Index investing has long been valued for its simplicity, low cost, and broad market exposure. For many investors, it forms the foundation of a strong portfolio. However, while index funds and ETFs offer efficiency, they also come with limitations. They lack flexibility when it comes to taxes and personalization.
Direct indexing is a modern approach that keeps the benefits of index investing while giving you more control. It has become increasingly accessible and may offer meaningful advantages, especially for investors with taxable accounts.
What Is Direct Indexing
Direct indexing is an investment strategy that aims to replicate the performance of a market index, such as the S&P 500, by owning individual stocks instead of a fund. These stocks are held in a separately managed account, giving you direct ownership rather than holding a share of a mutual fund or ETF.
Instead of buying every stock in the index, the portfolio holds a carefully selected group of companies that closely reflect the index’s performance. This allows you to stay invested in the broader market while gaining added flexibility.
By directly owning the stocks, you can take advantage of strategies like tax-loss harvesting and adjust your holdings to better fit your financial situation.
Why Investors Are Paying Attention
Tax-Loss Harvesting Opportunities
Owning individual securities allows you to sell specific holdings that have declined in value. This process, known as tax-loss harvesting, creates realized losses that can be used to offset gains or reduce taxable income. The key advantage is the ability to harvest these losses while continuing to hold a portfolio that is expected to deliver returns in line with the index. This added control can help improve your after-tax performance without sacrificing overall market exposure.
Personalized Investment Choices
Direct indexing offers a level of customization that traditional index funds cannot. While the overall portfolio is designed to track a broad market index, you have the flexibility to adjust individual holdings in ways that align with your financial objectives and planning strategies.
Control Over Capital Gains
With mutual funds, you can be taxed on capital gains generated by the fund’s internal trading, even if you did not sell any of your shares. Direct indexing avoids this by giving you direct ownership of the individual stocks, so gains are only realized when you choose to sell. This allows you to better manage the timing of gains based on your personal tax situation.
Automatic Rebalancing and Optimization
Many platforms that offer direct indexing use technology to monitor your portfolio and make ongoing adjustments. This includes regular rebalancing and frequent reviews for tax-loss harvesting opportunities. These features help maintain alignment with the index while improving tax efficiency over time.
Who Can Benefit
Direct indexing was once available only to institutional investors, but today it is more accessible through select providers. For example, the platform we use offers direct indexing with a minimum as low as $250,000.
This strategy may be a good fit if you:
- Have most of your money invested in after-tax investment accounts and want to dedicate a portion of your portfolio to a more tax-efficient strategy
- Are in a higher marginal tax bracket
- Have a large upcoming capital gain and want to build up losses to offset it
- Want more control over individual portfolio holdings and tax timing
Direct indexing is not the best choice for every investor, but for the right situation, it can offer powerful benefits. For those looking to maintain broad market exposure while improving tax outcomes and adding more flexibility to their investment strategy, direct indexing can be a compelling solution.
If you are curious about how this approach might fit into your overall financial plan, speaking with a qualified advisor can help determine whether it is worth exploring. Contact us today to start the conversation.
The commentary on this website reflects the personal opinions, viewpoints, and analyses of the Trinity Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Trinity Wealth Management, LLC or performance returns of any Trinity Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Trinity Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
