• Discounts and special offers
  • Subscriber-only articles and interviews
  • Breaking news and trending topics

Already a subscriber?

By signing up, you accept Moneywise's Terms of Use, Subscription Agreement, and Privacy Policy.

Not interested ?

What Is direct indexing?

The S&P 500 is made up of 500 of the biggest American stocks on the market. All listed stocks in the index must have a market capitalization of over $5.3 billion and four straight quarters of positive earnings, along with meeting several other requirements regarding liquidity and trading volumes.

Index funds allow you to buy all stocks in the index at once. You can use direct indexing with any index. But since the S&P 500 index is so popular, we’ll use that for our examples in this article.

With direct investing, an investor would buy all 500 stocks individually rather than in an index fund. Doing so gives an investor exposure to the entire index, with all the benefits of diversification that come with an index fund. But instead of an investment fund manager keeping the entire fund in balance with the S&P 500, you (or a computer or financial advisor) handle it directly.

Meet Your Retirement Goals Effortlessly

The road to retirement may seem long, but with WiserAdvisor, you can find a trusted partner to guide you every step of the way

WiserAdvisor matches you with vetted financial advisors that offer personalized advice to help you to make the right choices, invest wisely, and secure the retirement you've always dreamed of. Start planning early, and get your retirement mapped out today.

Get Started

Why direct indexing can beat index funds

With index funds, investors can buy a bucket of investments that is made up of all 500 stocks in Standard and Poor’s famous index. This is great because you get access to 500 stocks with having to pay only one trade commission.

But with direct indexing, you are able to take advantage of tax-loss harvesting at a scale not possible with traditional funds. After all, with a fund, when you buy or sell, you are buying or selling the entire list of stocks. Many robo advisors, such as Betterment and Wealthfront, offer opportunities for tax-loss harvesting. Betterment takes care of tax-loss harvesting only at a fund level. But direct indexing (and Wealthfront) allows tax-loss harvesting at the individual stock level.

More: Sign up for Betterment

More: Sign up for Wealthfront

While you may end up paying more fees for a managed direct indexing portfolio than you would with a low-fee index fund, tax-loss harvesting benefits can make up for those costs and then some.

To see how the numbers fall into place for your portfolio, let’s look at an example. Let’s say you bought a handful of S&P 500 stocks at the start of the year. From January to October, one stock you hold falls by $4,000. If you want to keep building your portfolio and avoid selling, you get no tax benefit from this scenario in an index fund. But with direct indexing, you can sell the stock with a $4,000 loss and buy a comparable S&P 500 stock with the proceeds. This locks a $4,000 capital loss into your portfolio, offsetting a future capital gain. At the 25% tax bracket, that is worth $1,000 in tax savings.

Is direct indexing the next evolution of index funds?

Index funds and lower trading fees have democratized the investment markets. But wealthy investors still have access to many options regular investors do not. However, technology is changing those norms.

Technologies at leading robo advisors give more investors access to tax-loss harvesting. And now, advances in trading technologies are opening up the markets to direct indexing from regular investors.

Not that long ago, investors had to call a stockbroker and pay a $50 fee to trade a single stock. Now you can trade stocks for $5 from many brokerages, and one app offers free trades. In recent years, a massive number of dollars have flowed into index funds, with industry leader Vanguard passing $4 trillion in assets under management. As of 2016, 42% of U.S. stock mutual fund assets are held in passive funds.

This 2 Minute Move Could Knock $500/Year off Your Car Insurance in 2024

Saving money on car insurance with BestMoney is a simple way to reduce your expenses. You’ll often get the same, or even better, insurance for less than what you’re paying right now.

There’s no reason not to at least try this free service. Check out BestMoney today, and take a turn in the right direction.

Get Started

How to get started with direct indexing

Wealthfront offers the most accessible route to direct indexing, with a $500,000 minimum for the advanced indexing plan. This gives the firm an edge over Betterment but only for investors with a six-figure portfolio.

Building a direct indexing portfolio on your own requires a ton of time and significant assets. For most investors, it would not be practical to attempt such a portfolio manually or without professional assistance.

However, that does not mean you should ignore tax-loss harvesting. A solid portfolio built with tax-loss harvesting can help you save up enough assets to eventually begin direct indexing. And you can learn a lot about tax-loss harvesting along the way.

Any form of tax-loss harvesting requires a fairly large portfolio to make a significant impact. But you can start with tax-loss harvesting in smaller portfolios as well. Tax-loss harvesting has some skeptics but many more fans. If you are looking for an option to take your portfolio and tax strategy to the next level, direct indexing may be perfect for you.

More: What are robo advisors?

Sponsored

Follow These Steps if you Want to Retire Early

Secure your financial future with a tailored plan to maximize investments, navigate taxes, and retire comfortably.

Zoe Financial is an online platform that can match you with a network of vetted fiduciary advisors who are evaluated based on their credentials, education, experience, and pricing. The best part? - there is no fee to find an advisor.

About the Author

Eric Rosenberg

Eric Rosenberg

Freelance Contributor

Eric Rosenberg is a finance, travel and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full time.

What to Read Next

Disclaimer

The content provided on Moneywise is information to help users become financially literate. It is neither tax nor legal advice, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional. We make no representation or warranty of any kind, either express or implied, with respect to the data provided, the timeliness thereof, the results to be obtained by the use thereof or any other matter.