Direct Indexing Demystified

Direct indexing may be the next big thing for investors.  By owning a basket of individual stocks, rather than an index fund, investors receive many benefits, such as greater control and tax efficiency. 

What is direct indexing?

Direct Indexing is a relatively new method that seeks to replicate the performance of an index fund or exchange-traded-fund (ETF) by owning the individual stocks directly.   Managed properly, it may be better for your unique circumstances and personal goals.

Why are more people discussing direct indexing now?

Direct indexing an attractive solution for many investors.

  • Taxes - New tax policy may increase taxes for high-net-worth investors. Managing capital gains and dividend and interest income is becoming more important.  
  • Cost - With the reduction of trade commissions the ability to manage individual stock portfolios has become more accessible to investors.
  • Personalization - Clients want more customization and more control over how they invest.

How we do it:

With sophisticated portfolio management and trading systems we can buy and manage a sample of individual stocks designed to track an index for clients.   

Research shows that you don’t have to own all 500 stocks in the S&P 500 to achieve the diversification benefits and return potential of the index.  With a carefully-constructed portfolio of 150 stocks, for example, it is possible to capture the benefits of indexing, with only minor deviations from index performance. 

Why consider direct investing?

The beauty of direct indexing is that your circumstances and preferences drive the process.  The potential benefits include:

  • Tax efficiency: Taxes can erode returns. See chart below.
    • Tax loss harvesting – If you purchase an index and the index goes up, you can’t do any tax loss harvesting. However, even if the index went up, there’s probably some stocks that went down.  With a direct index, you can sell just those losers.
    • Deferring gains – If you sell an index, you effectively sell every share in the index pro rata. With a direct index, you can selectively avoid selling the top gainers. 
  • Environmental, Social, and Governance (ESG) Preferences
    • You can’t ask the S&P 500 to sell just a few stocks in industries that you prefer not to own. You can with a direct index strategy.  In this way, you can align your values with your investment portfolio.
  • Enhanced return potential
    • The flexibility of direct indexing allows for favoring portfolio factors, such as value, profitability, momentum, and safety, which may increase returns over time.
  • Transition
    • Imagine you have a portfolio of stocks and you want to use a new advisor or change to a more diversified index strategy. With a direct index, you can incorporate your current holdings into your direct index.  The only trades you need to make are those required to reduce concentrations or exposure to unattractive stocks.  

Source:  Russell Investments

Signet has invested in sophisticated tools and technology, many of them proprietary, allowing us to help clients benefit from emerging trends like direct indexing. 

Signet is here to help.  To discuss if direct indexing is right for you, speak with your financial advisor.   

 

 

 

 

 

IMPORTANT DISCLOSURE

Past performance may not be indicative of future results. Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that their future performance will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. The statements made in this newsletter are, to the best of our ability and knowledge, accurate as of the date they were originally made. But due to various factors, including changing market conditions and/or applicable laws, the content may in the future no longer be reflective of current opinions or positions. Any forward-looking statements, information and opinions including descriptions of anticipated market changes and expectations of future activity contained in this newsletter are based upon reasonable estimates and assumptions. However, they are inherently uncertain and actual events or results may differ materially from those reflected in the newsletter. Nothing in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice. Please remember to contact Signet Financial Management, LLC, if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and/or services. No portion of the newsletter content should be construed as legal, tax, or accounting advice. A copy of Signet Financial Management, LLC’s current written disclosure statements discussing our advisory services, fees, investment advisory personnel and operations are available upon request.

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