Displaying items by tag: direct indexing

Unlike mutual funds or ETFs, personalized indexing permits harvesting losses at the security level, offering more opportunities for ultra-high-net-worth investors to capture additional tax advantages. Tax-loss harvesting involves selling an investment at a loss and reinvesting the proceeds into another asset, a key benefit of direct indexing. 

Direct indexing strategies involve selling stocks below their cost basis and instantly repurchasing correlated replacements to avoid wash-sale rule violations. Since investors own individual stocks in their portfolios, losses can be captured even when the index gains value. DI experts exemplifies this strategy by selling underperforming securities during market gains, using harvested losses to offset capital gains and taxable income up to $3,000 annually, with the option to carry over losses to future years. 

Maximizing tax alpha depends on the frequency of portfolio scans for harvesting opportunities, with daily scanning potentially improving after-tax returns by 1% to 2% or more. Commitment to direct indexing underscores its importance in tax-efficient investing. 

Finsum: The frequency through which a portfolio can be scanned for tax-loss harvesting is making the case extremely compelling for direct indexing.

The traditional perspective on direct indexing as solely an equity investing strategy is shifting, as highlighted by Jonathan Rocafort from Parametric Portfolio Associates, who advocates for its exploration in fixed income portfolios. 

Customized and tax-aware bond ladders present an intriguing opportunity, particularly for advisors with clients nearing retirement. While advisors are well-versed in tax-loss harvesting for equities, Rocafort notes a knowledge gap regarding tax-aware bond investing and the potential for tailored retirement income portfolios at scale. 

Direct indexing in equities involves purchasing individual stocks from an index, enabling tax optimization and customization beyond traditional funds. Similarly, managers can offer customizable bond ladders in municipal, corporate, or Treasury bonds, aligning with investors' values and tax strategies. Despite uncertainty in the interest rate cycle, there's optimism about utilizing fixed income strategies like bond ladders amid potential rate hikes in tax strategies.

Finsum: While it is still not the cheapest strategy, direct indexing could prove useful for HNW clients utilizing bonds as they near retirement.

Direct indexing, increasingly popular among investors, particularly benefits those with concentrated company stock positions by allowing them to replicate index performance while retaining control over individual securities. 

This strategy, once reserved for the ultra-wealthy, has become accessible and affordable for investors at all levels due to recent technological advancements. Through customization based on preferences and goals, direct indexing offers diversification and risk management, crucial for those with concentrated stock holdings. 

Tax efficiency through strategies like tax-loss harvesting further enhances its appeal, maximizing future value potential for investors. With its ability to reduce risk and enhance performance, direct indexing presents a compelling option for investors looking to protect and grow their assets.

Finsum: It used to be infeasible to use direct indexing, but technology improvements are giving smaller investors the edges in tax and diversification that was reserved for the ultra wealthy.

Direct indexing offers solutions for complex financial challenges but isn't suitable for every investor. Identifying which clients may benefit involves considering factors like tax-loss harvesting, ESG preferences, factor investing, and managing large positions or capital gains. 

High-net-worth clients with significant capital gains and taxable equity holdings stand to gain the most from daily tax-loss harvesting, potentially doubling their harvested losses. For clients passionate about ESG criteria, direct indexing allows for precise customization, albeit with a slight fee premium and potential tracking error. Factor investing via direct indexing suits clients with specific customization needs beyond prepackaged ETFs, although advisors must weigh the added complexity against potential benefits. 

Transitioning large existing positions into diversified portfolios using direct indexing offers tax efficiency, particularly for clients with concentrated holdings or restrictions on selling.

Finsum: Advisors need to gauge their clients benefits from direct indexing strategies, and the costs and concerns aren’t always a net positive. 

Burton Malkiel is one of the pioneers of passive investing with his classic, “A Random Walk Down Wall Street”, introducing the concept to millions of people. In his current role as CIO of Wealthfront, he has spoken about the power of direct indexing to enhance after-tax returns. In a recent blog post, he remarked that tax-loss harvesting is “the only reliable way for investors to outperform the market.” 

With direct indexing, portfolios are regularly scanned for tax-loss harvesting opportunities. This enables investors to capture the advantages of passive investing while still availing themselves of the tax loss benefits of a more active approach. 

Malkiel notes that passive strategies outperform active 90% of the time, and active returns are even worse after taking taxes into consideration. He sees direct indexing working well, especially for investors who are periodically putting money to work in their accounts and during periods of heightened volatility. 

In terms of other tax considerations, Malkiel believes that Roth IRAs are the best investment vehicles for the majority of investors. He recommends dollar-cost averaging when investors are in the ‘accumulation’ phase but not necessarily for those drawing down funds. And he reaffirms that keeping costs low is one of the keys to long-term investing success. 

Finsum: Burton Malkiel, the author of “Random Walk Down Wall Street” is an advocate for direct indexing given its power to boost after-tax returns.