What Is a Settlement Date?

Understanding T+1, T+2, and T+3

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Settlement date refers to the date on which payment is made to settle the purchase or sale of a security such as a stock, bond, mutual fund, or exchange-traded fund (ETF). If you purchase a security, the settlement date is the day you must pay for your purchase. If you sell a security, it is the date you will receive money for the sale.

The settlement date is different for different types of securities, but it typically occurs within three business days of the transaction or trade date. This article will review the settlement dates for different securities and explain why it is important.

Definition and Examples of a Settlement Date

Whether an investor is purchasing a security or selling one, the settlement date refers to the day on which the transaction is final. If you are purchasing securities, you must have enough money in your account by the settlement date to pay for the transaction. If you are selling securities, the settlement date marks the day you will receive payment for the sale.

The settlement date is often referred to as T plus the number of days until the transaction will be final. With stocks, for example, the settlement date can be referred to as T+2, while equity funds tend to settle within one day, noted as T+1.

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.

An investor locks in the cost of a security on the trade date, but does not actually hold or have ownership of that security until the settlement date.

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.

Key Takeaways

  • The settlement date is the date on which payment is made to settle the purchase or sale of a security such as a stock, bond, mutual fund, or exchange-traded fund (ETF).
  • Settlement dates are often referred to as T plus the number of days until the transaction will be final, such as T+2 in the case of stocks and bonds.
  • The settlement date was originally longer to make up for the time it would take for a certificate of sale to arrive manually, but since the introduction of electronic trades, the period between the trade date and the settlement date has shrunk to as little as one or two days for most securities.
  • The trade date locks in a buyer’s price for a security, but that buyer doesn’t actually take ownership of the security until the settlement date.