Contributors: Jack Pitcher and Suzanne Woolley
Updated on October 5, 5:00 AM EDT
What You Need To Know
There’s a new way of buying stock that makes the share price almost irrelevant.
Brokerages like Charles Schwab Corp. and Robinhood Markets have started to offer something known as fractional shares, which let people invest as little as $1 or 1 cent in a company.
The subtly radical product turns the concept of owning stock on its head. Instead of buying a fixed slice of a company at a certain price, you’re investing a specific amount of money, and in return getting a piece of the company. You get all the same benefits, proportionally, if the stock rises — and risk losing just as much if it falls.
Can’t afford to buy a single share of Amazon, which was trading at about $3,125 on Oct. 2? Why not buy $100 worth of the company instead? A 5% rise in the share price to $3,281 would make your stake worth $105. Or you can acquire a tiny bit of Google parent Alphabet Inc., rather than having to spend about $1,450 for a share.
Why It Matters
The barrier for entry to invest in high-flying stocks has now been lowered, just as more people buy and sell in the market on their own.
The flipside is that now more people can lose money in the market. And investors may soon learn that being out of the market for even just a few days can mean missing out on much of a year’s gains. Critics say that fractional shares encourage inexperienced investors to take risks they don’t fully understand. Of course, if all you put in is $5, you don’t have a lot to lose, and probably not a lot to gain, either.
Why Hasn’t This Been Available Until Now?
Fractional shares have been offered in the past, including by at least one company during the late 1990s dot-com boom. But until now, higher trading fees meant it usually didn’t make sense to buy shares in small dollar amounts. In the late 90s, some of the lowest commissions were still as high as $8 a trade. Now, you can trade for free.
Most of the largest U.S. brokerages began offering fractional shares for the first time in 2020, after smaller firms including Social Finance Inc. and Stash Investments LLC launched similar products over the last two years.
Though buying fractional shares on purpose is a relatively new concept, many people have probably owned them without knowing it. When dividends are reinvested, or when shares are divided up or combined — through stock splits, reverse splits or merger deals — sometimes investors are left with fractions of shares.
How It Works
Behind the scenes, a brokerage like Fidelity holds full shares, allocating portions to their customers and holding any remaining portion of the share in its inventory.
They pass on the dividends proportionally. Trades can typically be executed immediately, in part because the brokerages are mostly offering some of the most widely traded stocks. Some brokerages also pass on the equivalent percentage of stockholder voting rights.
At Charles Schwab, a customer on average invests just under $400 at a time and buys seven fractional shares in a single trade, and about 110,000 accounts have bought such shares since the program began on June 2. The number of such accounts at Fidelity Investments had more than tripled as of the end of July from 102,000 four months earlier.
Some brokerages only offer fractional shares in a limited number of companies. Schwab offers fractional shares in companies represented in the S&P 500 — not Tesla, then — while SoFi gives access to only a few dozen companies. Meanwhile, Fidelity, Robinhood and Stash have thousands of companies and ETFs available.
The Fine Print
One downside: You might not be able to simply transfer your fractional shares between brokerages. For example, if you use Robinhood and want to switch to another platform, you have to sell your fractional shares and move the cash. Of course, you can then buy fractional shares again with the new brokerage, but you might have to pay capital gains taxes on the shares you just sold. If you’ve held the stock for less than a year, you pay the short-term capital gains rate. For many people, that’s going to be a lot higher than the long-term capital gains rate, which is 0%, 15% or 20% depending on your filing status and your income.