Millions of investors use mutual funds to invest, leveraging their holdings diversified from a wide range of different asset types. Behind the scenes, mutual funds must comply with regulations regarding the settlement of purchases and sales of their stocks, and the rules they follow differ from what brokerage firms must do with stock transactions. Let’s take a closer look at the mutual fund settlement rules.
Buying and Selling Mutual Fund Units
Mutual fund trading differs from stock trading in many ways, but the most important difference is timing. In almost all cases, mutual fund trades are executed once a day after the financial markets close. If you miss the trade deadline for a particular day, your mutual fund trade will not be executed until the next day.
This difference in the way mutual fund stocks are managed also helps speed up the settlement process. With most mutual fund trades, the fund is able to settle the trade on the next business day. In contrast, stock transactions generally take three business days to settle. Occasionally, a fund may have provisions in its shareholders’ agreement that give it more time to settle transactions. Regardless of the length of the settlement period, fund buyers should ensure that they have cash available to make the purchase before the settlement date, and fund sellers will not be able to use cash products at other purposes until the transaction is settled.
Transactions in money market mutual funds follow specific rules. Because money market mutual funds are designed to be particularly liquid, transactions in the funds are settled on the same day the transaction takes place. This allows shareholders to use money market mutual funds as sweep options for brokerage accounts without having to wait an extra day to clear purchases and sales.
Finally, keep in mind that other types of funds that are governed by similar rules to mutual funds nevertheless have different settlement rules. Exchange-traded funds, for example, have a lot in common with mutual funds, but ETFs follow the same rules as stocks and take three days to settle. Closed-end funds work the same as their shares trade in secondary markets rather than directly through the fund company and therefore have a three-day settlement period.
Differences in mutual fund settlement rules can make them a major source of cash faster than selling stocks. Knowing these rules will help you avoid unfortunate mistakes by not having cash on hand in time for a purchase to settle.
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