A fractional share is a portion of a stock that represents less than one full share. While it may seem like a small concept, fractional shares have significant implications for both individual investors and financial markets. These shares can occur due to various corporate actions such as stock splits, mergers, acquisitions, and dividend reinvestment plans (DRIPs). However, despite their value to investors, fractional shares are often difficult to trade on the open market, making their sale somewhat tricky.

Key Takeaways

Understanding Fractional Shares

Fractional shares can come into existence through several mechanisms:

1. Dividend Reinvestment Plans (DRIPs)

Dividend reinvestment plans allow investors to reinvest their dividends to purchase additional shares of the same company. This process can lead to fractional shares since dividends may not always be enough to buy a whole share. For example, if an investor receives a $50 dividend, and the share price is $100, they can purchase 0.5 of a share, resulting in a fractional share.

2. Stock Splits

Stock splits occur when a company decides to increase its number of outstanding shares. For instance, a 3-for-2 stock split will grant three shares for every two shares owned by the investor. In such cases, if an investor owns an odd number of shares, they may end up with a fractional share value. For example, having 5 shares before the split would lead to having 7.5 shares after the split.

3. Mergers and Acquisitions

Mergers and acquisitions can also create fractional shares as companies combine their shares using a predetermined ratio. For instance, if Company A merges with Company B, and the share exchange ratio leads to fractional ownership, existing shareholders may receive fractional shares of the new company.

Benefits of Fractional Shares

Accessibility to High-Priced Stocks

One of the biggest advantages of fractional shares is that they make high-priced stocks accessible to a broader audience. Rather than needing to spend large sums to acquire a full share of companies like Amazon or Alphabet, investors can purchase fractions of shares, allowing them to invest with smaller amounts of capital. This democratization of investing opens doors for young investors or those with limited funds.

Diversification

Fractional shares allow investors to diversify their portfolios without needing substantial capital. For example, a young investor with $1,000 could buy fractional shares of high-value stocks and also invest in lower-priced stocks to create a diverse portfolio.

Trading Fractional Shares

Selling fractional shares is not as straightforward as selling whole shares. The only way to dispose of fractional shares is through major brokerage firms, which can aggregate fractional shares from different investors to form whole shares. If a stock does not have high demand, selling these fractional shares may take longer than anticipated. Investors may also find that brokerage firms provide the option of obtaining cash in lieu of fractional shares in certain situations, though this cash is taxable.

Real-World Impact

In late 2019, Interactive Brokers paved the way for fractional share trading by becoming the first major online broker to offer this service. Shortly after, Fidelity followed suit, expanding the accessibility of fractional shares to the general public. This shift represents a significant development in investing, providing more opportunities for individuals to enter the stock market.

Final Thoughts

In conclusion, fractional shares represent a cornerstone of modern investing, offering greater accessibility to high-priced stocks and enabling investor diversification with smaller amounts of money. With the growth of technology and online brokerage services, fractional share trading has become more commonplace, allowing more individuals to engage with the stock market than ever before. For those looking to maximize their investment potential, understanding fractional shares is key to navigating today's financial landscape.