Desirable stocks often come with undesirable price tags. Investors who indulge into stock trading are keen on investing in big stocks. That is where the fractional shares play a role.
The Indian government is set to build a framework for fractional shares. At present, investors can buy even one share of a company. With the democratized purchase of fractional shares in India, investors will be able to buy a particular share for a fixed amount of money. Let us take an example of MRF shares, the priciest in India. An investor needs to spend Rs.70,000 to own one MRF share. With the new regime of fractional shares, investors may be allowed to spend Rs.100 or Rs 1,000 or Rs.10,000 to buy a part of this share.
Currently, the Companies Act of India does not support such investments, but the ministry of corporate affairs may amend the Act soon to allow the trading of fractional shares. It will bring big companies’ shares within reach of small investors and new investors who may not have huge bank balances.
What are Fractional Shares?
As the name suggests, a fractional share is a unit of stock less than one whole share. In other words, a share is one unit of ownership of a company, and a fractional share is a portion of this one unit – a whole share. It is the smallest unit in the stock. Fractional shares usually emerge from mergers and acquisitions, stock splits, and bonus shares, or there can be similar corporate steps.
How does investing in fractional shares work?
A fractional share works the same as full shares. Like a whole share, it also offers dividends to its investors. Investors of fractional shares get the same percentage gains and have to bear the risk of losses as with full shares. It may or may not offer voting rights to the shareholders.
Suppose company B’s whole share is available at Rs.1000. An individual wants to invest just Rs.500 and receive ownership of ½ share of company B stock. If the company declares Rs.50 dividend, the shareholder will receive Rs.25 as a dividend. If the share price increases by 10% and is traded at Rs.1100 per share, your earnings will also increase by 10% to Rs.27.5.
How can you buy Fractional Shares?
Indian investors invest in the US markets through online trading platforms in the following ways:
Stock splits or reverse stock splits
The split issue of stocks refers to boosting a company’s share count by giving its shareholders additional shares. Stock splits don’t always result in an equal proportion of share allotment.
If it is a 3:2 stock split, you will get three shares for every two shares you own. So, if you own an odd number of shares, you will receive a fractional share after the split. Let us say you own 25 shares. You are entitled to receive 12.5 additional shares for the 25 shares you hold. After receiving 12.5 shares, your total number of shares is 37 ½ with split stocks. You will receive a half share as a fractional share of the stock. If it is a 3:2 reverse stock split, shareholders will receive two shares for every three you own. It may be that the company rounds up to the nearest whole number of shares instead of offering fractional shares.
Dividend Reinvestment Plan (DRIP)
Some companies and brokerages offer a dividend reinvestment plan (DRIP) in which they allow investors to buy more of the same shares using the dividend payouts. If the received dividend is insufficient to buy a full share, a fractional share can be created.
Mergers and Acquisitions
Fractional shares are also issued when a company merges with another company if there is an unequal share swap ratio fixed for the merger.
When companies are merged, the stocks of these companies may be exchanged for a new issue of shares. They announce a specific ratio to combine stocks from both companies. For example, five shares of firm X might become three shares of firm Y. This ratio often results in fractional shares since firms combine new stocks based on a predetermined ratio.
Suppose an individual holds 29 shares of company X, which merged recently with company Y. Let us say the new company Z brings an offer to credit its stock in a ratio of 1:5. It means one stock of company Z for every five stocks of company Y an individual holds. In this case, the shareholder of company X can get only 25 whole shares (5×5 = 25) of company Z. For the remaining 4 shares, the individual will receive a fractional share of 0.8 (4 shares / 5 = 0.8) of company Z.
What are the Benefits of Fractional Shares?
We are often asked if Fractional shares are good for a portfolio and whether or not an investor shall have it? The following section details the benefits of having fractional shares:
- Great for diversification at a cheaper cost
Fractional shares make it much easier for retail investors to diversify their investment portfolios across large companies at a much lower price as compared to owning full shares.
- Great to earn similar to whole shares without a huge investment
If the stock price rises by 10%, the shareholder will earn 10% on the investment even if it is a fractional share, just like an investment of full shares.
- Great for new investors as well
Fractional share investing does not require you to risk all your capital. If you are new to the market and want to invest in stable companies, fractional shares are an ideal investment.
What you should know before investing in fractional shares?
Fractional shares are not traded in the open market. Therefore, they are difficult to sell. These stocks can be sold through a major brokerage firm only. Another scenario is that the company designates a trustee to buy back those fractional shares from the investors. Inflated price is another limitation of fractional share investing that can be proved as a poor investment decision in the long run. Nonetheless, its various benefits trump the limitations.
Thus, fractional shares can be a great way to make easy investments in companies with expensive shares and diversify your portfolio on your financial terms. Same proportional benefits like whole shares must fascinate you to invest in fractional shares. Investors looking for a better path for their wealth and investments can seek assistance from RURASH, serving their clients to build a financially-abundant fortune.
RURASH is amongst the best Indian investment management firm, providing financial solutions to augment the client’s wealth and facilitate building a legacy.