Displaying items by tag: direct indexing

One of the reasons that direct indexing has been gaining in popularity is its ability to harvest tax losses in portfolios with regular scans and rebalancing. This technology can also be used to harvest taxable gains on assets that have appreciated considerably over a long period of time by raising the cost basis of securities. This will ultimately lead to a lower capital gains tax bill.

This strategy entails selling shares that are owned on a low-cost basis and then rebuying at a higher cost basis. Unlike tax loss harvesting, there is no wash rule which prevents the same shares from being rebought. It can be most effective when there is an offsetting capital gains loss in another part of the portfolio. 

Investors have not readily embraced this strategy as it conflicts with human nature and the desire not to sell a winning position. Advisors have an opportunity to serve their clients by explaining the benefits. 

However, they need to identify these opportunities with the right technology and holistic perspective. The best chance of gaining this perspective is with a unified management account. It can also aid recruitment as many potential clients are looking for advisors who have a firm grasp on technology and innovative solutions to reduce capital gains taxes.

Finsum: Direct indexing can help advisors and investors with harvesting tax gains in addition to tax losses. This entails selling winning positions and then rebuying at higher levels to lower future capital gains tax bills. 

As the year comes to a close, it presents an opportune moment for financial advisors to revisit strategies and offer valuable advice to clients. A timely topic is tax loss harvesting. And direct indexing is becoming a popular way for investors to accomplish this. Therefore, now is a great time to consider introducing the concept of direct indexing to your clients.

The Value of Tax Loss Harvesting

Tax loss harvesting is a technique that can reduce taxable income by selling securities that have incurred a loss. As we approach year-end, this tax-saving tactic may be appropriate for some of your clients, yet you need a convenient way to make these trades without upsetting their entire portfolio. Direct indexing allows you to accomplish this task.

Direct Indexing: No Longer Just for the Elite

Direct indexing, which involves buying individual stocks directly rather than through a fund, enhances the ability to tax loss harvest. While it's not a new concept, it's becoming more accessible to a broader range of investors. As author Medora Lee pointed out in her recent article in USA Today, "(direct indexing) was once mostly reserved for the affluent with at least $1 million to invest." But things are changing. "With better technology and zero- or low-commission trading now the norm, more people can use direct indexing."

Embracing the potential of direct indexing and tax loss harvesting is another way to demonstrate your value to your clients.

At one time, direct indexing was only available and viable for ultra high net worth investors. This is now changing due to technology which is simplifying the process, the sharp decline in trading commissions, and the fractionalization of shares. 

With direct indexing, investors and advisors can replicate any index in a managed account. Instead of buying a mutual fund or an ETF, an investor buys the actual components of an index. This comes with added benefits as they can tweak or adjust the holdings of the index to suit their own inclinations or unique situation. It also means that these investors can harvest tax losses which can then be used to offset taxes from capital gains in another part of the portfolio. 

With direct indexing, tax loss harvesting can lead to better performance especially in more volatile years for the market. Even in up years, some segments of the market may finish in the red which provides opportunities to harvest losses to offset gains. 

Direct indexing is particularly useful for investors who have strong beliefs or unique financial situations. For instance, an investor who does not want to invest in tobacco companies can eliminate these from an index and choose another stock which has similar factor scores to ensure that the benchmark continues to be tracked.

Finsum: Direct indexing is an effective strategy to lower tax bills but is only accessible for a tiny segment of investors . Now due to technology and lower commissions, it’s available to nearly everyone. 

When it comes to making clients happy, there is no substitute for a wide variety of offerings given that everyone has their own unique circumstances, priorities, risk tolerance levels, and goals. Ironically, the recent trend in wealth management over the past couple of decades has been the opposite with the rise of ubiquitous 60/40 portfolios and passive strategies.

However, the introduction and ongoing proliferation of direct indexing is an antidote and presents an opportunity for savvy advisors. In essence, direct indexing allows investors to recreate an index within a separately managed account by owning the actual individual stocks. This is now possible due to technology, lower commissions, and fractionalization of shares. 

The major benefit for clients and advisors is that these indexes can be customized as little or as much as clients desire. Thus, it retains the pros of passive investing, while allowing for personalization and the potential to harvest tax losses. 

For example, investors who have strong beliefs about climate change may look to eschew companies who are responsible for emissions or the production of fossil fuels. Instead, they may want to overweight stocks with high ESG scores. With direct indexing, an advisor can theoretically create custom products for each client, leading to greater satisfaction and success for both parties.

Finsum: Advisors should get comfortable with direct indexing given that it allows for personalized products that are more likely to appeal to an investor. 

Direct indexing is the convergence of two developments. One is that we increasingly live in a world of customization and personalization whether it comes to our newsfeeds, food orders, playlists, etc. The other is that research continues to show that most investors are better off investing passively rather than actively managing their portfolios.

At first glance, there seems to be a contradiction between these two notions. However, direct indexing manages to thread the needle by retaining the benefits of passive investing such as diversification and low costs while also allowing for customization in order to account for an investors’ goals and needs.

For instance, a tech executive may have outsized exposure to the industry due to some compensation in the form of stock options. In their own portfolio, they may look to reduce exposure to tech in order to create more diversification and dampen risk. 

Another benefit is that capital gains losses can be more effectively harvested with direct indexing. This means that if the tech executive were to sell some of their stock options, then the tax bill can be lowered by applying harvested tax losses from the direct indexing portfolio.   

Finsum: Direct indexing provides many advantages compared to passive or active management. Here are some of the benefits.