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Direct Stock Purchase Plans (DSPP)

I was recently asked about an article comment I posted a few weeks back about my strategy for direct stock purchases by a fellow SA reader. I found myself responding in a manner trying to sum up several months worth of research and planning into what would effectively be a 200 word private message. Since it's the holiday season and I have a few extra days off from the normal grind, I thought it would be fruitful to produce a much more verbose response. Much of this will be a story in chronological order so that you, the reader, can understand the logic in the path I pursued.

I am not a professional investor, have not worked in finance, nor have I ever taken a business course. However, I have spent most of my professional career paying attention to how my employers (of which I have had a few) managed and expanded their businesses. Putting all of the intrinsic value of each company aside, the bottom line was always the toughest number to increase or at least keep consistent. Whether it be employee turnover or just the cyclical nature of the profession I am in, the cost of providing the service defined how the company performed (at least financially).

The cost of investing.

I started this journey investigating mutual fund fees. The only mutual funds I have ever owned were no-load mutual funds that were managed by the brokerage company that I had my money with. The fees were fairly paltry compared to some higher end funds, but after converting the percentage points into dollars invested over time I was appalled. The idea of no-load sounds wonderful until they are run through the Finra fund analyzer. Using this tool and assuming a basic $10,000 investment with an annual return of 7% over 20 years for each of three mutual funds ($PRNEX, $PREIX, $VFINX), an investor would be losing $2,620.74, $1,147.89, and $706.29 respectively. Even if an investor made stock purchases four times a year for twenty years, he/she wouldn't be spending anywhere near that amount with the exception of the $VFINX fund and possibly with better returns. Now before anyone attacks me for arbitrarily picking three random mutual funds, let me explain that I understand there are other options on the table to choose from including less costly funds (although $VFINX is already pretty cheap) and ETFs. I picked these because they represented some of the lower price points for mutual fund fees. The issue at hand for me is paying that amount of money and getting a paltry 7% return (which is approximate based off of many published targets). I'm not going to claim that every investor out there is a financial genius (as I know some of this is just luck and not pure fundamentals), but I'm willing to bet that if he/she stayed active during the year he/she could easily beat that with just two handfuls of intelligently selected stocks.

Between this analysis and a bout of epic reading on sites like this one, I realized buying individual stocks was probably as effective if not a more effective way to invest. One of the issues that faces most individual investors with limited capital is brokerage fees. $20 or more for one trade is a little absurd if all you have is $2,000 every so often or $200 a month to utilize. That's a whopping 1%/10% just to purchase the rights to own a part of a company. That doesn't include selling it nor any possible loss in share price. Even the low-cost brokerage firms such as Sharebuilder or TD Ameritrade with trades of $6.95 make it more difficult to buy-on-a-whim when capital is hard to come by (although there are slightly cheaper plans they provide with caveats).

Two strategies present themselves at this point. The first is to save and buy a large lot of stock all at once or the second is to buy a little every month or quarter. Option one seems like the logical candidate and in most cases it's effective and appropriate. However, with the time spent waiting to accumulate enough capital for a purchase, an investor could lose the opportunity to buy stock at the price he/she wanted to. I won't argue that there are investing opportunities to be found every day, but the problem that presents itself is the time spent and wasted researching those companies. By the time one has the time to research another company and establish the appropriate buy-in price, that opportunity might pass by again (especially as the delivery of information perpetually moves faster in this day and age).

The second option really pertains to those who would prefer to deploy smaller amounts of capital per month but not pay outrageous fees for this convenience. Even with the $4.00 automatic monthly trade option that Sharebuilder has, that would still end up costing an individual investor 2% on monthly contributions of $200 a month.

Enter direct stock purchasing plans (DSPP).

This isn't a perfect solution for every investor, but it provides a low-cost or no-cost outlet for those that would like to invest with any sum of cash at hand. The first thing to understand about these plans are they are administered by a transfer agent. A company that maintains the balances, records, and transactions of the publicly-traded company's shares. Some companies choose to act as their own transfer agents, but many that did so in the past have chosen to outsource it in it's entirety. These transfer agents have the ability to reinvest dividends, purchase additional shares of stock, or sell shares of stock with a broker of their choosing. They are done in bulk on a monthly or weekly basis to keep the costs for them down. These plans' administrative fees are paid for by each participating company, but the purchasing or dividend reinvestment fees can vary greatly from all-expenses-paid to just-as-expensive-as-a-traditional-brokerage-firm.

The transfer agents that I am aware of currently are Computershare (and it's affiliates across the globe), American Stock Transfer & Trust, Registrar and Transfer Company, and Wells Fargo Shareowner Services.

An example of a no-cost purchasing plan would be Morgan Stanley. There is no setup, optional cash purchase, ongoing automatic investment, or per-share-purchasing fees at all. An investment of $100 or $1,000 a month would cost no additional money.

An example of a low-cost purchasing plan would be General Electric. There is a $7.50 setup fee, $3.00 optional cash purchase fee, $1.00 ongoing automatic investment fee, but no per-share-purchasing fee. An individual purchase of $2,400 once a year would only cost $3.00 (0.13%) for that year and a $200 a month automatic investment would cost $1.00 (0.5%) each month.

An example of a fairly-expensive purchasing plan would be Anheuser Busch. There is a $10.00 setup fee, $5.00 optional cash purchase fee, $5.00 ongoing automatic investment fee, a $0.10 per-share-purchasing fee, and 5% of dividend reinvested fee (with a maximum of $5.00 per reinvestment transaction). An individual purchase of $2,400 once a year would cost $7.26 (0.3%) for that year and a $200 a month automatic investment would cost $5.19 (2.6%) each month. These calculations do not take into account the additional money lost for dividend reinvestment.

As with most plans, if an individual wishes to sell their shares through Computershare, there are commissions to be paid. There are also minimum initial purchase amounts to setup an account. However, most of these are waived if an automatic investment plan is set up and maintained for a specific period of time.

Although I still do have a little money in mutual funds with a prototypical brokerage firm and in individual stocks with a low-cost brokerage firm, I have started heavily investing in a number of these no-cost purchasing plans so I can achieve a better overall return even with my low capital amounts available to me.

Not all companies participate in such plans, but many do. For those companies that provide such plans and for those individuals who wish to invest with such companies, he/she would do themselves a great disservice by not considering utilizing a DSPP.