A Demat account is where your shares and all other investment instruments are held in electronic format. It is similar to a bank account, where your monetary reserves are held electronically and physically. For investing and trading, you need a separate account that is a trading account. The term Demat is derived from the word, dematerialisation. A DP or depository participant, commonly known as a broker, must open the Demat account, either with NSDL (National Securities Depository Limited) or CDSL (Central Depository Services (India) Limited), as these are the two depositories registered with SEBI in India. The depository is the organisation that holds the debentures, shares, bonds, mutual funds, government securities, and other investments in electronic format. If a Demat account is like a bank account, a depository is like a bank.
Often traders and investors get confused about whether they need a Demat account for all types of investment options or only for investing in shares. There is a myth that a Demat account is required only for shares/equity investment. Investments in shares and ETFs cannot be made without a Demat account, while bonds, mutual funds, corporate FDs and other government securities can be done through your Demat account as well, it is not mandatory to have one. The only two instruments are futures and options, for which you do not need a Demat account, as there are no units that need to be held while trading these instruments.
One can open multiple Demat accounts as there is no limitation on the number per PAN card. If you are opening multiple Demat accounts, all will be linked to the same PAN card, and thus, SEBI can review all your trades at any given point in time. You can open different Demat accounts with different DPs to carry on a variety of trades across various asset classes or use different trading strategies.
A common myth is that you need to open a Demat account and a Trading Account. However, you can have just a Demat account without a trading account if you purchase shares in an IPO. The exception is, that if you buy shares and hold them from the secondary market, you need to have both accounts. When you buy shares in an IPO, you get share certificates in physical format as well, and thus only a Demat account will do for holding the shares.
There is no interest component you will receive on your holdings in the Demat account. It is just like a wallet to keep your investments safe.
Your investments are highly secured in a Demat account in electronic format. Though there may be specific risks involved (e.g. account getting hacked, technical glitches, losing your login credentials, etc.) usually Demat accounts are the safest option to keep your assets secure.
It is essential to know all the nuances and the misconceptions about a Demat account and then decide whether you need it or not. However, having a Demat and a trading account linked with your savings bank account is mandatory if you wish to invest in direct equity via stocks and shares. While opening one, make sure you know the facts about the account well in advance.
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