The stock market has a number of procedures that beginner investors would do well to know and remember. One of them is the T+2 rule in the trade settlement.
The T+2 rule can affect your receipt of dividends when you buy dividend-producing stocks. Depending on when your share purchase transaction settles, you may be ineligible for an upcoming dividend.
In this article, we will explain the T+2 rule. You will learn whether it is possible to sell stocks before the settlement date. You will also find out how soon you can sell stocks after you buy them.
Why Do Stocks Take Two Days to Settle? The T+2 Rule Explained
When you purchase shares, it takes a few days for the transaction to process. That is called the settlement period. The process involves transferring the ownership and payment between the buyer and the seller. Once the trade settles, your name will be listed on the company’s shareholder register, and you will be eligible to receive a dividend.
In the stock market, T+2 describes the number of days it takes to complete a trade. The “T” stands for the transaction date. That is the date when you made a trade such as buying or selling a stock.
It takes extra two business days from the transaction date for a stock trade to settle. Thus, the “2” stands for the extra days you need to wait for the transaction settlement. Under the T+2 rule, a trade made on Monday would settle on Wednesday.
The T+2 rule specifically applies to stocks. The settlement period may vary for other securities, such as corporate bonds and Treasury bills.
What Happens If There’s a Weekend or Holiday During the T+2 Settlement Days?
The SEC has been shortening the settlement period. Investors waited five days after a trade for the settlement process initially, which was dubbed the T+5 rule.
In 1993, the SEC shortened the settlement period to T+3. It reduced the waiting period further to T+2 in 2017. The regulator plans a further shortening of the settlement period to T+1 in 2024.
The settlement processing period excludes weekends and holidays. As a result, your stock purchase may take longer to settle due to weekend or holiday interruptions. You should time your trade to settle before the record date if you are eyeing a dividend.
How Does the T+2 Settlement Date Affect Dividend Eligibility?
When companies distribute dividends, they pay to shareholders on their register as of the record date, also called the date of record. Your name must be on the company’s register before or on the record date to be eligible for the dividend distribution.
Another important date in relation to dividends that you should remember is the ex-dividend date. It means that a stock is trading without the upcoming dividend on that date. The ex-dividend date typically comes one business day before the record date. As a result, the T+2 rule can affect your dividend eligibility.
Here is an example to illustrate how the T+2 rule can impact your eligibility for an upcoming dividend.
Let’s say Apple (AAPL) plans to pay dividends to its shareholders. It sets Friday as the record date. In that case, the ex-dividend date would be Thursday.
If you want to be eligible for the Apple dividend, you would need to have bought Apple shares by Wednesday. Because of the T+2 rule, a trade made on Wednesday would settle on Friday – the record date in this case.
You’re eligible for an upcoming dividend if your trade settles on or before the record date. As a result, you must make your buy trade for before the ex-dividend date, so that the transaction can settle on time for the date record.
The T+2 Settlement Date Causes Unsettled Fund Situations
If you sell a stock, the proceeds from the trade are considered unsettled funds until the T+2 settlement period has elapsed. Unsettled funds are also called unsettled cash.
Say you sell a stock for $1,000 on Tuesday. The T+2 rule means the transaction would conclude on Thursday. As a result, the proceeds are considered unsettled funds on Tuesday and Wednesday. They would become settled funds on Thursday when the T+2 settlement processing period ends.
You may use unsettled cash to purchase another stock. As a result, you could use the $1,000 sale proceeds to buy more shares from the day you the sale occurred on Tuesday without waiting until Thursday. However, you would be restricted on what you can do with the newly purchased stock before the Thursday settlement date of the previous sale.
Can You Sell Stocks Before the Settlement Date?
Since the settlement process happens behind the scenes, the stocks you purchase often show in your account immediately, when your buy order executes. However, you need to wait two business days for the ownership of those…