Take Advantage of Direct Indexing’s Tax-Loss Harvesting Abilities

Direct indexing used to be reserved for the “ultra, ultra-high-net-worth investor,” as Vanguard’s CEO Tim Buckley said at Exchange 2023. But direct indexing has been getting more attention from a wider array of investors. This is due to advancements in technology, increased investor awareness, and reductions in trading costs — and its tax-loss harvesting potential.

At the end of 2022, more than $260 billion was following direct indexes, according to a survey of some of the largest providers. Morningstar expects assets to continue growing at a steady pace.

See more: “How Tech Is Pushing Demand for Direct Indexing

Some Added Advantages

Direct indexing is a separately managed account designed to track an index. But unlike a pooled investment fund, the client owns the actual stocks in the account. Ben Hammer, head of client development for Vanguard Personalized Indexing, noted “some added advantages” to direct indexing at Exchange 2023. And one major advantage that directing indexing offers is tax-loss harvesting opportunities.

Tax-loss harvesting involves selling investments at a loss, reinvesting that cash elsewhere, and writing off those losses at tax time. Hammer explained: “any time the market is up while some of those stocks might be down, tax-loss harvest those.” The investor can then use the proceeds of the sale “to offset gains somewhere else in your portfolio.”

A service like VPI can automatically scan portfolios throughout the year for tax-loss harvesting and rebalancing opportunities. These scans can be made at a set frequency (daily, quarterly, or monthly). Generally, the more frequent the scans, the higher and more consistent it is. It can also help capitalize on volatile markets without violating the wash-sale rule.

Per 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, those with daily harvesting scans “is critical to achieving the maximum harvest in ‘typical’ (non-high) volatility environments,” Vanguard added.

More information about VPI can be found online.

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