How to Implement Direct Indexing in Your Portfolio

Tony Svach: Direct indexing has quickly become one of the most talked-about innovations in investing and for a good reason. Instead of owning a mutual fund or ETF (exchange-traded fund) that tracks an index like the S&P 500, an investor will own a representative subset of an index's individual stocks directly in a separately managed account. That direct ownership gives you three big advantages: flexibility, customization, and tax management, or potential tax savings. So, how do you actually implement direct indexing? One of the most common ways is by replacing an existing index fund or passive ETF. Since many investors already use those as core holdings to track an index, a direct indexing portfolio will feel familiar. It can replace its same index, but it's managed around your tax situation and your goals. That makes it a smarter, potentially more tax-efficient version of the core holdings that you may already use. The next step is funding the account and here's where direct indexing is flexible. You can start with cash, you can start with existing securities, models, or funds, or you can combine both. Some investors even fund new accounts through in-kind transfers, moving shares they already own into the new account to avoid triggering immediate capital gains. This adaptability can make direct indexing a fit, whether you're starting fresh or aiming to reshape an existing portfolio in a more tax-conscious way. Funding flexibility is especially valuable if you hold highly appreciated assets. Take a concentrated stock position, for example. Selling it all at once could mean a huge tax bill. With direct indexing, you can diversify gradually. Proceeds are deployed into index stocks over time. Harvested losses from some of these newly established stock holdings will help offset gains. The result? Reduced concentration risk, a lighter tax burden and a smoother path to a diversified portfolio. Another key element is how a direct indexing account is managed and how often it is reviewed. Some providers only act when a trigger opportunity is hit, like thresholds for a tax loss. Others act only on a monthly or quarterly basis. At Allspring, accounts are reviewed and optimized daily. Each morning, our team receives a report from our optimization tool, identifying opportunities to enhance portfolios. These opportunities for both tax loss harvesting and improvement in the tracking of the index, also known as tracking error, are considered together. In plain language, your portfolio isn't just chasing losses. It stays aligned with the market while capturing tax benefits when possible. This balance between tax efficiency and index tracking helps keep the strategy disciplined. Implementing direct indexing is about more than swapping one investment for another. It's about building a flexible tax-aware framework that adapts to your unique needs. Whether you're replacing an ETF, funding with cash or securities, diversifying a concentrated stock position, or preparing for retirement, direct indexing can become a core building block for a more tax-efficient, personalized portfolio.