Fractional share trading has become increasingly popular in recent years, revolutionizing the way individuals can invest in stocks.
However, beneath the surface, the rise of fractional share trading raises several concerns that demand careful consideration.
Fractional share trading allows investors to purchase fractions of a single share. In other words, instead of owning at least one full share of a company’s stock, you own a piece, or a fraction, of one share.
You can buy a half-share of a stock or a quarter of a share or, on some exchanges like Robinhood, you can buy 1/1,000,000th of a share.
But why would anyone want to buy one-millionth of one share?
Well, some stocks are so expensive that they generally aren’t accessible to most retail investors. For example, Berkshire Hathaway’s Class A stock trades in the hundreds of thousands of dollars.
Before fractional share trading, the minimum investment you’d have to make to own BRK-A would be $485,000. That’s $150,000 more than the average U.S. home price in 2022.
But now you can be an owner of BRK-A for as little as $1.
Proponents of fractional share trading say it empowers small-scale investors who may have limited funds. Brokerage houses have embraced this trend, promoting their fractional share services with catchy slogans like Fidelity's "Stocks by the Slice," creating an impression of friendliness and simplicity.
Nevertheless, while the accessibility fractional share trading offers may seem enticing, we must evaluate the potential risks and negative effects it could have on market dynamics.
One significant issue with fractional share trading is the disconnection it fosters between investors and the underlying assets.
Although owning a fraction of a share provides a sense of participation, it blurs the lines of ownership and shareholder rights. Investors holding fractional shares may find themselves losing their influence in crucial corporate decisions, such as voting on resolutions or electing board members.
This dilution of shareholder power undermines the concept of responsible ownership and the accountability that comes with it.
Furthermore, fractional share trading may inadvertently encourage speculative behavior by reducing financial barriers to entry.
While it may attract new investors, it also cultivates a culture of short-term trading and impulsive decision-making. Investors lacking a comprehensive understanding of the market may view it as a gambling platform rather than a means of long-term wealth creation.
This speculative mindset can have detrimental effects on market stability and exacerbate volatility.
Another worrisome aspect of fractional share trading is its potential to fuel emotional investing. Investors engaging in fractional trading may become more susceptible to market sentiment, following popular trends instead of conducting diligent research and analysis. This emotional bias can lead to irrational investment decisions driven by fear, greed, or social media hype.
Such behavior disregards the essence of sound investing and exposes individuals to unnecessary risks.
Perhaps the most significant problem associated with fractional share trading, however, is its potential to create distortions within the market.
As more investors participate in fractional trading, the demand for popular stocks intensifies, causing prices to detach from their intrinsic value. This distortion can result in inflated stock prices, creating a false sense of market performance.
Additionally, liquidity and price discovery mechanisms may be compromised, making it challenging for the market to accurately reflect supply-and-demand dynamics.
While fractional share trading may initially appear appealing, it is crucial to critically evaluate its implications. It poses a threat to the core principles of ownership, distorts market dynamics, promotes speculative behavior, introduces security challenges, and encourages emotional decision-making.
As investors, it is vital for us to maintain a holistic understanding of the market and prioritize long-term value creation over short-term gains.
Fractional share trading should, at the very least, be reviewed by the various regulatory bodies, and, in my opinion, every investor should be made aware of the practice before buying any stock.
