For example, an investor who purchases shares of stock on a Monday must have sufficient funds in their account to cover the cost of those shares (plus any brokerage fees) by Wednesday. The settlement date for stocks specifically is two days after a trade is executed.
How a Settlement Date Works
It has always been important to settle trades in financial markets as quickly as possible. Unsettled trades pose risks, particularly if market prices drop steeply and trading volume soars. A long period between trade and settlement in this situation increases the risk that investors could no longer pay for their transactions. To decrease the risk, the regulation regarding settlement dates has changed over the years. For many years, the settlement cycle for most securities on U.S. markets was five business days after the trade date. The U.S. Securities and Exchange Commission (SEC) shortened it to three business days (T+3) in 1995, then to two business days (T+2) in 2017, with some exceptions. In the past, the settlement process occurred manually. The period between the trade date and the settlement date allowed for manual transactions to be completed, and for actual certificates of purchase or confirmation of the sale to be sent to the investor. Because transactions now occur electronically, the time between trade date and settlement can be shorter. The first day of the settlement cycle starts on the first business day following the trade date. Business days are generally defined as days when the market is open. For example, if a trade is made on a Thursday, the first day of a two-day settlement cycle is Friday and the settlement day will be the following Monday.
Types of Settlement Dates
Settlement dates differ depending on the security you purchase. While there are some exceptions, the guidelines for settlement dates are generally as follows:
Stocks, bonds, and ETFs: two business days (T+2) following the purchase or sale Government securities and options: one business day (T+1) following the purchase or sale Mutual funds: Between one and three business days, depending upon the fund company and the fund type. (Equity and bond funds usually settle within one business day while other types of funds may take up to three business days.)
What It Means for Individual Investors
The settlement date informs an investor when the necessary funds to cover a purchase must be available in their account. In addition, the settlement date may be important for tax, accounting, and other purposes, including:
Whether a sale occurred before the end of a tax year Whether taxes on any dividends received are short-term or qualified dividends If purchasing a stock that pays dividends, what date you must be a shareholder to receive that period’s dividend payment
In most cases, the trade date and settlement date of a transaction come and go without much fanfare. However, it’s important to know the difference between the two terms and when a settlement date may impact a transaction.
Settlement Violations
Settlement violations occur when purchases go through and there is not sufficient settled cash in the investor’s account to pay for the trade on settlement day. A brokerage firm is responsible for settling a trade if the investor has not provided the funds by the settlement date. If payment for a purchase is not provided by the settlement date, a brokerage may sell the security (thereby canceling the transaction), and charge the investor for any loss resulting from a drop in the market value of the security. A brokerage may also charge interest or impose fees. Although many brokerages create margin accounts to allow investors to borrow money to purchase securities, many accounts only allow an investor to purchase a security if there is enough settled cash in the account to cover the cost of the trade.
