How Direct Indexing Automation Aids Tax-Loss Harvesting

Tax-loss harvesting is one of direct indexing’s biggest benefits. The automation that direct indexing provides greatly increases the strategy’s potential benefits.

Tax-loss harvesting involves selling an investment at a loss, then reinvesting the proceeds of that sale into another asset. Since harvesting opportunities don’t just spring up at the end of the year, the frequency at which a portfolio is scanned for tax-loss harvesting opportunities matters.

However, finding these opportunities remains a very manual process. That’s why most advisors wait until the end of the year to review their clients’ portfolios. But by then, many of the best opportunities have already passed.

See more: “4 Key Benefits of Tax-Loss Harvesting for Investors

The More Scans, the Better

Direct indexing software scans the portfolio for tax-loss harvesting opportunities at a set frequency (daily, quarterly, or monthly). Generally, the more frequent the scans, the higher and more consistent the results.

A direct indexing technology like Vanguard Personalized Indexing can automatically scan for tax-loss harvesting and rebalancing opportunities across dozens of investments and hundreds of investment lots.

According to Vanguard, the differences in tax-loss harvesting opportunities alpha can range from 20 to more than 100 basis points. When considering a direct indexing strategy for its tax-loss harvesting abilities, a strategy with daily harvesting scans “is critical to achieving the maximum harvest in ‘typical’ (non-high) volatility environments,” Vanguard added.

Direct indexing could grow at a faster rate than ETFs, mutual funds, and separate accounts over the next five years. Analysts expect the technology to reach more than $800 billion in assets by 2026. Vanguard CEO Tim Buckley said at Exchange 2023 that the company will “be investing heavily” in direct indexing.

For high net worth clients with significant capital gains, VPI can help capitalize on volatile markets without violating the wash-sale rule. More information about Vanguard Personalized Indexing can be found online.

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