First introduced in the 1970s, index funds have grown in popularity over time thanks to their ability to provide broad-based diversification at (typically) very low costs, making their benefits available to investors of any level of wealth. And while mutual funds and Exchange-Traded Funds (ETFs) have been the dominant way for investors to get index exposure, thanks to improved technological capabilities and reduced trading costs, direct indexing – buying the individual component stocks within an index – has emerged as an alternative tool with a range of potential use cases.
Historically, direct indexing was developed as a means to unlock the tax losses of individual stocks in an index – even if the index itself was up – and was primarily used only by the most affluent investors (who had the highest tax rates and benefitted the most from the available loss harvesting). However, direct indexing can be used not only to harvest tax losses but also to harvest capital gains (particularly for those taxpayers in the 10% and 12% tax brackets). In addition, direct indexing can provide tax benefits to investors who are charitably inclined by allowing them to donate the underlying shares within an index that have the largest gains, thereby helping them to maximize their tax savings.
For those whose primary goal is to benefit from a more personalized indexing strategy that still gains broad market exposure while specifically adjusting for personal preferences, using a personalized index can ensure the investor’s capital will support the exact industries or companies they wish to support (while also saving on the management fees otherwise charged by more packaged ESG/SRI mutual funds and ETFs).
This article from Kitches.com discusses in great details of 4 types of direct indexing -
Historically, direct indexing was developed as a means to unlock the tax losses of individual stocks in an index – even if the index itself was up – and was primarily used only by the most affluent investors (who had the highest tax rates and benefitted the most from the available loss harvesting). However, direct indexing can be used not only to harvest tax losses but also to harvest capital gains (particularly for those taxpayers in the 10% and 12% tax brackets). In addition, direct indexing can provide tax benefits to investors who are charitably inclined by allowing them to donate the underlying shares within an index that have the largest gains, thereby helping them to maximize their tax savings.
For those whose primary goal is to benefit from a more personalized indexing strategy that still gains broad market exposure while specifically adjusting for personal preferences, using a personalized index can ensure the investor’s capital will support the exact industries or companies they wish to support (while also saving on the management fees otherwise charged by more packaged ESG/SRI mutual funds and ETFs).
This article from Kitches.com discusses in great details of 4 types of direct indexing -
- Tax focused direct indexing
- Personalized direct indexing
- Rules-based direct indexing
- Customized direct indexing
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