With commission free trading now the norm, banks must find new ways to attract clients to boost other parts of the business — such as banking or financial advice or end up playing the float (take investor cash in money market funds and lend to institutions at higher rate) to make money. And so, Charles Schwab rolled out a new program that will let investors buy and sell fractions of shares in coming months as part of an effort to attract younger clients to its online brokerage platform.

Schwab’s move would be the first by a major online brokerage to allow investors to buy and sell fractions of stocks. Some of the most well-known and popular companies have high price tags. A share of Amazon.com Inc., for example, costs around $1,794. Warren Buffet’s Berkshire Hathaway A share is $313,200. The idea is to have fractional shares that help younger and less-wealthy investors diversify their investment portfolios by spreading relatively small pots of money over a broader range of stocks. And, in the process, Charles Schwab and others can make money through offering financial advice or offering loans etc.

Future Wealth View

Most investors, like it or not, end up with fractional shares at some point. When one owns stock in a company that goes through a major transformative event like a merger, shareholders in the target company often receive shares of the acquiring company in exchange for their existing holdings, and it’s rare for the ratio of new shares received to be a round number. Similarly, if a company spins off part of its business as a separately traded stock, shareholders might receive a certain number of shares of the spun-off entity for every share of the existing company they own. 

And then, the tax problems begin. Many brokers don’t do a good job of giving information about cash in lieu transactions. One may have the cost basis in whatever fractional shares produced the cash in lieu, and may or may not owe taxes on the full amount of the cash received. The problem is that the necessary basis information usually isn’t available until after the transaction goes through. Therefore, one has to correct the information on a 1099. In general, fractional shares are a nuisance, with the small amounts involved causing more trouble than they’re arguably worth. And Schwab’s efforts to allow people to buy fractional shares is going to backfire much like the $0 commission announcement last week.

Our view, at Future Wealth, is that if one is unable to buy a single share of Amazon or Google, they should not be investing in the stock market and should instead putting the money in the bank until they are able to get to a point where they are able to withstand the volatility of the stock market. Furthermore, the fractionalization and the diversification is already done for investors via a plethora of ETFs. So, why own a fraction of an individual stock? And for those who ask – how about buying a fractional share of Berkshire Hathaway? Well, it is already available as Berkshire Hathaway B shares at 1-1500th the price of an A share at $298.00. Ever the sage, Warren Buffett figured it out already, well before Charles Schwab came up with this novel, but misplaced, idea.