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Direct indexing becomes ‘democratized,’ as fees, account minimums drop


As demand grows for specialised portfolios, a trend referred to as direct indexing is quickly becoming an option for more investors.  

Quite than owning a mutual or exchange-traded fund, direct indexing is buying the stocks of an index to attain goals like tax efficiency, diversification or values-based investing. 

Traditionally utilized by institutional and high-net value investors, direct indexing is poised to grow greater than 12% per 12 months, faster than estimates for mutual funds and ETFs, in keeping with Cerulli Associates. 

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Corporations like Morgan Stanley, BlackRock, JPMorgan Chase, Vanguard, Franklin Templeton, Charles Schwab and Fidelity have already entered the space, betting on broader access. 

“It says quite a bit that these large fund providers are leaning into direct indexing,” said Adam Grealish, head of investments at Altruist, an advisor platform with a direct indexing product.

How direct indexing works

Charles Sachs, an authorized financial planner and chief investment officer at Kaufman Rossin Wealth in Miami, said certainly one of the most important perks of direct indexing is flexibility.

Here’s how it really works: Financial advisors buy a representative share of an index’s stocks and rebalance over time, typically in a taxable brokerage account.

Direct indexing generally works best for greater portfolios because it could be costly to own a whole index. Nonetheless, this barrier is shrinking as more brokers offer so-called fractional trading, allowing investors to purchase partial shares. 

Boost portfolio returns through tax-loss harvesting

One among the most important perks of direct indexing is so-called tax-loss harvesting, enabling investors to offset profits with losses when the stock market drops.   

Greater than half of actively-managed accounts don’t receive any tax treatment, in keeping with a Cerulli report.

“Direct indexing offers more opportunities to tax-loss harvest because there are simply more individual stocks,” Grealish said.

Direct indexing offers more opportunities to tax-loss harvest because there are simply more individual stocks.

Adam Grealish

Head of investments at Altruist

Financial experts say direct indexing may offer so-called tax alpha, providing higher returns through tax-saving techniques. 

Indeed, strategic tax-loss harvesting may boost portfolio returns by one percentage point or more, in keeping with research from Vanguard, which could also be significant over time.

Easier to customize your portfolio 

Direct indexing can also appeal to those on the lookout for portfolio customization, comparable to value-based investors who wish to divest from specific sectors.

“Everyone’s values are barely different,” said Grealish. “So a fund is never the most effective approach to get pinpoint accuracy in expressing your values.”

Customization can also be handy for somebody with many shares of a single stock who desires to diversify their portfolio.  

Nonetheless, direct indexing can have higher costs and more complexity than buying a passively-managed index fund, Sachs said.

Direct indexing becoming ‘democratized’

Although the concept has been around for many years, it’s becoming more accessible as major asset managers enter the space and costs and account minimums drop.

“It’s sort of being democratized,” said Pete Dietrich, head of wealth indexes at Morningstar.

While platforms with tax features and values-based investing customization can have cost around 0.35% a 12 months and a half ago, chances are you’ll see similar platforms around 0.3%, 0.2% and even lower today, Dietrich said. 

By comparison, the typical expense ratio for passively managed funds was 0.12% in 2020, in keeping with Morningstar.

“I believe you are beginning to see around $150,000 to $250,000 account minimums, coming down in a short time to $75,000,” he said, noting some platforms are even lower, depending on platform capability.

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