For many clients who want personalized solutions and have complicated financial needs, the traditional approach of mutual funds or ETFs fall short. For investors with more complex tax issues or who desire that their investments align with their values, direct indexing offers a more comprehensive strategy.
Direct indexing captures many of the benefits of passive investing such as diversification, low-costs, and investing in an index. But the key differences are that the actual components of an index are owned by the investor rather than the fund.
Thus, there is a greater level of customization as investors modify these holdings to reflect their own political, religious, or ethical beliefs. This is especially pertinent with the increasing traction of ESG or values-based investing.
This customization can lead to better risk management as portfolios can be adjusted to reflect a clients’ particular risk profile and long-term goals. Another benefit is increased tax efficiency as there is more control over when capital gains are realized. Tax losses can be regularly harvested and used to offset capital gains. Similarly, charitable giving through direct indexing can also have certain tax advantages while also giving clients an opportunity to support causes or organizations that they believe in.
Finsum: Direct indexing has specific benefits that may appeal to clients looking to optimize their tax situation, align their investment with their values, while still retaining the benefits of passive investing.