The Securties & Exchange Commission is behind the exponential growth in direct purchase plans. The SEC has drastically cut the red tape and the fees involved in a company setting up an open enrollment program.
For the long term investor, DRPs offer a convienient and low-cost way to build a stock portfolio. A participant in a DRP, rather than taking dividends in the form of cash, reinvests the dividends into the company which purchases additional shares of stock. Most mutual funds and closed end funds had DRPs available long before individual companies were permitted to offer them in 1968.
What are the benefits to the companies that offer DRPs? Stockholder loyalty is one. DRPs attract small investors who are more loyal than the big institutions and hold stocks longer, which reduces volatility. Additionally, if a company issues new shares for its plan, rather than buying them in the open market, it is an inexpensive way to raise capital. That is one key reason capital-intensive industries and banks are well represented by DRPs.
Joining a DRP is an easy process. An investor need only complete an authorization form and return it to the transfer agent which is administering the plan. However, this is done only after receiving a prospectus which lists all of the plan details and outlines possible risks to the investor.
Particpants then receive periodic statements showing the amount of full and fractional shares purchased, and the price paid. The investor will also receive a 1099 form at the end of the year, even though the investor receives no dividends, they are treated as taxable income and must be declared.
When a participant wishes to withdraw from a plan, they must simply notify the company in writing, or in many cases, via the telephone. Most companies impose only a nominal fee for the sale of shares and no fee to purchase shares.
Most DRP plans allow an investor to make optional cash purchases of stock, and when combined with the reinvesting of dividends, it is a powerful tool for small investors . An increasing number of companies now offer automatic withdrawals from checking or savings accounts for optional cash purchases, which makes building a portfolio easier than ever.
Another advantage of DRPs is dollar cost averaging. This systematic buying plan allows an investor to invest similar dollar amounts at fixed intervals. In other words, the investor buys fewer shares when prices are high, and more shares when prices are low. Thus, over the years, the average cost per share will be lower using this method than the average of the purchase prices, providing the stock is in a long-term uptrend.
As with any investment, DRPs have their drawbacks: the investor has no control in timing purchases or sales, dividens are counted as taxable income even though not received in the form of cash, stock purchased at a discount is taxed on the difference. For long-term investors, however, the pluses far outweigh the minuses.
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