For many new investors, buying companies listed in the S&P 500 is a good place to start. This market index comprises 500 of the largest companies trading on the New York Stock Exchange and Nasdaq, and investing in large companies is generally seen as less risky.
But many of the best-known companies in the S&P 500 come with a very high share price. For example, Google parent Alphabet (GOOG +0.48%), (GOOGL +0.56%) had a share price topping $1,300 as of May 15; Amazon.com (AMZN 0.78%) was priced at more than $2,400 for a single share.
While investors can gain exposure to the stocks on the S&P by purchasing an exchange-traded fund (ETF) tracking the index, a share of most of these ETFs will also set you back several hundred dollars. For those just getting started, it could take months to save enough to buy just one share of an S&P index fund, and even longer to buy shares of the best-known companies among the 500. And sinking so much cash into a single investment can make it difficult to build a diversified portfolio.
But you don't need thousands of dollars to buy shares in companies that are household names. An increasing number of online brokerage firms, including major brokers such as Schwab, are offering fractional shares, which allows investors to buy even smaller slices of a company and lowers the cost of entry dramatically.
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Why fractional shares could be the key to investing in expensive stocks
Fractional shares make it possible to buy a portion of a share of a company like Alphabet, Amazon, or Berkshire Hathaway (BRK.A +0.00%) (BRK.B 0.11%). You can also buy partial shares of exchange-traded funds, such as the SPDR S&P 500 Trust (SPY 0.13%), which is designed to track the S&P 500.
With some brokerage firms, you can buy as little as 0.001 of a share, so a small ownership stake in a company with a $1,300 valuation would cost you as little as $1.30.
While buying such a small portion of a company may not seem like it would do much for you, you'll earn the same percentage on your investment as any other investor with full shares.
Say, for example, one year ago on May 14, 2019, you had $100 to invest, so you purchased some fractional shares of Alphabet. The stock was selling for $1,137.21 per share, so that would've bought you around 0.087 of a share. Today, that $100 investment would be worth around $120. You would have made $20 while a full share owner would have made around $232 -- but you'd both have earned the same return (around 20%) on your invested funds.
Should you buy fractional shares?
With so many brokers offering fractional shares, purchasing them is easier than ever. Many discount online brokers have also eliminated commissions, which has made it more practical to invest small sums of money and still earn a reasonable rate of return without trading fees taking too big of a bite. With these recent changes, it's much easier for beginning investors to put their money to work.
For a starting investor with a small balance (say, $1,500), buying a single share of Alphabet would leave little or nothing left to diversify across other companies. Rather than tying the performance of your entire portfolio to one stock, you could invest that $1,500 across fractional shares of several companies, thereby reducing risk.
It's important to remember, though, that a high share price doesn't necessarily correlate with a high value. Whether you're buying Alphabet, Amazon, or any other stock, it's essential to research the fundamentals of the company and invest only if you think the business is likely to perform well over the long term.
If you've done your research, there's little reason not to dive in and purchase fractional shares. They enable you to build a diversified portfolio of companies you love but couldn't otherwise afford to invest in.
