What Are Fractional Shares & How Do They Work?

Until recently, fractional shares were like leftovers—merely a byproduct of corporate actions such as stock splits or mergers and acquisitions, and of portfolio strategies such as dividend reinvestment plans and dollar-cost averaging.

Now, securities brokerages and mutual-fund companies have begun to directly offer fractions of shares of companies such as Amazon and Alphabet (parent of Google), as well as fractional shares of exchange-traded funds, many of which track the performance of stock-market indexes or sectors.

What is a fractional share?

Simply put, a fractional share is anything less than a full share in a publicly traded company. If a company’s stock costs $100 a share, a quarter share would cost $25, for example.

Fractional shares give investors a chance at ownership of companies with high stock prices. Brokerage firms used to try to limit investors to buying or selling in increments of 100 shares, or so-called “round lots,” which worked well when companies had more affordable stock prices. Through the 1980s, many big companies such as General Electric, Coca-Cola, Cigna, IBM, and Pfizer cost less than $10 a share. Some had never traded above $100—once considered a threshold for a company to consider splitting its stock.

But things have changed. As of July 2021, 37 of the 50 biggest U.S. companies ranked by total market capitalization were trading above $100 a share. What’s more, 27 of the 100 biggest companies are trading higher than $300. Amazon trades at about $3,350 and Google parent Alphabet is more than $2,700.

(The extreme example, Berkshire Hathaway Inc., trades at about $420,000 per Class A share, the highest in the world, and is not available as fractional shares; its Class B shares, which lack voting rights, trade at about $280).

At the same time, fewer stock splits among companies make an investor’s search for affordable shares even more challenging. Stock splits among major U.S. companies are much rarer today compared with a decade ago—as of mid-2021, there were only three splits among the S&P 500 companies. Ten years ago, there were 18 splits in the S&P 500.

The fractional-share market was inaugurated by Interactive Brokers in late 2019 and followed soon after by Fidelity Investments. Other brokerages have since entered this market. Exchange-traded funds (ETFs), many of them tracking stock-market indexes and sectors such as the technology and health-care industries, also are now sold in fractions. It’s cost-efficient for investors, as many brokerages have pushed down transaction fees to near zero.

How fractional shares are created

If you already have a brokerage or investment account, you may have some experience with fractional shares. If you’ve chosen to automatically reinvest any periodic dividends and capital-gains distributions, the reinvestment probably will include fractional shares.

Dividends

Let’s say you bought 1,000 shares of Apple Inc. 10 years ago, when the price was about $13.50 a share. You told your broker this year to start reinvesting any Apple dividend payments into more Apple shares. Apple in late July declared a quarterly dividend of 22 cents a share. Your dividends totaled 1,000 x $0.22 = $220 when they were paid in August. With dividend reinvestment, your broker will buy Apple shares when your account receives the payout.

Assume Apple is trading at $145 a share when you receive the dividend. The fractional share reinvestment would look like this:

$220 dividends/$145 = 1.517 Apple shares‍

Many investors choose a fixed dollar amount they want to invest periodically in a company’s shares, or in shares of a fund that gives them diversification -- a basket of pieces of many stocks. This strategy, known as dollar-cost averaging, also results in fractional share purchases.

Let’s say you have an account at Vanguard, Fidelity or Charles Schwab, with an investment in an ETF that tracks the S&P 500 index. Your account has an automatic investment plan, which deducts $200 from your bank checking account on the 15th of each month. You want the $200 invested in the SPDR S&P 500 ETF, which tracks the total return (price change plus dividend payments) of the S&P 500 index.

On July 15, your broker bought SPDR at $433 a share when the $200 monthly contribution was received from your bank. The purchase looked like this:‍

$200/$433 = 0.462 share of SPDR

Stock splits

To see how stock splits can create fractional shares, let’s imagine that a company called Cyberwatch Corp. declares a 3-for-2 split. You own 25 shares. The split leaves you with 37.5 shares (25 shares times 3, divided by 2).

Before the split, Cyberwatch was trading at $50 a share. For every two shares at $50, Cyberwatch’s split now gives three shares worth $33.33 each. Different number of shares, lower per-share price, same value to investors. But in your case, it includes half a share.

Reverse splits also can result in fractional shares. Let’s say Widget Corp. is trading at $5 a share and the company decides on a 1-for-6 reverse split to make its stock more attractive to fund managers; a $5 price looks a little forlorn. For a holder of 100 Widget shares, this means she would get 16.67 shares after the split. The consolidated shares would be valued at $30, so her investment in Widget is still $500, but she is stuck with a fractional share.

Mergers and acquisitions

Corporate mergers involving the exchange of stock, called a stock swap, often create fractional shares. Dow Chemical Co. acquired E.I. DuPont through a stock-swap merger in 2017. The terms called for holders of each DuPont share to receive 1.282 shares of the new combined company. So 100 duPont shares would be swapped for 128.2 new DowDuPont shares.

Companies typically offer to pay cash for fractional shares created in mergers or stock splits.

Advantages to fractional shares

• Lower barrier to entry.

  The past decade’s record climb in stock market valuation and decline in stock splits have raised the barrier to entry for small investors. The new market for fractional share offerings was created to allow access to a wider array of choices in the stock market.‍

• You can still receive dividends.

  Fractional shares allow investors to proportionately receive dividends. If you own half a share of Apple and the quarterly dividend payment is 22 cents a share, you would get 11 cents. Your half a share also would experience the market’s ups and downs. For example if Apple rose $2 a share for the day to $147, your half share would gain $1 to $73.50.

Drawbacks to fractional shares

• Limits to availability

  . Different brokers have different universes of offerings. Some have a wide selection of fractional shares, others less. Some have both stock and ETF fractional shares, others have only stocks. Some deal only in a select list of securities, such as the companies in the S&P 500. Some will both sell fractional shares outright and reinvest client dividends in fractions; others don’t sell fractional shares but will reinvest.
  

• Difficult to sell or move

  . Brokers typically will wait until they can consolidate fractions into whole shares before they can sell. Also, some fractional shares don’t have consistent demand; selling a small biotech company’s fractional share isn’t the same as selling a slice of Amazon, Alphabet or Home Depot. So you may need some patience if you want your fraction sold. At the same time, some brokers don't allow transfers of fractional shares to other firms; they will sell the fraction and give you cash. That would trigger a capital gain or loss, with tax consequences.
  
  Example: imagine you bought a third of an Amazon share for $1,000 in July 2020, when Amazon  was trading at $3,000. Your broker was RaveTrade Co. A year later, you tell RaveTrade that you're moving your account to ABC Securities Inc. RaveTrade says fine, sorry to lose your business, but it doesn’t provide transfer services for fractional shares—it can sell your Amazon fraction, and you can reinvest in Amazon with your new broker.
  
  Amazon is now trading at $3,600. RaveTrade sells your fraction for $1,200. You made a capital gain of $200 on your fraction—and you’ll be paying capital-gains tax on it. Also, if you want to get back into Amazon, it will cost you $1,200 for a third of a share.‍

• No voting rights

  . Holders of common stock are entitled to vote on matters brought to a company’s annual meeting of shareholders. Whole shares have a vote; fractions don’t. This may not matter much in most cases—what’s a third of an Amazon share in an ocean of 504 million Amazon shares outstanding, for instance? But it’s worth noting.

Fractional shares are an evolving market. Investors would be smart to ask a brokerage or fund company what exactly it provides in fractional-share services.‍