Displaying items by tag: direct indexing taxes

In a piece for Vettafi’s ETFTrends, James Comtois covers how direct indexing can improve portfolios through increased diversification while also leading to savings on capital gains taxes. The strategy achieves both objectives by helping portfolios from becoming overly concentrated.

Typically, no stock should account for more than 10% of a portfolio due to the risk of a significant decline in price or a bankruptcy filing. Portfolios can become overly concentrated due to a client receiving stock options, early investments in a company, or large holdings of vested stock. 

For clients in these unique situations, the traditional investing strategy would not suffice. Instead, they need a unique solution. Simply selling these positions is not prudent as it could lead to a massive tax bill. 

A better option is direct indexing which lets clients own the actual index holdings in their portfolio. Then, the portfolio can be adjusted to reduce overconcentration. Further, tax losses can be harvested on a regular basis during periods of market volatility. Subsequently, holdings of the overconcentrated position can be sold with the capital gains offset by these harvested losses. 

Finsum: A unique problem for some investors is becoming overconcentrated in one position. Direct indexing offers a solution as it can help reduce the tax bill of selling these positions and lead to more diversification.

In an article for ETFTrends’ Direct Indexing Channel, James Comtois discusses how direct indexing essentially means that advisors and investors become portfolio managers, since they own the stocks directly and can customize their holdings based on their goals, preferences, and individual circumstances.

Contrast this to passive ETFs which continue to be the dominant investment vehicle for investors and advisors in which stocks are indirectly owned with no possibility of customization. Some drawbacks to indirect ownership are no shareholder rights in terms of voting on Board members or other issues. Additionally, there is no possibility of harvesting tax losses during periods of volatility to offset capital gains in other holdings. 

Many younger investors are passionate about their investments reflecting their values. This is simply not possible through passive ETFs. For instance an investor may not want to own companies in the defense industry, direct indexing allows them to exclude these companies and replace them with stocks that have similar factor scores to ensure integrity with the underlying index.

Given these benefits, it’s understandable why the category has seen major growth in the last couple of years. And, this growth will continue especially as direct indexing is no longer only available to high net worth investors. It’s increasingly being offered to those with smaller sums to invest through firms like Vanguard and Schwab. 

Finsum: Direct indexing is rapidly growing due to the benefits it offers investors which include increased customization and tax loss harvesting.