How Direct Indexing Benefits High-Net-Worth Individuals

On this episode of A Wiser Retirement™ Podcast, Casey Smith is joined by Andrew Pratt to talk about what direct indexing is, the pros and cons, and how it benefits high-net-worth individuals. Listen to this episode to see if Direct Indexing is the right strategy for you!

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Summary

What is direct indexing?

Direct indexing is an investment strategy that uses technology software to systematically optimize, or rebalance the portfolio, a legacy account to a target benchmark’s risk exposure overtime. Strategies range from broad U.S. market cap and style exposures, to even broad international equity indices

3 Primary Benefits of Direct Indexing

1. Tax Efficiency

• Maximize tax loss harvesting efficiency. Losses can be used elsewhere.
• Realized loss capture leads to after-tax outperformance vs index.

2. Reduce Concentrated Stock Risk

• You can reduce it for accounts that transfer in large basis legacy stocks.
• Recycled TLH proceeds can be recycled and used to help to reduce tracking error which leads to increased diversification.

3. It’s Customizable

• This is only recommended in certain situations, but you can exclude individual stocks or industries as long as the account stay’s within the strategy’s permitted tracking error.

3 Direct Indexing Shortcomings

1. Higher Costs

• Providers charge an asset management fee which typically ranges from 0.2% – 1.0%.

2. Higher Investment Minimums

• Most Direct Indexing providers’ minimum investment amount is $250,000.
• Larger capital outlay vs traditional investing.

3. Investment Implementation Time Lag

• It takes more time to onboard, open a SMA account, implement, etc. vs traditional investing (ETFs).

Who should be utilizing this strategy?

Direct indexing is an investment strategy best suited for a specific group of investors who can truly benefit from its unique advantages. High net worth individuals, particularly those with investable assets greater than $750,000, stand to gain significantly from direct indexing due to the personalized investment approach and potential for enhanced after-tax returns. This strategy is also highly advantageous for taxable investors who are looking to leverage core benefits such as tax-loss harvesting and the ability to tailor the portfolio to personal values or investment preferences. Additionally, direct indexing is a fitting choice for someone who is comfortable with holding a separately managed account (SMA). An SMA provides the investor with direct ownership of the individual securities in their portfolio, as opposed to owning shares of a mutual fund or ETF, allowing for a greater level of customization and tax management. Therefore, individuals fitting these descriptions are the ideal candidates for utilizing direct indexing to optimize their investment outcomes.

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