What's changed lately?
In the past, direct indexing would require a relatively significant amount of money to buy all of the stocks in a particular index needed to replicate its performance. Additionally, the need to periodically rebalance (i.e., adjust your holdings so that the percentages of stocks you own align with that of the index) and reconstitute (i.e., sell stocks that drop out of the index and buy stocks that are added) to continue to track the index's performance was relatively costly due to commissions and other trading costs. Having to buy a relatively large number of individual stocks that make up an index, in the percentage needed to replicate its performance, has traditionally been an impediment for most investors to use this strategy. Consequently, direct indexing was effectively limited to wealthier investors.
Several factors have changed this dynamic somewhat, including the adoption of fractional shares trading.
According to Bloomberg, the average stock price of the S&P 500 is $209, as of October 25, 2021 (with many stocks priced significantly more per share). The availability of dollar-based fractional shares trading makes it a little easier to buy the holdings of an index in the percentages needed to closely replicate the performance of that benchmark with a relatively lower amount of money.
The increasing prevalence of zero-commission trades has been another important factor. Rebalancing and reconstituting a portfolio to track an index can be costly for investors that do not have access to commission-free stock trades. More brokerage companies offering zero-commission stock trades has contributed to more investors considering direct indexing.
In next blogpost, we will discuss advantage of direct indexing.