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. But this strategy for reducing an investor’s tax bill can’t be found in an ETF or mutual fund. Instead, tax-loss harvesting is one of the main benefits of direct indexing.
Direct indexing is a separately managed account that attempts to replicate the performance of an index. But unlike an index fund, the investor directly owns the individual stocks in the account. And the advisor can add or remove securities that fit the investor’s values and investment goals.
Tax-Loss Harvesting Made Easy
Direct indexing makes tax-loss harvesting easy, “since it’s easy to sell underperforming individual stocks,” according to Forbes. “Take the cash from each tax-loss sale and buy shares in similar companies to balance your portfolio’s allocations. Meanwhile, you’ve generated a capital loss that you can use to reduce your overall tax liability.”
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 TLH alpha. And the differences in TLH alpha can be very wide. Research from Vanguard found that the difference can range from 20 basis points to more than 100.
When considering a direct indexing strategy for its tax-loss harvesting abilities, Vanguard writes that those with daily harvesting scans “is critical to achieving the maximum harvest in ‘typical’ (non-high) volatility environments.”
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.