Dear long-term investors, as of 2022, more and more brokers are offering fractional shares. eToro has also been making fractional investing possible for some time. What are fractional shares anyway? How does it work, what are the pro’s and con’s and where can I buy fractional shares? For retail investors, fractional investing is a solution that can help reduce risk. Continue to read to find out why.
Towards profitable investing and beyond!
Table of Contents:
What are fractional shares?
A fractional share (fractional share) is a portion of one whole share. They can be created in stock splits, where the current stock position is split. Sometimes fractional shares are created in acquisitions. For example, we may own not 1, but 1.25 shares.
Nowadays, there is a new development around fractional shares. Now it is possible to deliberately buy a fractional share. This is useful if the share price is high.
Suppose. We want to buy Alphabet shares. One share currently costs $2900. For small, beginning investors, this is too high an amount. After all, with a small budget, we can just about buy or not buy Alphabet. And if we can, we will only have one share in our portfolio. Obviously, this is insufficient for adequate risk diversification.
Fractional shares offer the solution.
We can now buy a fractional share. We can buy 1/10th share of Alphabet. This share will cost us $290. If Alphabet increases in price by +10%, our 1/10th share will also increase by 10%. Therefore, the price return remains the same, but we have a small position in this company.
Fractional shares offer some interesting practical advantages for the small investor, such as: (1) getting in with small amounts, (2) more diversification, and (3) easier Dollar Costing Averaging. How that works we explain below.
How fractional investing works: pro’s and con’s
Fractional investing offers interesting advantages investing with small amounts. On the other hand, it also gives disadvantages. In most cases, it is wiser not to buy a fractional share if you can. For small investors, however, it can be wise if it is used to create more risk diversification.
These are advantages of buying fractional shares:
- Getting in with small amounts
- Apply more diversification in stocks
- Monthly investing becomes easier
In all cases, you want to buy the best stocks or the best dividend ETFs. In some cases, they have a high share price. An Alphabet stock currently costs $2900. The iShares S&P 500 ETF has a stock price of $470. This price says nothing (!) about the value of the stock. But as a small investor, it becomes difficult to invest in this (monthly).
Fractional investing make monthly or periodic investing more accessible. For example, you can divide a smaller amount each month into several fractional shares. This leads to being able to buy multiple shares, which helps spread the risk in our portfolio.
Keep in mind that a stock price says nothing about how expensive a stock is. Alphabet shares at $2900 are much cheaper than Tesla shares at $1000. This has to do with the price/earnings ratio and other financial ratios. For example, it regularly happens that a $1 share of company X is in reality extremely expensive. In short, don't stare at the price but look at the valuation.
Buying fractional shares also has disadvantages. The biggest disadvantage is that it works on a CFD structure. With a CFD you buy the underlying value of an asset. This has specific risks. One of the practical risks is that CFDs can also often be bought with levers. For example, we can buy 10% Alphabet stock for $290 with leverage x5. When the price goes +10%, our profit is +50% (x5). But at -10% we have lost half of our money (-50%).
Avoid CFD investing at all times. This gives unnecessary risks and more than 80% lose money.
Another disadvantage is that fractional shares can lead to higher transaction costs. The more orders made, the higher the transaction costs. Therefore, choose cheap brokers. Below we explain where to buy fractional shares.
Where can I buy fractional shares?
There are currently several investment platforms that allow buying fractional shares, including eToro, NAGA, and BUX Zero. There are other brokers, but they are not accessible to Dutch and Belgian Investors. NAGA is an emerging investment platform. Interesting features, but as yet not suitable for long-term investors. This NAGA review explains why.
For fractional share buying, eToro and BUX Zero are two suitable options.
eToro is (one of) the first provider(s) for buying fractional shares. They cleverly combine this with their marketing strategy of 0% transaction fees. This is a powerful combination, as fractional shares can lead to higher transaction costs (see below). With eToro, this is not the case. Also, compared to BUX Zero, they offer more shares. This means that you have more choice of which shares can be purchased. In addition to fractional shares, eToro also offers other features, including CryptoPortfolios and AutoCopy. Interesting for the novice investor, but pay close attention to the increased risks and never invest with levers!
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