Listen Full Article
Have you ever stood in front of a cake shop and thought, ‘Wouldn’t it be great if I could just buy a piece of this cake?”. And surprisingly, the shopkeeper does allow you to buy them in slices.
If a share of an asset is an entire cake, a fractional share is like a slice of that cake. Not everyone wants to eat an entire cake, nor can they afford it, but buying them in slices (fractions) could give the same end result.
So what are fractional shares? How do they work? Let’s find out.
What Are Fractional Shares?
Fractional shares, as the name suggests, are nothing but fractions of a share. Suppose you want to invest in an asset and a single unit is beyond expensive; buying them in fractions could allow you to invest with whatever you have.
Suppose you come across a very lucrative share of stock, but it is valued at ₹30,000. In this situation, if you think you cannot afford the entire stock, you can choose to buy a part of the share. These parts (or fractions) of the share are called fractional shares.
Fractional shares are also applicable to cryptocurrency. Take Bitcoin, for example – A single Bitcoin is divided into 100 million units, and each unit is called a “Satoshi” (a homage to the creator(s) of Bitcoin).
Currently, one Bitcoin costs you ~₹45 lakhs – a price that could seem uninvestable for most investors. As a result, most people believe that they cannot invest in bitcoin. However, with the possibility of buying Bitcoin in fractions over 5 million retail investors invest/trade in Bitcoin. Also, the CoinSwitch Kuber app allows users to invest with as low as ₹100.
Earlier, the concept of buying shares in fractions was almost non-existent. The only way to buy/sell those fractions was through big brokerage firms. Thanks to the industry’s transition, brokers now allow the buying and selling of fractional shares in India.
How Do Fractional Shares Work?
They work exactly like any share you invest in. When you buy a fractional share, you will be treated exactly like any other investor. You are entitled to the same percentage of profits and losses, opportunities and risks. You will still have a stake in the asset.
If you want to sell your fractional share, you can do it like how you’d sell a regular share. You can place an order with your broker to sell your share, and if it matches with another buy order, you can cash out your holdings.
How Are Fractional Shares Created?
There are two ways in which Fractional Shares are created:
Through Stock Splitting
In the case of stocks, these fractional shares could arise because of stock splittings.
For example, if a company’s stock becomes too expensive, the number of investors who buy that stock decreases, hence the company splits the stock in multiples of 4 or 5 splits.
Let us say you have 150 stocks of a company, and the company decides to split their single stocks in 4. After splitting, you get 150+(150/4) = 187.5 shares.
Since the number of shares you are holding can’t be divisible by 4, you end up getting fractional shares.
A dividend reinvestment plan is a sub-variant of the dividend plan. This plan reinvests the dividend to buy new units. There might be cases where the dividend amount is lower than the fund NAV (Net Asset Value).
In such situations, the fund manager may buy a fraction of the unit instead of the whole unit.
Mergers and Acquisitions
Sometimes when companies go through mergers or acquisitions, it could result in creating fractional shares. These companies create new stocks using a predetermined ratio, which often results in fractional shares for the stakeholders.
Some brokerage firms split high-value shares into fractions to make them more accessible to their clients. This division is most of done on blue-chip stocks whose price is too high for retail investors.
Advantages of fractional shares
Invest whatever you can afford
Such shares allow investors to buy high-value stocks and cryptocurrencies like bitcoin or ethereum with little money. Because of limited funds, many times, investors end up buying penny stocks.
But now that many big brokers allow the trading of fractional shares, investors can now buy quality stocks with the sum they hold.
Diversification is essential for the steady growth of the portfolio. By buying fractions of top quality companies, you can diversify your portfolio. This reduces the risk of sudden downfalls.
Earlier, diversification used to be tricky because of the high priced stock. But fractional shares solves that problem. Even with a small amount of money, you can diversify your portfolio.
If you want to buy an entire share, you may want to save up money for buying the asset at its present value. However, with fractional shares, you can make use of rupee cost averaging.
Rupee cost averaging allows you to invest a certain fixed amount at regular intervals. Whether the market is up or down, you can continue to buy shares in fractions.
Disadvantages of Fractional Shares
Here’s what you must keep in mind while investing in fractional shares:
You may end up paying high brokerage charges
To diversify the portfolio, sometimes you may end up buying fractions of too many companies. And every time you buy a share or a fraction of a share, you need to pay extra charges like brokerage, STT/CTT, transaction charges, GST, SEBI charges and stamp duty charges. In the process of diversification, you may end up paying more charges to the broker and the government.
But, in the case of cryptocurrency, the charges for buying fractions of a currency are generally low to zero. CoinSwitch Kuber offers Bitcoin and cryptocurrency for a minimum investment of ₹100.
Not all brokers allow it.
Not all brokers allow you to invest in fractional shares. Only a few big brokers offer this service. If you cannot find one, it might not be easy to sell your fractional shares.
In conclusion, before buying fractional shares, ensure that you are fully aware of its pro’s and cons. Before investing in any shares or fractional shares, do thorough research and understand how it will affect your portfolio.
Source : coinswitch