What is Fractional Investing?
Typically, if you want to buy shares in a company, you need to purchase a whole number of shares. Fractional share investing lets investors buy less than a full share at a time, or in the case of alternative assets, allows investors to buy less than a whole hard asset.
The introduction of fractional investing makes it possible to invest the exact amount of money you would like to, regardless of the share price of each asset.
Put simply, a fractional share is a portion of a stock divided into many — instead of owning 1 share of XYZ company, an investor can own .25 or .003 of an individual share of a company. Being able to purchase a fraction of a share makes investing more affordable and accessible for those who do not have much capital to invest.
Types of Fractional Investments
Fractional shares are a relatively new development for investment vehicles other than mutual funds.
Mutual funds have long supported fractional investing, but only through traditional methods such as Dividend Reinvestment Plans (DRIPs), stock splits, or mergers and acquisitions.
Sometimes referred to as stock slices, a fractional stock share is a portion of a whole stock sold at that fraction of the share price. For example, if a company’s market share price is $200 a share, and you were buying $20 worth of it, you would own 0.1 (10%) of a share. Fractionalized shares provide a simple, low-cost way to invest in a public company.
Real assets such as real estate and luxury cars can be an attractive financial product, but they can often come with a hefty price tag.
For example, investment-grade wine can go for upwards of $5,000 per bottle, while collector watches can be in the tens of thousands. Access to these hard assets used to be exclusive to the ultra-rich, but with fractional investing, more investors are able to invest into the pot.
Fractional shares of alternative assets work in basically the same way as fractional equity shares — instead of purchasing a $100,000 Ferrari outright, an investment platform, for example, can sell 5,000 shares for $20 each. Once the platform sells the Ferrari, hopefully for a profit, the profit would be divided amongst all investors based on how many shares they owned, less any fees or expenses.
To Invest in More Expensive Assets
Many blue-chip stock names have increasingly high stock prices, by nature of them appreciating in value. Unfortunately, this means that purchasing a whole share of names like UnitedHealth Group (UNH), Mastercard (MA), or Autozone (AZO) requires at least a few hundred dollars.
In July 2022, a single share of Berkshire Hathaway (BRK) cost $423,630.00 while Autozone (AZO) cost $2,195.80. While BRK shares are an outlier, even shares that cost a few hundred dollars can be more than an investor would like to buy for shares in a single company.
Fractional trading allows investors to purchase the amount they can afford, whether $5 or $500.
In addition, fractional share investing opens up the opportunity to invest in portions of expensive real assets including real estate, fine art, or vintage cars. Most investors cannot afford to purchase a $95.4 million Roy Lichtenstein, but many more may be able to afford a $25 investment.
To Build a Diversified Portfolio
When the price of investing in a variety of different companies and assets is reduced, it becomes easier to create a diversified portfolio. With fractional shares of stock, an investor can allocate a certain percentage of their portfolio to each stock or asset, regardless of their share price.
Alternative assets can be a useful tool for portfolio diversification, but the majority of real assets are not tradable through an index or exchange-traded fund (ETF). Outside of a few exceptions (gold and oil for example), real assets can be inaccessible unless an investor has access to extensive starting capital.
Fractional investing has given retail investors a much wider array of alternative assets to include in their portfolios. There are numerous investment strategies investors can implement to diversify, alternative assets offer one strategy because they tend to have a low or negative correlation with the stock market.
According to Citi Private Bank Research from March 2022, hedge funds have only a 0.77 correlation with developed equities, 0.52 for real estate, 0.11 for commodities, 0.09 for fine art, and -0.04 for Post-War & Contemporary Art.
J.P. Morgan’s 1Q 2022 “Guide to Alternatives” notes that allocating 30% to alternatives in a portfolio can increase returns, while also strengthening stability and minimizing risk for institutional investors. Standard asset allocation models for retail and sophisticated investors are increasingly recommending at least a 10% allocation to alternatives. Without offering fractional shares, this is near impossible for some retail investors.
Better Dollar Cost Averaging Options
With dollar cost averaging, an investor invests a set amount of money on a regular basis. Over time, an investor may pay less per share than if all shares were bought at once. Because dollar cost averaging is based on a consistent dollar amount and not a consistent share amount, it can be advantageous to be able to invest the full amount each time.
Without fractional shares, some amount of money will have to sit in a cash account before there is enough to buy a share.
For alternative assets, an investor often has to work within that specific company’s platform in order to trade. Even for fractional stocks, it is unlikely that an investor will be able to transfer shares, which is a big difference from the ease by which investors can move whole shares. If fractional shares must be sold before switching brokerages, this could come with tax implications, fees, or other costs.
Fractional shares may also have different liquidities than standard equity shares. Some brokerage firms have indicated that they do not guarantee the liquidity of fractional shares, even if full shares of the stock are liquid. This means there may be difficulty selling fractional shares in certain circumstances and could potentially lose money on the investment.
On the other hand, for some alternatives, fractional investments can allow for smoother exits and higher liquidity compared to owning a complete hard asset such as a house or a piece of fine art. In this situation, there is no need to find potential buyers and go through a third party such as an auction house, you are able to simply notify the investing platform.
Many online brokerage platforms sell fractional shares, including Charles Schwab, Fidelity, and SoFi Invest. Some robo-advisors like Acorns and Betterment purchase fractional shares for your brokerage account.
Specific guidelines for buying and selling fractional shares will differ based on the platform chosen — some may still require an account minimum, while some platforms will not include all stocks or ETFs. For example, Charles Schwab only sells fractional shares of companies in the S&P 500.
When it comes to fractional shares of alternatives, investors will generally have to create brokerage accounts within each platform that offers the fractional shares or funds.
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This material is provided for informational and educational purposes only. It is not intended to be investment advice and should not be relied upon to form the basis of an investment decision.