What is direct indexing?
Direct indexing is a type of index investing. Rather than buying an index mutual fund or index exchange-traded fund (ETF), direct indexing involves buying the individual stocks in an index. For instance, an investor who wants to replicate the S&P 500 index could buy several hundred stocks in an effort to mirror the risk and return of the S&P 500, rather than purchasing a single index fund.
Why would an investor choose direct indexing?
Tax Loss Harvesting
Investors can implement tax-loss harvesting (TLH) in portfolios of funds and MFA does TLH for clients who own mutual funds and ETFs. However, TLH can be done more frequently and in more market environments with individual stocks than with funds. Thus, direct indexing may be more beneficial to investors who are in higher tax brackets.
There are many great socially responsible, sustainable, and ESG-oriented funds, but funds are not personalized to individual investors. Direct indexing allows us to align portfolios with each client's values, rather than a generic set of beliefs.
Clients who receive stock options and restricted stock may have concentrated positions and exposure to their employer's stock. Rather than purchase an index fund that owns even more of the stock, we can exclude specific companies, industries, and sectors in order to limit concentration risk.
Integrate Low-Basis and Other Legacy Positions
Clients who own existing positions with low cost basis or want to continue holding legacy positions can integrate those positions into their portfolio. Rather than realizing taxable capital gains or increasing risk exposures, direct indexing allows us to build index portfolios around existing positions
Who should consider direct indexing?
Direct Indexing may be appropriate for clients who:
- Are in a high tax bracket
- Own stock with a low cost basis
- Have large capital gains tax liability
- Desire a customized portfolio that is aligned with their personal values
- Have a philanthropic intent and/or goals
The above is for educational purposes only. Direct indexing is not appropriate for all investors. Our team of financial advisors work with each client individually to determine whether index funds or direct indexing is more appropriate.