Connect with us

Research

Why Fractional Shares Don’t Make Sense

Published

Why Fractional Shares Don’t Make Sense

Charles Schwab wants to offer investors the ability to trade fractional shares of stock. You know, in case you don’t have enough money for one share of stock.

I oppose this, because as you all know, I am the Grinch who wants to take Christmas from all the Whos down in Whoville.

I’m sure some people will say that about me. I am accustomed to it. Let’s rationalize this.

The average stock is about $30.

If you don’t have $30…

You probably lack the sophistication and the risk tolerance to be investing in the stock market.

Like, if the only money you have is $5, maybe you should put that in the bank?

And besides, the first $10,000 you save should be in the bank, anyway, as an emergency fund.

And even if you do have more than $10,000, my suggestion to you is that you invest in open-end mutual funds, instead. Load or no-load, I don’t care.

You really should only be investing in individual stocks if you have $100,000, and you can build a portfolio of 20 stocks, with $5,000 positions in each of them.

If you don’t have a portfolio of 20 stocks, I would not call that investing. I would characterize that as “screwing around” in stocks.

Ok—there is a need to screw around in stocks from time to time. It’s good for people to experiment and learn how the market works. But don’t call it investing. Call it what it is—screwing around.

Investing Is Hard and Should Be Hard

The push over the last 20 years, going back to the early days of online discount brokerages, in the late ‘90s, has been to make investing cheaper and easier.

I think investing should be harder and more expensive.

And I have a bit of a problem with the “do-it-yourself” revolution, where someone can pick stocks and funds from a laptop in their bedroom.

At some point in their investing career, everyone gets tested, and it’s good to have help, a calm voice of reason to keep you from doing stupid things.

Most people have exceptionally poor ideas about risk. This is why the stock market returns eight percent, on average, but lots of folks are lucky to make zero.

As for the expensive part, I have written before that high fees should not be the enemy of investors, because high fees discourage overtrading. People in the brokerage industry have made public statements about how they hope zero commissions will not lead to overtrading.

Belief in the upward-sloping demand curve persists.

Of course, people will overtrade. The goal here is to buy and hold. High commissions encourage people to hold…for long periods of time.

I sincerely believe this—that about half the country should not be involved in the stock market at all. They should save, in a bank account. Maybe I would change their mind if, once invested, they were denied access to their brokerage account until age 70.

But there is an irresistible temptation to sell the winners and let the losers run. It is human nature. People got Nobel Prizes over this.

I Am Not the Enemy of Investors

Au contraire, I am the friend of investors. People are beginning to think about the behavioral aspects of investing, which is good.

We should all be thinking about what kind of systems we want to put in place that encourage people to buy and hold forever. Zero commissions and fractional shares ain’t gonna do it. I see this as a step backward.

Yes, fees eat into returns—but only if you trade a lot. And the higher the fees are, the less you trade. I like loads on mutual funds the best. Ain’t nobody going to whip around load mutual funds. When you invest in a fund with a 3% load, you are making at least a 10-year decision.

Some people approach fees with the indignation of Bernie Sanders, thinking that financial services employees are overpaid. Maybe. Probably not. It has nothing to do with that. Transactions costs are not the enemy.

I also think it wouldn’t be the worst thing in the world if we ditched decimalization and went back to fractions—for a whole bunch of reasons.

Anyway, enjoy your zero commissions. Wait until you day trade Snapchat 600 times in a year, make $12 in profit, and then have to type in 600 trades into TurboTax off your 1099-B.

And look:

If you can invest for basically no cost…

And buy and hold forever, without ever being tempted to sell…

Then congratulations, you are a steely-eyed missile man. And you were able to take full advantage of the low costs produced by competitive forces in the brokerage industry.

Lots of people want to own the next AMZN. But they won’t, if they sell it after it goes up 40%. Which they will be tempted to do if there is no cost to doing so. Dead horse is dead.

Get Contrarian Investment Ideas from a Wall Street Veteran

Jared Dillian writes The 10th Mana free weekly newsletter for contrarian investorsEvery Thursday, he delivers a torpedo of incisive commentary that crushes consensus thinking and exposes the true workings of “Mr. Market.”  Subscribe now!

Related: When the Market Gets Expensive, Invest in Yourself

Continue Reading

Trending