You may have seen ads saying you can invest in Google or Amazon for as little as $1. You may have wondered: Is this legit? It's understandable if your spidey senses are triggered here.
A single share of Google parent company Alphabet costs over $2,100 as of Feb. 18, 2021. A share of Amazon would set you back more than $3,300.
But the claims that you can invest in big-name companies with as little as $1 or $5 are actually legit. The concept is known as fractional shares, and it's a game-changer for beginning investors.
What Are Fractional Shares?
With fractional shares you name your price when you invest in stocks. You decide the dollar amount you want to invest and you get a proportional fraction of a share.
For example, let's say you want to invest in Netflix, but you only want to spend $25. It doesn't matter if a share of Netflix costs $400 or $500 or even $1,000. If $25 is what you want to spend, that's what you'll pay. If Netflix was trading for $500, you'd get 5% of a share.
That's a big deal for investors who don't have deep pockets. Even if you don't have hundreds or thousands of dollars to spend to buy a share of Amazon or Google or Netflix, fractional shares make it so you aren't priced out of investing in them.
Fractional shares technically aren't new. For example, many stocks pay a dividend, which means a company gives part of its profits back to investors. Many investors opt to reinvest their dividends. So if you owned one share of a $100 stock that paid a $3 dividend and you reinvested it, you'd be getting 3% of a share.
The concept is similar to what you get when you invest in a mutual fund or an exchange-traded fund (ETF), because each share is invested in a tiny stake of multiple different companies, though technically you owe shares of the fund, not fractional shares of the companies it's invested in.
In the old days if you wanted to buy a stock, you'd have to cough up at least the cost of a single share. Some traditional stock brokers wouldn't even deal with you unless you bought round lots, which are share orders in multiples of 100.
Online brokerages made it easier to buy smaller amounts of stock. But due to commissions, buying a single share often didn't make sense. Paying a $9.99 commission to buy a $100 stock would seriously eat into your returns.
Investment apps like Robinhood, Stash and SoFi were among the first to start offering fractional shares. In 2020, many traditional brokerages, including Charles Schwab and Fidelity, followed suit.
Fractional shares have soared in popularity particularly in the past year, as people have taken up stock trading in greater numbers. Because many platforms now offer commission-free trades, one of the biggest arguments against investing smaller amounts has disappeared.
What Stocks Can You Buy Fractional Shares of?
You can buy fractional shares of stocks and ETFs, which are bought and sold like stocks on exchanges. But the specific stocks and ETFs you can invest in will depend on the platform you're using. For example:
- Charles Schwab's Stock Slices lets you invest in any stock in the S&P 500 but doesn't allow fractional ETF investing.
- Fidelity's Stocks by the Slice offers fractional investing for 7,000 U.S. stocks and ETFs.
- Robinhood lets you buy fractional shares of stocks and ETFs with a market capitalization of $25 million that trade for at least $1.
- SoFi offers 43 stocks and ETFs as fractional investments.
These are just a few of the platforms that offer fractional investing. When you're investing in fractional shares, look for an app or brokerage that doesn't charge commissions or monthly account fees. When you're investing small amounts, even a $1 charge can eat away at your returns fast.
6 Things to Know Before Investing in Fractional Shares
If you want to start investing in fractional shares, here are some important things to understand if you're ready to maximize those returns.
1. Fractional shares don't reduce your risk of losing money.
Your potential gains and losses are the same with fractional shares as when you buy whole shares. If the stock's value drops by 50% and you sell, you've still lost 50% of your money. However, fractional investing is a good way to limit your potential losses by putting smaller amounts into pricy stocks.
Also keep in mind that you're not going to build a nest egg by investing small amounts like $1 or $5. For example, Amazon shares soared 72% in 2020. Had you invested $5 at the beginning of 2020, you would have had $8.60 at year's end.
2. They're best used in conjunction with index funds.
You've probably heard that you need a diversified portfolio â€" but it's really hard to build one, even if you're investing in multiple companies using fractional shares. One of the big reasons to buy stock slices is to get in on the popular stocks everyone wants to buy. Right now, those are heavily concentrated in the tech sector. People aren't exactly rushing out to buy fractional shares of utility and agricultural stocks in droves.
A good strategy is to make index funds the backbone of your investing strategy. With an S&P 500 index fund, you're investing in 500 of the biggest companies in the U.S. across all 11 stock market sectors. Then you can use fractional shares on top of your index funds to test your hand at investing in individual stocks.
For example, you could aim to max out your Roth IRA by investing $500 in index funds each month in 2021. If you have an extra $50 a month to invest, put that toward fractional investing using a brokerage account or an investment app.
3. Dollar-cost averaging is a great strategy for fractional shares.
If you have a monthly investment budget, you're probably practicing dollar-cost averaging. That's a strategy of committing to invest on a regular schedule no matter what happens in the stock market. If you truly believe in a certain stock, dollar-cost averaging with fractional shares is a great way to invest over time.
Stock prices can fluctuate a lot. The advantage of budgeting a certain dollar amount to invest each month in a company you like is that some months, the stock will be down and you'll lock in a bargain price.
4. You may have to sell your shares if you switch brokerages.
Make sure you've read all the fine print and that you want to stick with your brokerage before you buy fractional shares. While it's pretty easy to transfer whole shares from account to account, you'll typically have to sell off your fractional shares to close out your account. You could face tax consequences as a result.
5. They're way better than penny stocks.
When you're looking to invest a small amount of money, fractional shares beat out penny stocks any day. Penny stocks are dirt-cheap stocks that you can buy whole shares of for a couple dollars or less. But there's a good reason they trade for so cheap. Many of the companies behind them are either in financial trouble or have zero track record. Penny stocks are also widely associated with scams. Investing a small amount in a proven company, even if you can't buy an entire share, is a way smarter bet.
6. Whether you're buying whole or fractional shares, long-term investing pays off.
The big risk of fractional shares is that those low prices and commission-free trading make frequent buying and selling easy. Regardless of whether you buy fractional or whole shares, the most successful investors take a buy-and-hold approach. That means they buy stocks they want to own in the long term. They hold on even if share prices drop after a disappointing earnings report or the stock market crashes, because they believe the company has a bright future.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected].
This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.
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