Displaying items by tag: capital gains tax

Schwab Asset Management conducted its annual ETF and Beyond report in which it surveys a sampling of its own clients to gain insight into how investors are thinking. One of the most interesting findings was that Millennial investors are the demographic most interested in personalizing their portfolios and having their investments align with their values.

But, that instinct is shared by other age groups to a lesser degree. Overall, 88% of respondents said that they are looking to personalize their portfolios, while 78% want to align their investments with their personal values. 

65% of ETF investors said that it’s important to have more control over their investments, 61% want a greater ability to customize investments, and 61% are looking to optimize their tax situation. Of course, these factors are why direct indexing has been gaining in popularity in recent years. 

There’s also increased awareness as 87% of ETF investors are now familiar with the strategy in comparison to 80% last year. 69% of ETF investors, not in any direct indexing product, expressed interest in doing so over the next year. 

Not surprisingly, direct indexing is even more popular with Millennials as 53% are interested in learning more about it, in contrast to 34% of Gen X and 22% of Baby Boomers. Overall, all investors want more control of their portfolios and alignment with their values, but this trend is even more pronounced among younger investors. 

Finsum: Investors are looking for more control over their investments, tax savings, and alignment with their values. All 3 are possible with direct indexing. 

Direct indexing is in the midst of a boom due to increasing awareness of its benefits from investors and adoption by advisors. Some of the major benefits for clients are increased tax efficiency and more personalization while remaining diversified with low costs. For advisors, it’s an opportunity to add value to clients and provide more specialized services. Overall, it’s estimated that direct indexing can add between 30 and 50 basis points in annual returns.

However, most continue to think of direct indexing in terms of equities, but the technology can also be applied to fixed income. With stocks, most direct indexing strategies are based on re-creating an index within a separately managed account with some adjustments to better fit a client’s financial needs and goals.

In contrast on the fixed income side, indices are not replicated, but it can provide more control, flexibility, and personalization. They can also find increased tax efficiency through regular portfolio scans just like with equities to harvest tax losses which can be used to offset capital gains in other parts of the portfolio. Another benefit is that investors can fine-tune their fixed income portfolios and optimize for different characteristics such as duration, credit risk, income, or geography. 

Finsum: Direct indexing is in the midst of a boom. While many are now familiar with its benefit for equities, it can also be used with fixed income. 

According to a report from Cerulli Associates, direct indexing will grow faster than ETFs, mutual funds, and separately managed accounts (SMA) over the next 5 years. Currently, it’s estimated that total assets under management for direct indexing strategies will exceed $800 billion by 2026 from $462 billion at the beginning of last year. 

Another factor that should support direct indexing’s growth is that only 14% of financial advisors are aware of direct indexing and actively recommend it to clients. It’s estimated that 63% of advisors have a client with over $500,000 in investable assets, while 14% of advisors focus on clients with over $5 million in assets. Direct indexing offers the most clear advantages for high net worth clients. For advisors, it’s an opportunity to offer a differentiated service especially as tax management and customization are highly valued by many prospects. 

Direct indexing is growing in popularity as it allows investors to retain the major benefits of index investing while accessing greater personalization and unlocking certain tax advantages. With direct indexing, clients own the actual components of an index as opposed to an ETF or mutual fund. This leads to more potential for tax loss harvesting and customization to suit a clients’ particular needs or construct a portfolio that aligns with their values. 

Finsum: Direct indexing is forecast to grow faster than many ETFs, mutual funds, and SMAs over the next 5 years. Here are some of the key reasons for its growth, and why advisors should pay attention.  

One of the major benefits of direct indexing is that tax losses can be harvested during up and down years. This option is not available to clients who are invested in indices. This is because clients will own the actual components of an index in their account rather than an ETF or a mutual fund. With regular scans, losing positions can be sold to harvest tax losses which can then be used to offset gains in the future or other parts of the portfolio.

This is because some components of the index will be in the red even in up years. These positions are sold and then other stocks with similar factor scores are added to ensure the benchmark continues to be tracked. 

According to Vanguard, “Because investors directly own the individual securities in their direct indexing portfolios, you can harvest losses for them even in years when the index is up. You can use these losses to offset your clients’ capital gains, and help them keep more of what their portfolios earn.” Overall, it believes that the strategy can add between 1% and 2% in annual returns in after-tax alpha for clients with large capital gains in addition to helping optimize short and long-term holding periods to minimize capital gains taxes. 

Finsum: Direct indexing has several benefits for investors such as tax-loss harvesting. While many are familiar with its application during down years, less are aware that it can be used to add alpha even in up years. 

For many clients who want personalized solutions and have complicated financial needs, the traditional approach of mutual funds or ETFs fall short. For investors with more complex tax issues or who desire that their investments align with their values, direct indexing offers a more comprehensive strategy.

Direct indexing captures many of the benefits of passive investing such as diversification, low-costs, and investing in an index. But the key differences are that the actual components of an index are owned by the investor rather than the fund. 

Thus, there is a greater level of customization as investors modify these holdings to reflect their own political, religious, or ethical beliefs. This is especially pertinent with the increasing traction of ESG or values-based investing. 

This customization can lead to better risk management as portfolios can be adjusted to reflect a clients’ particular risk profile and long-term goals. Another benefit is increased tax efficiency as there is more control over when capital gains are realized. Tax losses can be regularly harvested and used to offset capital gains. Similarly, charitable giving through direct indexing can also have certain tax advantages while also giving clients an opportunity to support causes or organizations that they believe in. 

Finsum: Direct indexing has specific benefits that may appeal to clients looking to optimize their tax situation, align their investment with their values, while still retaining the benefits of passive investing.