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.
Invest in real estate without the headache of being a landlord
Imagine owning a portfolio of thousands of well-managed single family rentals or a collection of cutting-edge industrial warehouses. You can now gain access to a $1B portfolio of income-producing real estate assets designed to deliver long-term growth from the comforts of your couch.
The best part? You don’t have to be a millionaire and can start investing in minutes.
Learn MoreWhy 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: Learn more about 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.
Retire richer: The secret to building wealth faster
Most people miss out on key opportunities to grow their wealth. Partnering with the right financial advisor can help you secure a brighter future. Learn how to make your money work harder for you today.
Discover the secretHow 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?
The richest 1% use an advisor. Do you?
Wealthy people know that having money is not the same as being good with money. Advisor.com can help you shape your financial future and connect with expert guidance . A trusted advisor helps you make smart choices about investments, retirement savings, and tax planning.
Try it now
