What exactly are fractional shares?
Some online trading platforms offer to invest in fractional shares, including shares of large US technology companies with high unit value (several thousand dollars). The idea, aimed at popularizing stock market investment among individuals with “limited means” to build a portfolio, is appealing. But these offers do not always explain very clearly what you are investing in. Let’s take a closer look.
Under the name “fractional shares”, there are actually several types of offers on the market and it is important to read the commercial and regulatory documentation carefully to understand what you are being offered to buy.
The essential questions to ask yourself are therefore:
- What is the exact nature of this product, do I understand it?
- What are my rights and in particular, am I the owner of the title?
The good ones : Some offers allow you to actually buy fractions of shares, in particular through a monthly investment program, and automatically consolidate the fractions into “whole” shares as soon as possible. It is then, neither more nor less, an investment in shares (this is the case of Trade Republic for example). But you must make sure you understand the rules for bundling fractional shares.
The villains : Other offers are actually financial securities or financial contracts (derivatives) whose value fluctuates according to the evolution of the price of the underlying asset, i.e. the action whose you believe you are buying a fraction. You are not the holder of the share but only of a financial instrument replicating the performance of this share. You are in fact the creditor of the issuer of this financial instrument.
We are not going to lie to each other, almost all brokerage services that offer you fractional shares fall into the second category. They sell you derivatives or certificates. You are not the owner and therefore cannot make shareholder decisions. Your rights are reduced, and your risk increases. You are indeed bound to the contract with this issuer, it only has value as long as your issuer is alive and recognizes the existence of this contract.
Even if fractional shares allow on paper to offer access to many companies whose shares are too high for many individuals wishing to invest in the stock market, you must remain vigilant as to what you are really offered. Those who hadn’t seen these intricacies may finally wonder what the difference is with a stock split.
What is the difference with a stock split?
It happens that the listed company itself decides to divide its shares (by 2, by 4, by 10, by 100, etc.) when the unit value becomes too high to remain accessible to the general public. I am thinking in particular of Amazon which has recently split its stock in 20 from $2460 to $123, or Alphabet which will do so in July 2022 whose current price is $2342. It then proceeds to a “stock split”, a division of the so-called “nominal” value of the share: a division by 10 amounts to multiplying by 10 the number of shares in circulation. On the day of the operation, the price is mechanically divided by 10: you have 10 times more shares than before but the value of your portfolio has not changed and you have proportionally the same rights (vote and dividend). This security transaction is completely independent of split shares.
That’s it, you now (perhaps) know a little more about the stock split and the difference with a split.