You’ve probably seen the ads for fractional shares. They’re all over the place.
Fidelity is calling fractional shares “Stocks by the Slice.” Schwab has dubbed them “Stock Slices.” And it’s letting people invest as little as $5 in a company.
This is a terrible idea. If you only have $5 to invest, you should not put it in the stock market. Add that money to your emergency fund, pay down your debts, or go buy yourself a sandwich. But please, do not buy fractional shares.
When you buy a fractional share, you don’t technically own the stock. You need to buy at least one share to do that.
Instead, you put in $5, and the broker pools your order with other people who put in $5, $20, $40—some amount less than the cost of one share—and you all get a proportional interest.
Now, there is simply no way that the people buying fractional shares are researching the companies they’re investing in. And they’re not building diversified portfolios, either.
Instead, they’re downloading a free trading app and treating it like a $5 slot machine. And you know what happens with slot machines... in the long run, the house always wins.
Some people look at a stock like Amazon (AMZN), which trades for about $3,000 a share, and think, “Well, how am I supposed to buy Amazon without fractional shares?”
This is how: Save up $3,000.
The harsh reality is, buying individual stocks is a rich man’s game. You should have $100,000 to invest before you play along.
If you’re not there yet, you can still invest...
Start by setting up your emergency fund and paying down debt if you have any. From there, you can set aside $17 a day, which comes to $500 a month, or $6,000 a year. That is all you need to max out an individual retirement account (IRA).
Do that for 40 years, and you’ve got $240,000 before any investment returns. Factor in an average annual return of 7.9%, and you’re looking at over $1.5 million.
As a bonus, you’ll also lower your taxes, since contributions to a traditional IRA are tax deductible.
Maxing out your IRA every year is fantastic. But ideally, you want to save and invest as much money as humanly possible.
If you’re in your 20s, that means at least 20% of your take-home pay. For example, if your take-home pay is $4,000 a month, 20% of that is $800. That’s the minimum you want to add to your investment account every month. More is better.
If you’re only starting to invest in your 40s or 50s, you want to up the ante and invest 50% of your take-home pay.
I just said you shouldn’t buy individual stocks without $100,000 to invest. So what the heck are you supposed to buy?
A diversified portfolio of exchange-traded funds (ETFs) is a great way to begin.
More specifically, you want a portfolio with some stocks, some bonds, some cash, some gold, and some real estate—20% each. Start with that goal and fill in the specific funds from there. (I share my top picks for this strategy in The Awesome Portfolio.)
Then you hold on. Forever. That is how you build real, lasting wealth.
I’ve made life-changing amounts of money in the markets, but I’ve also been at this in a professional capacity for over two decades.
That is not going to happen for people buying fractional shares. They might enjoy a short-lived run of beginners’ luck... and post aspirational pictures of Lamborghinis and infinity pools on Instagram. But they’re headed for a doublewide.
Please don’t follow their lead.
P.S. The strategy I lay out in The Awesome Portfolio is the antithesis of the slot-machine gambling I see among people buying fractional shares. It’s a strongly diversified portfolio backed by copious amounts of research. And it’s a smart way for you to start investing in the market, even if you’re beginning with a modest amount of money. Learn more by clicking here.