How Direct Indexing Can Offer Potential Tax Savings and Flexibility

SUMMARY

Direct indexing is a method used to track and measure the performance of an investment portfolio. It involves creating a customized index that mirrors the holdings of the portfolio. This approach eliminates the need for a mutual fund or exchange-traded fund (ETF) to represent the index. Instead, investors can directly own the individual securities in the index. By investing in the underlying assets, investors can enjoy greater control over their portfolios and potentially reduce costs. Direct indexing allows for tax-loss harvesting, selling securities at a loss to offset capital gains and lower tax obligations. Additionally, it offers the flexibility to exclude certain companies or industries from the portfolio for ethical or personal reasons. Overall, direct indexing provides an innovative and personalized approach to investing.

TAX LOSS HARVESTING

A major benefit of direct indexing strategies is the use of tax loss harvesting.Tax loss harvesting is a strategy used by investors to minimize their taxable income. It involves selling investments that have experienced a loss in order to offset capital gains and reduce the overall tax liability. When an investment is sold at a loss, this loss can be used to offset any capital gains realized throughout the year. If the losses exceed the gains, up to $3,000 can be deducted from ordinary income, with any remaining losses carried forward to future years. This is a popular technique used by investors to not only reduce their tax bill but also to rebalance their investment portfolio. By strategically selling underperforming assets and reinvesting the proceeds, investors can potentially improve their overall returns over time. However, it's important to note that tax loss harvesting should be done with careful consideration of the investor's specific tax situation and investment goals.

CUSTOMIZATION

Another potential benefit of direct indexing that you won’t find with a typical index fund is the ability to customize your portfolio’s holdings. Index ETFs are essentially a package deal—you get every stock that’s part of the index. But with direct indexing, you can tailor your holdings to align more closely with your financial goals or personal values. For example, if you’re an environmentally conscious investor, direct indexing may allow you to avoid certain companies with high carbon emissions. Or perhaps you feel you have too much exposure to a certain stock or sector that you view as risky; direct indexing can help you diversify around that position to help mitigate the risk. You can make adjustments as you see fit with help from a Financial Advisor who will monitor, periodically update and rebalance your investments so they don’t stray far from performance targets.

IS IT FOR YOU?

Direct indexing strategies are suitable for investors who are seeking greater control and customization over their investment portfolios. These strategies are particularly beneficial for high-net-worth individuals or institutional investors who have substantial assets to invest. By directly owning individual stocks or bonds instead of using mutual funds or exchange-traded funds (ETFs), investors can tailor their portfolios to match their specific investment goals and preferences. Additionally, direct indexing allows investors to implement tax-loss harvesting techniques, which can help minimize tax liabilities. However, it's important to note that direct indexing strategies require a higher level of knowledge and expertise in investment management, as well as access to sophisticated technology platforms. Therefore, these strategies may not be suitable for all investors and should be carefully considered based on individual circumstances and goals.

You can learn more about the technology our Savvy Direct Indexing is built on here.