‘T+1’: How The New Trading Rule Impacts Investors (2024)

Securities trading—including stocks, bonds, exchange-traded funds and many mutual funds—is now slightly safer, thanks to a new rule known as “T+1.” T+1, or T plus one, refers to the maximum time allowed for the settlement of trades. It stands for trade-day-plus-one-business-day.

That time period is the new settlement cycle for most broker-dealer transactions. It replaces the twice-as-long former settlement cycle, which is known as T+2. T+2 allowed two business days after a trade for settlement, or finalization of a transaction.

Does T+1 Make Trading Safer?

T+1 makes trading safer, at least in theory, by cutting in half the amount of time in which a glitch can occur that would cost either a buyer or seller money.

The risk in any settlement cycle is that a buyer might fail to put up money, a seller might fail to turn over an asset or an intermediary might somehow gum up the works. Shrinking the size of the settlement cycle should reduce the second-by-second opportunities for mistakes, deceit and delays.

The shorter settlement deadline cuts down the amount of time buyers have to actually hand over money, and it slashes the amount of time sellers have to surrender their security. This also pares down the amount of time intermediaries such as brokers have to complete their tasks.

“The move to T+1 reflects improvements in technology that allow trades to settle more quickly,” the Financial Industry Regulatory Authority, or FINRA, said in a statement published on its website. FINRA regulates the broker-dealer industry in the U.S.

“With most trading and banking activity occurring online, extra days to physically deliver securities or funds are no longer needed,” FINRA’s statement added.

Avoiding a GameStop Replay

The financial services industry and its regulators see a shorter settlement cycle as helpful in avoiding or mitigating problems such as those created by the 2021 controversy centered on video game vendor GameStop Corporation (GME).

In early 2021, a group of amateur investors organized via a thread on the Reddit website to buy GME stock, thus pushing its price up and squeezing out industry traders who had shorted the stock.

This could have been a potentially catastrophic occurrence for portions of the financial services industry if brokerage sites such as Robinhood had not halted trading on GME, the now infamous “meme stock.”

T+1 Will Affect Margin Trading

The longer a settlement cycle is—such as the T+2 settlement cycle ruling the GameStop debacle—the easier and less expensive it can be for short traders to bet against a stock.

A longer settlement cycle means short traders do not have to put their own money at risk as quickly. Brokerages can get stuck with losses stemming from clients who borrow money but have not backed it with cash yet. This is referred to as margin trading.

Michael Ashley Schulman, a chartered financial analyst who is partner and chief investment officer of Running Point Capital Advisors, says, “When you short a stock you use margin and if the equity goes up, your losses could be 1x, 2x, 3x or much greater and feel limitless.”

An investor trades on margin when they do not have enough money in their brokerage account to cover the total amount of their trade. In this instance, the investor borrows money from their broker on margin. Using the purchased securities as collateral, the trader will then pay their broker back once the trade settles.

This is an extremely risky form of stock trading and should only be employed by experienced investors.

“During times when asset prices are extremely volatile, like with GameStop a few years ago moving by more than 50% in a day, shorter settlement periods lessen the risk that a brokerage firm won’t have the funds available to cover its clients’ daily losses on shorts—which is money owed to other investors and brokers,” Schulman says.

How T+1 Could Help Investors

How could T+1 help you? Broker-dealers now have only half as much time to finalize your securities trades as they did before. That slashes in half the maximum amount of time before you get paid for any securities you sell.

The flip side of the new rule, however, is that if you are buying securities subject to the T+1 settlement cycle—and odds are that your securities will indeed be ruled by T+1—you’ll likely need to pay for your transactions one business day earlier, unless you’ve already put enough cash in an account with your broker.

Which Securities Are Impacted by T+1?

Securities affected by the new rule include stocks, bonds, municipal securities, ETFs and certain mutual funds.

Also subject to the new rule are trades in securities for limited partnerships that trade on an exchange.

Evolution of the Settlement Cycle

While the new rule is important, it is not the first time U.S. investors have had to deal with a shorter trading settlement deadline. Settlement times for options and government securities began to operate on a next-business-day, or T+1, settlement schedule before the recent move to T+1 by stocks, bonds, ETFs and many mutual funds.

In 1995, the U.S. Securities and Exchange Commission, or SEC, shortened the settlement cycle from trade day plus five business days to T+3. The securities watchdog shortened the settlement cycle again from T+3 to T+2 in 2017. Under T+2, if you sold shares of any stock on a Monday, the transaction would settle on Wednesday.