Direct indexing is a new investment strategy that is gaining popularity among investors who want more control over their portfolios. Direct indexing is different from traditional index investing in that it allows investors to hold and manage individual stocks instead of a passively managed fund that tracks a market index. This new strategy is now available at major firms like Schwab, Fidelity and Vanguard, so it certainly is moving mainstream.
What is Direct Indexing?
Direct indexing is a form of customized index investing where the investor holds and manages a portfolio of individual stocks that match a market index. For example, instead of investing in an S&P 500 index fund, an investor could directly index the S&P 500 by holding and managing individual stocks that make up the index. The goal of direct indexing is to provide investors with a customized portfolio that matches their specific investment objectives and goals.
Benefits of Direct Indexing
There are several benefits of direct indexing that make it an attractive investment strategy for many investors.
- Lower Costs: One of the biggest benefits of direct indexing is that it can be significantly less expensive than traditional index investing. This is because direct indexing eliminates the need for a fund manager and the associated management fees, which can be a significant cost for investors.
- Customization: Direct indexing allows investors to create a customized portfolio that matches their specific investment objectives and goals. This can be especially beneficial for investors who have unique investment needs, such as tax optimization, sector exposure, or ESG considerations.
- Greater Control: Direct indexing gives investors greater control over their portfolios. With traditional index investing, the portfolio is passively managed and rebalanced only periodically. With direct indexing, investors can make changes to their portfolios at any time to reflect changes in their investment objectives or market conditions.
- Increased Transparency: Direct indexing provides investors with increased transparency into their portfolios. With traditional index investing, it can be difficult to understand the specific stocks and sectors that make up the portfolio. With direct indexing, investors have full visibility into the individual stocks that make up their portfolios, allowing them to make informed investment decisions.
- Better Tax Management: Direct indexing allows investors to better manage their tax liability by allowing them to sell individual stocks that have declined in value, thus realizing a tax loss, and offsetting any capital gains. This can result in significant tax savings for investors, particularly in volatile markets.
Direct indexing has many positive attributes and despite being fast adopted by investors and institutions alike, it is best to consult with your financial advisor before diving in too deep to this new solution.
Related: When Is a Stock Too Expensive?