Fractional shares have been a hot topic recently and with good reason. A growing number of brokerages are now offering the opportunity for those without a lot of money to invest to purchase stocks that have high share prices by buying partial shares instead of full ones.
Purchasing fractional shares is also called dollar-based investing because you don't place an order to purchase a specific number of stock shares, but instead specify the amount you want to invest in a particular company. Some brokerages require you to invest a minimum of $5, while for others you can buy as little as a penny's worth of stock as long as you're buying at least 0.001% of a share.
This new type of trading has democratized investing somewhat and made it possible for anyone to get their money in the market, but it's also created some new risks. To make sure you're trading fractional shares wisely, you'll want to avoid these two big pitfalls.
1. Not Doing Sufficient Research Because the Cost of Entry Is So Low
For most people, the amount of research they do before making a purchase is directly correlated with the amount of money they're spending. After all, chances are good if you're going to buy a car, you're going to take some more time to find the right one than if you're buying a pack of gum.
Sadly, that understandable behavioral phenomenon could lead to some investors -- especially younger or beginning ones -- purchasing fractional shares without really taking the time to consider whether they're making a sound investment simply because they can do so with very little cash. That can obviously be a problem because it creates an outsized risk of losing money -- and even if you just lose $5, it's still a loss. But it actually creates much bigger issues than it may seem.
If you're always rushing to buy something as soon as you have a few spare dollars to purchase fractional shares, you may never amass "enough" money that you feel the need to make more responsible investments. Your unsuccessful fractional share purchases will chip away at your ability to build wealth because every $5 you lose is money you won't have to invest later.
You could also lose out on the chance to develop a sound investment strategy that enables you to pick winning stocks -- especially if you get frustrated seeing your portfolio balance go down. And learning how to be a smart investor can be the key to real wealth-building.
2. Confusing Share Price With a Company's Value
Another big problem is that people often conflate an expensive price with a high value. And if you can suddenly purchase something "expensive" that was beyond your reach, you may be excited to jump in and do so without ever stopping to think if the purchase is worth it.
You may, for example, have been priced out of purchasing shares of Amazon or Netflix before, but can now afford to buy in thanks to fractional shares. But just because Amazon is selling at over $3,400 a share or Netflix has a per-share price above $500 doesn't necessarily mean these stocks are "worth" that much.
If you've put in the work and have decided a company's stock is one you want to own for the long term, it's great news that fractional shares have opened the door to you being able to buy it. But if you're rushing to purchase stocks with a high share price just because you now can, you may find yourself with a portfolio you're very disappointed in when the trading day is done.