What Is Fractional Trading?

Fractional trading is increasingly being offered by online brokerages in recent weeks. It’s ok if you haven’t noticed given all the other news in the markets and elsewhere. However, it does open up various options for smaller investors that can be useful. However, just because you can start trading easily 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 buy of an investment is generally a single share. For big investors and institutions that’s generally fine, they are trading in amounts where they are always buying large amounts of shares and so the need to buy less than a share seldom happens. However, for a smaller investor, especially one looking to diversify, buying companies with share prices over $1,000 becomes a major undertaking.

With fractional trading you don’t need to do that. Rather than fork out almost $3,000 for a share of Amazon
AMZN
, for example, you can now just purchase an amount less than that. If you want $100 of Amazon, you can buy it and you’ll end up with 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 time of writing. Then that fraction of a share will move just as other Amazon shares do.

So if you previously wanted to invest but lacked the funds to get started fractional trading may have removed a barrier. There are some portfolio construction aspects too that we’ll get to next.

Portfolio Construction

Portfolio construction is a fancy way of discussing the stocks you hold. Unless you’re an expert stock picker, it can be better to spread your bets across different investments. This is often called diversification. Fractional investing can make that easier too. Maybe you had no trouble buying an Amazon share, but buying your favorite 50 stocks was complicated, and you couldn’t buy them in equal amounts anyway. Fractional trading makes that easier. Now you buy the amount you want, without regard to the stock price. So it’s easier to buy the amount you want and spread your bets.

Can Doesn’t Mean Should

Now, just because it’s easy to start trading with say $100, helped by the launch fractional trading and commission-free trades, does not mean you should rush in. The markets have historically been a robust way to build wealth over time, but the short-term swings in the market can be very large. Hence markets are best used for money you don’t need for several years, or ideally even longer. Plus markets, especially in the U.S. look pretty pricey right now on historical measures.

So it’s great that fractional trading is opening up market access, but you should still be careful about putting money into the market that will need to go on essentials like rent in a few months. It’s good to build up an emergency fund to cover a few months of expenses before you think about investing.

The rise of fractional investing is generally a good thing. Paired with the move to commission-free trading at many brokerages, it really is opening up market access. Hopefully investors can now get the starting portfolio they ideally want rather than have to deal with arbitrary share price amounts shaping their allocation. It can also be a good way to test the waters, and what was previously a test portfolio on paper, can now be tried in reality for as little as, say, $50. Still, just because the barriers to investing are falling, doesn’t mean investing is appropriate in all situations.