Direct indexing has been gaining attention as a more customizable investment option than ETFs or mutual funds. However, it’s not for every client.
So, which investors are most likely to benefit from direct indexing? Per Vanguard, advisors should look for clients in higher tax brackets experiencing at least one of these four common situations:
Large Recurring Capital Gains
Direct indexing may be ideal for high-net-worth investors with extensive recurring capital gains. This includes investors with active equity, private equity, and other hedge-fund-like holdings. It also may be right for retirees who take distributions to meet their annual spending needs. Paired with daily scans for tax-loss harvesting opportunities can increase after-tax alpha by 20 to over 100 basis points.
See more: “Tax-Loss Harvesting Isn’t Just for Year-End”
Estate Plans With Charitable Intent
Investors planning to make large charitable donations can also benefit. Charitable giving through direct indexing can help investors gain tax efficiency while supporting causes that align with their values. Nonprofits don’t owe federal income tax on gifts. So, donating individual securities from taxable accounts to charity can provide the investor with significant tax breaks.
Portfolios With Highly Appreciated or Concentrated Exposure
Some high-net-worth investors may be overweight a certain security. CEOs with a concentrated position in their company’s stock, for example. Investors looking to reduce a highly concentrated position may want to consider direct indexing. However, Vanguard notes that this scenario is ideal for investors looking to offset taxes.
Substantial New Portfolio Contributions
Ultimately, direct indexing is for high-net-worth investors seeking significant tax alpha. For high-net-worth investors sitting on cash who want to reinvest that money in stocks, it may be worth considering. Investors who infuse significant new cash into their portfolios can help delay portfolio ossification.
For high-net-worth clients with significant capital gains, Vanguard Personalized Indexing can automatically scan portfolios throughout the year for tax-loss harvesting and rebalancing opportunities. It can also help capitalize on volatile markets without violating the wash-sale rule. More information about Vanguard Personalized Indexing can be found online.
For more news, information, and analysis, visit the Direct Indexing Channel.