Fractional Shares: Beneficial For Investors In The Early Stages Of Wealth Accumulation

By SA Editor Jason Kirsch:

One of the main tenets of portfolio management is that an investment should not be viewed only on its individual merits but also by how it fits into a larger investment portfolio. This accomplishes two goals:

  1. It helps investors build a portfolio of complementary components (e.g. stocks, bonds, real estate, etc.) that help smooth the growth trajectory of your savings.
  2. It ensures that investors don’t put all of their eggs in the same basket, which protects against risks inherently specific to a single security or company.

In recent history, both goals were effectively achieved through investing in several investment funds, primarily mutual funds or ETFs. The principal value of these investment funds is that, for a single lump-sum investment, you can own a piece of hundreds of assets that are rebalanced periodically by a team of money managers or, for an index-fund, a sampling formula.

While the merits of mutual funds and ETFs are clear, some investors seek more control over their portfolio. For instance, an investor may want to own the stock of companies he or she is familiar with. Some may want to hold a more concentrated portfolio of stocks. Some investors contribute to their savings periodically and seek to invest the same specific dollar amount into their portfolio regularly while keeping their asset allocation constant. To accomplish this in the past, investors had to purchase a certain number of shares which, depending on the price per share of stock (and the brokerage commission), required a large sum of money. And because of this high cost, maintaining a diversified stock portfolio of underlying securities has generally only made economic sense for wealthy investors.

A few select financial firms now offer the ability to purchase fractional shares of stock, which allow investors with a limited amount of capital to build a diversified portfolio of underlying securities of their choosing. Like whole shares of stock, fractional shareholders receive dividends and can exercise voting rights for the whole share portion of the position. Fractional shares are available for National Market System ((NMS)) exchange-listed stocks, such as those that trade on the New York Stock Exchange (NYSE) and NASDAQ.

For Young Investors Who Want Control Over Their Investments

Fractional shares are attractive to investors in the early stages of wealth accumulation who want to take a more active role in their investment approach while keeping costs low. Not only may they allow you to build a stock portfolio of companies of your choosing but they can help you save money by limiting the costs of investment funds, and offer more control over taxes, especially in non-qualified brokerage accounts.

According to Morningstar research, the average ETF expense ratio is .23% per year (the average active mutual fund expense ratio is 1.45%). As for taxes, capital gains on mutual funds are largely based on the fund manager’s buying and selling decisions.

If a mutual fund manager sells a stock that is trading higher than when the fund purchased it, the mutual fund must distribute at least 95% of the gains to shareholders, which results in a taxable event. The structure of an ETF is more tax-friendly but by holding individual securities, investors can better control the timing of their capital gains by timing the sale of winning stocks against that of losing stocks.

There are other costs associated with investing such as bid-ask spreads, index-tracking error cost and trading commissions, but these are outside the scope of this article. Fidelity, the first major financial brokerage to offer fractional shares, provides investors with the power to trade them without commission. You can even set up a periodic contribution to your account which will invest in fractional shares to ensure your allocation remains constant.

There are a variety of factors that influence investors’ decisions. At the end of the day, one should manage their portfolio in the way that’s best for them. What is effective for one investor may be ineffective for another. Investors should conduct due diligence and consult with a financial professional.

See also PerkinElmer: The Market Completely Missed The Transformation on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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