A share is a single unit of ownership of a company. When you purchase a significant part of a company’s capital, you become a shareholder in that company. You also receive a share of the company’s profits as an annual dividend.
In a situation wherein a company faces merger, bonus issue or stock split, you may get a fraction of a share, say, one-third or one-half of a share. What do you call such stocks? How are they paid to you? What are the income tax implications?
A fractional share is a unit of stock that is less than one whole share. Fractional shares usually emerge from stock splits, bonus shares, mergers and acquisitions or similar corporate steps. Instances such as dollar-cost averaging, capital gains, and dividend reinvestment plans often leave the investor with fractional shares. Fractional shares do not trade in the open market. The only way to sell fractional shares is through a major brokerage. While such shares aren’t available from the stock market, they have value to investors, and they are also difficult to sell.
More about Fractional Shares
Fractional shares are usually traded through big brokerage firms. In case the selling stock does not have a high demand in the marketplace, selling the fractional shares might take longer than imagined. Fractional shares are created in different ways, as mentioned below.
It is a step by the top company officials to increase the number of shares that are outstanding by issuing more shares to existing shareholders. This is a step taken to boost the company’s liquidity. The most common stock splits are 2-for-1 or 3-for-1.
Mergers and Acquisitions
Sometimes brokerages split whole shares so that they can sell fractional shares to clients. This is usually done with high priced stocks such as Amazon, Alphabet, Google’s parent company. Fractional stocks are sometimes the only way an individual investor can buy in such companies.
Dividend Reinvestment Plans
Dividend Reinvestment Plans (DRIP) also create fractional shares. A dividend reinvestment plan is a strategy by which a company lets its investors use dividend payouts to purchase more of the same shares. As the dividend is used to buy the same stocks, it might not be substantial to buy a full share, resulting in fractional shares.
How do you sell fractional shares?
Usually, you sell the fractional shares for cash to companies. The company appoints a trustee to buy the fractional shares from the investors.
Advantages of fractional shares
Fractional share investing happens by allowing a relatively new or amateur investor to enter the market with limited risk. Without fractional shares, it would be tough for a regular investor to build a portfolio with companies that have a high stock price. Fractional shares have also made it easy for seasoned investors to invest in their favoured stocks.
A few brokerages and trading platforms now allow fraction investing. It will enable investors to invest small amounts in expensive securities, that is otherwise beyond their reach. With fractional shares, you could divide your investments among more stocks to achieve a more diversified portfolio and use small cash balances to work quickly to get maximum returns.
These days, fractional shares have become very popular in the Indian stock market. If you wish to know more on this, you may start trading with Angel One!