Top 5 Reasons to Use Direct Indexing

Executive summary:

  • Most mutual funds or ETFs can't solve certain issues that your high-net-worth clients may face today
  • Direct Indexing can help investors with tax management, diversifying concentrated positions or imposing restrictions for a variety of reasons.
  • Direct Indexing may help solve investment challenges that requires personalization and tax management

Anyone who came of age in the 1980s or 1990s knows that David Letterman was "must-see" late-night television viewing. His show was a staple for many of our generation. While today the thought of staying up to midnight to watch a TV show is unfathomable, back then I didn't think twice. Of course, the highlight of the show was the Top 10 list when Letterman would read out the usually silly or ridiculous top 10 signs, items or issues on some bizarre topic and the audience would laugh.

So, when I began to write this blog about the main reasons for incorporating Direct Indexing into your client's investment portfolio, I thought I would take a page out of Letterman's book. While my list certainly won't be as funny, nor as long, it might be interesting and maybe just a bit educational.

Let's start by quickly addressing mutual funds and Exchange-Traded Funds (ETFs). These investment vehicles have served investors well over the years, but they can't solve certain issues that many high-net-worth investors face today. Fortunately, there are other options, such as Direct Indexing, that are available when mutual funds and ETFs aren't able to meet the needs of the individual investor. So with that being said…

The top five reasons you should consider Direct Indexing for an investment portfolio are:

Drumroll please…

#1: Tax management

One of the most common issues for investors is managing the tax liability associated with their investment portfolio. Recent market volatility, along with potential changes coming out of Washington, DC, have led many investors to think more about the tax implications of their investments than they have in the past.

Using a direct indexing strategy can potentially reduce the tax burden of a portfolio and improve after-tax outcomes. Unlike a mutual fund, where the investor cannot take advantage of the individual losses on the stocks in the fund, with direct indexing, the investor owns a basket of individual securities, each with their own cost basis. This allows the investor to sell the stocks that are down and replace them with similar names. The losses taken from the stocks that were sold can be used to offset capital gains now or a taxable event in the future, such as the sale of a business, property or stocks and bonds.