How does a Demat Account work?

The demat account makes investing in shares a safe and streamlined experience. As the share certificates get converted to electronic format, it increases their accessibility and ease of handling.

As per the Securities and Exchange Board of India, opening a Demat account is necessary if you want to buy, store and sell shares. Demat accounts can be opened without possessing any shares and maintaining a zero balance. For this, you need a depository and a participant registered with the depository.

A depository is a central entity where the stocks, shares and other financial securities are stored in an electronic or dematerialized format. It facilitates buying and selling of securities online for investors while maintaining comprehensive data of the holdings and ownership records.

Depository Participants (DP) are authorized links between the Depositories and investors. It can be a bank or a brokerage firm or any financial institution which is registered with the SEBI as a facilitator of trade in equity investments.

In India, there are two Central Depositories – the National Securities Depositories Limited (NSDL), promoted by the National Stock Exchange (NSE) and the Central Depositories Services Limited (CDSL), promoted by the Bombay Stock Exchange (BSE), through which the authorized DPs can hold and manage financial securities.

A DP, apart from being registered, has to follow all the rules and guidelines laid down by the SEBI for a safe, transparent, seamless and streamlined Demat trading. It has to keep comprehensive records of each investor and provide a secure environment to trade. It should make offers and security procedures available to its investors and charge fair brokerage, wherever applicable.

Once an investor decides to trade in online equity shares and other investment options like mutual funds, bonds, government securities, and exchange-traded funds, he can approach a Depository Participant registered with either the NSDL or the CDSL. Once the documentation process is complete, the DP opens a Demat account for the investor, either with the NSDL or the CDSL.

The investor is provided with a Unique ID, your Demat account number. The total characters in every demat account number in India are 16; however, the format of the account number depends upon which central depository the account is opened with. In NSDL, the first two characters are alphabets determining the country the investor belong to (e.g., IN12345678987654 for India). For CDSL, every character is a numerical (e.g., 1234567898765432).

Every account number is a combination of the DP ID + investor's client ID. The client ID is unique to every investor and identifies their specific portfolio. The first 8 digits are the DP ID, which is the unique identification number provided to the Depository Participant by the Central Depository. The next 8 digits are the investor's client ID. So for the NSDL, IN123456 is the DP ID, and 78987654 is the client ID.

If they wish to start buying the securities, the investors may have to provide a cheque. The DP, now as the investment broker, will purchase the electronic or dematerialized shares for you and maintain them in your Demat account. The investor can view them in the Statement of Holdings. If the investor chooses an online platform, the holdings can be viewed online. Generally, the shares are credited by the DP on a T+2 basis, i.e., Trading Day + 2 days.

If the investor wishes to sell the shares, a delivery note with detailed information regarding the stock to be sold has to be given to the Depository Participant (DP). The DP will sell the respective shares, and the money will be credited to the investor. If the investor is using an online platform, the debit of shares and the credit of money are immediately visible in the account.

When the listed companies give out dividends or bonus, they get a list of their shareholders from the NSDL or the CDSL and thus credit the investor accounts.

To ensure effective and profitable trading for the investor, the Depository Participant creates and manages a unique investment portfolio for every investor. A portfolio is a collection of different investment instruments as well as the combination of specific types of shares. These contents of a portfolio are known as holdings. The variety of holdings in a portfolio, determine the diversification of a portfolio. Usually, Depository Participants advocate a diversified portfolio with stocks of varied sectors, bonds of varying maturities, etc. However, the specific objectives, income, the risk-security ratio of individual investors determine the diversity or type of holdings in a portfolio. Understanding, discussing and then organizing the holdings for a portfolio is known as portfolio management.

Portfolio management is an art of creating a portfolio with the correct holding allocation based upon the investor objectives, balancing the risk and performance. It is identifying either the appetite for risk or the need for security and creating a mix best suited for the requirements, keeping the expected rate of returns in mind.

An investor, who is just starting out with his investments, with a long term goal, can afford an affinity towards a “high risk, high returns” portfolio. However, an investor nearing his retirement or someone with a low unsteady income prefers a “low risk, steady return” portfolio.

A demat account enables an investor to opt for a safe platform to trade in equities and diversify his investment portfolio. The Depository participants provide the requisite knowledge and support to these investors so that they can make a well-informed decision regarding their investment. The DPs help investors recognizing their investments goals and objectives, and find the perfect portfolio with the correct mix of holdings. The central depositories, NSDL and CDSL, ensure a comprehensive database and records of all the investors in the country.

Before 1996, investing in shares entailed a lengthy procedure with cumbersome paperwork. It involved the hassle of managing paper-based share certificates and was a costly affair. Dematerialization of shares and the regulation of the online platform through SEBI, has made trading in shares easy and accessible for every individual who wishes to invest in the diverse instruments.