Until recently, direct indexing has typically been applied for equities. Its benefits in terms of creating after-tax alpha and increased customization are well-known. However, advisors should also be aware that direct indexing can also be leveraged for fixed income portfolios, and it can be especially impactful for clients nearing retirement. 

Direct indexing with equities means that investors own the actual constituents of an index rather than a fund. This leads to opportunities for tax-loss harvesting and personalization. Similarly, direct indexing with fixed income means that investors own the actual bonds held by a fund which also allows for tax-loss harvesting and increased personalization.

These portfolios can be optimized based on desired characteristics of credit quality, duration, and maturity. Essentially, this creates a custom, bond ladder portfolio with various fixed income securities.

Research also shows that tax-loss harvesting has more potential benefits in a fixed income portfolio. This is because there are proceeds from maturing bonds and coupons that can be used for reinvestment or lowering a cost basis. Further, the bond ladder can also be optimized based on an investors’ tax rate and/or location, to maximize accretive, after-tax returns. 

Finsum: By now, most are familiar with direct indexing for equities. Now, we are starting to see it applied to fixed income portfolios where the benefits are possibly greater.