Displaying items by tag: direct indexing

It’s hard to tell if direct indexing is a fad or a true innovation in the financial world but the data is trickling in and it appears to be garnering genuine interest. Custom indexing has long been a tool for institutional and high-net-worth individuals but the new wave of fintech companies who have leveraged innovation to deliver and lower minimums has it gaining traction among a wider audience. Cerulli Associates has direct indexing pegged at growing by 12% annually which will outpace ETFs and mutual fund competitors. Direct indexing differentiates itself from ETFs by giving investors autonomy because they own the underlying assets. This gives the flexibility to add/drop stocks as they can see fit. The most common usage for this type of investment vehicle is for tax-alpha where investors can drop poor performers to tax-loss harvest.

Finsum: Custom indexing is really bringing more options and flexibility to investors which makes investments more democratic than ever. 

You have probably seen a half dozen headlines in the last six months (at least) that point to a mainstream financial firm buying out a new fintech platform for their custom/direct indexing technology. There has been extreme demand for custom, tax-efficient, solutions for portfolios that give the flexibility, formally reserved for the ultra-wealthy, for much lower initial investments. The biggest advantage is tax alpha which is generated by reducing taxable liabilities through loss harvesting. However, that was really only possible with extremely high net worth as the active management was just too costly. Firms like BlackRock, JPMorgan, and Vanguard have snatched up DI solutions for other reasons as well such as ESG which gives much more flexibility to their clients.

Finsum: The race for low fee/ low initial investment DI is on, but its shape will change as the goldilocks solution has yet to be found. 

Direct indexing is an investment strategy where investors own the underlying components of the index, and is rapidly widening in popularity. The full potential may yet to be unleashed however because the strategy could develop as a way to increase charitable contributions. Custom indexing could be used as a means to increase charitable flexibility by gifting stocks or bonds that couldn’t be traded in a comparable ETF. In addition to giving for charity investors could select stocks or bonds that have exhibited losses in order to offset the taxable amounts. This benefit could be double-sided, because charitable contributions reduce tax burden as well. A financial advisor in conjunction with a CPA could harness the full power of direct indexing to maximize investor alpha.

Finsum: While deciding between cash and equity charitable givings is difficult, direct indexing adds a whole new dimension to charitable giving that could unlock new potential.

Direct Indexing is being touted as the best way to generate tax alpha in a portfolio but is it all that it's cracked up to be? Experts say it has limits and diminishing marginal returns over time because as stocks are dropped, replacements with a lower cost basis will be more expensive to unload later on. Moreover one of the less talked about aspects is that as opportunities narrow as stock is unloaded there is less upside to growth opportunities as the portfolio is smaller. Investors should look to capitalize on direct indexing as they offload specific accounts for inheritance and retirement which is a relatively more minor portion of the portfolio.

Finsum: There may be a shift from custom indexing as a primary ESG focus if it fails to deliver tax alpha and is better suited to dropping greenwashers.