Novice investors interested in tapping into the stock market may be intimidated by not having much capital to start out with, but with the introduction of fractional shares disrupting the investment industry, they can now have skin in the game.
Fractional-share investing involves purchasing a portion of a stock or an exchange-traded fund rather than buying one whole share. You can now put just about any amount you want toward an individual company. This is helpful for investors who are just getting started and working with limited funds.
Fractional shares are changing investors’ focus from the price of a company’s stock to its valuation. High-cost shares will no longer stop you from buying slices of large, well-established companies.
“We are seeing a trend toward democratization of investing where a self-directed money management platform offers extra layers of ease, simplicity and automation, so every dollar is put to use,” says Brian Barnes, founder and CEO of M1 Finance in Chicago.
There are many firms that offer fractional-share investing. Here’s what you need to know when you’re deciding which service to use:
[READ: How to Recover After Stock Market Losses.]
M1 Finance: M1 is a free, automated investing and money management app that uses fractional shares to keep every investor’s portfolio fully allocated and balanced to their specifications.
The way an investor builds their portfolio is through creating pies — a weighted portfolio that has slices where investors choose stocks or ETFs that hold different weights, automatically aligning to their target asset allocation.
M1 doesn’t allow day trading. M1 rebalances once per day based on deposits, withdrawals and dividend payments. M1 also offers banking services: a digital checking account with an available 1% annual percentage yield, a debit card featuring 1% cash back on qualified purchases and personal loans.
Charles Schwab: With Schwab Stock Slices, investors can own any company in the S&P 500 with a $5 minimum and a maximum of $10,000 for a single transaction. Investors have the option to buy shares of up to 10 U.S. companies per transaction. There is no limit to the number of fractional shares you can buy through Schwab Stock Slices, and investors can invest as often as they like.
Schwab Stock Slices is more for the seasoned investor who may be fee-conscious and could require additional services beyond buying zero-commission stocks.
Fidelity: Fidelity is a long-standing, discount brokerage firm that has rolled out Stocks by the Slice fractional shares. Fractional-share quantities can be entered out to three decimal places as long as the value of the order is at least 1 cent. Participants can place both market and limit orders, which are good for the day of the trade only. Fractional-share trading is only available through the Fidelity mobile app.
The way it works is you determine how much money you want to invest and what security you want to invest in, click Transact then Trade in the Fidelity mobile app, then select the quantity type of your trade.
[See: Top Stocks to Watch With Diverse Leadership]
Robinhood: Robinhood is rolling out fractional shares incrementally to its customers, but clients can sign up for early access on the app or website. This discount brokerage firm has been disrupting the investing game, aimed at attracting younger generations that don’t have a lot of money to invest. Its mobile app is easy to use, and you can trade fractional shares in dollars or shares.
When you place a market order to buy or sell in dollars, Robinhood will convert the cash to the equivalent number of shares and buy or sell the stock at the best price. If you choose to buy or sell in shares, you can do so in an amount as little as 0.000001 of a share.
Fractional Shares Will Alter Conventional Investing
Fractional investing helps people adopt the pillars of investing: dollar cost averaging, compound investing and diversification.
“Fractionalization allows people to build diversified portfolios with investable savings they can afford,” says Robert S. Cortright, CEO of DriveWealth , a brokerage infrastructure provider in Jersey City, New Jersey.
What’s great about fractional investing is it widens investing globally, allowing investors to access the U.S. and international markets with limited money, making a diversified portfolio.
“For emerging economies, this becomes relevant in allowing foreign investors access to familiar global brands,” Cortright says.
This doesn’t necessarily just attract investors in the U.S. “It’s a great tool for young people to build portfolios and allows people of different affluences to invest on a global scale. That’s the real power and it’s just beginning,” Cortright says.
With the proliferation of online brokerages, millennial audiences are attracted by zero commissions and user-friendly applications. There is a misconception, however, that young people are day trading with online brokerages. In reality, they’re trading low-priced stocks.
There’s a big distinction between trading low-priced stocks and fractional investing, Cortright says. “Our average customer buys five to eight securities at a time and are not speculating when buying Google or Apple. This is different than trading shares of low-priced stocks, which involves more speculative trading,” he says.
However, novice investors may not notice this difference. Fractional-shares trading may lead inexperienced traders to excessive transactions, resulting in losses.
In addition, active traders should consider the possible tax implications when they hold on to stocks for less than a year.
Notably, fractional shares cannot be transferred from one broker to another. This, says Joshua Krafchick, owner of 369 Financial, an investment advising firm near Jacksonville, Florida, “is one of the many reasons why big faceless organizations are allowing fractional shares — it forces investors to keep their investments with them.”
“Otherwise, investors will be forced to sell and may have potential tax consequences,” Krafchick says.
Still, fractional investing allows you to put more of your money to work.
“When you’re investing, the purpose is to put it (cash) in the investments, but when you only invest in whole shares, you have a lot of leftover cash,” Barnes says.
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The Next Generation of Investors
The future of investing includes removing obstacles, such as needing a lot of money and high-risk tolerance, that may prevent people from entering the market.
“Back in the heyday, you used to have to go through a broker, get the daily newspaper to check stock prices; investing was extremely time-consuming,” says Krafchick.
Now, he says, anyone with access to the internet can open an investment account and begin trading on the same day.
“This will create more curiosity amongst the general population, and curiosity will turn into a passion,” Krafchick says.
Through fractional shares, a new wave of investors can access the stock market, using a more personalized method of investing.
“By giving investors with smaller accounts an alternative to the commodity-driven approach of diversification through mutual funds and ETFs,” Charlie Haims, vice president of marketing, MyVest in San Francisco, says investors “can own a diversified portfolio of individual securities tailored to their own personal circumstances — their demographics, their tax profile, their values and their life stage.”
Even though teaching good financial behavior can be a tough challenge, fractional shares empower investors to manage money more efficiently.
Buying fractional shares is a step toward “moving from a brokerage mentality to embedded finance,” Cortright says, where people are becoming more efficient around their personal finances and are aware that a more productive management of their money will lead to greater financial literacy and a more stable financial well-being.
Fractional shares allow people to fully participate in the market. For long-term investors who want to be able to buy industry-leading companies, they can engage in the markets, learn with less money and lower risk as markets go up and down.
Younger investors have more time to add to their portfolios. If you consistently and incrementally add money, even in low amounts, after a period of time you will have a growing portfolio with a bundle of strong stocks.
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