Fractional Shares: Compare the Pros & Cons

If you want to invest in a company, you need to be stock or shares in that business.

Businesses issue a number of shares and each share represents a portion of that business.

For example, if a company issues 1,000 shares, each share represents 0.1% of that company’s ownership.

Previously, you usually couldn’t divide ownership in a company further than a single share, but fractional shares have become more and more common.

What Are Fractional Shares?

A fractional share is less than a full share in a company.

In other words, it’s a fraction of a share.

For example, instead of purchasing a full share in a business, you could purchase 1/10th of a share, or .1 share in the business.

There are a lot of benefits to fractional shares.

One is that they make it easier for people to invest in companies with high share prices.

For example, at the time of writing, a single share in Tesla cost almost $1,900. Without fractional shares, the only people who could invest in Tesla are those who can afford to put $1,900 into the company. The high share price also makes it difficult to invest a precise amount in a company. With Tesla, people could only invest in $1,900 increments, which would be annoying if someone wanted to invest a certain amount, like $2,500.

Fractional shares let people purchase less than a full share, making it easy for anyone to invest in a company, regardless of its stock price.

Fractional shares also make it easier for people to invest the desired amount in a company’s stock.

How Investors End Up With Fractional Shares

There are a few ways that investors can wind up with fractional shares.

Buy fractional shares

Though it was less common in the past, many brokerages now let their customers buy fractional shares.

Instead of making people buy a whole number of shares, these brokerages let their investors invest in stocks based on dollar amounts, even if that means buying less than a full share.

For example, an investor buying shares that cost $40 each could decide to buy $500 worth of shares. Without fractional shares, they’d buy 12 shares and have $20 leftover. A brokerage that lets them buy fractional shares would instead process the transaction, giving the investor 12.50 shares.

Some of the brokerages that allow fractional shares include:

• Robinhood
• M1 Finance
• Stash
• Public
• Fidelity
• SoFi
• Stockpile
• Betterment

Stock splits

Companies sometimes undergo stock splits, dividing each share into multiple shares.

One of the primary reasons for a stock split is to help a company control its stock price.

If shares become too pricy, they can be too expensive for an individual investor to buy. Splitting shares reduces the per-share price without affecting the overall value of the business.

Companies can do stock splits in almost any ratio, and this can result in some investors owning fractional shares.

For example, a company may do a 4-for-5 split, where it turns each share into 1.25 shares. Someone who owns 4 shares will now have 5 shares. Someone with 40 shares will now have 50.

Someone who owns a number of shares that isn’t divisible by four will wind up with fractional shares. For example, an investor who only owns 3 shares will wind up with 3.75 shares after the split.

DRIP

Dividend reinvestment plans (DRIPs) often result in investors owning fractional shares in a company.

A dividend reinvestment plan is exactly what it sounds like. Many companies make regular dividend payments to their shareholders.

If a shareholder signs up for a DRIP, they automatically use the dividends they receive to purchase new shares (reinvesting their dividends into the company).

Now:

The dividends a shareholder receives aren’t always sufficient to buy a whole share or aren’t divisible by the share price.

For example, someone owns 10 shares in a $40 stock that pays a dividend of $0.25. They’ll get $2.50 with every dividend payment. If the stock still costs $40, that’s enough to buy .0625 shares.

Now that the investor owns 10.0625 shares, they’ll get $2.515625 as their next dividend payment. If the shares are still $40 each, that will buy them .0629 shares.

Over time, the investor will continue buying fractions of shares with their dividends, increasing the dividends they receive each quarter.

Recordkeeping

Recordkeeping for fractional shares is very similar to recordkeeping for buying shares in whole amounts.

Calculating cost basis and taxes

When you buy investments, you need to keep track of your cost basis, or how much you paid for the investment.

For example, if you buy a share in a company for $100, you need to remember that your cost basis is $100.

Cost basis is important for taxes.

If you sell an investment for more than its cost basis, you have to pay capital gains taxes on the profits. If you bought a share at $100 and sold for $125, you owe taxes on the $25 gain.

If you sell an investment for less than you paid (its cost basis), you can deduct the losses from your investment income (and regular income, up to limits) when calculating your income tax.

If you own fractional shares, you track cost basis in a similar way. If you bought ¼ of a share that worth $100, you paid $25 for that ¼ of a share, making its cost basis $25.

When you sell that fractional share, you have to calculate your gain or loss based on the difference in the sale price and the purchase price.

Pros

There are a lot of benefits to fractional shares.

One major benefit is that it makes it easier for anyone to invest in any company, regardless of that company’s share price.

If you can only buy shares in whole amounts, it can be difficult for smaller investors to buy stock in companies with very high share prices. That can lock entire groups of investors out of investing in certain companies.

Fractional shares also make it easier to invest precise amounts in a company.

You don’t have to choose the amount to invest based on whether the amount is divisible by the share price. You can simply decide how much to invest and buy as much of a stake in the company as you want to, down to the decimal point.

Cons

There are a few drawbacks to investing in fractional shares.

Easy to rack up fees

One drawback is that fractional shares can make it easy to buy very small stakes in many different companies.

If your brokerage charges commissions, you might wind up paying a lot of fees due to the temptation to invest in many different companies.

Not available everywhere

Another drawback is that not every brokerage allows customers to buy or hold fractional shares.

So, you might have to limit your choice of brokerages to work with if fractional shares are part of your investing plan.

Conclusion

Fractional shares are a great way for investors to buy parts of a share in companies with high stock prices.

They also make it easy to invest precise amounts in a company.

Many brokerages have begun offering customers the opportunity to buy fractional shares, so if you’re in the market for a new brokerage account, take the time to see if the companies you’re considering offer this benefit.