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At the time of this writing, one share of Amazon would cost you about $1,900. That’s a hefty price to pay, especially if you’re just starting out in investing. But did you know there is a way to buy expensive stocks like Amazon and Google for as little as $19?
How? The answer is fractional shares.
With fractional shares, you can buy shares of great companies at just a fraction of their original cost.
In this article, you’ll learn what fractional shares are and how you can use them to invest in companies you previously couldn’t afford. To help you get started, we’ll also show you steps on how to buy fractional shares.
If you’re new to investing or have limited funds to invest, this article will be especially helpful to you.
What Are Fractional Shares?
As the name suggests, fractional shares are divided portions of a full share.
In the past, fractional shares are only available as a result of stock splits, mergers and acquisitions — meaning that you can’t get your hands on them unless you’re an existing shareholder.
Now however, many brokerages such as Interactive Brokers, M1 Finance and Fidelity are offering clients the ability to buy fractional shares. This means that instead of buying one full share (which can be pricey), you can now choose to buy just a portion of it, at a fraction of the price of course.
Here’s an example to help you better understand how fractional shares work.
Imagine you have $5 and want to buy some pie at a bakery. Sadly, it turns out they only sell whole pies at $30 so you can’t afford it. You visit another bakery and find that they are selling the same pie for $30 as well but allow customers to buy individual slices at $5. So now, you can actually afford to get a slice of the pie.
How to Take Advantage of Fractional Shares
So, what does this mean for you as an investor?
Well, for one, you can now invest in companies that you previously found too expensive. For example, instead of having to spend $1,900 on an Amazon share, you can now invest in Amazon with just $19, by buying 1/100 of a share! This allows you to invest in your favorite companies while ensuring good diversification in your portfolio. Let’s take a deeper look into the benefits of fractional shares.
1. Better diversify your portfolio and size your positions
A well-diversified portfolio is important in ensuring you are not overly exposed to any one company, industry or sector. As the saying goes, “Never put all your eggs in one basket”.
We must NEVER invest all our capital into just one stock! This protects our account from getting wiped out in the event the business goes bust.
Comparatively, if you diversify into different companies in different sectors and industries, you reduce the risk of any one company having a significant impact to your overall portfolio.
Generally, we want to have at least 8 − 12 stocks from different categories to ensure we are sufficiently diversifying our portfolio.
In the past, if you have a small capital, diversification becomes hard especially if you want to own shares that are more highly priced (e.g. Google, Amazon).
For example, let’s say you have a capital of $10,000 to start with and want to diversify into 10 different stocks, allocating $1,000 each.
If one of the companies you want to invest in is Amazon (current share price of about $1,900), you won’t be able to allocate just $1,000 to it.
What would most beginner investors do here? They either give up on the stock, or buy one share of Amazon at $1,900. This immediately results in an over-allocation of capital to Amazon, as the initial plan was to just allocate $1,000.
Since Amazon now takes up a substantial one-fifth of the portfolio, the account will suffer a bigger hit if a negative market event causes Amazon’s share price to plunge.
Now the good news is, with fractional shares, you can afford to invest in a wider variety of companies regardless of their price per share. Instead of forking out $1,900, investors can now buy 0.53 share (worth $1,000) to gain exposure to Amazon while ensuring a well-diversified portfolio.
For those of you who struggle with diversifying your portfolio due to a small account size, this is your solution.
2. Better employ dollar-cost averaging
For those of you who’ve taken the Whale Investor™ Value Momentum Investing course, you would know that we use the dollar-cost averaging approach when investing.
This means that when we invest in a company, we don’t add our full position in one go. Instead, we divide it into a few tranches until we get our desired full position.
This is because no one can predict the short-term price movement of a stock, so dollar-cost averaging ensures you get a nice average purchase price by averaging out the highs and lows.
Take for example Facebook, which is now trading at about $150 per share. If you want to invest a total of $1,000 into Facebook, you should not buy your full position right away. Instead, you could divide your entry into 4 tranches, entering 25% of a position (or $250 in this case) each time.
This leads us to the next point on how the use of fractional shares allows investors to better employ dollar-cost averaging.
Using the same example of Facebook above, if we want to divide a $1,000 position into 4 tranches, we’ll be investing $250 for each entry. However, without the use of fractional shares, if the stock is currently trading at $150 per share, we can only enter either $150 (for one share) or $300 (for two shares), neither of which allows us to just invest $250.
With the use of fractional shares, this problem no longer exists as we can tweak the proportion/fraction of shares to ensure we invest based on our desired dollar amount.
In fact, most brokerages allow you to buy shares by the dollar amount. So instead of keying in an order of 1.67 shares (which equates to $250) for Facebook, we can just key in an order by the dollar amount of $250.
This saves us the trouble of punching the calculator every time we want to buy shares, since all the calculation is done for us in an instant.
Again, for those of you with limited funds, the use of fractional shares here proves extremely useful.
How to Buy Fractional Shares
Now that you understand the power of this investing feature, let us show you how to buy fractional shares in 3 simple steps:
1. Find a broker that offers fractional shares
Not all brokers offer clients the option to buy fractional shares, so you got to use a broker that offers this service. An example of such a broker would be Interactive Brokers.
An important factor to note here would be the degree of access the broker gives for fractional share buying.
Find out what is the smallest proportion of a share you can buy with the broker, and what are the types of stocks you can buy using fractional shares. For example, Interactive Brokers only provides the fractional share service for US-listed stocks.
2. Activate your access to fractional shares
This varies from broker to broker. Some brokers give you automatic access to fractional shares as soon as you open an account with them, while some require you to activate your access manually.
So remember to do a check to see if you have access to buying fractional shares.
3. Place your buy order
Last but not least, place your buy order on your desired stock.
As mentioned earlier, some brokers allow you to key in your order by dollar amount instead of share position.
Using Interactive Brokers as an example, to invest in Amazon, you can simply key in your desired position size. Here, we are buying 0.01 share.
Alternatively, you can key in your order by dollar figure. Here, we are buying $19 worth of Amazon shares.
Commonly Asked Questions about Fractional Shares
Here, we cover a couple of common questions investors ask about fractional shares!
Do fractional shares pay dividends?
Fractional shares work just like normal shares except in a smaller proportion. Hence, you’ll still receive dividends depending on how much of a share you own. For example, if company A pays a dividend of $2 per share and you own 0.5 shares, you’ll get $1 in dividends.
Do I need a minimum starting capital to buy fractional shares?
In general, you would not need to have a minimum capital before you’re allowed to buy fractional shares. However, this may vary from broker to broker so it is best to check with your own broker.
On a Last Note
We hope this article has given you a better understanding of how to improve your investing with fractional shares.
Of course, just because you can now buy shares of expensive companies doesn’t mean you should go all out and buy them all.
Remember to always do your own due diligence and only invest in fundamentally strong companies at good technical levels.
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