The smallest trade you can make on a stock exchange is one share. Because exchange-traded funds trade as stock, you might find the idea of fractional ETF shares irrelevant. Yet you can accumulate fractional shares in an ETF, even if you can only buy and sell whole shares. Your broker can accomplish this feat by allocating partial shares to your account. Not all brokers are willing to deal with fractional shares, and some will only do so for a fee.
An ETF starts life as an initial public offering of stock. The stock is backed by a basket of assets such as bonds, commodities, futures or other stocks. Once issued, the ETF shares trade on a stock exchange just like any other stock. You normally need a brokerage account to buy and sell shares of an ETF and will pay a commission for each transaction. ETFs can pay cash dividends to shareholders and may also provide capital gains or losses when the ETF sells some of its portfolio or you sell some of your shares.
ETF dividends can be for any odd amount of cash that translates into fractional shares if reinvested. Mutual fund investors can instruct their fund companies to automatically reinvest dividends, which is not a problem, as mutual funds deal with partial shares all the time. However, the same is not necessarily true for ETF investors. Some brokers are happy to reinvest dividends in the ETF, some will do so for a fee and some refuse to do so at all. Accommodating brokers will credit partial shares to a brokerage account, but the partial shares are but a virtual prorated portion of a real share held by the broker.
Dividend Reinvestment Plans
Dividend reinvestment plans, or DRIPS, are programs set up by stock issuers or third parties to automatically reinvest dividends in a particular stock. DRIPs allow for the purchase of partial shares. Because ETFs contain assets from multiple sources, ETF DRIPs operate a little differently from traditional reinvestment plans. A broker may make an arrangement to buy ETF shares directly from a fund manager instead of on the open market. In return, the broker will work with a DRIP set up by the ETF manager. Most such plans are fee free, and all permit fractional shares.
Dollar Cost Averaging
Dollar cost averaging is a technique for buying shares over an extended period. For example, you might make uniform monthly purchases of a stock you wish to accumulate. When the stock price is high, you buy fewer shares than you would receive if the price was low. In this way, you can achieve a portfolio cost that is weighted toward cheaper shares. DRIPs are happy to set up automatic dollar cost averaging programs with shareholders, bypassing brokers entirely. The fixed monthly investments often result in fractional shares. ETF managers who offer DRIPs accept dollar cost averaging investments and allocate fractional shares.
- Exchange-Traded Funds for Dummies; Russell Wild
- The ETF Book: All You Need to Know About Exchange-Traded Funds; Richard A. Ferri
- ETFs for the Long Run: What They Are, How They Work, and Simple Strategies for Successful Long-Term Investing; Lawrence Carrel
- All About DRIPs and DSPs; George Fisher
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