If you have done some basic research with respect to the stock market, it is highly likely that you would have come across the term ‘Demat account.’ If you have just stumbled upon the term and want to know more, this article is for you. By the end of this reading, most of your questions like – What is a Demat account? Why would you need it? What are its types? What is the pre-requisite knowledge you need to have to open a Demat account? What mistakes should you avoid while opening a Demat account? And more will be answered. So, let us dive right in!
What is a Demat Account?
Demat is an acronym for dematerialization. Let us first understand the term dematerialization. It is a procedure where physical securities like share certificates and the like, are converted to and stored in electronic form. In order to dematerialize your securities, there is a procedure to be followed, the steps to which are easily available on multiple websites on the internet.
Why is dematerialization popular? It provides a wide range of benefits.
- Anything in electronic form provides better accessibility
- Paperwork is eliminated, which in turn leads to faster transaction
- Provides better security
The Fundamentals of Demat Account
A Demat account is an account that is used to store shares and securities in electronic format. It facilitates easy trade among users. It acts as a central repository for an individual’s bonds, government securities, shares, and mutual funds.
A recent report by the Economic Times claims that the financial year 2017-18 saw almost 3.76 million new Demat accounts being opened. So, more & more people are getting introduced to the Demat account. If you want to make investments, you need to have three accounts (which are inter-linked) – a Bank account, a Demat account, and a Trading account.
To be able to trade seamlessly, it is advised to have your Demat and trading account with the same institution. This is sometimes also known as a three-in-one account.
What is the importance of a Demat account?
Demat accounts are considered important because of the benefits they provide.
- When the securities are in dematerialized form, time taken to complete a transaction is greatly reduced because there is practically no paperwork involved
- If your share certificates are in physical form only, you will have to bear additional expenses such as handling charges and stamp duty. These extra charges can be eliminated with a Demat account.
- Only specific quantities can be sold or bought with physical share certificates. With Demat accounts, odd lots are conveniently dealt with.
- Maintenance of physical certificates may prove to be difficult.
- Securities in the physical form are more prone to damage and theft. A Demat account provides better security against losses of any kind.
Some added benefits associated with Demat Accounts are:
- The securities held in Demat accounts can be pledged to avail loans. They serve as collateral.
- Users are allowed to freeze their Demat Accounts for a certain period of time if they want to.
- Users can access their accounts from multiple devices such as PC, mobile phones, tablets, etc.
- Dematerialization does not only help in trading stocks. It works for debt instruments like bonds as well as mutual funds.
What are the types of Demat account?
Demat accounts can be classified into 3 categories :
- If you are an investor who is an Indian resident, your account is a regular Demat Account.
- If you are an NRI investor and you want to hold a Demat Account under which funds can be transferred, such an account is called a repatriable Demat Account.
- If you are an NRI investor and you hold a Demat Account under which funds cannot be transferred abroad, it is a non-repatriable Demat Account.
How does Demat Account Work?
As mentioned earlier, you will need three accounts to start investing. The working of Demat Account is closely related to the other two accounts.
- The trading account is linked to your Demat Account and has a unique login ID and password. It is used to buy and sell shares.
- You need to have a bank account linked to your trading account and Demat Account.
To buy or sell a share, you need to first login to your trading account. Then, you need to place a ‘buy’ or ‘sell’ request. The request will be forwarded to the stock exchange by your Depository Participant (DP). Let’s say you have placed a request to buy, and the stock exchange looks for a seller willing to sell shares of the same quantity. Once a match is found, the number of shares from the seller’s account is debited, and it gets credited to the Demat Account of the buyer.
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Four parties mainly involved in the working of the Demat Account are:
1. The stock exchange, which is the central place for trades and transactions.
2. Clearance houses which are responsible for maintaining the debiting and crediting shares in accounts of buyers and sellers. The two main clearance houses in the country are:
- National Securities Clearing Corporation Ltd (NSCCL) under NSE
- Indian Clearing Corporation Ltd (ICCL) under BSE
3. Depository participants – these are the brokerage firms that provide trading and Demat accounts. Popular brokerage firms in India include HDFC Securities, Zerodha, Fyers, Axis Direct, and ICICI direct.
4. Depositaries that handle Demat Accounts. India has two depositaries that are responsible for handling Demat Accounts:
- Central Depositary Services Limited (CDSL), which operates under BSE
- National Securities Depositary Limited (NSDL), which functions under NSE
Things to know before opening a Demat Account
Listed below are some of the important things to know before you open a Demat account.
- Nominee – When you open an account, you will be asked to choose a nominee. This is the person to whom all your investments will get transferred in case of your death. The person you select, as the nominee, should be aware of it. They also need to be aware of your financial goals for the future.
- User interface – Check with your company if they have a user-friendly software. A good application would not require their end users to have any prior technical knowledge. You should not have to spend a lot of time trying to figure out how to use the app. The app should be self-explanatory and easy to use.
- Support – No technology is perfect. Thus, you may face issues while making a transaction. In case of break down, is the customer support team well-equipped to help you with the issue you are facing? How well do they resolve issues? Find out about the quality of customer service.
- Charges – Broking charges are an important factor while deciding a broker for a Demat account. Different brokers offer accounts at different charges. There is an opening fee, a maintenance fee that is charged annually, and a transaction fee. You will be charged a transaction fee for every transaction you make. There are different pricing plans. The most basic one and the one that is usually recommended is the flat charge – where the broking charge is constant and doesn’t depend on the volume of the transaction. There are other kinds of charges too, which you may explore. Choose a plan that suits your transaction patterns.
- Types of brokers – In the share market, you need to select a broker through whom you will make transactions. There are 2 types of brokerage firms – discount broker and a full-service broker — the difference between the two lies in the products and services. If you are with a discount broker, your trading instructions are carried out as they are whereas, a full-service broker provides additional services such as investment options for mutual funds and initial public offerings.
What are the common mistakes that can be avoided while opening a Demat account?
Here are three classic mistakes investors make, along with suggestions on how to avoid making those mistakes.
- Disregarding the time of activation – As a popular saying goes – ‘What is well-begun is half-done,’ your initial moves in the share market matter a lot. You need to make sure that your Demat account gets activated at a time when the market dynamics are in your favor. Do not get tempted by companies that promise quicker activation of your Demat account; look for those that provide account activation at the right time.
- Not checking the credibility – A mistake that many first-time investors make is opening an account without verifying the company’s credibility. Although there are laws to help you, should anything go wrong, it is better to be safe than sorry. Do not blindly trust a friend’s recommendation. Do some research on the company history, its stability, security, customer service, and other such factors before going ahead and opening a Demat account with them.
- Not paying attention to convenience features – Features differ from app to app. These features affect your trading in more ways than you imagine. After you have verified the company’s credibility, check for users’ ratings and reviews of the app. A good app should have an attractive user-interface and be bug-free.
Thus, we have covered all the basic questions that a first-time investor may have – regarding the use and functioning of Demat accounts.