These days we’re used to financial transactions that happen instantly. Buy groceries with your debit card and you see your bank account updated immediately. Send a friend money with an Interac transfer and it’s in their hands in seconds. Yet when you buy or sell an ETF or mutual fund, the trade doesn’t settle for three business days, a practice known as T+3. It’s a convention that seems as outdated as traveller’s cheques.
The good news is this is about to change: on Tuesday, September 5, markets in Canada and the United States will be moving to a T+2 cycle, with settlement two business days after the trade.
This change will mostly affect financial institutions and their intermediaries, but if you regularly buy ETFs, mutual funds, and other investments through an online brokerage there are a number of details you should understand.
Out of order
Before diving into the details, let’s review what settlement means in this context. A trade is considered settled when the buyer has delivered the cash to the seller, at which point ownership of the security officially changes hands. Strictly speaking, you don’t have to pay for your ETF or mutual fund units until three business days after you make the purchase. Depending on your brokerage and account type, you may be able to buy shares with no cash in your account, as long as you deposit that cash before settlement.
Most people don’t do this, of course. Normally we buy ETFs and mutual funds using the cash balances that are already in our accounts. Indeed, the whole idea of a three-day settlement period is largely invisible to buy-and-hold investors. But there are a number of situations when it can cause confusion:
You buy and sell securities with different settlement periods. Stocks, bonds, mutual funds and ETFs all currently use a T+3 settlement period. But several other investments are on a T+1 cycle, with settlement the next business day. These include T-bills, high-interest savings accounts (HISAs) and money market funds. GICs may settle the same day or T+1, depending on the dealer. This means if you sell one investment and buy another with a different cycle, your trades could settle out of order.
Let’s say on a Monday you sell $10,000 worth of an ETF. Though the proceeds will appear in your cash balance immediately, but settlement won’t officially occur until T+3. So if you use that cash to buy a high-interest savings account (T+1), you’ll have a problem. The HISA purchase will settle on Tuesday, but the money won’t actually be available until your ETF sale settles on Thursday. This trade could be rejected by your brokerage, or you’ll be charged two days’ worth of interest.
Canada and the US have different holidays. The settlement cycle is based on business days, which excludes weekends and holidays when markets are closed. This can create problems when markets are closed in Canada but not in the US, or vice-versa.
Consider an investor who sells a US-listed ETF and uses the proceeds to buy one that trades on the TSX. She makes both trades on the Friday in January before Martin Luther King Jr. Day, which is a holiday only in US. The sale of the US-listed ETF will not settle until the following Thursday, but the purchase of the Canadian ETF will settle on Wednesday. Her brokerage may charge her a day’s interest for being out of order.
You buy or sell an ETF near the dividend record date. When an ETF (or individual company) declares it will be paying a dividend, it specifies a record date. To receive the dividend, you must own shares in the ETF on that date. So if the record date is Friday and you purchase the fund on Wednesday or Thursday, your trade would not settle until the following week and you would not receive the dividend. For this reason, ETFs and stocks are said to trade “ex-dividend” on the two days before the record date.
It works the other way around, too. Continuing the same example, if you already owned an ETF with a record date of Friday and you sold it on Wednesday or Thursday, you would still receive the dividend. If you had a dividend reinvestment plan (DRIP) in place, you might even find yourself holding a couple of new shares in the ETF, and these will cost you an extra commission to sell.
When the dust settles
Even after the settlement cycle changes from three days to two on September 5, the issues described above still need to be considered. It will still be possible for trades made on the same day to settle out of order. But the shortened settlement period is generally good news for investors. A few examples:
- If your trades settle out of order because the securities use a different cycle (such as ETFs and high-interest savings accounts or GICs), you may end up paying only one day’s worth of interest instead of two.
- If you convert currency using Norbert’s gambit with the Horizons US Dollar Currency ETF (DLR and DLR.U), your brokerage may require you to wait until the first trade settles before you journal the shares to the other side of your account. With the new T+2 settlement period you’ll be able to do this one day sooner.
- If you buy or sell an ETF near the dividend record date, the window for confusion is a little smaller. Once T+2 settlement becomes reality, an ETF will only trade ex-dividend on the one business day before the record date, rather than during the previous two days.
Great summary. Thanks !
Cool. Thank you for doing the service of posting this up. I’m sure that otherwise, I’d not have known until something showed up on a future statement, probably causing me to become confused and waste 20 mins trying to ask the brokerage what was up. ;)
One other big advantage from T+2 settlement is Canadians can now submit trades during the Christmas holidays and have them settled before the end of the calendar year. Because in the US the statutory holidays are Dec 24 & 25, but in Canada they are Dec 25 & 26, this is a privilege that, until now, the US has enjoyed but Canada has not.
At last, I can put off my tax-loss harvesting and other end-of-year financial tasks until Christmas break, rather than having to get it done sooner. :)
Ahhh yes, this happened to me when I first started out. I didn’t know why & it was explained to me by my discount brokerage who were also kind enough to refund the interest charged !
Thanks for an informative post !
Oh. Never knew this.
If I buy vcn for 30.00 on a Tuesday it’ll settle on Thursday. But vcn is now 35.00. So I pay 30 or 35?
@Charlie: The price you pay for the ETF is set at the moment you place the trade. It’s simply that you have to deliver payment by the settlement date.
In the past I stumbled upon this post by the Canadian Capitalist:
I have used these HISAs in the past when I was just parking some cash somewhere for a short period of time. I used TDB8150. In my discount brokerage account at TD Direct Investing, the money invested in TDB8150 was available (like cash) allowing me to purchase an ETF even if I had no cash (and no margin). I could buy the ETF, then sell an appropriate amount of TDB8150 to cover the cost of the ETF purchase before the settlement date.
This T+2 change shouldn’t really prevent me from doing the same thing, right? I can still buy the ETF first, then sell the TDB8150 that same day and things still work out, right? I believe the TDB8150 would be sold at the end of the trading day that the sell order is placed and then it turns into cash in the account the next day or maybe the day after that. Does this sound right? Or are TDB8150 and ETF’s both T+2, so there is a chance I could run into some troubles?
I really look forward to each new post on this blog and I have read and reread so much stuff here. Thanks.
@Diego: The shorter settlement period won’t change what you’re doing now: buying the ETF first, and then selling TDB8150 to cover the cost. The HISA trade will settle next day (T+1), and the ETF trade the day after (T+2). The only problem would arise if you did it the other way around. For example, you sold $10,000 worth of an ETF and then immediately placed a trade to park that $10,000 in a HISA. These trades would settle out or order.
Dan, this is somewhat off-topic, but current. When I clicked through to my Royal Direct account this morning, I received two notices. One was the T+2 notice that your post talked about. The second was about currency exchanges. Here’s what it said:
“A Real-Time Foreign Exchange feature is now available on our website. …you are now able to obtain real-time foreign exchange rates when converting from Canadian Dollars to US Dollars or vice versa.
What this means for you
RBC Direct Investing no longer converts available funds in clients’ accounts from Canadian Dollars to US Dollars or US Dollars to Canadian Dollars when trades are settled. Clients must process their own foreign exchange conversions.’
My question is, does this effectively end the use of Norbert’s Gambit in converting funds from Can to US or vice versa?
@TrevorC: It’s hard for me to comment on the policies of a specific brokerage. But from the sounds of it this doesn’t affect the use of Norbert’s gambit. First, the exchange rates offered by the brokerage are likely to be just as unfavourable as they were before: they will just be more transparent now. So Norbert’s gambit is likely to get you a better rate. Second, it sounds like this applies only to automatic currency conversion: for example, if you buy a US-listed security in a CAD account. With Norbert’s gambit this does not happen: the CAD trade is made in a CAD account, and the USD trade is made in a USD account.
Thanks very much, Dan. That clarifies things for me.
I hope this isn’t too random of a place to post this question…
I was hoping you could help me understand why according to “the news” Canada’s economy is heating up and the Canadian dollar has reached its highest point since 2005 and yet my Canadian index fund (XIC) continues to trend down for nearly 6 months? What is the relationship between the dollar, the “perceived” economic growth and the Canadian index itself?
Thanks so much,
I think we should just turn the news off and passively invest with risk level of ones choice. Most people don’t view the economy as heating up, record debt level and still borrowing can’t continue. Most of the jobs being created are low paying which means people don’t have extra money to invest, company execs compensation continue to increase while the worker is left behind.
Big Banks continue with non stop big profits quarter after quarter yet you hear commentary about how the financial institutions have had a hard time in the low interest rate environment.
Diversify, US and International equities have had a good year so far. A balanced portfolio of bonds, can, us and int equities is up 2-4% depending on if hedged or non hedged to canadian dollar, not stellar but positive none the less.
And don’t forget if something is down it’s a buying opportunity, if you saw a store sale would you say to yourself i won’t buy now, i will wait till the price goes up ?
I am not commenting on whether the Canadian economy is actually heating up or not. However, if the Canadian dollar has reached a higher point, then other things being equal (i.e. assuming the Canadian economy and US Economy have remained neutral), would not the Canadian nominal Equity Index prices tend to remain the same and the US Equity Index prices in Canadian dollars tend to drop? Just trying to understand the relationships better.
hi cpp, i think i posted this in an older post and it never got replied to, or showed up online; i am new to investing, currently i have quite a large part of my portfolio invested in XBB and ZAGG, i know intellectually i am not to look at the amounts, for they fluctuate each month; i guess recently i did; and saw my “value” go down by hundreds of dollars, like $1179 in the past two months
i was to be honest shocked by this, for the feelings in my stomach are worst than the intellectual knowing that i need not look at it
in the post about bonds, you indicated that the volatility of some bonds are quite high and it is for that reason that you do not keep most of your own portfolios in this, is this gleaned from experience on your end? ie you made a similar dip in the sea and felt the stomach turns when you saw your hard earned money move to up and down
my other question is, currently, the money has only been invested in there for three months i think, and it has only seen downward fluctuations, i log on maybe once a month or twice, and each time, i just see negative numbers – is this something to be concerned about?
i know in your previous post, you indicated that people holding XBB for example need to hold it for its entire duration of 6.3 years to see the 3% average yields that it was averaging… i guess i am new to this and this all makes me want to puke; i just need some re-assuring words on how this will look in the future, and that i should stay in …
@jill: I responded at length to your comment on this page:
This has nothing to do with settlement, but does anyone else have any Blackrock ETFs that have moved from the TSX to the Aequitas NEO exchange? Two examples are CJP and CRQ. Quotes for these ETFs are not available on sites like Yahoo or Google Finance, nor do the quotes download to Quicken. Very annoying!
Wish I had remembered reading this article before I sold $140K of ETFs in my taxable account to build a GIC ladder. RBC DI did *not* make it clear I would be going into a debt position in buying those GICs, reporting both a positive cash balance and positive buying power after the sell order was fulfilled.
The lesson for my error was just short of $100. The price of failing to heed the advice Dan writes about here.
RRSP and TFSAs stock and ETF trades are settled T+2 days.
If you buy a security say US ETF SPY for $10k with all available cash, and then sell say May 9th, does that mean you won’t be able to repurchase or purchase another security until the cash is settled and available on May 11th (2 business days excluding US Holidays) assuming that $10k USD is all you have in the Registered Account.
For Questrade, based on their margin interest page, it suggests that RRSP / TFSA at Questrade brokerage allow some sort of Margin borrowing? Or is that more applicable for if you are do not have enough USD cash/buying power, and you purchase something to go negative, you could borrow USD against available CAD to execute the trade?
@FL: Brokerages have different practices, but in general, if you a sell a stock or ETF, you can repurchase another one with the proceeds right away. Both trades will then settle on the same day, and you will not be charged interest. You don’t have to wait for settlement before using the proceeds of the sale.