What Is Direct Indexing & How Does It Work?

At Seaside Wealth Management, we are always looking out for new technologies and ways to benefit our clients. We currently use ETFs, which provide a diversified portfolio that combats the effects of inflation in the long term at a very low cost. Now, we are exploring another element of investment portfolios called direct indexing that we may be adding in addition to the ETFs. Read more to learn about it:

Investing in the stock market might seem like a labyrinth, but have you ever heard about direct indexing? It's an investment strategy that places you in the driver's seat, letting you replicate big-name stock indexes like the S&P 500 or the Russell 3000 in your taxable account by directly owning the individual stocks.

This approach to crafting your investment portfolio promises not just a custom-fit that aligns with your financial goals but also opens up pathways for optimized tax strategies like tax-loss harvesting, potentially amplifying your returns through tax alpha.

The Benefits of Direct Indexing

Direct indexing is not just a buzzword in the investment world; it's a strategy that offers a plethora of benefits tailored to meet your specific financial goals and ethical values. Here’s why it stands out:

• Tax Efficiency and Loss Harvesting: Direct indexing shines in its ability to enhance tax efficiency through strategies like tax-loss harvesting. This method allows for the selling of securities at a loss to offset capital gains in other parts of your portfolio, potentially saving thousands in taxes each year. It's a tactic that has been used by the wealthy for decades, now accessible to more investors, making it a cornerstone of direct indexing's appeal.
• Customization and Control: At the heart of direct indexing is the power it hands back to you, the investor. You're not just a passive participant; you're in the driver's seat, able to tailor your portfolio to reflect your values, risk tolerance, and investment goals. Whether you're passionate about environmental, social, and governance (ESG) factors, looking to avoid specific industries, or seeking to over or underweight certain sectors, direct indexing allows for a level of personalization that's simply not possible with traditional index funds or ETFs.
• Accessibility and Transparency: Gone are the days when direct indexing was a privilege reserved for the ultra-wealthy. With some platforms offering entry points as low as $5,000, it's becoming a viable option for a broader audience. This democratization is coupled with unparalleled transparency; you have a clear view of what you own and why, enabling informed decisions and adjustments to your investment strategy. Plus, the ability to quickly and easily make changes offers flexibility that's hard to find in the more rigid structures of mutual funds or ETFs.

In essence, direct indexing is redefining what it means to invest, offering a blend of tax efficiency, customization, and accessibility that puts you in control of your financial future.

Understanding the Mechanics of Direct Indexing

Direct indexing, at its core, is an investment strategy designed to replicate the performance of a stock index by investing in its underlying securities. Here's a closer look at how it works:

Replication and Customization:

• Objective: Mimic the performance of a major stock index, such as the S&P 500 or the Russell 3000.
• Method: Purchase individual stocks that constitute the index, maintaining the same weights as the index itself.
• Customization: Allows for adjustments based on personal ethical values, tax considerations, or specific investment goals.

Technology and Management:

• Sophisticated Technology: Utilizes advanced algorithms to manage the portfolio, ensuring it remains aligned with the index and optimizing for tax-loss harvesting opportunities.
• Active Management: Requires ongoing rebalancing and management to maintain the desired asset allocation and to adapt to market changes.

Accessibility and Investment Thresholds:

• Historical Accessibility: Initially, direct indexing was an option only for investors with at least $1 million
• Current Accessibility: Advances in technology and zero-commission trading have lowered the entry point to as little as $5,000 for some platforms.
• Considerations: Despite increased accessibility, direct indexing typically requires a higher minimum investment ($250,000) compared to traditional index funds, and may involve higher management fees due to the level of customization and management involved.

This strategy leverages the benefits of index investing while offering a personalized investment experience, making it an attractive option for investors looking for more control over their portfolios and seeking to optimize for tax efficiency.

Comparison with Traditional Investment Vehicles

When comparing direct indexing with traditional investment vehicles like ETFs, it's essential to understand the nuances that might influence your investment strategy. Here's a quick breakdown:

Ownership and Accessibility:

• ETFs: Provide indirect ownership through ETF shares, not the actual stocks or bonds within the fund. They boast lower minimum investment requirements, making them highly accessible to retail investors.
• Direct Indexing: Offers direct ownership of individual stocks within an index, allowing for greater customization. However, this comes with generally higher minimum investment thresholds.

Cost Considerations:

• ETFs are known for their cost efficiency, primarily due to lower transaction costs and management fees.
• Direct Indexing, while offering personalized investment strategies and potential tax benefits, may incur higher management fees and transaction costs due to its customized nature and active management.

Suitability:

• Direct Indexing is best suited for your taxable accounts. We prefer not to use them in IRA's. What we really like about direct indexing is the low cost diversification and the added tax benefits it provides.
• ETFs, with their simplicity and lower cost, might be more suitable for investors looking for an easy-to-manage, diversified investment option without the need for customization, especially inside of your IRA

At Seaside, we make sure to align your investments with your financial plan which is based on your goals and values.

Conclusion

Our team is here to help you navigate your financial journey. Whether you have questions about investments, long-term goals, or retirement planning, we're here to provide the guidance and support you need. We will also keep you up to date with any additions we make to our financial planning and investment strategies. It is our pleasure to serve you and help you create peace around the issue of money.

This commentary reflects the personal opinions, viewpoints and analyses of the Seaside Wealth Management, Inc. employees providing such comments, and should not be regarded as a description of advisory services provided by Seaside Wealth Management, Inc. or performance returns of any Seaside Wealth Management, Inc. client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Seaside Wealth Management, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.