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Recently I heard an advisor tout the benefits of “direct indexing”. This concept is for index fund investors who want to be able to time and take tax losses from sales of individual stock. You basically replicate an index by owning say, shares in 500 companies instead of an S&P 500 index fund.
Does this make sense? Couldn’t you still own the index fund and own shares in just a few companies to occasionally take tax losses, assuming it was worth it for such losses.
Owning shares in 500 companies seems a preposterous way to get the benefits of indexing. What say you?
Too.Much.Trouble
Hi Paul. Direct indexing is 180 degrees from my ‘keep it simple stupid’ philosophy. I wonder what the advisor’s AUM fee is? For me it’s a lousy idea for all the reasons Mike, Bill, and Mark discuss below.
So the idea is sound especially for tax harvesting purposes. The big but is that it requires discipline and time, qualities that many struggle with. Tax loss harvesting can be a powerful tool within that framework, but the cost in paying an advisor or doing it yourself may be unappealing to the masses.
I think it’s a terrible idea. It’s basically another way for an advisor to complicate your financial life, to make you locked in with an advisor so they have to manage your finances. Once implemented most folks won’t know how to manage 500 or more stock positions- if they do figure out after a while that direct indexing isn’t working out, they would then have to figure out how to unwind the mess of hundreds of stock positions, and dealing with a tax nightmare. Direct indexing may provide some tax losses early on, but in a rising market over several years, I believe the losses will be minimal as time goes on. A few friends that have implemented direct indexing have related this issue to me in recent years.
Adam Grossman wrote about direct indexing in this article: https://humbledollar.com/2024/04/no-big-loss/
On your idea of holding an index fund plus a few individual stocks to harvest losses, how would you decide which stocks to buy? A stock only produces a loss if it falls below your purchase price, and it’s hard to know in advance which ones will. With hundreds of stocks, some are almost always in the red, which I take to be the appeal of direct indexing.