Key Drawbacks of Direct Stock Purchase Plans

A direct stock purchase plan allows investors to buy stocks directly from a company without using a broker. The main advantage of this method is that it saves brokerage fees by eliminating brokers. Additionally, these plans automate monthly purchases, which makes it easier to invest regularly. Investors can do so by setting up “automatic withdrawals” from their bank accounts.
 

However, a direct stock purchase plan is costly as you incur an initial setup fee and an automatic investment fee every time you invest. Also, it is not ideal for short-term traders as the process of purchasing stocks directly from a company is slow and less flexible.

For more clarity, let’s see the five major drawbacks of this method.

• Direct stock purchase plans have initial setup and automatic investment fees. This reduces your returns over time.
• This method is not ideal for short-term traders due to slower transaction processes and less flexibility.
• They are better suited for long-term investors who want steady growth and dividends.
• Direct purchasing of stocks often leads to a lack of diversification, as you’re buying stock in individual companies. 

This way of investing eliminates brokerage fees and makes regular investing easier. However, it comes with certain notable drawbacks, like initial setup fees, automatic investment fees, and limited portfolio diversification. Let’s understand in detail:
 

1. Initial setup fees  

When you open a direct stock purchase plan account, most companies charge a small initial setup fee. This fee covers administrative expenses related to managing your stock purchases. While the cost may seem minor, be aware that it can add up for multiple smaller investments. Therefore, if you plan to invest only for the short term, using a broker is better.
 

However, for long-term investments, this fee may be lower overall when compared to the ongoing brokerage fees and commissions.

2. Automatic investment fees  

After the initial setup, direct stock purchase plans usually have automatic investment fees. This fee is applied each time you make a recurring investment. For example:
 

• Say you want to invest Rs. 5,000 monthly in a stock.
• In this case, you might have to pay an additional Rs. 20 per transaction as a fee.
   

Usually, these fees vary depending on the company and can reduce your overall returns if not considered carefully. Therefore, always check these ongoing fees before investing via this method.

3. Not suitable for short-term traders  

A direct stock purchase plan is not ideal for short-term traders who frequently buy and sell stocks. The process of investing directly through a company is slower and involves more fees. Such traders should ideally consider “discount brokers” that offer lower costs and more flexibility for short-term transactions.
 

Generally, this method works best for long-term investors who wish to:

• Gradually grow their portfolios
  and
• Benefit from dividend payments

4. Lack of diversity  

A direct stock purchase plan leads to a lack of diversification in your investment portfolio. This happens because you are investing in one company at a time. Hence, to spread risk, you need to invest across multiple sectors and companies.
 

However, be aware that for each company you might have to incur a different:

• Setup fees
• Automatic investment fees
• Other administrative costs
   

As a result, these fees can reduce the effectiveness of “rupee cost averaging”. For those unaware, rupee-cost averaging is a strategy where you invest a fixed amount regularly. This lowers the average cost of your investments over time.
 

However, if the direct stock purchase plan fees keep adding up, they can eat into your returns and make this strategy less effective. This happens as a portion of your regular investment goes toward paying fees instead of buying more stocks.

5. Multiplicity of accounts  

It is worth mentioning that in a direct stock purchase plan, each stock is handled through the individual company or its third-party agent. This creates multiple accounts for each investment which makes it harder to track and manage your overall portfolio.
 

If you as an investor prefer having all your investments in one place, this way of investing will be less convenient for you. Instead, you should use a broker as they consolidate all your holdings into a single account.