-diversification, investors may have to pay more charges to the broker.
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1. Why are fractional shares bad?
A. Whether a product is good or bad depends on the usage of the individual. It may be good for the investors who do proper investment research and diversification. It may be bad for the investors who are reckless with their money and buying everything on the stock market.
2. Is there a downside to fractional shares?
A. Yes, there are a few downsides. Not all company stocks are available in the form of fractional shares. Fractional shares trading is not famous and not possible with all brokers. So, there can be liquidity issues. Fractional share transferring is difficult among the brokers.
3. Are fractional shares legal?
A. Yes. Fractional shares are legal.
4. Are fractional shares hard to sell?
A. Yes. In case of less liquidity, fractional shares can be hard to sell.
5. Do fractional shares pay dividends?
A. Yes, fractional shares pay dividends. But if the investor holds half a portion of the share, he/she gets only half of the divided amount.
6. Is fractional share trading is possible in India?
A. Currently, No.