Selling mutual funds to buy into a model portfolio is common practice amongst Advisors using trading automation tools like Trading. If Advisors are not careful, this process can result in debit balances due to custodian rules around pre-settlement cash. This article explains why this is the case and outlines best practices for preventing debit balances in client accounts.
Selling Mutual Funds at your Custodian
After you place a sell order for a mutual fund, your custodian will credit your client account with 90% of the mutual fund sell value for 24 hours. After 24 hours, your client receives access to the remaining 10%. Custodians enforce this rule to protect you from the potential difference in estimated vs actual execution price. Because Mutual Funds are priced at the end of the day, it's possible the price you're projecting to sell at differ significantly from the price you execute.
What Causes a Debit Balance?
A debit balance occurs in an account whenever the value of all buy orders exceeds the value of all sell orders plus current cash after a rebalance. If you're manually entering trades into your custodian today - adding or selling a few shares here and there, you've likely never had to worry about this, however, because a models based trading platform like Trading will allocate 100% of a client account (less cash), it's possible that if some of the sell orders are mutual funds, a portion of the account value needed to cover your buys will be locked up for 24 hours.
Preventing Debit Balances
To prevent a debit balance during a rebalance where you are selling mutual funds we recommend the following approach.
1. Perform your rebalance as usual, and upload your trade files into you custodian.
2. Submit all sell orders for mutual funds, but do not submit any buy orders.
3. Wait 24 hours for your custodian to give you access to 100% of the mutual fund sell value.
4. Execute all buy orders you left in your trading dashboard.
In very rare occasions where the market moves significantly overnight, it's possible that waiting 24 hours between placing your sell and buy orders could result in accounts with more or less cash than desired, however, Trading's 1% required minimum cash should prevent this from being an issue in almost every case.