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 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.
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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,
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