Share prices can be steep for the average investor. That’s where fractional shares come into play. What if instead of buying one share, you bought just a fraction of a share (i.e. a fractional share), for a fraction of the price? For example, a single Amazon share could set you back more than $100 USD. But if you only want to buy $25 worth of shares of Amazon, no problem – you would get a corresponding fraction of that share.
With fractional shares, you never need to think about how much a single share costs. You simply say, “I want $25 dollars worth,” and you can buy a part of a share instead. Simple, right?
Not so fast. Fractional shares have become more and more popular at some retail brokerage firms, however, there are many costs to be aware of before you consider investing in fractional shares.
1. Dividend service fees
If you buy a fraction of a dividend-paying stock, you might be subject to a fee charged to your account every time you are paid a dividend. If you buy a stock that pays a dividend, you may only receive 75% of the dividend you are entitled to, while the broker keeps the remaining 25%, to cover the service costs. That’s a quarter of your dividend earnings going straight into the broker’s pocket.
For example, if you bought 85% of a share in a specific stock, which pays a $1 dividend, you might think you would receive 85 cents as your dividend, but you will only get 64 cents. With fractional shares, these fees can add up very quickly, hurting your bottom line.
2. Transaction costs
Some brokers will charge a minimum fee for buying a fractional share. This could be 1% of the transaction value or a minimum of $1. You will also pay this fee to sell the shares. This can be an extremely high transaction cost, depending on the transaction size, which in turn will negatively impact your return.
Brokers do not offer fractional shares on all securities. Therefore, you have a very limited selection of what you can purchase. If you want to buy fractional shares, do your due diligence and compare options to ensure that the broker you choose allows you to trade the fractional shares of the security you are interested in purchasing. While you are verifying if they allow that security to be traded as a fraction, you will also want to verify the fees they will be charging you on this fractional share purchase.
Are there better alternatives to fractional shares?
Exchange-traded funds (ETF) and pooled funds allow investors to pool their money together to gain economies of scale. Similar to fractional shares, they offer investors the opportunity to buy a group of company shares, at a much lower and affordable price with the benefit of diversification.