Combine Direct Indexing With Active to Maximize After-Tax Outcomes

When it comes to deciding whether to invest in ETFs or use direct indexing, investors don’t have to choose one or the other. In fact, Vanguard argues that combining direct indexing with daily tax-loss harvesting scans with active equity ETFs could potentially lead to higher after-tax wealth outcomes.

“The tax-loss harvesting feature of direct indexing also offers you the opportunity to increase your clients’ allocations to active equity strategies, like hedge funds and private equity,” according to Vanguard. “It not only helps increase clients’ available ‘shelf space’ for actively managed equity strategies, but it also lets you shelter taxable bonds in clients’ tax-advantaged accounts, maximizing clients’ after-tax returns.”

Direct indexing, also known as personalized indexing, is an individual account that’s managed to track an index, like a separately managed account. Unlike investing in a mutual fund or ETF, with direct indexing, the investor can customize which securities are in the account. Plus, the investor owns the individual securities while an asset manager manages the account on their behalf.

One of the biggest advantages of direct indexing is that it can offer scalable, automatic tax-loss harvesting to high-net-worth investors. For high-net-worth clients with significant capital gains, Vanguard Personalized Indexing can automatically scan portfolios each day for tax-loss harvesting and rebalancing opportunities.

Direct indexing services with daily scans for tax-loss harvesting opportunities can increase after-tax alpha by from 20 basis points to more than 100 bps for a direct indexing investor with big recurring capital gains.

See more: “Use Direct Indexing for Customized ESG Investments

At Exchange 2023, Ben Hammer, head of client development for Vanguard Personalized Indexing, said that direct indexing provides “some added advantages because you own the individual stocks, and any time the market is up while some of those stocks might be down, [you] tax-loss harvest those, use those to offset gains somewhere else in your portfolio.”

Also at Exchange, Vanguard CEO Tim Buckley said that direct indexing is something the company will “be investing heavily” in.

More information about Vanguard Personalized Indexing can be found online.

For more news, information, and analysis, visit the Direct Indexing Channel.