What is the settlement date?

Definition and Examples of Settlement Date

The settlement date refers to the date when payment is made to settle a purchase or sale of a security such as stocks, bonds, mutual funds, or exchange-traded funds (ETFs). If you purchase a security, the settlement date is the day you must pay for the purchase. If you sell a security, it is the date you will receive the money from the sale.

How Does the Settlement Date Work?

It has always been important to settle trades in financial markets as quickly as possible. Unsettled trades pose risks, especially if market prices decline sharply and trading volumes increase. A long period between the trade date and the settlement date can increase the risk of investors not being able to pay for their trades.

To mitigate risks, regulations regarding settlement dates have evolved over the years. For many years, the settlement period for most securities in U.S. markets was five business days after the trade date. The U.S. Securities and Exchange Commission (SEC) shortened this period to three business days (T+3) in 1995, and then to two business days (T+2) in 2017, with some exceptions.

In the past, the settlement process was done manually. The period between the trade date and the settlement date allowed for the completion of manual transactions, sending actual purchase certificates or confirmations of sales to the investor. As transactions are now done electronically, the time between the trade date and the settlement date can be shorter.

The first day of the settlement cycle begins on the first business day after the trade date. Business days are generally defined as days when the market is open. For example, if a trade occurs on Thursday, the first day of the two-day settlement cycle is Friday, and the settlement date will be the following Monday.

Types of Settlement Dates

Settlement dates vary depending on the security you are purchasing. Although there are some exceptions, general guidelines for settlement dates are as follows: Stocks and bonds and ETFs: two business days (T+2) after the purchase or sale. Government securities and options: one business day (T+1) after the purchase or sale. Mutual funds: between one and three business days, depending on the fund company and type of fund. (Stock and bond funds typically settle in one business day, while other types of funds can take up to three business days.)

What Does This Mean for Individual Investors?

The settlement date informs investors when the funds needed to cover the purchase must be available in their account. Additionally, the settlement date may be important for tax, accounting, and other purposes, including: whether the sale occurred before the end of the tax year. Whether the taxes on any profits you received are short-term gains or qualified dividends. If you are purchasing a stock that pays dividends, what date you must be a shareholder to receive the dividend payment for that period.

In most cases, the trade date and settlement date for a transaction pass without much fanfare. However, it is important to know the difference between the terms and when the settlement date can affect the transaction.

Settlement Violations

Settlement violations occur when purchases are executed and there are insufficient funds settled in the investor’s account to pay for the trade on the settlement date. The brokerage firm is responsible for settling the trade if the investor does not provide the funds by the settlement date. If payment for the purchase is not provided by the settlement date, the brokerage firm may sell the security (thus canceling the trade) and charge the investor for any losses resulting from the market value decline of the security. The brokerage firm may also impose interest or fees.

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Although many brokerage firms create margin accounts that allow investors to borrow money to purchase securities, many accounts only allow the investor to buy a security if there are sufficient funds settled in the account to cover the cost of the transaction.

Source: https://www.thebalancemoney.com/what-is-a-settlement-date-5203035