Investing in securities is one of the few potential areas where you can invest and grow your money with only a little bit of sensible effort. To do so, you need to know and follow a set of rules and regulations.
One of the key components of understanding the stock market and the art and science of investing is by understanding the concept of dematerialisation.
Technology and digitalisation have changed how we work and live. Even money-making activities have changed considerably and we have benefitted from it. Stock exchanges have evolved too and stock trading has moved from physical share certificates and hard copy ledgers to dematerialised (or demat) accounts.
Ever since the Bombay Stock Exchange (BSE) was established in 1875 and much later into the 20th century, traders used to shout out the prices of stocks they wanted to buy and sell. The money would be exchanged through physical receipts called certificates. This resulted in heavy paperwork that took up a lot of time. Lengthy paper-based processes also delayed settlements as both buyers and sellers had to deliver the certificates to start the transfer process.
To counter this and to take advantage of electronic trading that had gained traction in the West and Asian markets, the process of dematerialisation of shares was initiated in 1996. Physical certificates were converted into securities of equivalent numbers in the electronic form and credited to the investor’s demat account. This can be said to be the advent of the demat way of trading.
Benefits of Dematerialisation:
Dematerialisation offers a number of benefits that are not known to all. Some of those benefits are explained here.
- Common Bank: Dematerialisation does not only help in trading stocks. It works for debt instruments like bonds as well as mutual funds. An investor can hold all his investments in a single demat account.
- Automatic Updates: Despite being a common account for all your securities transactions, you do not have to provide your details every time you deal with a company. Your demat account represents you and has all the necessary information regarding the transaction.
- Odd-Lot Problem Resolved: This was a big obstacle in resolving the settlements as shares were sold in lots. Buyers and sellers could not transact a single or odd number of securities. Demat account has solved this problem and investors can trade any number of shares they want.
- Delivery Risks: With no paperwork involved, the risk of fake shares, theft, and wrong deliveries have also been eliminated. This is perhaps one of the biggest benefits of the electronic trading process. The system will always credit securities in the right demat account automatically, regardless of number and type of shares. This is applicable to other share transactions such as stock splits and stock bonuses as well.
- Cost Reduction: A demat account does not require stamp duty for securities. This has resulted in significant cost reduction. Earlier, the stamp duty was 0.5% for each stock that can now be avoided completely through dematerialisation.
- Easy to Hold: Paper certificates are vulnerable to several types of physical damage such as water damage, fire, pests, etc. Even a minor damage can cost you a fortune. However, this is not the case with demat account Your demat account company bears the responsibility of maintaining and safeguarding your account. This is the best way to hold securities. The demat account also has a nomination facility in case the account holder passes on. The securities and their authority is automatically transferred to the nominee.
A demat account is opened by the investor at the time of registering with the investment broker or sub-broker. This account is preferred for trading (buying and selling of stocks) to enable electronic settlements. Almost every shareholder must have this account to trade in stocks as required under Securities and Exchange Board of India (SEBI) laws. One cannot trade in stocks without having a legitimate demat account.
How Does a Demat Account Work?
Your demat account holds all your shares and investments in an electronic or dematerialised form. It holds all your government securities, bonds, shares, mutual funds, and Exchange Traded Funds (ETFs). It is important to understand a few bodies and processes to know the complete functioning of a demat account. The functioning of a demat account is explained here.
- Central Depository: The two major depositories in the country are Central Depository of Securities Ltd. (CDSL) and National Depository of Securities Ltd. (NDSL). They hold the details of your account on your behalf. This works similar to a bank.
- Unique ID: Every demat account has a unique verification number for identification. This comes in handy in various situations. This can be used for transactions or it can be used for the stock exchange to help the companies identify and credit the securities to your account.
- Depository Participants: The depository can be accessed only through the depository participants (DPs). These are intermediaries between the CDSL and the investor. DPs can be banks, brokers or financial institutions that are authorised to offer demat services.
- Portfolio Holding: Your demat account holds all your holdings and every time you check it, you can see your account status with all its details. This is because the account is updated automatically each time you transact (buy or sell securities).
There are hundreds of depository participants one can choose from but having a bank as a depository participant has its own advantages. Having a demat account with a bank offers fast processing, anytime accessibility, and online transaction facility to the investor. Banks always credit your demat account right on the day of purchase of shares. They also credit your savings account on the 3rd day after you sell your shares. Such processes are automatics and you do not have to follow any additional procedure for that. Having a huge number of branches is another advantage of banks as you can open your demat account in the nearest branch or choose a branch as per your convenience. Most private sector banks also provide online access to your demat account.
Opening a Demat Account:
A demat account can be opened with no shares at all. It does not require any minimum balance. The first step towards opening a demat account is to select a DP, fill up the account opening form, and submit the document. Having a PAN card is a compulsory requirement for opening a demat account. The rest of the steps are explained here.
- Once you submit the form, you will get a copy of rules and regulations, terms of agreement, and the charges you will incur.
- An in-person verification is also necessary. A member of the DP staff will contact the individual to verify the details provided in the account opening form.
- After the verification, the DP person will provide an account number or client ID. You can also check these details by checking your account details online.
- An annual maintenance fee is paid for a demat account. This fee covers the account transaction charges. The fee is levied for debiting securities to and from the account on a monthly basis. The charges are subject to your choice of the DP. Some DPs charge as per the amount of the transaction while the others charge a flat fee which is same for every transaction. The fee can also vary on the type of transaction (buying or selling). There can be another fee for converting the share into physical form or vice-versa.
Advantages of Investing in Share Market:
After understanding the demat account and its functioning, it’s important to know about stock trading and its benefits. Many people perceive stock market as a game of cards and they buy and sell shares according to their intuition. However, investing in the stock market is more than that. It can be your secondary or even primary source of earning if managed properly. Here are some benefits of investing in the stock/share market.
- Investment Gains: This can be your best chance to grow your money as fast as you can. Even if the stock prices rise and fall every day. The overall value of stock market rises eventually. Investments made in stable and reliable companies always grow and tend to make good money. In addition, investing in different types of stocks allows you to target various sectors and leverage growth. This can be a good deal even if some of your stocks lose their value.
- Dividend Income: Some stocks offer income in the form of dividends. These deliver annual payments to investors based on the dividend declared by the company on its shares. Dividends can help you build retirement corpus or grow your investment.
- Diversification: A stock market investment always offers diversified investment for investors. Share prices keep moving up and down and this means you ought to have a diversified portfolio of stocks so you do not lose any money in case one or two of your stocks lose ground on prices due to performance of the company or of the industry, or for any other reason.
- Ownership: Shares or stock means you have an ownership of the chosen company. This can be a huge benefit since a profitable and stable company means that you can always earn money through these stocks. Owning a stock in the company you work also expresses your loyalty to the company and binds your personal finances to the success of the business as a whole.