Overview
- When you buy securities through your cash account, there are two separate dates involved in the transaction: the trading date and the settlement date.
- While the trade takes place immediately, the settlement date is when the trade becomes final – the buyer makes the payment to the seller and the seller transfers the equities to the buyer.
- The settlement date for stocks and bonds is two business days after the trading date. Before the settlement date, the proceeds from the sale are considered unsettled.
- You can use unsettled funds to purchase new securities, but you could trigger a violation if you sell those securities before the funds used to purchase them have settled.
If you trade through your brokerage’s cash account, you’ll see two different types of funds in your account: settled funds and unsettled funds.
Settled funds (also called settled cash) refer to newly deposited funds (such as a check deposit or wire) and settled proceeds of fully paid for securities.
Unsettled funds (also called unsettled cash) refer to proceeds from a sale of fully paid for securities prior to the settlement date.
Here’s what that means.
What is a settlement date?
When you purchase something online, you place your order, it gets filled by the vendor, the package arrives, and then the order is settled. The date you purchased the item is different from the date the order becomes finalized.
The process is similar when you buy and sell securities through your brokerage cash account. When you sell a security, the trade takes place immediately and you’re able to use the proceeds from the sale to make new trades. However, the funds from the sale are not considered “settled” until the settlement date. When you place new trades with funds that have not settled, you’re technically using unsettled funds (money that isn’t yours yet).
When is the settlement date?
The settlement date is the day in which the trade becomes finalized. The buyer makes the payment to the seller, and the seller transfers the securities to the buyer. Different securities have different settlement times.
- For mutual funds, options and government bonds, the settlement date is one business day after the trade date (commonly referred to as T+1).
- For stocks and bonds, the settlement date is two business days after the trade date (commonly referred to as T+2).
For example, if you sell a stock on Monday, the settlement date would be Wednesday. If you sell a stock on Thursday, the settlement date would be Monday. While the trade takes immediately, the transaction is not finalized until the settlement date two business days later.
Settlement dates aren’t unique to any individual brokerage. All brokerages follow the same industry standard rules and procedures when it comes to settlement dates.
Can you make trades with unsettled funds?
Yes, you can use unsettled funds to purchase new securities. However, while there are no rules around buying securities with unsettled funds, there are some rules when it comes to selling.
If you purchase securities in your cash account using unsettled funds, you must hold those securities until the funds used to purchase them become settled. If you sell before the settlement date, you’ll receive something called a good faith violation in your account.
Nothing happens when you receive your first two good faith violations. However, if you get 3 good faith violations in a period of 12 months, your account will get restricted for 90 days, and you will only be able to purchase securities using settled funds.
Let’s go through an example
On Monday, Jim sells $5,000 worth of Stock A in order to get cash to purchase Stock B. He completes the trades on Monday afternoon. Because Jim used unsettled funds from the sale of Stock A to purchase Stock B, he cannot sell his shares of Stock B until the funds from the Stock A sale have settled, which would be on Wednesday (two business days later).
Should you avoid trading with unsettled funds?
The best way to avoid violations in your trading account is to only trade with settled funds in your account. However, it’s not against the rules to use unsettled funds to buy new securities. Problems only arise when you sell before you actually pay for them.
It’s perfectly fine to place new trades with unsettled funds in your cash account. However, if you decide to do so, you’ll just have to be cautious not to sell those securities until the funds used to purchase them have reached their settlement date.
Unsettled funds can also refer to uncleared deposits
Uncleared deposits can also be considered as unsettled funds in your account. Trading with this type of unsettled cash is more dangerous than using unsettled proceeds from the sale of securities because you’re trading with money that you never had in the first place.
For example, let’s say you deposit $5,000 into your cash account on Monday and use the entire amount to purchase shares of Stock A. On Wednesday, due to issues at your bank, the deposit gets returned and never makes it into your account. The same day, you decide to sell your shares of Stock A in order to fund the initial purchase you made on Monday.
In this example, you bought and sold shares of Stock A with money you never had. This would be considered a freeriding violation, and the penalties are less lenient than a good faith violation. Instead of being given a penalty on your third violation, your account gets restricted for 90 days on the first freeriding violation.
To avoid the freeriding violation, you’ll have to make sure to hold the security until you pay for it fully with a new deposit. You cannot pay for the trade by selling the securities you bought with unsettled funds.
Does a buyer receive the stock on the trade date or settlement date?
The buyer of a stock does not own the stock until the settlement date, which is two business days after the trading date.
This becomes especially important to consider when you’re making trades during the last few days of the year. If you make a trade (whether buying or selling) at yearend, but the settlement date falls the next year, the gain or loss on the sale is recorded in the tax year of the settlement date.