The financial industry is particularly notorious for using hard-to-understand jargon. One example that stumps beginners and experienced investors alike has to do with the process that occurs whenever you buy or sell a stock or other investment. After you make a trade, you might notice on your brokerage confirmation that there are multiple dates listed, one called the trade date and the other called the settlement date. Most people never think twice about those two dates, but there are a couple of situations in which it makes a huge difference knowing how trade dates and settlement dates differ. Let's take a look at the various uses of both dates and what you need to know to avoid some nasty surprises.

An archaic distinction
Technology has turned professional investing into a game of speed, where milliseconds matter and can produce huge profits for those who get in ahead of the crowd. You can wire money around the world at lightning speed, and you can enter a trade on your computer or mobile device and have it executed less than a second later. Yet there's still an antiquated process that your broker has to follow in order to get the stocks, ETFs, and other securities you buy or sell into or out of your account, and that's where trade dates and settlement dates come in.

Dice labeled BUY and SELL on top of LCD screen showing stock charts

Image source: Getty Images.

Of these two terms, the trade date makes more sense intuitively. It's the date on which you actually entered and executed the trade. Most investors think of the trade date as the only one that truly matters, as it's the one that you have the most control over.

The settlement date, on the other hand, reflects the date on which your broker actually "settles" the trade. Technically, even though your online brokerage account will typically list the shares you've just bought among your holdings, your broker doesn't actually take the money out of your account and put the shares in until a later date. With stocks and exchange-traded funds, the settlement date is three business days after the trade date. Mutual funds and options settle more quickly, with a settlement date that's the next business day after the trade date.

Why trade and settlement dates matter
The trade date is the key date for one very important aspect of investing: tax rules. For instance, if you want to sell a stock before year-end in order to take advantage of a tax loss, then the trade date has to be Dec. 31 or earlier. So as long as you get that trade executed before the market closes on the last day of the year, it doesn't matter that the settlement date comes later. Also, when measuring how long you've owned a stock to determine whether a gain is short-term or long-term, you'll use the trade date to measure your holding period.

Settlement dates matter because of funding requirements from your broker. Some brokers will let you buy stock even if you don't have enough money currently in your account to pay for the shares, relying on you to deposit cash at some point between the trade date and the settlement date to cover the cost of the stock. Having the settlement-date lag can actually be helpful from a liquidity standpoint.

But the Securities and Exchange Commission also pays attention to settlement dates, and it has rules that can trip up investors who aren't mindful of those dates. If you have a cash brokerage account, then the SEC requires that you have enough available cash to pay for the purchase of any stock before you sell it. Otherwise, you're engaged in what's called "free riding" and violating the Federal Reserve's rules on extending credit to brokerage customers. To avoid violating the rule, you have to wait until the trade settles, and then you can sell the stock you bought.

For most investors, trade dates are the most important aspect of when you buy or sell a stock. But occasionally, settlement dates have a big impact. Knowing the difference can help you be smart about your investing and stop you from getting into unexpected trouble.

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