Trading a security–like most transactions in our hyperconnected world–can feel like an instantaneous process. However, there is a difference between when you execute a trade and when it settles. For the past few years, it has taken two business days for the transaction to become official. This coming May, that will be reduced to one business day, or T+1. Here is how this upcoming change will impact your portfolio.
The importance of the change from T+2 to T+1 is more than just a mere formality. It will directly influence the point in time when the stock changes hands, which, depending on the circumstances in which you are conducting trades, can have an impact on your bottom line.
How Are Stocks Bought and Sold?
Securities are bought and sold on an exchange, with the two most popular in the U.S. being the New York Stock Exchange (NYSE) and the Nasdaq (NASDAQ:NDAQ). Two parties will agree on the price of a stock, and a transaction will take place.
In practice, money is exchanged for the ownership rights of a security. Nowadays, this is mostly executed electronically, though in the past, this meant the physical exchange of cash for a certificate or other document asserting ownership.
As horses and ships gave way to more modern forms of transportation and exchange, the lag time between the purchase and the official settlement decreased. Brokerage houses and those facilitating the trades must still ensure that the exchange of property takes place, though technology has enabled this to take place much faster. In 2017, the T+2 rule was enacted, whereby the settlement took place two business days after the transaction occurred. Previously, the amount of time had been three days.
On May 28, the U.S. Securities and Exchange Commission will adopt the T+1 rule. This will speed up the process even further, making the transaction official one business day after the buyer and seller reach an agreement.
What Does T+1 Mean for Investors?
The new T+1 rule applies to publicly-traded securities, bonds, ETFs, municipal bonds, and some mutual funds, among other assets. This will not affect government bonds or options, as these assets have already been trading on the T+1 schedule.
Most investors will not notice much of a difference in their trading portfolios. Due to the electronic nature of the transactions, ownership and money are mostly sent into and from accounts online and handled by brokerage firms.
However, the lag time between the transaction and the official change in ownership can have implications for the cash that is exchanging hands.
Beforehand, according to the T+2 rule, it would take two business days for the cash to officially become yours after you sold an asset. Until the asset or cash is fully in your account, there are certain restrictions on what you can do with these funds. The new rule change will lessen the time that buyers and sellers need to wait before they are fully capable of using their cash or assets.
Conclusion: Purchasing for the Long-Term
The technical mechanisms of selling assets might not be the most interesting topic. This will not impact most investors in any meaningful way, especially since most of those making trades will not be involved in the physical exchange of property. For those trading with long-term time horizons, one day here or there will not materially impact their investment returns.
That being said, one should remember that stock markets and public exchanges are essentially about the facilitation of transactions. Though the physical means by which this is carried out has changed over time, those investing in the stock market are engaged in the buying and selling of property. There are rules and regulations to abide by when doing so, and understanding when the transaction becomes official is an important part of the equation.
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