If you’re looking for a smarter, more personalized way to invest—especially in a taxable account—direct indexing might be worth a closer look.
Instead of buying an ETF or mutual fund that tracks an index like the S&P 500, direct indexing lets you own the individual stocks directly. That means more control, greater tax efficiency, and the ability to customize your portfolio to fit your goals or values.
It’s a powerful strategy that used to be available only to the ultra-wealthy. But thanks to technology (and being an independent advisor!), it’s now much more accessible—and potentially a game-changer for long-term wealth building.
What exactly IS Direct Indexing??
Direct indexing is a personalized investment strategy where a client owns the individual stocks of an index (like the S&P 500) instead of buying a mutual fund or ETF that tracks it.
Here’s how it works and why it’s beneficial for certain clients.
How Direct Indexing Works:
- Replicates an Index:A portfolio is built to mimic the performance of a broad index (like the S&P 500) by buying many (NOT all) of its individual stocks.
- Customizable: You can tailor the portfolio to exclude specific sectors or companies based on client preferences (e.g., ESG considerations or concentration risk).
- Tax-Loss Harvesting: This is one of the biggest advantages and why this strategy really matters! Individual stocks that decline in value can be sold to capture tax losses, which can offset gains elsewhere and reduce tax liability—something you can’t do with a mutual fund or ETF.
- Ongoing Management: Portfolios are often rebalanced and monitored for opportunities to harvest tax losses or reflect the client’s changing goals or restrictions.
Before I explain who benefits the most about Direct Indexing, here’s a little history about it:
Direct indexing has been around for decades, but it gained more mainstream traction in the 2000s as technology advanced, making it easier and more cost-effective to manage individual stocks at scale. Originally, it was more commonly used by institutional investors and high-net-worth individuals, as the technology and resources to handle the complexity were not widely available.
In the past 10–15 years, the development of robo-advisors and fractional share trading has made direct indexing more accessible to a broader group of investors, including those with smaller portfolios and less capital to invest. The ability to automate tax-loss harvesting and rebalance personalized portfolios has particularly accelerated its adoption.
So, while the strategy itself isn’t new, its availability and practicality for a wider range of investors (like millennials, small business owners, and even families) have only been growing rapidly in recent years.
Who benefits most from Direct Indexing??
Direct indexing is best suited for clients who meet some or all of the following criteria:
1. High-Income Earners or High Net-Worth Individuals
- They benefit most from tax-loss harvesting, which helps offset capital gains and reduce taxable income.
- Especially valuable in high-tax states or for those subject to the Net Investment Income Tax (NIIT).
2. Clients with Large Taxable Investment Accounts
- Direct indexing is not ideal in tax-advantaged accounts like IRAs or 401(k)s since tax-loss harvesting isn’t relevant there.
- It shines in taxable brokerage accounts where managing capital gains and losses can significantly impact after-tax returns.
3. Clients that own a business
- When a business is sold, the owner usually faces a large capital gains tax bill. With direct indexing, the client may already have accumulated realized capital losses from tax-loss harvesting in their investment account.
- Offset capital gains from the sale, reducing the overall tax hit.
- Carry forward unused losses to future years, continuing the tax benefit even after the sale.
4. Charitably Inclined Clients
- Can donate appreciated individual stocks directly for greater tax efficiency (skip capital gains and take a deduction).
5. Clients with Concentrated Stock Holdings
- If a client already has a large position in a stock (e.g., employer stock purchase plans, employer stock options, inherited stock), direct indexing allows them to exclude that stock or sector to manage risk and diversify more effectively.
- There are even strategies that help add a little more protection AROUND your stock position, especially if you don’t want to sell, or only want to sell a little.
6. Clients with ESG or Values-Based Preferences
- Direct indexing allows for personalized screens (e.g., excluding tobacco, fossil fuels, or gun companies) that aren’t always possible in ETFs or mutual funds.
7. Clients with a minimum of $250k + to Invest
- Due to the number of individual stocks involved, there’s a minimum investment threshold, and depending on the complexity and who we ultimately use to deploy this strategy, it might require more.
This is one of the many reasons why it's beneficial to have an independent Financial Advisor, like me, (and also one of the many reasons why I left the bank channel) 😉. This wasn’t even an option for clients through the bank, and I know some of you reading this have very complex situations. I wanted to associate myself with a firm that has advanced planning capabilities, such as direct indexing.
Curious if this is a fit for you? Have any questions about direct indexing or want to get a portfolio manager on the phone? Are you a business owner and want to start planning ahead? Or maybe you're tired of getting slammed by the taxes in your investment portfolio- give me a call or send me an email.
(806) 474-7891
hhennigh@osaicwealth.com