Discover the Potential of Fractional Shares
Less than one full share of equity is termed as a fractional share. These shares can result from stock splits, dividend reinvestment plans (DRIPs), and other corporate actions. Typically, fractional shares are not available on the stock market. While they do hold value for investors, they can be challenging to sell.
Key Takeaways
- A fractional share is a part of an equity stock that represents less than one full share.
- Fractional shares often arise from stock splits, which do not always result in a whole number of shares.
- Mergers or acquisitions can result in fractional shares, as companies combine new common stock using a defined ratio.
- Capital gains, dollar-cost averaging, and dividend reinvestment plans can leave investors with fractional shares.
- Fractional shares are not traded on the public market and can only be managed through a major brokerage.
Understanding Fractional Shares
Fractional shares are generated in various ways, including through dividend reinvestment plans, stock splits, mergers, and acquisitions.
Dividend Reinvestment Plans – A Smart Strategy
Dividend reinvestment plans (DRIP) often result in the creation of fractional shares. These plans allow dividend-offering corporations or brokerage firms to let investors use their dividend payouts to purchase more of the same shares. Danish small businesses and global corporations might use such strategies. The amounts get reinvested without being limited to whole shares. Reinvesting capital gain distributions and dollar-cost averaging programs can also lead to the acquisition of fractional shares.
Stock Splits—The Hidden Opportunity
Stock splits don’t always result in even numbers of shares. For instance, a 3-for-2 stock split would create three shares for every two shares an investor owns. Consequently, if an investor holds an odd number of shares, they end up with a fractional share following the split. Three shares become 4½, five become 7½, and so forth.
Mergers and Acquisitions—Creating Value
Mergers and acquisitions may also bring about fractional shares since combining new common stocks using a predetermined ratio often leaves shareholders with fractional shares.
Certain brokerage firms may intentionally split whole shares to sell fractional shares to clients. This is particularly common with high-priced stocks like Amazon or Alphabet, Google’s parent company. For instance, as of March 2020, Amazon shares were priced at over $1,800 each, and Google shares over $1,100 each. Fractional shares provide individual investors a route to invest in such high-priced stocks.
Example: A young investor with limited funds might aspire to buy stock in Amazon. Starting with $1,000, they wouldn’t be able to afford an entire share. However, they could find a brokerage willing to sell a fractional share. Thus, they could purchase one-third of a share of Amazon and use the remaining funds to invest in lower-priced stocks, acquiring full shares.
In scenarios involving stock splits, mergers, or acquisitions, shareholders might be given the option of receiving cash instead of the fractional shares. The received income is taxable.
Trading Fractional Shares—Your Path to Flexibility
The only route to sell fractional shares is through a major brokerage firm, which consolidates them with other fractional shares until a whole share is amassed. However, if there’s low demand for the stock, selling fractional shares might take longer than expected.
Many investors prefer not to hold onto fractional shares, especially if acquired unintentionally, such as through stock splits. Consider an investor who holds 225 shares of XYZ stock, each priced at $12. After a 3-for-2 stock split, they end up with 337½ shares, each now priced at $8. If XYZ stock is in high demand, they may quickly find a brokerage firm willing to acquire the fractional share. Alternatively, they could find a brokerage willing to sell an additional half share, bringing their total to 338 shares.
Embrace Fractional Shares—A Real-World Insight
In November of 2019, Interactive Brokers became a pioneer as the first major online broker to offer fractional shares trading. Subsequently, on January 29, 2020, Fidelity announced it would start offering the trading of fractional shares for equities and ETFs.
Related Terms: dividend reinvestment plan, stock split, mergers and acquisitions, brokerage firms, equity.
References
- Yahoo! Finance. “Amazon.com, Inc”.
- Yahoo! Finance. “Alphabet Inc”.
- Interactive Brokers. “Interactive Brokers Offering Fractional Share Trading Broker Broadening Access to More Expensive Stocks and Facilitating Portfolio Diversification”.
- Fidelity. “Fidelity Simplifies Investing Again with Launch of Real-time Fractional Shares Trading for Stocks and ETFs”.
