Ultra high net worth investors have been using direct indexing to reduce their annual tax bill for years. But thanks to breakthroughs in technology and the ability to buy fractional shares, direct indexing has become more accessible. A wider array of investors can now enjoy direct indexing’s tax-loss harvesting (TLH) capabilities.
Tax-loss harvesting involves selling investments at a loss to use the losses to offset gains in other investments. The investor uses the money from the sale to buy an investment that fills a similar role in the portfolio.
It’s a process that can potentially help investors earn better returns and lower their taxes. It’s also a process that is one of direct indexing’s superpowers.
See more: Boost Your Clients’ After-Tax Returns With Direct Indexing
A direct indexing account sells securities that drop below their cost basis. It then uses the proceeds to immediately buy correlated (but not substantially identical) replacement stocks.
Checking Accounts Daily for TLH Opportunities
A service like Vanguard Personalized Indexing scan accounts quarterly, monthly, or even daily for tax-loss harvesting opportunities. VPI’s algorithms automatically review each account and harvest individual security losses as opportunities arise.
And personalized indexing with daily TLH has boosted some investors’ after-tax returns by more than 2%, according to Vanguard. Tax-loss harvesting can continue to deliver tax alpha for high net worth investors even if the market experiences some degree of volatility. Vanguard added that strategies with daily scans “is critical to achieving the maximum harvest in ‘typical’ (non-high) volatility environments.”
Vanguard CEO Tim Buckley said at Exchange 2023 that direct indexing used to be a tool only “reserved for the ultra, ultra high net worth” investor. But he noted that its use cases could be expanding to a broader investor base. Buckley added that Vanguard will “be investing heavily” in direct indexing.
More information about VPI can be found online.
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