Online brokerages are increasingly providing fractional trading in recent weeks. It’s ok if you haven’t noticed given the rest of the news in the investment world and elsewhere. Fractional trading can open up various options for smaller sized investors that can be useful. However, merely because you can start trading quickly for $5 or less doesn’t always mean you should.
How Fractional Trading Works
The easiest way to think about fractional trading is what happens without it. Without fractional trading, the smallest amount you can purchase of investment is generally a single show. For big investors and institutions that are usually ok, they are trading in quantities where they are always buying large amounts of shares, so the need to buy less than a single share seldom happens. Even so, for a smaller investor, precisely one looking to diversify, buying companies with share prices over $1,000 turns into a significant undertaking.
With fractional trading, you don’t need to do that. Rather than spend practically $3,000 for a share of Amazon AMZN, for instance, you can just purchase a quantity less than that. If you want $100 of Amazon, you can buy it, and you’ll end up with a fraction of a share of Amazon. That is to say that you’ll pay your $100 and you’ll receive about 0.038 of an Amazon share at the period of writing. Afterwards, that fraction of a stock will move as other Amazon shares do.
So if you previously wanted to invest but lacked the funds, to begin with, fractional trading can remove that barrier. There are a few portfolio construction aspects as well that we’ll get into next.
Portfolio construction is a fancy way of discussing the stocks you possess. Unless you’re a specialist stock picker, it might be better to pass on your bets across different investments. This is called diversification. Fractional investing can too make that easier. Before, you maybe had no issues buying an Amazon share, but buying your chosen 50 stocks was challenging, and you couldn’t get them in equal sums anyway. Fractional trading can make that process easy. Now the total amount you buy is dictated by you, without regard to the current stock price. So it’s much easier to buy the amount you desire and spread your investments.
Can Doesn’t Mean Should
Now, just because it’s simple to start off trading with a small amount of money, helped by the launch of fractional trading and commission-free trades, it does not mean that you should buy-in. The markets have already been a robust way to build wealth over time historically, but the short-term swings on the market can be incredibly significant. Hence markets are usually a place to put the money you don’t need for several years, or ideally even longer. Plus markets, especially in the U.S., look pretty pricey at the moment on historical measures.
So it’s excellent that fractional trading is helping with market access, but you should be careful about putting money into the market that you will use for essentials like rent in a couple of months. It’s good to build up a crisis fund to cover a couple of months of expenses before you start investing.
The rise of fractional investing is a good thing generally. Paired with the commission-free trading at various brokerages, it is increasing market access. Hopefully, investors can now get the starting portfolio they ideally want instead of having to cope with arbitrary share price amounts shaping their allocation. It can even be an excellent way to test the waters, and that which was a test portfolio in writing previously can now be tested for as little as, say, $50. Still, because the barriers to investing are falling, it doesn’t mean investing in fractional shares is appropriate in all situations.