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The industry was abuzz in December 2019 when mobile-based trading platform Robinhood announced it would be offering fractional share purchases to investors. While Robinhood is not the first to offer the ability to buy stocks for less than the sticker price, it is arguably one of the most well-known and recognized platforms to get into the game. Investors looking to diversify and invest by purchasing stocks with high absolute share prices will now be able to thanks to Robinhood.
What is a fractional share?
By definition, a fractional share is a position in a stock that is less than the entire share value. Instead of owning one whole share of stock, an investor might be able to own 1.5 shares or even something like 0.25 shares of stock. Fractional shares allow investors to purchase stocks in less-than-whole increments, which gives them the ability to purchase stocks they might not have otherwise been able to afford if they were forced to purchase an entire share.
“Fractional shares offer opportunities to smaller investors to be able to participate in some of the biggest companies in the capital market that otherwise they couldn’t own in their portfolios,” says Brennan Drew, managing director at WestPac Wealth Partners. “However, it’s important to consider fees associated with the trades. A flat fee can eat into a significant portion of smaller portfolios.”
Robinhood’s fractional shares explained
Imagine you went to a pie store that only let you buy a whole pie. What happens if you want a slice of delicious apple pie and don’t want to have to pay for the whole thing? Well, thankfully, most pie stores believe in fractional pie sales. This analogy is exactly how Robinhood fractional shares program will work. If you can’t afford or don’t want to buy an entire share of stock, you can now buy a smaller portion.
Remember, some stocks like Alphabet — which owns Google — and Tesla are well over $500 a share. If you’ve got limited investing funds or are just starting out, you might not want to put the bulk of your funds into one stock.
Let’s take the analogy one step further to show why this works so well with Robinhood’s platform. Imagine you went to the pie store and the store is willing to cut the pie for you so you could buy a single slice. Everything is great until you find out the store charges a $5 fee for boxing up every pie. You find out that even though you’re only getting one slice, the fee is still the same.
If you’re purchasing a whole pie, you’re fine with this because it’s a smaller portion of the purchase price. However, paying the boxing fee for just one slice of pie is enough to make you not want to purchase. This is much like a trading fee when you purchase stocks. Before platforms like Robinhood, investors had to buy shares in large blocks, or else the trading fee would eat up any potential profits.
Robinhood is famous for offering fee-free trades, though. This means purchasing just a few dollars’ worth of stock can now be a part of a fiscally smart investment plan since each trade costs $0 in fees. Imagine trying to buy $1 worth of stock and being charged $7 to execute the trade. Any hopes of a profit would be dashed.
Currently, Robinhood has not announced the exact date it will be opening up fractional shares to its clients. The December announcement on the company’s blog was light on details about how the program will operate. The company does state that investments as small as $1 will be accepted and that major companies like Amazon, Apple, Disney and Berkshire Hathaway (which costs over $115,000 for one share) would be among the thousands of covered stocks.
The company did offer a few additional details when you dig further into the platform. ETFs and stocks will both be covered, but not all ETFs and stocks. Fractional stocks will be able to be purchased based on dollar amounts or on share amounts. In other words, you can say you want to purchase “$10 worth of Amazon,” or that you want to purchase “0.6 shares of Amazon.” The smallest purchases you can make are $1 for the buy-in-dollars option or 0.000001 for the buy-by-shares option.
Regarding supported stocks, the company states that stocks worth over $1.00 per share and with a market cap of at least $25M will be supported. If this expands, the company says it will notify customers.
Voting rights for stocks will be aggregated and submitted based on percentage ownership. Dividends will be paid out in the same manner. Stock transfers are not allowed for fractional shares. If you move to transfer your account and positions out of Robinhood, the fractional shares will be sold and converted to cash.
Other fractional shares
As mentioned, Robinhood is not the first to offer fractional share purchases to investors. Companies like M1 Finance, Motif, Stash and Stockpile also offer fractional shares. While some of these options could be great choices, Robinhood will quickly rise to the upper echelons of the list once it launches its own fractional shares trading. Fee-free trading and the trust that comes with a platform used by over 10 million traders can’t be ignored.
As Robinhood is one of the first major players to enter fractional share trading, it won’t be the last. Investing giant Charles Schwab announced in a recent Wall Street Journal interview that the platform would be releasing the option later this year to try and woo younger investors to the table.
The bottom line
Whether you’re immediately interested in fractional shares or not, you can’t argue with the fact that more flexibility is always a good thing. New investors and those with smaller funds to work with can now invest just like the big guns without having to dedicate all their funds to one share of stock. With major players like Robinhood and Charles Schwab joining the party, expect fractional share purchases to become a lasting staple of the investing world.