Brokers are touting fractional shares as a way to democratize trading pricey stocks. That's only part of the story - here's why they want to get you hooked on $1 slices.

• A handful of firms have started allowing customers to trade small slices of individual stocks, or have plans to roll out that offering. Those moves come on the heels of a fierce commission price war among discount brokers this fall.
• Firms invoke "democratization," the industry buzzword du jour, to describe the fractional trading feature. Startups and legacy players talk of leveling the playing field for all users regardless of whether they can afford a share of highly-priced stocks.
• But companies have good reason to attract investors while they're still building wealth. For instance, they can lock in young customers with the hopes of cross-selling products to them down the line.
• And depending on how brokers clear the shares, fractional trading could offer another revenue stream after axing commissions to zero.
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Fractional share trading has quickly become a buzzword in the discount brokerage industry, signalling a new front in the fiercely competitive space.

In the fall, brokers raced to slash trading commissions on stocks and options to zero, doing away with one potential revenue stream in the process. With that fierce price war behind them, startups and legacy brokers alike are now looking to stand out, lock in customers, and build out new ways of bringing in money.

Firms have been making noise about launching platforms that allow investors to buy and sell tiny portions of stocks. Many are marketing the offering as a way to democratize investing and allow average customers to own popular but highly priced stocks like Amazon and Alphabet.

Industry experts say fractional share trading serves as a way to lock in customers early in their investing careers with the hopes of cross-selling products to them down the line. It also hooks customers on a subscription-like model of regularly putting their cash into stocks - putting investing on the same kind of auto-pilot as paying your Netflix bill.

"It's a broader effort to court younger investors," Jen Butler, the director of asset management and brokerage research at Corporate Insight, said in an interview.

And the process of splitting up shares and matching them with buyers and sellers could offer another source of revenue for the firms, even if the trade involved no commission.

The growth of fractional share offerings highlights firms' ongoing efforts to lure and keep a young set of investors that have grown accustomed to automated, dirt-cheap investment options - thanks to the rise of passive indexing, digital trading platforms, and low-cost robo-advisers.

Going after so-called "HENRYs," or "high earners, not rich yet" customers and maintaining scale in an ultra-competitive environment have become important themes for brokerage and wealth management firms, said Pauline Bell, an equity research analyst at CFRA Research.

"It's about volume, getting more customers, and cross-selling other products," Bell said in an interview.

Still, creating a portfolio of stock slivers is at once a complex strategy and one intended to capture newer investors.

"On the one hand, you have to be sophisticated just to know that this product exists, but on the other hand, they are trying to get younger investors to be involved," Bell said.

Allowing investors the chance to buy portions of stocks is not entirely new. Many firms already offer the feature in the form of dividend reinvestment programs (DRIPs), which allow shareholders to reinvest their holdings' dividends into additional or fractional shares.

M1 Finance was one of the first adopters of fractional share trading, offering it when the fintech launched in September 2016. More than three years later, it has grown to be one of the largest fractional share utilizers in the marketplace, Brian Barnes, M1's founder and CEO, told Business Insider.

The Chicago-based startup, which averages 250,000 customer transactions a day, encourages customers to think of their portfolios in terms of percentages of different stocks as opposed to buying and selling specific shares.

"Don't care about price-per-share. Care about the value of the company and what portion of it is represented in your portfolio," Barnes said.

For Barnes, fractional share trading is about more than simply being able to afford stocks that might be out of a customer's price range.

Instead, he believes the approach is a good way to cater to customers' behaviors. Investments aren't typically one-off events, Barnes said. Instead, people are more likely to continue to put money into their portfolio, treating it like a monthly subscription service.

"The ongoing $500 every two weeks is just a smaller dollar amount, and being able to divvy that into the right amount of securities and across many securities, you sort of need fractionalization to support that," Barnes said.

The digital personal finance company SoFi launched a fractional share program for customers last summer with a $1 minimum, though it offers access to only around 50 different stocks and exchange-traded funds.

Since going live, 51% of all trades on SoFi Invest are fractional, according to data provided by the company, and 78% of customers' first trades are fractional.

The investing app Stash launched fractional stock-trading in March 2019, and JPMorgan's YouInvest launched fractional trading in November.

Others were earlier to offer the program to customers. Invstr, an app with 500,000 users that offers fractional trading through the fintech DriveWealth, launched the feature in 2017.

Acorns, the micro-investing app, launched in 2014 with fractional ownership as a key part of its offering - though its pre-selected securities differ from other self-directed platforms that place the ability to stock-pick in users' hands. Still, it's marketed toward a younger investor.

"Investing can seem like an intimidating act of adulting, especially when buying even a single share of certain companies can require hundreds of dollars," the company said in a recent blog post. "Enter: fractional shares."

But some firms have recently renewed interest with announcements to push into the space. And much like when they made the cuts to zero commissions, they have all tended to move together.

Charles Schwab has plans to allow fractional share trading, the Wall Street Journal first reported in October, which would make it among the first of the major online brokerage players to allow fractional share trading. Schwab did not disclose to the outlet when it would launch the program, and a company spokesperson did not respond to our request for comment.

The stock-trading startup Robinhood, which was valued at $7.6 billion in its latest funding round, said last month that it would begin rolling out fractional share trading, a feature it said many users requested, as well as a DRIP program.

"We believe that fractional shares trading will open up investing to even more people, and we'll continue to find ways to democratize the financial system so everyone can participate," the company said in a blog post.

Interactive Brokers, which rocked the industry early this fall when it said before its bigger competitors that it would launch a commission-free trading product, said in November that it would introduce the ability to buy and sell fractional shares of nearly any US-listed stock.

Robinhood began launching fractional share trading to one set of customers in mid-December, and will continue rolling them out to customers through early 2020, a company spokesperson said.

Business Insider reported last month that MoneyLion, the digital banking company geared toward people who need help managing their finances on a day-to-day basis, will roll out traditional and fractional stock-trading this year.

"Right from the outset, it'll be fractional and full shares," Jon Stevenson, MoneyLion's head of wealth management and banking, said. "But right now the focus is so much on fractional, which is - it's an overused term, but it truly does 'democratize' access to investing in single stocks."

Fractional shares do have some complications for investors. Unlike regular shares, you may not be able to move them to other brokerages without liquidating them - and potentially taking a capital gains tax hit on gains for a portfolio of partial shares in pricey stocks.

Fractional shares also present a potential revenue opportunity for brokerages. The process can be done one of two ways.

One approach is batch trading, where the broker accumulates orders throughout the day, rounding up to the nearest whole number before executing them simultaneously. Considered the industry norm, it provides little in the way of a real revenue stream.

Real-time trading of fractional shares, however, has the potential to serve as a new revenue stream. Brokerages maintain an inventory of stocks which they trade directly with clients. Firms may be able to charge a slightly higher price for the same percentage of a share than what would be executed in the broader market, thereby making a slight profit.

Only a handful of firms have pushed to offer real-time trading. But as brokerages look to make up the revenue lost from dropping trading commissions in 2019, fractional shares could help to bridge that gap.

M1's Barnes said the process could be on par with the revenue generated from selling order flow, the controversial practice of getting paid to send customer trades to market-makers as opposed to executing them directly on exchanges.

More importantly, though, Barnes said there is also the possibility of increasing customers' trading activity. He compared it to lowering the minimum bet at a blackjack table.

"I think the question becomes does it massively increase the amount of transaction volume because people can trade $25 in and out and back and forth over and over again," Barnes said. "Are they going to trade a lot more than having to spend $200 in and out?"