Treavor Dodsworth CFP®, CPA, CKA®
#111 - Direct Indexing
Technology is constantly changing. The financial industry is no exception. Remember when you had to call the stockbroker to buy a stock? Now by clicking my mouse, I can get into a portfolio that represents 10,000+ stocks with $10. One technology that I am excited to see become more mainstream is direct indexing. Currently, passive investors typically invest by buying ETFs or Mutual Funds that track an underlying index of stocks. With direct indexing, you buy the underlying stocks directly instead of buying the ETF or Mutual Fund. In other words, instead of buying an ETF that tracks the S&P 500, I could buy the roughly 500 stocks in the S&P 500 directly. Three are several advantages that emerge from doing this:
The ability to better manage concentrated exposure in a stock. For example, let's say you work at Google and own a large amount of Google stock due to the equity compensation you received. With direct indexing, you could choose to buy all the stocks in the S&P 500 but exclude Google so that you are not further increasing your exposure to that company.
The ability to exclude stocks based on ethical concerns. For example, I want to buy all the stocks in this index except the stocks that deal in adult entertainment.
Engaging in tax-loss harvesting at an individual stock level instead of at an ETF or Mutual Fund level. This has the potential to increase the tax-adjusted rate of return for investors.
There are several advantages to direct indexing but it does not come without disadvantages as well. The Morningstar article below goes into a few of them in further detail.
Interesting Article(s) or Video(s)
Morningstar.com - What is Direct Indexing?
Karen Wallace not only explains direct indexing but also goes into some of the cons. Namely that direct indexing could essentially result in turning a lot of passive investors into active investors and the potential costs involved.
Thank you for reading!