High-net-worth (HNW) investors often have strong convictions about where they want their money invested and the charitable causes that they support. Direct indexing can be a particularly useful and efficient tool for investing according to an investor’s convictions and for transferring donations to charities they support. That’s where the “direct” part of its name kicks in.
Investors who opt to use direct indexing are directly owning the actual stocks in the created index via an SMA rather than owning shares of an ETF or mutual fund. That’s a crucial difference, as it gives the investor far more power over the portfolio’s contents than they would have with a different type of investment vehicle. It’s that direct ownership that empowers the socially conscious investor to support their beliefs in both the purchasing and the selling of stocks.
A Customized Approach
Socially responsible strategies in ETF or mutual fund wrappers are often rife with compromises. Some strategies still provide exposure to industries that an investor may abhor but only focus on the “less bad” actors within the category. Often, a company that scores poorly in one area could make the cut because it scores highly in another.
Categories that one methodology may exclude could be something that an investor wants exposure to. For example, depending on someone’s geopolitical views, nuclear weapons, which are often excluded, may not be an area they necessarily want to avoid. Or perhaps someone wants to make sure their money isn’t supporting companies involved in alcohol or gambling, which are often not addressed in ESG methodologies.
Maybe the investor adheres to a particular religion and wants to invest in companies that align with all or some of those beliefs. Given the personal nature of religious beliefs, though, even members of the same faith may hold opposing views, so a strategy inspired by a specific religion may not satisfy all of its adherents. However, direct indexing allows an investor to customize their investments to align with all kinds of personal values.
Direct Indexing Opportunities in Rebalancing
An investor in an ETF or mutual fund has no involvement in the rebalancing of those funds. However, an investor using a direct indexing approach can make an impact even when removing stocks from their portfolio.
Rebalancing generally involves selling off securities that have performed well, which can result in capital gains taxes on that appreciation. However, an investor using direct indexing can simply rebalance their portfolio by offloading shares that have not seen significant appreciation. If an investor has a charity that they support, they can donate those highly appreciated shares that would otherwise incur tax consequences.
The investor can transfer the shares to a charity which is then free to hold onto the investment or sell it. Charities don’t have to pay federal income taxes on gifts, and the investor never has to pay the taxes that they would have if they had sold the stock for a profit.
The investor can also possibly claim a tax write-off associated with their donation in addition to supporting a cause they value. Because direct indexing can allow for very personalized decision making, a truly forward-looking investor can even make sure the shares they donate align with the charity’s stated goals. For example, an investor could donate shares in a solar energy company to a charity aimed at stopping global warming.
Essentially, for a socially responsible HNW investor, direct indexing offers the opportunity to have a positive impact from multiple angles.
For more news, information, and analysis, visit the Direct Indexing Channel.
