Direct indexing is an investment approach that allows you to own individual stocks within an index, rather than investing in a pooled vehicle like a mutual fund or ETF. At Wealthquest, we offer direct indexing as part of our investment management strategy, particularly for clients who can benefit from a more personalized and tax-aware portfolio.
How is direct indexing different from buying an index fund?
Traditionally, investors gain exposure to markets like the S&P 500 by buying an index fund. That fund bundles all the underlying stocks into a single investment. While this is efficient and low-cost, it also limits flexibility.
Direct indexing takes a different approach. Instead of owning the whole fund, you own the individual stocks that make up the index. This structure opens the door to more customization and proactive tax strategies that are not possible in a fund format.
How does Wealthquest use direct indexing?
At Wealthquest, direct indexing is primarily used as a tool for tax loss harvesting and portfolio customization. While not every client needs direct indexing, it can be especially valuable for taxable investment accounts.
Here are the key ways that we use direct indexing:
1. Tax loss harvesting
This is the most common use case. Because you own individual securities, we can selectively sell positions that have declined in value to realize losses. These losses can be used to offset gains elsewhere in your portfolio or even reduce taxable income, subject to IRS rules.
We then reinvest the proceeds into similar securities to maintain your market exposure. Over time, this can help improve after-tax returns without changing your overall investment strategy.
2. Portfolio customization
Direct indexing allows us to tailor your portfolio in ways that traditional funds cannot. For example:
- Avoiding certain companies or sectors
- Managing concentrated stock positions
- Aligning the portfolio with personal preferences or restrictions
This level of customization is especially helpful for clients with legacy holdings, executive compensation in stock, or specific planning considerations.
3. ESG and values-based investing
Direct indexing can also support environmental, social, and governance (ESG) preferences. If there are companies or industries you prefer to avoid or emphasize, we can incorporate those guidelines into the construction of your portfolio while still maintaining broad diversification.
Why does this matter for clients?
For many investors, the biggest benefit of direct indexing is tax efficiency. Taxes are one of the few variables we can actively manage, and over time, thoughtful tax strategies can meaningfully impact net returns.
Direct indexing also provides a more personalized experience. Rather than a one-size-fits-all fund, your investments can reflect your unique financial situation, goals, and values. This aligns well with our broader philosophy of building portfolios that are tailored to you, based on your goals, and integrated with your overall financial plan.
That being said, direct indexing is not necessary for everyone. It typically requires a certain account size to implement effectively, and it may not add significant value in tax-advantaged accounts like IRAs. We evaluate this on a case-by-case basis to determine whether direct indexing fits within your broader strategy.
A thoughtful, disciplined approach
Direct indexing is one of several tools we use to enhance outcomes when appropriate. Our focus remains on long-term, disciplined investing aligned with your goals, risk tolerance, and tax situation.
We also monitor and manage these portfolios continuously to ensure they stay aligned with their intended purposes, including rebalancing, tax management, and ongoing adjustments as your circumstances evolve.
Summary
Direct indexing is a flexible investment approach that allows you to own the individual components of an index, opening up opportunities for tax management and customization. Wealthquest offers direct indexing for clients where it adds clear value, most commonly through tax loss harvesting and personalized portfolio construction, including ESG considerations.
If you are interested in learning whether direct indexing could benefit your situation, we would be happy to talk through how it fits into your overall financial plan and investment strategy.
