ETFs provide many benefits to a portfolio, from their tax-efficient nature to their low costs to their trading flexibility. But ETFs may not be ideal for every situation — or investor. For some high-net-worth investors with very customized needs for their portfolios, direct indexing may be something worth looking into.
Direct indexing, also known as personalized indexing, is an individual account that’s managed to track an index, like a separately managed account. The investor owns the individual securities while an asset manager manages the account on their behalf.
One of the biggest advantages personalized indexing offers is customization. Unlike investing in a mutual fund or ETF, an investor can customize which securities are in their direct indexing account. Direct indexing can be particularly useful for investors with precise environmental, social, and governance (ESG) needs that an off-the-shelf ESG fund won’t provide.
A direct indexing portfolio can allow investors can customize their needs and preferences, include their religious preferences, avoid companies they believe are involved in objectionable activities, or support businesses that pay their employees a fair living wage or that advance diversity on their boards.
Another major benefit that direct or personalized indexing provides is tax-loss harvesting opportunities. Tax loss harvesting involves selling an investment at a loss, then reinvesting the proceeds of that sale into another asset.
While investors can’t sell individual failing stocks for tax-loss harvesting purposes within a mutual fund or ETF, they can sell securities at a loss to offset capital gains through direct indexing. And unlike a traditional SMA, direct indexing offers scalable, automatic tax-loss harvesting.
At Exchange 2023, Ben Hammer, head of client development for Vanguard Personalized Indexing, said that direct indexing provides “some added advantages because you own the individual stocks, and any time the market is up while some of those stocks might be down, [you] tax-loss harvest those, use those to offset gains somewhere else in your portfolio.”
Also at Exchange, Vanguard CEO Tim Buckley said that the use cases for direct indexing could expand to a broader investor base beyond “the ultra, ultra-high-net-worth” investor, and is something the company will “be investing heavily” in.
High-net-worth investors looking to benefit from the tax optimization and customization features of direct indexing may want to consider Vanguard Personalized Indexing. VPI’s algorithms automatically review each account daily and harvest individual security losses as opportunities arise. More information about VPI can be found online.
For more news, information, and analysis, visit the Direct Indexing Channel.