Fractional Shares

A fractional share is an ownership interest in less than one whole share of a security. The Securities and Exchange Commission puts it plainly: "A fractional share is when you own less than one full share of a stock or other security." They arise in several ways, including buying a fixed dollar amount of a high-priced stock, reinvesting a dividend that does not divide evenly into the share price, stock splits, and corporate actions such as mergers.

The distinction that organizes everything else is between a fractional interest in a fund and a fractional share of a stock held through a brokerage program. In a mutual fund, fractional ownership is ordinary and unremarkable: you transact with the fund itself, the fund issues you whatever fraction your money buys, and nothing about your rights differs from a whole-share holder's. A fractional share of a listed stock is different. A whole share is an interest in a company with rights defined by corporate law and recorded in the company's register. Less than one share is generally a position your brokerage firm maintains in its own books, and its characteristics come from that firm's program rather than from the security.

That is why the SEC's investor bulletin on the subject is written almost entirely as a list of questions to put to your brokerage firm. The bulletin represents the views of the staff of the Office of Investor Education and Advocacy and, like all staff guidance, is not a rule, regulation or statement of the Commission.

The SEC's bulletin identifies several ways a fractional share can behave differently from a whole one, and each is expressed as something that varies by firm.

Orders may be aggregated. Rather than filling each fractional share order in real time, the firm may collect these orders through the day and then execute one or more large orders. The practical consequence is that the price you receive may not be the price you saw when you placed the order, and the timing of execution is the firm's rather than yours.

Order types may be restricted. Some firms only allow market orders for fractional share investing, so the ability to set a price limit on the purchase may not be available. Market orders and limit orders are covered on their own pages; the point here is that the choice between them may be made for you.

Dividends are paid pro rata. The SEC's example is exact: if you own .75 shares of a stock and it distributes a dividend of $10.00 per share, you would receive $7.50. Nothing is lost, but the amounts are small and, in a taxable account, still reportable.

Voting rights may not exist. The SEC states that you may not have voting rights if you own fractional shares, and that your ability to exercise proxy voting will depend on how your brokerage firm's fractional share investing program works. This is the clearest illustration of the general point: a right that attaches to a share as a matter of corporate law does not necessarily reach the holder of a fraction held in a firm's program.

Liquidity is not guaranteed. Some brokerage firms have indicated that they do not guarantee the liquidity of fractional shares, even if full shares of the stock are liquid. So the ease of selling a fraction is a property of the firm's program rather than of the market in the underlying stock.

They generally cannot be moved, and this is the most consequential one. The SEC's bulletin, under a heading of its own, states that you generally cannot transfer fractional shares to another brokerage firm, and that if you decide to transfer your brokerage account to a different brokerage firm you may have to sell any fractional shares in your account.

That last point has a tax consequence the bulletin does not draw out. A transfer of whole shares between brokers is generally an in-kind movement that changes nothing for tax purposes: the position and its cost basis follow you. Selling a fractional share is not that. It is a disposition, and in a taxable account it realizes a capital gain or loss for that year. The amounts involved are usually small, because a fraction of a share is by definition worth less than one share. But the character of the event is different from what a transferring investor is expecting, and it happens on the firm's timetable in the middle of a move undertaken for entirely unrelated reasons. This is worth knowing before the move rather than after it by anyone holding fractional positions in a taxable account, and it is one of the few reasons to prefer whole shares where the choice exists.

Set against all of that is a real and simple benefit. Fractional shares break the link between how much you want to invest and what one share happens to cost. A $250 contribution can be fully invested in a stock trading at $400 a share rather than sitting in cash, and a portfolio can be built to intended proportions rather than rounded to whole shares. For regular investing of fixed amounts, and for diversifying a small account across many holdings, that is the whole argument and it is a strong one.

You enter an order for a dollar amount rather than a number of shares. How the firm then sources the fraction is a matter for the firm: the SEC notes that some fill fractional orders in real time as they do whole shares, while others aggregate customer orders through the day and execute one or more large orders to fulfill them. Your account shows a decimal quantity. Dividends are credited in proportion, and on a sale the fraction is disposed of along with everything else.

A hypothetical example. Ravi wants to invest $250 in a stock trading at $412.00 a share. Without fractional shares he can buy nothing, since one share costs more than he has, and the $250 stays in cash. With them, the $250 buys about 0.6068 of a share ($250 ÷ $412.00).

If the company then pays a dividend of $3.20 a share, Ravi receives about $1.94 (0.6068 × $3.20), which is his proportional share and is reportable in a taxable account like any other dividend.

Two years later he decides to move his account to a different brokerage firm. Whole shares generally transfer in kind, with the position and its cost basis intact. The 0.6068 of a share may not, and he may have to sell it as part of the move. If the stock has risen to $500.00, that fraction is worth about $303.40 (0.6068 × $500.00), so selling it realizes a gain of about $53.40 ($303.40 − $250.00), reportable for that year. The amount is small. The point is that a transfer he thought of as moving his account without selling anything included a sale.

Pros

• The amount you want to invest no longer has to be a multiple of one share price, so contributions can be fully invested rather than partly left in cash.
• A small account can be spread across many holdings in intended proportions rather than in whatever whole shares happen to fit.
• High-priced shares stop being a barrier, which widens the practical investable universe for a small investor.
• They make regular fixed-amount investing and full dividend reinvestment work exactly rather than approximately.

Cons

• The SEC states that you generally cannot transfer them to another brokerage firm, and that moving your account may require selling them, which is a taxable disposition in a taxable account.
• Voting rights may not be available, depending on how the firm's program works.
• Orders may be aggregated and executed at times the firm chooses rather than in real time, so the execution price may differ from what you saw.
• Some firms only permit market orders for fractional investing, removing the ability to set a price limit.
• Some firms do not guarantee the liquidity of fractional shares even where the whole shares are liquid.