Major Disadvantages of Direct Stock Purchase Plans

How do you purchase stocks?

Mostly through brokers, right?

What if I say there is another way to purchase stocks that do not involve brokers and thereby save on the cost to invest in a particular organization. Yes, there exists an option and it is known as Direct Stock Purchase Plan (DSPP).

They are also known as no-load stocks.

Though not common, DSPP are plans that are set up directly with the company we want to invest in or through third-party transfer agents appointed by the company itself.

These are generally available for large, well-established companies, wherein we can agree to automate monthly withdrawals from checking savings accounts to purchase more stocks.

Note: A third-party transfer agent represents the company. It may be a bank, a trusted company, or a similar organization. Some companies choose to act as their own transfer agent, but most use a third party.

Let us, therefore, discuss this in detail. This will also help our investors make an informed decision.

Using DSPP has two benefits as compared to other traditional ways we use to purchase stocks.

Disadvantages of Direct Stock Purchase Plans

1. Initial Set up Fee

Most companies charge initial setup costs when an investor opens an account. These costs pertain to general administrative expenses which are carried out throughout the purchase of stocks.

Though the cost is minimal in such cases, we can opt for a traditional method i.e. buying through brokers.

However, if we were to hold the investment for a long term, such costs might be low as compared to brokerage fees and commissions.

2. Automatic Investment Fees

This referred to the subsequent fees that are over and above the initial setup fees. This is one of the major disadvantages of DSPPs.

For example, we as investors have bought an INR 5000 automatic investment plan for Stock X and have paid initial set up costs of INR 500.

We also need to pay INR 20 as an ongoing fee every time an automatic investment is made. The amount charged might be different in the case of different companies.

However, this should be taken as an important parameter to look at before buying any stock through DSPP.

3. Unsuitable for Short-Term Traders

This method of investing is not suitable for traders as they move in and out of markets quite often. For traders, the best option is to stick with a low-cost discount broker. Therefore, DSPP is suitable for long-term dividend investors.

3. Lack of Diversity

One of the major drawbacks of DSPP is that the portfolio of a common retail investor is not well diversified unless the investor puts money across a variety of industries.

This might entail higher initial costs as every company may not have the same setup costs. Also, the administrative costs that may seem low at the beginning actually add up over time. Such large costs defeat the very purpose of rupee cost averaging into a stock.

4. Multiplicity of Accounts

By purchasing stocks directly from a company or third-party transfer agent through DSPP, investors lose the ability to consolidate their holdings into a single account.

People who want to consolidate their holdings into a single account must not go through the route of DSPP. Instead, they should consider investing through brokers. This helps in saving time as well as simplifies tracking and managing investments.