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If you have been exploring the M1 Finance app, or researching the platform online, you have probably come across this term; fractional shares.
To put it simply, a fractional share is a fraction of one share of a company.
But wait a second… a share of a company is a fraction of that company. So, why do we need a fraction of a fraction of a company?
The answer: not all shares are created equally.
Take Amazon for example. Right now, there are around 488 million shares of this company. The market capitalization, or market value, of this company is around $935 billion. As such, each share is valued at around $1,916 per share.
Now, let’s consider Ford. Right now, there are around 3.91 billion shares of this company. The market capitalization, or market value, of this company is around $37.7 billion. As such, each share is valued at around $9.64 per share.
Now, we don’t know exactly how many shares of Ford or Amazon are out there, so that results in some price deviation. But what we have here is two popular stocks with a drastically different share price.
So, let’s say you are an investor and you like Ford and Amazon. You want to own an equal amount of Ford stock and Amazon stock. You are just getting started with investing, so you have $3,000 to invest.
In a perfect world, you could invest $1,500 into each stock. (Spoiler alert, you can)
BUT! You are only able to invest in whole shares of each of these stocks.
Your only option is to invest $1,918 in one share of Amazon stock and invest the rest in Ford stock. After buying your share of Amazon stock, you have $1,082 left. You are able to purchase 114 shares of Ford stock. On top of that, you end up with $3.56 left over.
This is what your investment portfolio would look like…
Wait a second… you liked both of these companies equally! You wanted to invest half of your money in Amazon and half of your money in Ford. Now, you are overweight in Amazon and underweight in Ford.
This exact situation has been a frustrating predicament for investors for years. You set your goals for diversification, but that pesky share price causes your actual allocations to change.
Enter M1 Finance. M1 Finance was launched in 2016 and is an online roboadvisor for everyday people who want to invest in stocks or exchange traded funds (ETFs). One of the biggest benefits of this investing platform is the fact that you can invest in fractional shares.
M1 Finance splits every share into 1/10,000th of a share. This allows you to trade the exact amount and achieve your portfolio allocation goals.
Back to our example, let’s consider Amazon stock. With M1 Finance, you can buy as little as 1/10,000th of a share of this stock. Each of these fractional shares would have a value of 19.18 cents.
Now, your $1,500 investment in Amazon stock would actually be about 78% of one whole share. (7,819/10,000 for the math people)
This means that with M1 Finance, you can set your allocations for each stock and meet those allocations regardless of the share price.
M1 Finance allows investors to purchase fractional shares. The fractional share allows small investors to invest in stocks with a high share price. Traditionally, you could not buy Amazon stock unless you could afford a whole share. This also allows investors to better diversify their portfolio without ending up overweight in a certain stock simply due to the share price. Finally, fractional shares also allow investors to remain fully invested.
Remember that $3.56 left over from the first example? While it may seem insignificant, that is money that is sitting in cash that is not being put to work through investment. With M1 Finance, you could invest that money in fractional shares.
Now, did M1 Finance invent this concept of fractional shares? The answer is no. In the past, brokers have offered fractional shares to investors but they would typically charge a fee for this convenience. M1 Finance does not charge a penny.
To recap, fractional shares have these benefits:
- They allow small investors to consider stocks with high share prices like Amazon or Google
- They allow you to remain fully invested and reduce or eliminate idle cash
- They allow you to reinvest your dividends into partial shares of the issuing stock
- They allow you to allocate your portfolio as close to your allocation targets as possible
- With M1 Finance, fractional shares are available free of charge