When Direct Indexing Is the Right Choice

Direct indexing can be a powerful tool for investors. But it’s not for everyone. Ideally, this process, also called personalized indexing, is for high-net-worth investors with complex financial problems.

With that in mind, Vanguard lists some scenarios where investors might benefit from direct indexing.

Gaining Tax Alpha With Direct Indexing

High-net-worth investors with taxable accounts looking to offset significant capital gains could benefit from direct indexing’s tax-loss harvesting capabilities. These strategies can automatically scan portfolios for tax-loss harvesting opportunities at a set frequency. That frequency can be monthly, quarterly, or even daily.

The frequency at which a portfolio is scanned matters. In general, the more frequent the scans, the higher and more consistent the results.

A service like Vanguard Personalized Indexing can scan for opportunities across dozens of investments and hundreds of investment lots. The differences in tax-loss harvesting opportunities alpha can range from 20 to more than 100 basis points.

See more: “Taxes and ESG on Your Mind? Consider Direct Indexing

Customizing ESG Preferences

Some investors may have strong ESG convictions that require an increased level of precision to screen or tilt individual stocks. For these investors, personalized indexing could be an ideal solution.

A direct indexing portfolio is a separately managed account based on a benchmark. But unlike a mutual fund or ETF, the investor owns the individual stocks that represent the chosen index.

With an indexing account, investors can customize their needs and preferences. This includes religious preferences, avoiding companies they believe are involved in objectionable activities, or supporting businesses that pay their employees a fair living wage or advance diversity on their boards.

Applying Factor Exposures for Direct Indexing

Customization is a big benefit of direct indexing. In addition to allowing advisors to customize ESG preferences, this process also enables expressing specific market views or outlooks.

Personalized indexing enables advisors to tilt portfolios on their clients’ behalf to integrate such risk factors as momentum or value. A service like Vanguard Personalized Indexing can also enable advisors to diversify factor exposure around their clients’ broader portfolios.

Diversifying Concentrated Positions

Say an investor’s portfolio has a concentrated position. Or they have a large amount of highly appreciated stock. They’re a CEO with an overabundance of their company’s stock, for example. With direct indexing, advisors can build tax-efficient completion portfolios around large existing stock holdings at the individual security level.

Vanguard Personalized Indexing can be a way to transition to a diversified portfolio. As an investor’s concentrated position is gradually sold into a more diversified direct indexing portfolio, harvested losses can be used to offset capital gains generated by those sales.

Ultimately, this approach may be appropriate for investors seeking a tax-efficient, customized solution that mutual funds or ETFs can’t provide. Vanguard Personalized Indexing allows advisors to generate custom separately managed accounts and generate impact and performance reports on demand. More information about Vanguard Personalized Indexing can be found online.

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