5 Advantages & 4 Disadvantages of Investing in a Direct Stock Purchase Plan (DSPP)

By Chika

-

Last Updated: October 5, 2021

Share

690
0

The usual way of purchasing stocks is by buying through a brokerage.

The broker acts as a middle man between the investor and the company whose shares are being traded. However, using a brokerage also comes with extra costs.

The investor is required to pay commissions per transaction to the broker. There is also the question of bid-ask spread, which affects how much an investor would spend or the number of shares that can be acquired. 

However, there is a less popular way of owning stocks that does not require the investor to go through a brokerage.

Through the Direct Stock Purchase Program, an investor can acquire shares of a company without having the need of a middle man. This article highlights what the DSPP is about, its merits, and demerits including how to use it to purchase stocks for your portfolio.

 

What Is a Direct Stock Purchase Plan?

A direct stock purchase plan (DSPP) is a plan that allows investors to purchase stock directly from the issuing company. Rather than going through a brokerage, an investor can purchase shares directly from the company through a transfer agent.

These are third-party institutions that handle DSPP transactions, issue certificates, and perform other related administrative duties.

Direct stock purchases can also come in the form of employee stock ownership plans (ESOP), which is a plan that allows a company’s employees to purchase its shares at a discounted price.

DSPP usually has requirements that are more stringent than when purchasing through a broker.

For example, a company may decide to set a minimum amount of shares that can be purchased through its DSPP. Not all companies offer a DSPP, so you have to make sure that the company whose stock you want to purchase offers a DSPP.

 

5 Benefits of Purchasing Stocks Through DSPP

There are a variety of reasons why investors would decide to purchase shares through DSPP rather than going through the conventional route of using a broker. Some benefits of using DSPP includes:

1. No brokerage fees or commissions

The most obvious advantage of the DSPP is that you do not have to pay brokerage fees or commissions when purchasing shares.

Traditional brokers charge commissions for every transaction conducted on their platform. When accrued, this can reduce portfolio returns. By purchasing directly from the company, investors can save more money on transaction costs.

 

2. Simplified investing experience

Purchasing through a DSPP simplifies the investing experience.

When choosing a broker, there are certain parameters to consider. You have to ascertain the level of security, number of tradable assets, minimum capital balance, and payment options amongst other things.

This process can be cumbersome as you would need to find a broker that meets your criteria. This process is nonexistent when purchasing shares directly.

 

3. Lower share price

When you purchase shares directly, you buy below the current market price. This gives you a head-start towards accruing profit, especially when you consider the fact that you would also not be paying brokerage fees or commissions.

 

4. Dividend reinvestment

Some DSPPs come with the option of dividend reinvestment plans (DRIPs) which can increase your portfolio returns. A DRIP allows an investor to automatically reinvest dividends thereby creating the opportunity for profit increase.

 

5. Prevents short-selling

Buying shares through DSPP prevents short selling because shares purchased through direct stock purchases cannot be shorted. This reduces the short-interest ratio on the stock and any volatility that may arise from short trading.

 

4 Disadvantages of Direct Stock Purchases

1. Hidden charges

Though you avoid brokerage fees and commissions when buying shares directly, there can also be hidden charges. An investor buying shares through DSPP would be required to pay extra charges such as account setup and transaction fees. They may also be charged fees to sell.

 

2. Limits portfolio diversification

Direct stock purchase limits the options for portfolio diversification. When buying from a brokerage, the investor has access to assets that are tradable on the broker’s platform. However, when buying shares through DSPP, you can only buy one type of share from the company.

Secondly, not all companies offer DSPP, so purchasing stocks through this method limits your options.

 

3. Less control over price and trading.

When purchasing stocks directly, it is difficult to know the stock price and at what day the stock would trade.

Sometimes, a transaction can take weeks to complete. This is in contrast to buying from a traditional brokerage where you can buy stocks in real-time at the current market price. As such, buying through a DSPP can be problematic for investors who want to time the market.

 

4. Buying limit

Investors purchasing shares through DSPP usually have a maximum amount of shares.

This can limit the returns on a portfolio, especially if you are convinced the stock is undervalued and have the firepower to go all-in.

 

How To Invest in a DSPP

Buying shares through DSPP is much different than doing the same through traditional brokerages. There are ways in which investors can invest in DSPP.

Find companies that have DSPP

Not all companies have DSPP.

So, the first step is finding out which companies allow investors to purchase their shares directly. You can search the internet broadly for companies that offer DSPP. If you have a particular company in mind, you can go to the investors relations page on the website to find out if they offer DSPP.

Alternatively, you can check out transfer agencies for a list of companies that sell stocks through a DSPP.

Have a window for when shares would be traded

As stated previously, it is difficult to know when shares would be offered through DSPP.

Having an estimated timeframe when the issuer would be issuing new shares to the public can help you make better investment decisions. This allows you to accommodate volatility from price action when the direct purchase transaction is still processing.

For example, if you want to purchase shares of Coca-Cola directly, you can give a three-month window for when the transaction would fall through.

In that 3-month window, estimate how much drawback or increment you would be expecting from the stock. This would allow you to make provision for any shifts in price and also psychologically prepare you for such changes.

Ascertain minimum investment level

When buying shares directly, there are usually limits on the minimum number of shares one can purchase. This helps you with budgeting and structuring your portfolio. It also helps you to calculate estimated returns and set a threshold for potential losses.

 

When you should invest through DSPP

Purchasing shares directly may not work well for everyone.

If you want to enjoy the advantages of investing through DSPP, you should be a long-term investor. You can automate your investment plan to purchase shares and reinvest your dividends.

Also, when you have a large amount of capital, then investing through DSPP would be a good idea. With huge capital, you can take advantage of purchasing shares below the market price which can boost portfolio returns.

 

Final Word

Direct stock purchase plans allow investors to sidestep brokerages to purchase shares directly from companies.

Though they come with benefits such as lower commissions and brokerage fees, including purchasing shares below the market price, they also come with the downside of limiting investable options and hidden charges.

Also, when you consider the fact that brokerages are now operating on a zero commission basis, investing through DSPP is becoming less attractive. As such, when investing through DSPP, try to ascertain if it would be beneficial to you and your investment in the long term.

If you have a little capital to invest, it's better you start up with a traditional brokerage that has zero commission on transactions. However, if you have loads of cash, perhaps a DSPP can work well for you.

Photo by jose aljovin on Unsplash

 

YOU MIGHT ALSO LIKE

Leave a Reply

Your email address will not be published. Required fields are marked *

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

LATEST

Subscribe for daily financial content

Daily articles, financial messages and affirmations to best help you navigate your financial future.