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Fractional ETF Trading’s Future

Lara Crigger

Last month, discount brokerage Charles Schwab made waves when it announced it would soon introduce trading of fractional shares of stock in an effort to entice younger investors to its platform. Fractional trading of ETF shares is another matter, however.

When ETF.com reached out to Schwab for comment, company spokesperson Erin Montgomery said in an email that while fractional stock trading should debut sometime in 2020, the company has no current plans to introduce trading of fractional ETF shares.

"We are … exploring how fractional share trading could be applied in other areas, such as with ETFs, but our focus right now is on individual stocks," she wrote.

‘Holy Grail’ For Younger Investors

For years, fractional trading has been something of a holy grail for the ETF industry. Although mutual funds may be bought and sold in fractional amounts, ETFs must be traded in whole lots.

To some extent, the bar for investment in ETFs is already lower than for mutual funds. Typically, ETFs have lower investment minimums than mutual funds, which can cost $1,000, $3,000 or even $10,000 per share, or even individual stocks: Berkshire Hathaway (BRK) currently costs a whopping $332,000 per share.

Still, per-share prices of ETFs can be hefty, especially to investors with smaller asset bases. The most expensive-per-share ETF is the SPDR S&P Midcap 400 ETF Trust (MDY), which currently costs $364/share.

Not only would more widespread fractional trading allow sophisticated investors to more precisely replicate model ETF portfolios, it would allow investors with smaller asset bases to build diversified portfolios via dollar cost averaging (such as through regular paycheck contributions).

How Fractional Ownership Works

Some brokerages already allow for partial-share ownership of ETFs by inserting themselves as a middleman: After bundling all the necessary trades across their client accounts, they then buy and sell whole ETF shares as needed.

Those ETF shares are then put in a collective trust, shares of which are then redistributed to their clients on a fractional basis (read: "Has Schwab Cracked 401(k) Code For ETFs?").

M1 Finance, for example, allows investors to invest in fractional amounts as granular as 1/10,000th of a share.

Doing things this way introduces some risks, however. Since the firm must trade in whole lots, it assumes some risk in owning the "leftover" fractions of ETFs—though if the brokerage trades in enough bulk, that risk may be small. Furthermore, the cost of managing the trust in which to place the whole ETF shares is usually on the order of a few basis points.

Additionally, no matter how small a slice of a share is offered, it still may not be precise enough for some investors' needs. For example, 1/10,000th of one share of MDY is about $0.04, meaning an investor who wants to trade in multiples smaller than that will have to accept some rounding error, however small it may be.

Using ETFs In 401(k)s?

Still, partial-share ETF ownership dramatically lowers the bar to investment for the lowest asset base investors, encouraging market participation at younger ages. If and when brokerages like Schwab decide to offer fractional trading of ETF shares, it could dramatically improve the attractiveness of using ETFs in employer-offered 401(k) plans, for example.

Something that might also boost ETF usage in 401(k) plans is the momentum toward commission-free trading. Discount brokerage Robinhood helped to popularize the zero-commission trading platform, and in recent months, Interactive Brokers, TD Ameritrade, E*Trade and Schwab have also recently dropped commissions on all trades.

Contact Lara Crigger at lcrigger@etf.com

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