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Do any HumbleDollar readers use direct indexing? (If you have to ask what that is, you are not likely using this.) If you are either using this relatively new financial tool, or if you seriously considered it and made a reasoned decision not to use it, I’d appreciate hearing from you.
My personal situation is an overallocation to cash (55%) caused primarily by selling out of a low-basis ETF that created an overconcentration in tech stocks. As we continue to sell out of that position while considering retirement in the next few years, we have the opportunity to direct index and harvest capital losses to offset additional capital gains.
I have an annual membership (free in 1st year) with Range Investments that offers direct investing at 12 -22 basis points, which will likely continue to drop in price in future years. It’s very tempting to get the loss-harvesting benefits in the first several years of this strategy, but the continuing drag of the slightly higher basis points in later years – in comparison to total market ETFs at 3 – 5 basis points – is giving me some pause.
Here’s a Gift Article for the May 16 Wall Street Journal piece Stock Gains Without All the Taxes? How the Hottest Trade on Wall Street Works.
I do direct investing, but not using a financial product. Rather I have a list of 25 companies and I invest approximately equal dollar amounts in each one. This is a form of direct investing because I have an “index” that I am buying directly. There are various benefits to this:
1) It is like the Dow Jones industrials, but a different set of equities, which I have selected based on my preferences regarding fundamentals, diversification, and analytics.
2) Because I own each equity directly I can select shares to sell based on tax considerations. This is a form of heightened tax efficiency.
3) Abitragers regularly skim money off the market. Direct investing enables me to keep some of this money through active trading strategies.
4) While past results are no guarantee of future performance and DI will not exactly follow any index, this strategy has over 1,3, and 5 year horizons provided lower risk and higher return than owning a total market fund.
5) Obviously there are no management fees, but equally obviously I must make the management decisions. The size of the portfolio and the value of my time influence whether this is a good strategy.
I’m familiar and have been curious about it for a few years. In fact there’s a new article (today, I think) in the Wall St Journal about the next-gen of this, as given the tear of the market lately there are fewer ‘losers’ to sell to offset the wild gains by the tech high flyers. I’ve not (yet) pulled the trigger on this, but it’s a consideration. I’d personally only do it in a system intended to mirror a main indices like the S&P 500 vs some other sector. But ultimately I’m trying to sort if the juice (improved tax efficiency) is worth the squeeze (fees).
Here are some additional thoughts about direct indexing:
When the direct indexing software sells losing positions, you’re paying a bid-ask spread. When the software buys similar stocks as replacements for those sold, you’re paying a bid-ask spread. These are costs not reflected in the management fee. The tax benefit you enjoy must overcome these additional expenses.
When the software buys similar stocks, you’re likely introducing tracking error because those similar stocks might not be in the index. Your returns will no longer mimic the returns of the underlying index.
If personal preferences lead you to filter out certain companies or sectors, you’re no longer tracking the index. You must accept that you are engaging in active management.
If you happen to own the Vanguard Total US Stock Market ETF (VTI) instead of the S&P 500 ETF, would you (or could you) employ direct indexing? VTI holds 3,494 stocks. It would seem that an attempt to directly index this fund would be overwhelming. Maybe direct indexing by its nature, is best suited to funds tracking indexes with relatively fewer constituents, like the S&P 500.
DI is a lot more work than most want to spend on managing their finances, especially in retirement. Way too complex to take into late retirement. A direct investor is likely overfunded or will be, you have better uses of your time unless finances is your hobby. DI will not make or break a retirement portfolio, an optimization strategy at best.
Each week I learn from Humble Dollar. On this subject I needed more explanation which I found in a summary. This may help explain more as it did for me. Sure hope this helps many.
What is direct indexing accounts
A direct indexing account is a personalized investment strategy that gives you the benefits of an index fund (like the S&P 500 or Nasdaq-100) but with a massive twist: instead of buying a single share of an ETF like VOO or QQQ, you directly buy and own the individual stocks that make up that index. It is typically set up as a Separately Managed Account (SMA) through a wealth advisor or a major brokerage platform.
To understand why investors use them, it helps to look at the contrast between a traditional fund and direct indexing, along with the specific benefits it offers.
The Difference: ETF vs. Direct Indexing
Why Do Investors Use It?There are two primary reasons why someone moves capital into a direct indexing account:
1. Aggressive, Continuous Tax-Loss Harvesting (The Big Draw)In a standard taxable account, you can only harvest a loss if the entire index fund drops. If the S&P 500 is up 12% for the year, your ETF is up, and there are no losses to harvest.
With direct indexing, you own the individual components. Even when the S&P 500 is having a banner year and is up overall, there are always 50 to 100 individual companies inside the index that are losing money at any given moment.
2. Portfolio CustomizationBecause you own the raw ingredients of the index, you can filter things out.
The Trade-OffsWhile direct indexing sounds ideal, it isn’t a perfect fit for every portfolio due to three main constraints:
The SummaryThink of an ETF as buying a pre-made cake from the bakery, while direct indexing is buying all the flour, sugar, and eggs separately. It takes more work and costs a bit more to organize, but it allows you to change the recipe and use the scraps to offset your taxes.
This 2023 article by Allan Roth summarizes direct indexing’s pro and cons better than most. His conclusion?
“Direct indexing is generally not as good as buying broad ultra-low-cost index funds. That said, it could be beneficial in certain circumstances:
· You want to donate to charity in a few years so you can harvest the tax loss and then donate the appreciated securities to the charity, thereby never paying taxes on the appreciation.
· You currently have large taxable long-term gains at the 23.8% marginal federal tax rate (20% +3.8% investment income tax) but soon will be in a lower rate.
· You are in a high tax bracket but have a very short life expectancy and the kids will soon inherit the money with a step-up basis.”
Roth ended with this: “Direct indexing is good. It’s just generally not as good as owning broad ETFs.”
Thanks to all who responded. Please update here if you use direct indexing and learn something worth sharing.
After reading a few of the comments, I would like to clarify that direct indexing, or separately managed accounts do not create any extra paperwork in preparing my annual income tax returns. I receive a 1099 just as I would for any other similar account. As noted, the 1099s are very long but you do not enter every position. The provider totals everything up and you only need to enter the summary data. These investments are not for everyone, but in the right situation can be very beneficial. I have not paid any capital gains tax for 10 years.
Thank you for clarifying this, Howard.
Not knowing much about direct indexing, I’m curious how the IRS considers ownership at death. Would each indexed stock need to be tracked separately on the estate tax form? As an executor, I recall many supplemental pages accompanying IRS form 706 for the ninety-nine individual assets that my father held. Probably less of a consideration nowadays with higher estate tax exclusions, but still a painful memory!
Around 2015 the IRS added an additional reporting requirement for taxable estates in addition to Form 706 with Form 8971.
Form 8971, titled Information Regarding Beneficiaries
Acquiring Property From a Decedent
requires (per the IRS instructions) for
Executors file this form to report the final estate tax value of property distributed or to be distributed from the estate, if the estate tax return is filed after July 2015. This form, along with a copy of every Schedule A, is used to report values to the IRS. One Schedule A is provided to each beneficiary receiving property from an estate.
I recall one taxable 706 where the decedent had three adult beneficiaries where in essence the large number of individual stock holdings at death as reported on the Form 706 had to be split three ways with a full description of each stock including # of shares, full stock name, CUSIP and date of death value on the 8971 with three schedule A’s (multiple pages), one for each beneficiary. I am grateful that the broker was able to provide a detailed schedule of date of value. As the client had died on the weekend the FMV of each individual share holding was determined by the average of the high and low on the Friday before his death and the Monday after his death when the stock markets were open.
IRS instructions for 8971 –
Due date. Form 8971 must be filed with the IRS and each
required Schedule A (see Required Schedules A, later) must be
furnished to only the beneficiary listed on that Schedule A, no
later than the earlier of:
• The date that is 30 days after the date on which Form 706 or
Form 706-NA is required to be filed (including extensions) with
the IRS; or
• The date that is 30 days after the date Form 706 or Form
706-NA is filed with the IRS.
Also required –
The executor must certify on Form 8971, Part II, column (d),
the date on which Schedule A was provided to each beneficiary
and should keep proof of mailing, proof of delivery,
acknowledgment of receipt, or other information relevant for the
estate’s records. In cases where a trust or another estate is a
beneficiary and has multiple trustees or executors, providing
Schedule A to one trustee or executor is sufficient.
Final 8971 hurdle (Per the 2025 instructions) –
Form 8971 cannot be filed electronically; it must be printed and mailed to the IRS. While electronic signatures are permitted on the document and Schedule A can be delivered to beneficiaries electronically, the final Form 8971 must be submitted via paper mail to the IRS (at the appropriate address, not currently the address the address the 706 is sent to.)
So if you are fortunate enough to be able to amass sufficient wealth that requires a federal 706 to be filed after you die I hope you have taken appropriate actions to make the administrative burden lighter and your estate administrative costs less on those you care the most for.
Best, Bill
Sounds like a potential Hollywood blockbuster movie; Nightmare On Wall Street. Thanks for the explanation, Bill.
KISS-keep your portfolio simple for too many reasons to note
3-5 rtfs max. total intl. total us. small cap and another 1-2choices
I’ve been reading Humble Dollar for about two years, and this is my first post.
I’ve used direct indexing for about five years, and given my situation and results, I’m a strong believer. I’m 60 and retired from Corporate America 15 months ago. I’m in the highest federal tax bracket, live in a state with a relatively low flat tax, and expect to remain in the top federal bracket for the foreseeable future.
My equity allocation is roughly two-thirds index funds and one-third actively managed funds (Capital Group and Dimensional), with no individual stocks outside my direct-indexing accounts. I don’t trade actively, and in a typical year, I sell funds only to rebalance in tax-deferred accounts or to harvest losses during major market pullbacks.
I use direct-indexing accounts for the S&P 500 and MSCI EAFE (international). Each direct account is about 20% the size of my index-fund holdings in that area.
In my experience, the direct-indexing accounts have outperformed the underlying indexes by about 40–50 basis points per year, net of incremental costs, even after five years. It’s essentially hands-off on my end…trades are executed automatically. If I transfer new money into an account it is invested the next trading day with no effort from my side.
I track everything daily in Quicken, and dividends post almost daily and once or twice a month there’s a batch of tax-loss sales and reinvestments. Doing this manually in spreadsheets would be overwhelming. And the first 1099 you receive for a direct-indexing account can be eye-opening—mine was more than 150 pages.
This approach isn’t for everyone, but it’s been a good fit for me. I’ll keep monitoring whether the advantage fades over time, but so far it hasn’t in the current market environment.
Thank you for your first post!
You wrote: “I use direct-indexing accounts for the S&P 500 and MSCI EAFE (international). Each direct account is about 20% the size of my index-fund holdings in that area.” This is very close to my situation, so this is helpful info.
Our earned income plus interest/dividends does not put us in the highest bracket, though, so my case isn’t quite as compelling as yours. Selling out of this concentrated tech position has pushed me into the 20% capital gains bracket plus the 3.8% NIIT (Net Investment Income Tax) for the last couple of years, though, when I could have definitely put harvested losses to good use.
I use several Separately Managed Accounts from Fidelity and one from Schwab which are a different name for direct indexing. They work as advertised. The tax losses were greater initially but are still significant after 10 years. Each year is different. 2022 had large paper losses. 2025 did not. It depends on the market. My suggestion is to avoid them for the reasons discussed below unless you need the losses to offset gains or you have significant assets to invest. By the way, if you do not just make an initial deposit but continue to add assets, the paper losses can continue. For most investors a simple index fund is probably a better choice and you can harvest losses yourself if the market drops after your purchase.
I’ve been pitched direct indexing a few times by Fidelity for about 30-35 bps fee. They say the returns are superior to holding a simple index fund because they can tax loss harvest the losers in my account over time. I think that might be true for a few years (at best), but as years go by those rebalancing opportunities will be limited, especially in a rising equity market. The main issue I had with implementing such a strategy, was Fidelity wanted to sell off my current indexed portfolio which has substantial gains, and pay large capital gain taxes now. I said no thank you! I prefer the simplicity of holding a few funds to capture the market returns. IMO, I feel direct indexing is a new product being marketed by advisors to investors as the latest and greatest scheme for superior returns. YMMV
Selling off the current large capital gains was my issue as well.
Does YMMV stand for “your mileage may vary?”
Yes. Sorry bout that- you learned a new acronym!
Not knowing the acronym myself, I first thought YMMV meant “Your Mongoose May Vanish.”
It’s no big deal, but aren’t the The Humble Dollar comment guidelines supposed to discourage acronyms for exactly this reason?
https://advisors.vanguard.com/investments/personalized-indexing/what-is-direct-indexing#overview
Here is a good description of these separately managed accounts (SMA). A financial advisor recommended one of these for my taxable account, however, after several years it lagged 2% a year behind my index funds and had higher fees. I found the tax loss harvesting sometimes couldn’t compensate for spiking prices in a few stocks that were dominating the fund, eg Tesla tripled, which was good, but it is hard to balance the fund without suffering high taxes. Tax loss harvesting is also available with index funds, though, I realize there are fewer levers. The total US fund can easily be taxed harvested, for example, with a S@P500 fund. I simplified and used tax efficient total market index funds rather than SMA and changed advisors.
I don’t equate direct indexing to the need for a separately managed account with AUM fees. I am able to direct index at Range Investments for an all-in annual fee of less than $3000. This includes investment management AND personal finance advice.
Like most HD readers, it goes against my grain to pay ANYTHING for financial advice. But for a flat fee this low, and qualified professionals to manage our investments and provide advice – especially to my wife if something were to happen to me — I’ve about decided it’s a value proposition that may work for us.
To keep to the topic of this post, though, direct indexing in a U.S. stock index costs only 12 basis points and not require AUM fees in a separately managed account at all custodians.
I also hate to pay for advice on Finances, I have been doing it alone for 57 years. The part that strikes me most, is when I pass, I will need someone to step in, so my plan is to get affiliated with a Wealth Firm. They will give me a FREE tuneup, and then we will have a relationship for my wife if I am gone. To me good insurance, and I will be happy to pay their fee so my wife can sleep at night.
I also have not personally used direct indexing but I was exposed to 1040 tax clients who did.
Clients liked the tax savings in the early years after they first adopted such a direct indexing program.
What clients did not like –
I see tax direct indexing as a unneeded complexity best to avoid.
Just my thoughts.
Bill
I’m glad this question was asked so you could answer it. I’ll steer clear.
There have been a few HumbleDollar posts; search for, e.g.,
“Going Direct” by Phil Kernen (Aug 23, 2021)
“Build Your Own?” by Mike Zaccardi (Oct 10, 2021)
“One Stock at a Time” by Adam Grossman (Feb 16, 2025)
“Tax Efficient Investing for Retirees with High Net Worth: Direct Indexing?” by R L (May 8, 2025)
I tried to search for these articles or the authors and was unsuccessful.
I was able to access Adam’s article with the link in the next comment down.
I found the articles using the search box labeled “Search Site” that’s available on HumbleDollar pages (at the top or at the bottom). I just used the words direct index and several articles came up.
I didn’t include the links because I’ve read that embedding more than one link requires moderation. I’ll try just listing the links here:
Kernen
https://humbledollar.com/2021/08/going-direct/
Zaccardi
https://humbledollar.com/2021/10/build-your-own/
Grossman
https://humbledollar.com/2025/02/one-stock-at-a-time/
R L
https://humbledollar.com/forum/tax-efficient-investing-for-retirees-with-high-net-worth-direct-indexing/
I haven’t used direct indexing, but Adam Grossman wrote this article about the topic:
https://humbledollar.com/2025/02/one-stock-at-a-time/