The pros and cons of fractional shares
THE STACK #36Fractional shares are a popular way for investors to own shares they can't afford otherwise. It eliminates the barrier to entry into the stock market and enables investors to purchase shares with as little as $1.
I personally like fractional shares because I don't like having any unused cash in my investment accounts. By using fractional shares, I can invest the total amount I have without any leftover cash.
However, as with all investing, certain guidelines need to be followed.
In today's edition of The Stack, we will review the best practices for purchasing fractional shares.
THE STACK
What are fractional shares?
A fractional share is any share quantity that is less than one.
For example:
You have $200 and want to buy shares of NVDA, which are currently at $822/share.
With $200, you cannot afford to buy a full share of NVDA at its current price of $822.
By the time you would have saved up an additional $622 to purchase a full share, the price could have increased again, making it difficult for you to buy the stock.
So, you opt to purchase fractional shares with your $200.
This will give you 0.24 shares of NVDA.
Where can you buy fractional shares?
There are two types of fractional shares:
Direct Fractional shares enable investors to buy a portion of a share of a specific stock. The method of filling orders for fractional shares varies among brokerages. Some brokerages accumulate multiple fractional orders from investors and purchase whole shares from the stock exchange at the end of the trading day, then redistribute them as fractional shares to investors.
Currently, in Canada, only Wealthsimple Trade and Interactive Brokers offer fractional shares of stocks and ETFs. (Interactive Brokers does not allow fractional shares inside an RRSP or TFSA).
Indirect Fractional shares provide you with the option to purchase fractional shares of mutual funds and index funds. Unlike stocks, mutual funds and index funds are not traded on a stock exchange, which means that their orders are not filled immediately. This makes it relatively simple for the fund manager to sell fractional shares of the funds.
You can buy fractional shares of Mutual Funds and Index funds from any financial institution that offers these products.
Pros of buying fractional shares
Fractional shares remove the barrier to entry into the stock market.
They allow investors to participate in the growth of companies they otherwise cannot afford.
Fractional shares help investors get the full value for the available cash they have to invest. For example, if you have $200 available to invest and want to purchase an ETF that costs $23/share. You can only buy 8 shares for $184; the remaining $16 will sit as cash in your investment account. But you can invest the complete $200 with fractional shares, giving you 8.69 shares.
With fractional shares, investors can build a well-diversified portfolio by purchasing small quantities of multiple stocks.
Fractional shares are perfect for dollar-cost averaging as they help you invest a specific dollar amount consistently, which helps minimize your risk from the stock market's volatility.
Cons of buying fractional shares
Fractional shares are difficult to sell because they cannot be sold on the open market. So you have to wait for your brokerage to fill in your order, which could take hours or days and lead to losses in a volatile or bear market.
Transferring fractional shares to another brokerage can be challenging, as they are not easily sellable. If your brokerage does not support fractional shares, you may be unable to transfer them, and you may have to sell them prematurely. This could result in a loss or early taxes if the share price is low or if you are not ready to sell.
It's important to note that some brokerages may fill your order at the end of the trading day. This means that your order could be filled at a much higher price than what it was trading for when you placed your order. As a result, the total number of shares you end up with may be reduced. Here's an example: let's say you placed a fractional order for $200 at $23/share. However, at the end of the trading day, the price increased to $26. Instead of receiving the expected 8.69 shares, you will only end up with 7.69 shares.
Best practices when purchasing fractional shares
Some brokerages (*coughs* Wealthsimple Trade) do not offer the ability to place limit orders for fractional shares, which means you will not have complete control of the price at which your order will be filled.
To avoid significant losses, instead of entering an order for the total dollar value you have to invest, enter one limit order for a whole share and the remainder for a fractional share.
For example, if you have $200 to invest in a stock, that is at $22/share. Instead of placing a fractional order for the complete $200, you could place two orders:
One limit order for 9 whole shares worth $198.
One fractional order for 0.09 shares worth $2.
Let’s say the value of the stock went up to $26. If you only put in one fractional order for $200, you will have $7.69 shares. But if you put in two separate orders, you will have 9 whole shares and 0.07 fractional shares.
By putting in two separate orders, you ended up with two more whole shares, minimizing your losses.
Note that this method will not apply if the amount you want to invest cannot buy one whole share. For example, if you want to buy $200 worth of a stock trading at $822, you can only buy fractional shares.
THE TOOL
This week’s recommendation is my February read - Be Your Future Self Now, by Benjamin Hardy.
Some of my key takeaways from this book that I plan on implementing are as follows:
Spend time visualizing who you want to become and what you want to achieve.
Determine which habits will have the most significant impact on your journey towards your future self and start incorporating them into your daily routine.
Break down your goals into actionable steps with deadlines and create a plan to follow through.
Find someone or a group to hold you accountable for your progress and keep you motivated.
Regularly review your progress, adjust your plans as needed, and stay committed to your vision of your future self.
Write letters or record videos to your future self one year, five years, ten years, fifteen years and twenty years from now. Your future self will appreciate how far you have come and remember some of the dreams and goals your old self had.
THE ACCOUNTABILITY
Tax season is currently underway. Have you already filed your taxes? If not, consider scheduling an appointment with your accountant to assist you with filing.
If you typically file your taxes on your own, allocate at least two hours this week to complete the task. The sooner you file, the sooner you might receive a refund! (if you are eligible for one).
THE COURAGE
THE KNOWLEDGE
Market Order
A market order is a type of order to buy or sell a security at the current market price. This means that the order will be executed immediately at the best available price.
Market orders are often used when the trader wants to buy or sell a security quickly without waiting for the price to change. However, it's important to note that the price at which the order is executed may not be the same as the current market price, especially for volatile securities.
Limit Order
A limit order is a type of order to buy or sell a security at a specified price or better. When you place a limit order, you specify the maximum price (for a sell order) or minimum price (for a buy order) that you are willing to accept for the security. Once the security reaches the specified price, the order is executed.
Limit orders allow you to have more control over the price at which your trade is executed, but there is no guarantee that the trade will be executed since the security may not reach the specified price.
Keep Stacking!
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