Millions of investors use mutual funds to invest, taking advantage of their diversified holdings of a wide array of different types of assets. Behind the scenes, mutual funds have to comply with regulations regarding settlement of purchases and sales of their shares, and the rules they follow differ from what brokerage firms have to do with stock trades. Let's take a closer look at mutual fund settlement rules.
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Buying and selling mutual fund shares
Mutual fund trading differs from stock trading in many ways, but the most important difference has to do with timing. In nearly all cases, mutual fund trades execute once every day after the financial markets close. If you miss the trading deadline for a particular day, your mutual fund trade won't get executed until the following day.
This difference in how mutual fund shares get handled also helps speed the settlement process. With most mutual fund trades, the fund is able to settle the transaction on the next business day. By contrast, stock trades typically take three business days to settle. Occasionally, a fund might have provisions in its shareholder agreement that give it more time to settle transactions. However long the settlement period is, fund buyers have to make sure they have cash available to make the purchase by the settlement date, and fund sellers won't be able to use cash proceeds for other purposes until the trade settles.
Money-market mutual fund transactions follow special rules. Because money market mutual funds are designed to be especially liquid, fund transactions settle on the same day that the trade is effective. That 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, bear in mind that other types of funds that are governed by some similar rules to mutual funds nevertheless have different settlement rules. Exchange-traded funds, for instance, 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 similarly, as their shares trade on secondary markets rather than directly through the fund company and thus have a three-day settlement period.
The differences in mutual fund settlement rules can make them an important source of cash that's faster than selling stock. Knowing those rules will help you avoid unfortunate mistakes in not having cash on hand in time for a purchase to settle.
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