When an emergency arises and there’s a need for funds, you may feel tempted to sell your shares kept in your Demat account. However, experts suggest that selling shares might not always be the best option. Instead, pledging those shares for a loan can be a more prudent decision, allowing you to meet your financial requirements without parting with your investment.
How pledging of shares works
Loan Against Share (LAS), or loan by pledging shares, is a secured loan facility where you can pledge your shares to secure a loan. Numerous banks and non-banking financial companies (NBFCs) offer this option. Typically, the loan amount is limited to 50% of the market value of the shares, but you retain ownership of your shares even after taking the loan.
Rajani Tandale, Senior Vice President, Mutual Fund at 1 Finance, explains that “pledging demat shares for a loan can be a more prudent choice than outright selling, particularly for short-term needs”. She adds, however, that LAS may not be ideal for long-term financial goals. Tandale highlights that while LAS may seem attractive initially, research shows that, over time, the compounding interest on LAS can significantly affect investment returns. “With LAS offering a fixed, linear interest rate, it raises questions about the benefit of holding securities long-term while incurring this debt,” she notes, as the returns can often be eroded by the cost of the loan.
Moreover, the volatility of stock market returns complicates the decision, as “a long-term CAGR (Compound Annual Growth Rate) does not ensure consistent annual returns,” Tandale explains. The emotional costs of loans, such as stress and financial uncertainty, should also be taken into account. “When leveraging securities, it’s essential to weigh these risks against potential returns and align your decision with both your financial goals and risk tolerance,” she advises.
Benefits of pledging shares
In contrast, Vivek Iyer, Partner at Grant Thornton Bharat, points out that pledging demat shares for a loan allows investors to “monetize your financial asset without losing the upside on the asset.” He emphasizes that liquidity needs sometimes overpower the focus on investment growth, leading to the unnecessary dilution of good investments. “Loan against shares offers a great option to avail credit without having to dilute your investment position,” says Iyer.
However, he also warns that investors must be mindful of potential risks. “If the financial asset falls in value, there may be margin calls that the investor would need to honor,” Iyer notes. This is an important consideration, as it underscores the need for careful planning and understanding of the risks associated with pledging shares.
Documents required for loan against shares
To avail a loan against shares, you will typically need to provide the following documents:
-PAN Card and Aadhaar Card for KYC verification
-Demat account statements
-Bank statements, salary slips, and IT returns for age verification
Conclusion:
Pledging demat shares for a loan offers investors a way to access funds without liquidating their investments, but it’s essential to understand both the benefits and risks involved. As Tandale and Iyer explain, while this option can be beneficial for short-term liquidity needs, it may not always be the best solution for long-term financial growth. Investors should carefully assess their financial situation, risk tolerance, and investment goals before deciding whether to pledge their shares or sell them.