Displaying items by tag: capital gains tax

Advisors can use direct indexing to optimize their clients’ portfolios, reduce tax bills, and offer more customized solutions. It also offers an opportunity for an advisor to differentiate themselves and increase their appeal to high net worth prospects with specific needs.

Direct indexing offers more flexibility and solutions than traditional passive investing while retaining the major benefits. One example is that it can be used to reduce concentrated stock positions in a manner that can offset capital gains taxes and help lead to a more diversified and balanced long-term portfolio.

With direct indexing, tax losses can be harvested and set aside. This effectively turns them into assets which isn’t possible with investing in index funds. It could be especially of value to clients expecting a future financial windfall who are interested in proactive steps to reduce the future tax burden. 

Indices can also be modified to offset a large allocation to a specific stock or sector in another part of the portfolio. For instance, someone who works in the tech industry with a large number of stock options may not want tech exposure in their personal portfolio. 

Advisors can start this conversation with prospects by discussing matters like future windfalls, concentrated positions, reducing capital gains taxes, and more personalized solutions.

Finsum: Direct indexing is a way to optimize clients’ portfolios especially those with large capital gains taxes, concentrated positions, and expectations of a future financial windfall. 

One of the reasons that direct indexing has been gaining in popularity is its ability to harvest tax losses in portfolios with regular scans and rebalancing. This technology can also be used to harvest taxable gains on assets that have appreciated considerably over a long period of time by raising the cost basis of securities. This will ultimately lead to a lower capital gains tax bill.

This strategy entails selling shares that are owned on a low-cost basis and then rebuying at a higher cost basis. Unlike tax loss harvesting, there is no wash rule which prevents the same shares from being rebought. It can be most effective when there is an offsetting capital gains loss in another part of the portfolio. 

Investors have not readily embraced this strategy as it conflicts with human nature and the desire not to sell a winning position. Advisors have an opportunity to serve their clients by explaining the benefits. 

However, they need to identify these opportunities with the right technology and holistic perspective. The best chance of gaining this perspective is with a unified management account. It can also aid recruitment as many potential clients are looking for advisors who have a firm grasp on technology and innovative solutions to reduce capital gains taxes.

Finsum: Direct indexing can help advisors and investors with harvesting tax gains in addition to tax losses. This entails selling winning positions and then rebuying at higher levels to lower future capital gains tax bills. 

At one time, direct indexing was only available and viable for ultra high net worth investors. This is now changing due to technology which is simplifying the process, the sharp decline in trading commissions, and the fractionalization of shares. 

With direct indexing, investors and advisors can replicate any index in a managed account. Instead of buying a mutual fund or an ETF, an investor buys the actual components of an index. This comes with added benefits as they can tweak or adjust the holdings of the index to suit their own inclinations or unique situation. It also means that these investors can harvest tax losses which can then be used to offset taxes from capital gains in another part of the portfolio. 

With direct indexing, tax loss harvesting can lead to better performance especially in more volatile years for the market. Even in up years, some segments of the market may finish in the red which provides opportunities to harvest losses to offset gains. 

Direct indexing is particularly useful for investors who have strong beliefs or unique financial situations. For instance, an investor who does not want to invest in tobacco companies can eliminate these from an index and choose another stock which has similar factor scores to ensure that the benchmark continues to be tracked.

Finsum: Direct indexing is an effective strategy to lower tax bills but is only accessible for a tiny segment of investors . Now due to technology and lower commissions, it’s available to nearly everyone. 

Direct indexing is the convergence of two developments. One is that we increasingly live in a world of customization and personalization whether it comes to our newsfeeds, food orders, playlists, etc. The other is that research continues to show that most investors are better off investing passively rather than actively managing their portfolios.

At first glance, there seems to be a contradiction between these two notions. However, direct indexing manages to thread the needle by retaining the benefits of passive investing such as diversification and low costs while also allowing for customization in order to account for an investors’ goals and needs.

For instance, a tech executive may have outsized exposure to the industry due to some compensation in the form of stock options. In their own portfolio, they may look to reduce exposure to tech in order to create more diversification and dampen risk. 

Another benefit is that capital gains losses can be more effectively harvested with direct indexing. This means that if the tech executive were to sell some of their stock options, then the tax bill can be lowered by applying harvested tax losses from the direct indexing portfolio.   

Finsum: Direct indexing provides many advantages compared to passive or active management. Here are some of the benefits.

Ben Hammer, the Head of Client Development for Vanguard, recently spoke to an audience of financial advisors about direct indexing. The asset manager clearly sees it as a major growth avenue especially as most advisors and investors remain unfamiliar with the concept and its benefits.

According to surveys of investors and advisors, the most appealing part of direct indexing is the potential tax savings which is not possible with traditional passive investing. By recreating indexes within an individual investors’ account, losing positions can be sold while stocks with similar factor scores are added in substitution to maintain consistency with the benchmark. Another benefit is customization as investors can adjust a portfolio’s holding based on their own situation, values, or preferences. 

Hammer also stressed that direct indexing wouldn’t be available to a wide swathe of the investing universe because of its cost and complexity. However, these issues have been solved by technology as trading costs have plummeted, while software handles the regular scans for tax loss harvesting opportunities and rebalancing.

Still, direct indexing is probably not necessary for most investors. It can be the perfect solution for those who want more tax savings and customization while retaining the benefits of passive investing. 

Finsum: At a recent conference for financial advisors, Vanguard’s Ben Hammer spoke about the evolution of direct indexing and its growth prospects.