Direct indexing has recently become a hot topic in the financial industry and for advisors looking to differentiate themselves from the pack, fund giant Vanguard recently identified four situations that they should consider using direct indexing. The first is tax-loss harvesting. For example, when an index is up, some of its holdings can be trading at a loss. An investor in a direct indexing strategy can sell those stocks and create a tax loss that can be used to offset taxes that are due as a result of an overall gain for the index. The firm also lists ESG as another reason. A custom index can be designed to avoid shares of firms involved with fossil fuels. The third situation is factor investing, or investing in companies that have specific factors such as growth, value, or quality. A custom index can be created to meet those criteria. The last situation Vanguard recommends is diversification. A custom index can be built to accommodate an investor that may be required to hold a certain number of shares in his or her employer.
Finsum:According toVanguard, tax-loss harvesting, ESG, factor investing, and diversification are four strategies that advisors should consider when building custom indexes.