Direct indexing with daily scans for tax-loss harvesting opportunities can increase after-tax alpha by at least 20 basis points. In some cases, that after-tax alpha can increase by more than 100 basis points.
A direct indexing portfolio is a separately managed account based on a benchmark index. But unlike traditional SMAs, direct indexing offers scalable, automatic tax-loss harvesting.
Tax-loss harvesting involves selling an investment at a loss, then reinvesting the proceeds of that sale into another asset. Since harvesting opportunities don’t just spring up at the end of the year, the frequency at which a portfolio is scanned for tax-loss harvesting opportunities matters.
Direct indexing software scans the portfolio for tax-loss harvesting opportunities at a set frequency (daily, quarterly, or monthly). Generally, the more frequent the scans, the higher and more consistent the results.
For Investors With Extensive Recurring Capital Gains
According to Vanguard, direct indexing services with daily tax-loss harvesting scans could be a huge boon to investors with extensive recurring capital gains. This harvesting strategy enables investors to increase their allocations to such active equity strategies as hedge funds and private equity.
Vanguard wrote that this strategy helps increase investors’ available “shelf space” for active equity strategies. Plus, it lets advisors shelter taxable bonds in their clients’ tax-advantaged accounts. This maximizes investors’ after-tax returns.
Vanguard also suggests pairing active equity ETFs with direct indexing. This chocolate-meets-peanut butter investment approach could lead to higher after-tax wealth outcomes than if neither strategy was used.
Vanguard Personalized Indexing can automatically scan for harvesting and rebalancing opportunities across dozens of investments and hundreds of investment lots. VPI can also help high-net-worth clients with significant capital gains capitalize on volatile markets without violating the wash-sale rule.
Vanguard CEO Tim Buckley said at Exchange 2023 that the company will “be investing heavily” in direct indexing. More information about Vanguard Personalized Indexing "can be found online":https://advisors.vanguard.com/iwe/pdf/FASPRGDE.pdf.
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