Defer Capital Gains With Direct Indexing

In 2021, which was a record year for IPOs, many high-net-worth investors exited large positions from holdings in private assets. During this time, an advisory client of Vanguard would roll those capital gains from these exits “into an opportunity zone.” That opportunity zone was in direct indexing.

Direct indexing is a separately managed account designed to replicate the performance of a chosen benchmark index. But unlike index funds, investors directly own each stock in a direct indexing account.

One of the biggest advantages to direct indexing services is the ability to scan portfolios for tax-loss harvesting opportunities. Tax-loss harvesting involves selling off assets at a loss to offset gains made elsewhere in the portfolio. The proceeds from that sale can then be used to invest in similar investments.

See more: “Get Precise Tax-Loss Harvesting With Direct Indexing

Leading to Better Outcomes

Morling Financial Advisor’s managing partner Matt Shibata said that his team would use direct indexing to defer capital gains for clients. Shibata said that Morling Financial could “defer that capital gain through the opportunity zone for many years into the future.” He added: “At that point, it was about five or six years, now it’s a little bit shorter.”

“We could harvest losses in the meantime, through the personalized indexing strategy, to offset current gains or to carry those gains forward to when that tax liability would be due in 2026, 2027,” Shibata said. He added that marrying “personalized indexing with other alternative investments,” led to “even better outcomes” for their clients.

A service like Vanguard Personalized Indexing can automatically scan portfolios for tax-loss harvesting opportunities at a set frequency. That frequency can be monthly, quarterly, or even daily. VPI can also scan for opportunities across dozens of investments and hundreds of investment lots.

The more frequent the scans, the higher and more consistent the tax-loss harvesting alpha. Research from Vanguard found that the difference in alpha can range from 20 basis points to more than 100.

Vanguard CEO Tim Buckley said at Exchange 2023 that the company will “be investing heavily” in direct indexing. More information about VPI can be found online.

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