A share is a single unit of ownership of a company. Owning a share helps you become a shareholder in that company and you may also receive a share of the company’s profits as dividend. However, you can also own a fraction of that unit or share – the ownership held then becomes known as a fractional share.
For example, in a situation wherein a company faces merger, bonus issue or stock split, you may get a fraction of a share, say, one-third or one-half of a share. What do you call such stocks? How are they paid to you? What are the income tax implications?
We learn the answers to these questions in the following sections.
Introducing Fractional Shares
A fractional share is a unit of stock that is less than one whole share. Fractional shares usually emerge from stock splits, bonus shares, mergers and acquisitions or similar corporate steps. Instances such as dollar-cost averaging, capital gains, and dividend reinvestment plans often leave the investor with fractional shares.
Fractional shares do not trade in the open market. The only way to sell fractional shares is through a major brokerage. While such shares aren’t available from the stock market, they have value to investors, and they are also difficult to sell.
Fractional shares are usually traded through big brokerage firms. In case the selling stock does not have a high demand in the marketplace, selling the fractional shares might take longer than imagined.
Fractional shares are created in different ways, as mentioned below.
1. Stock Splits
It is a step by the top company officials to increase the number of shares that are outstanding by issuing more shares to existing shareholders. This is a step taken to boost the company’s liquidity. The most common stock splits are 2-for-1 or 3-for-1.
2. Mergers and Acquisitions
Sometimes brokerages split whole shares so that they can sell fractional shares to clients. This is usually done with high priced stocks such as Amazon, Alphabet, Google’s parent company. Fractional stocks are sometimes the only way an individual investor can buy in such companies.
3. Dividend Reinvestment Plans
Dividend Reinvestment Plans (DRIP) also create fractional shares. A dividend reinvestment plan is a strategy by which a company lets its investors use dividend payouts to purchase more of the same shares. As the dividend is used to buy the same stocks, it might not be substantial to buy a full share, resulting in fractional shares.
Example of Fractional Share
Let’s say you own 7 shares of DEF Company. They announce a 3-for-2 stock split. This means you’d typically get (7 *3/2) = 10.5 new shares. But companies often round up, so you might receive 11 whole shares instead.
Fractional shares can also appear in mergers. Imagine you have 17 shares of DEF before it merges with GHI at a 1:5 ratio (i.e. you get 1 GHI shares for every 5 DEF). You’d get (17/5) = 3.4 whole shares of GHI, leaving you with 3 whole shares of GHI and an additional fractional share of 0.4.
How Do You Sell Fractional Shares?
Usually, you sell the fractional shares for cash to companies. The company appoints a trustee to buy the fractional shares from the investors.
Advantages of Fractional Shares
Fractional share investing happens by allowing a relatively new or amateur investor to enter the market with limited risk. Without fractional shares, it would be tough for a regular investor to build a portfolio with companies that have a high stock price. Fractional shares have also made it easy for seasoned investors to invest in their favoured stocks. Overall, the following can be termed as advantages of fractional shares:
- Lower barrier to entry: Invest in expensive stocks like Amazon with just a fraction of the share price.
- Enhanced diversification: Spread your money across more companies for a well-rounded portfolio, even with limited funds.
- Perfect for dollar-cost averaging: Invest fixed amounts regularly, automatically buying fractional shares when needed.
- Maximise small cash balances: Put spare money to work instead of letting it sit idle.
- Great for beginner investors: Start building your portfolio without risking a large sum on a single stock.
- Benefit seasoned investors: Invest in your preferred stocks without needing the full share price.
- Increased accessibility: Opens the stock market to a wider range of individuals.
- Flexibility: Invest in precise amounts that align with your investment goals.
- Compounding benefits: Start earning returns on your investment sooner.
- Potential for higher returns: Diversification can help mitigate risk and potentially increase overall returns.
Final Words
A few brokerages and trading platforms now allow fraction investing. It will enable investors to invest small amounts in expensive securities, that is otherwise beyond their reach. With fractional shares, you could divide your investments among more stocks to achieve a more diversified portfolio and use small cash balances to work quickly to get maximum returns.
Fractional shares are a useful instrument for new entrants in the stock market. If you are new to the stock market too, start your investment journey by opening a free demat account with Angel One!
FAQs
What are fractional shares?
Fractional shares are portions of a single company’s stock that are less than one whole share. They can arise from stock splits, mergers, dividend reinvestment plans, or even regular investment strategies like dollar-cost averaging.
How can I buy and sell fractional shares?
While not all brokerages offer them, many online platforms now allow fractional share investing. You can usually buy and sell them directly through your brokerage account, similar to whole shares.
Are there any downsides to fractional shares?
Selling fractional shares might take longer than whole shares, especially for less-demanded stocks. Additionally, some brokerages may charge fees for buying and selling fractional shares.
What are the benefits of fractional shares?
Fractional shares allow you to invest in expensive companies with a smaller amount of money. This helps with portfolio diversification and lets you put small cash balances to work. They’re also a great way for beginners to enter the stock market without risking a large sum on a single stock.
Do fractional shares pay dividends?
Yes, fractional shares entitle you to a portion of the company’s dividend payouts, proportionate to the fraction of a share you own.
