More investors are adopting direct or personalized indexing strategies to personalize their portfolios. But while the strategy may be garnering attention, not everyone knows how it works—or who it benefits. So, which investors could benefit from direct indexing?
With a mutual fund or ETF, investors own shares within a basket of securities. These securities often track a given benchmark, such as the S&P 500 or the Russell 3000. But through direct indexing, investors directly own individual stocks in a separately managed account that represents a chosen market-capitalization-weighted benchmark.
With direct indexing, investors gain unique opportunities for tax efficiency and personalization that aren’t available through ETFs or mutual funds. So, Vanguard lists three main benefits that direct or personalized indexing provides.
See more: “Why Direct Indexing Is So Important for Tax-Loss Harvesting”
1. Enhanced tax efficiency
Tax-loss harvesting opportunities are the biggest benefit to direct or personalized indexing strategies. Direct indexing provides increased tax-loss harvesting opportunities, which can help capture additional tax alpha. The technology also allows advisors to guide clients through tax-effective transitions to personalized indexing.
2. Expressing ESG Preferences and Factor Tilts
Direct indexing programs can help investors express environmental, social, and governance (ESG) or socially responsible investing (SRI) preferences. They can also tilt portfolios toward stocks with certain characteristics like momentum or value, known as factors. Direct indexing allows a deeper level of customization that ETFs can’t provide.
Transparency is another benefit of direct or personalized indexing strategies. A financial advisor knows what’s in their client’s portfolio. So, with a direct indexing strategy, advisors can construct completion portfolios around concentrated positions at the individual security level. Plus, this can be done all while minimizing the tax impact.
High-net-worth investors looking to benefit from the features of direct indexing may want to consider Vanguard Personalized Indexing. VPI’s algorithms automatically review each account daily and harvest individual security losses as opportunities arise.
Vanguard CEO Tim Buckley said at Exchange 2023 that the company will “be investing heavily” in direct indexing. More information on Vanguard Personalized Indexing can be found online.
For more news, information, and analysis, visit the Direct Indexing Channel.