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Fractional trading, or investing with small amounts
How about investing in equities with small amounts despite a company share costing several hundred dollars? That’s an exciting prospect for some people. Fractional trading has made this possible since the end of 2019. We look at how you can invest with small amounts, where partial shares are traded and the pros and cons of such trading.
Fractional – what does that mean?
Fractional trading means trading in partial shares – whether equities or crypto-currencies. Unlike in conventional trading, you can now purchase a fraction of a share, and not just whole ones. This example shows why it can be advantageous for some investors:
Let’s assume Veronica would like to buy a share in Lindt & Sprüngli on a budget of CHF 50. She’ll soon realize she can’t afford a whole share with a budget of CHF 50 as a Lindt & Sprüngli share costs over CHF 100,000 on 22 December 2021, the day on which Veronica wants to invest in equities.
That’s where fractional trading comes into play. Various online brokers provide the opportunity to invest in small parts of a share through fractional trading. These service providers are making it easier for some investors to access the market.
New type of trading, new audience?
Trading on the stock market seems complex and inaccessible to many people which is why they often leave it to the professionals.
Also when investing in other types of security, such as funds, people often rely on a bank advisor. This may be due to time constraints, a lack of knowledge, but also anxiety over the major obstacle which the financial market presents.
But fractional trading may be particularly appealing to market newcomers with little experience. On one hand, they can invest with a smaller budget, while, on the other, smartphone banking apps – in other words fintech apps – help overcome the barriers to trading on the stock exchange. Apps achieve the latter primarily through intuitive process design, providing a high-quality user experience adapted to our increasingly digital everyday life. After all, we download and use apps all the time, so why shouldn’t we do the same for investment?
Fractional trading makes participating in the market easier and more attractive for a wider audience. You can find out more about fintech apps and neo-banks in our article “Neo-banks: the bank in your pocket”. A younger audience is also currently participating in
fractional trading. In fact, 45% of all fractional traders with Fidelity – a US fintech trading app – are aged 18 to 35 (as at: 2020).
The number of newly reached private customers has also risen enormously thanks to fractional trading services: the share of private trading on the US financial market is now as big as that of investment and hedge funds (as at: 2021) despite most private investors usually only having a limited budget. Researchers see a link here with the emergence of fractional trading, but also with the changes in working practices and leisure-time behaviour since the COVID-19 pandemic and the reduction of fees.
Where are they traded?
Some online brokers are offering fractional trading. Neo-banks, in particular, are already enabling this type of trading via smartphone apps.
Examples abroad of such apps include Robinhood, a zero-commission trading app, and Charles Schwab, a US bank that also operates a trading app.
In Switzerland such solutions are still relatively new and include the fintech app Yuh, which combines payment, saving and investment – also in fractional shares – in a single app.
Key point: fractional shares are not traded directly on the traditional stock exchange. This means providers, such as Yuh and other online brokers, play an essential role for private investors wishing to trade fractional shares. The online providers wait until they have enough parts of a share to make up a full one and then trade it on the stock exchange.
How to invest with smaller amounts
There’s now nothing stopping investors from participating in fractional trading. The following things are needed:
- An account with a fintech trading app that offers fractional trading
- An amount of money that you won’t miss
- Information about transaction costs and other fees so you’ve got an overview of your expenses
- A plan of the equities or cryptocurrencies you’d like to invest in
You can of course withdraw the money invested at any time. But you’ve also got to accept the risk that the value of (fractional) shares and currencies traded on the market may fluctuate.
Pros and cons of the trend
There are pros and cons to every market innovation – and so too with fractional trading. While investing with smaller amounts may sound appealing, it’s also worth bearing the following points in mind.
Everything’s easier now!
The main benefit of fractional trading is that it makes everything much easier for market newcomers. The following benefits stand out:
- You can invest small amounts in shares with high valuations: The major benefit seems to be the core element of the fractional trading business – investing in a strong and varied equity portfolio on a small budget.
- You receive a dividend: even with fractions of a share, you receive a dividend based on the proportion of the share purchased.
- Equity savings plans possible: you can regularly invest amounts in select securities through fractional trading and develop a savings plan completely in line with your requirements.
- The apps are user-friendly and transparent.
The example of Yuh shows how simple fractional trading can be. You don’t need to complete any complex preliminary tasks in order to invest – there’s no need to open a custody account or pay management fees for it. After signing the contract for access to the app and your investment account, you know exactly what you’re investing in and the transaction fees are also set out transparently.
- Portfolio diversification: fractional trading also makes it easier to diversify your portfolio. Whereas you’d have needed several thousand francs to achieve a certain level of diversification before, now you can invest in a wide range of equities on a limited budget. You’re no longer tied to the price of a full share. Why diversification is so important in your portfolio and how it works is explained in our articles “Diversification – why you shouldn’t put all your eggs in one basket” and “Diversification – explained by way of examples”.
There are still downsides
Despite the many benefits, there’s also a downside to fractional trading. The following points are worth bearing in mind:
- limited selection of securities: not all equities are available as fractional shares. The selection is limited, depending on the platform you trade on.
- No shareholder rights: Holding partial shares does not provide any voting rights as they can’t be entered in the share register.
- Transferability: Fractional shares often can’t be transferred from one platform to another, but instead have to be sold and then re-purchased on the new platform.
Adopt a prudent approach
Fractional trading has clearly made it easier for private investors to invest with small amounts. While prices and rates seem tempting and other benefits also exist, you need to reflect carefully on which investments are worthwhile. It’s worth keeping a close eye on fees as they’re paid on every trade. So if you trade small amounts frequently, your fee costs will soon start mounting up.
In general, investors should try to trade rationally and to maximize their gains by always being aware of the financial consequences of buying and selling and consistently choosing the most profitable option. But people don’t always think rationally and or make the most profitable decisions. That’s because emotions sometimes win over logic. This means we need to understand the impact irrational patterns of behaviour can have and learn to make sound decisions. If you’d like to find out more about the various irrational behaviour patterns, then read our article “Behavioural finance: making more rational investment decisions”.