What’s All the Fuss About Direct Indexing? – Kiplinger’s Personal Finance

You may have heard about direct indexing recently. It isn’t new, but it may feel that way given all the attention and interest it is generating these days. The elimination of trading commissions has been a major factor in making direct indexing significantly more accessible. A strategy that was once relevant only to very wealthy investors is now something that almost any investor can consider. But is it right for you?

To help answer that, I put together a primer covering some of the basics – what direct indexing is and how it works, the primary benefits it is designed to offer, and some things to consider if you’re curious about learning more.

What is direct indexing?

It’s pretty simple, really. Direct indexing – which we call “personalized indexing” at Schwab – means you own the stocks (or a subset of stocks) that make up an index directly. This differs from traditional index mutual fund and ETF investing where you own shares in the fund (alongside many other shareholders), but it’s the fund that owns the stocks. The price of your shares therefore rises and falls with the stocks in the index, but you don’t actually own the underlying stocks themselves. Your exposure to them is indirect.

Ownership matters because it allows you to customize the stocks held in your account. At one time that would have been very expensive to do because trading came with commission costs, and you had to buy stocks in increments of whole shares. Not anymore. With the large-scale elimination of commissions, direct indexing suddenly emerged as a viable strategy for investors of all kinds.

That said, it’s not for everyone. 

Benefits

Direct indexing allows you to personalize your investing approach. There are a number of potential features associated with that, but for the sake of simplicity I’m going to focus on the two primary benefits:

Tax efficiency

It may sound counterintuitive but stocks with losses can represent an opportunity to help a portfolio.  When you sell a stock that has gone down in value, the tax code allows you to use that capital loss to offset capital gains that come when you sell another stock that has gone up in value. It can either be done right away or banked for future use. It’s called “tax-loss harvesting,” and it spans more than just stocks – it can be applied to different securities, such as bonds, and different investment products, such as mutual funds and ETFs. So as markets fluctuate, opportunities emerge to create losses that can be offset with taxable gains, thereby lowering your tax liabilities over time.

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Source: https://www.kiplinger.com/investing/605101/whats-all-the-fuss-about-direct-indexing

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