Robinhood just announced fractional shares…
This year has been a good year for investors; the S&P 500 has returned 20%, and the market has been hitting record highs as we close out the year and move into 2020. Gains are not the only good thing that 2019 has brought to investors. No Fee trading has essentially become the standard for all brokerage houses. Robinhood mainstreamed this concept in 2015. Robinhood is at it again, this time with a feature called - fractional shares. Robinhood is not the first to come out with the feature, but they might have enough influence to make it standard in 2020. If you have never heard of fractional shares this article will bring to light the problem it solves, the reason stocks have such dramatic price differences, and why it is good for investors.
The problem being solved
When people finally get the money to start investing, they want to buy companies they recognize. They want to buy shares in companies they use and buy products from think of Facebook, Apple, Amazon, Netflix, Google (now Alphabet). This collection is called FAANG. CNBC’s Jim Cramer created this saying. The average price of a share of one of these companies is $803 a share. This high of a price for a share would prevent most early investors from being able to buy shares in these companies.
Many investors then make their first stock purchases in companies such as Ford, GE, Sirius. These companies may have strong name recognition, but their stocks have not had great returns. These investments have given many investors a bad taste in their mouths. They think that all stocks perform like this. It leads them to believe that the only way to make money in the market is to invest in speculative companies. This could not be further from the truth. Over the last 5 years, the previously mentioned FAANG has returned 260% to its investors.
Now with increased availability to fractional shares, investors can put their money in companies they want regardless of the share price. Fractional shares allow investors to participate in dollar-cost average trading with their favorite companies. Dollar-cost average trading is when you consistently put the same amount of money into an investment regularly. So when the stock is up, you get fewer shares, but when it goes down, you get more shares.
So if you think a company has longterm growth potential and you want to increase your stake in this company, dollar cost averaging is a great way to do this. With fractional trading, you can do dollar-cost averaging with as little as $25 a month into shares of your favorite companies. This investing used to be exclusive to mutual funds.
Why do some companies have much higher share prices?
A common mistake I see new investors make is they see a high stock price, and they think that stock must be good. That is why it is so expensive. For example, people will see a share of Amazon trading at $1,700 and think “Amazon is so much better than Microsoft because Microsoft is only trading for $150 a share!” There is a reason why some share prices are considerably lower than the others. The reason for this is that companies wanted to make their shares more approachable to investors. There was a long-held belief that the best stock price was $100. If a companies share price got higher than this, the company would split the shares. Meaning if you owned one share and the company did a 2:1 split, you would now have 2 shares of that company instead of 1 — the same value of the company just more shares.
With the creation of mutual funds and electronically traded funds (ETFs), companies do not have to worry about their shares being out of reach for most investors. The overwhelming majority of investors do not invest in individual shares but collections of companies through mutual funds and ETFs.
Even though a company may have a stock price above $1,000, it could have a lower market cap (worth of all the companies stock) than a company that only trades at $100 a share. There also is a belief in corporate America that having a stock price above $1,000 is prestigious. I am not sure if that is the main reason that companies let their stocks go so high in place of just splitting the shares and bringing them down.
There is not much proof that having a stock above $1,000 is beneficial or detrimental to its performance. Most likely, the reason is that again, most people are not buying individual stocks they are buying collections in funds.
How this benefits the market…
I think the normalization of fractional sharing is going to be great for the market as well as individual investors. It gives beginning investors access to individual companies they want. Do not get me wrong investing in an S&P 500 mutual fund should be a foundational investment for everyone. However, being able to take some risk and buy some individual companies is great too!
Another benefit to this that most people do not talk about is you can vote on issues the company faces. So being a shareholder of many companies gives you a vote in important decisions for the company. For example, a stock I owned last year had a vote on whether should they have to disclose their political contributions in their annual reports. I got one vote per share of my stock, which was not enough to move the needle in either way, but it is good to know my vote was counted. When you invest in mutual funds or ETFs, you do not get the right to vote on any issues that the fund has in its stock portfolio. I think this is a very underrated benefit of fractional shares that I hope many people take full advantage of it!
I hope 2020 is the year where fractional trading becomes mainstream, just like 2019 marked the year where no-fee trading became mainstream! Now if this knowledge has you excited at the opportunity to invest in individual stocks let me know! I have plenty of books I can recommend and resources I can send you so you can learn more about how to become an investor!
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