Brokerage firms ranging from Fidelity to Robinhood this year opened up investing for those with smaller amounts of cash to invest by offering fractional shares.
These are partial investments in a company’s stocks or an exchange-traded fund and are ideal for investors who want to participate in the market, but lack the funds to purchase full shares.
“I love the concept of fractional shares since it’s a great learning tool for new investors and true financial innovation,” said Jeff Yastine, senior investment strategist at WealthPress, an investment newsletter publisher.
Here are the pros and cons of investing in fractional shares if you’re considering purchasing some.
They help you accumulate stock market wisdom
If you’re a new investor with little to no experience trading in the market, fractional shares are a helpful stepping stone.
“The most valuable commodity is stock market wisdom,” Yastine said. “If you can grow your initial $500 to $1000 over a reasonable period of time — without blowing up your original stake on ill-considered, impatient bets to ‘make a killing’ — then chances are you’re ready to invest and speculate responsibility with larger sums.”
A recent study from AssetMark Investment Services pointed to this need, finding that 46% of non-investors said they don’t know enough to start investing in the stock market.
“I believe the intention of fractional shares, on its face, is meant to be positive or even empowering in nature for retail investors,” said Daniel Milan, managing partner of Cornerstone Financial Services, “especially those that are in the early stages of investing and learning how to best invest, while now being able to own parts of expensive companies like Berkshire that were maybe previously unattainable.”
Berkshire Hathaway (BRK-A) shares currently trade for over $340,000 at the same time when 2 in 5 Americans don’t have enough cash to cover an unexpected $400 emergency, according to the Federal Reserve.
People may treat fractional shares as ‘gambling long shots’
Other experts are concerned that, in the long run, people may misconstrue investing in smaller shares with having less risk and therefore invest beyond their means.
“It is too early to really know if those pros will play out over the long term and also too early for us to really know the potential cons or pitfalls of fractional share availability,” said Daniel Milan, managing partner of Cornerstone Financial Services. “For example, will it create an incentive for retail investors to treat fractional shares more like gambling long shots trying to time or beat the market ‘pros’ just because they feel they have less risk because their holdings aren’t full shares?”
A similar scenario played out early in the pandemic, when jobless claims soared to unprecedented heights, but the stock continued to rally. One hypothesis is that millions of everyday investors poured into the market, buy the dip in March and boosting stocks afterward.
Mobile app Robinhood gained more than 3 million followers at the time, while Charles Schwab experienced an all time record of more than 600,000 accounts registered in the second quarter.
“While it’s too early to say, I think there is some evidence of that type of trading/betting mentality taking place this year throughout the pandemic, as there were not a lot of other things for people to do,” Milan said. “So, the question is: Was that a short-term effect of a pandemic ridden year or a sign of a negative effect of fractional shares becoming readily available? Again, probably too soon to say either way.”
Some experts also are worried that the movement into fractional shares may be akin to previous stock market bubbles, where investors dumped money into specific sectors instead of diversifying their investment.
“The downside is that investors might be taking too much risk buying single stock concentrations,” said John Smallwood, senior wealth advisor of Smallwood Wealth management, a financial consulting firm. “While single stock concentrations can be great, it can also be painful if things don’t go well such as 20 years ago when everyone was rushing into the dot.com craze.”
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