What Is Direct Indexing?

Manju Boraiah: Remember when we all had to buy entire CDs just to get one song we wanted? Today you can create your own playlist, skip the songs you don't like, repeat your favorites, and still discover new music. Now, imagine having the same flexibility when you're designing your own portfolios for investing—being able to create your own personalized investment playlist. We believe direct indexing offers a compelling solution for investors seeking to meet their own needs and goals. So, what is direct indexing? Direct indexing is an investment strategy that allows investors to directly own the individual securities that make up an index—just like the S&P 500—rather than having to invest in a fund that tracks an index. Because of its customization features, it offers more control and flexibility than traditional index investing. Now, here's how it works. Direct indexing portfolios are managed in a separately managed account, or an SMA, which contains a portfolio of individual stocks that mirror an index. But here's the difference—unlike a fund that seeks to track an index, a direct indexing portfolio can be customized to reflect you or your client’s preferences. For instance, maybe you prefer to exclude a particular company's stock within the portfolio or exclude an entire industry of stocks. With direct indexing, these and a wide range of other portfolio adjustments are made possible. But here's where direct indexing can get even more interesting. Because investors actually own the individual securities within their portfolio, they can benefit from additional capabilities like ongoing tax management, portfolio transparency, and transition planning. First, let's start with the tax benefits. Direct indexing portfolios offer robust tax management capabilities. Capturing losses to offset gains for tax-loss harvesting purposes can take place continually and systematically at the individual security level. Now, here's an example of harvesting losses on a single stock. Let's say Stock A has a value of $50,000. Over time, Stock A loses value and is now only worth $40,000. Stock A can then be sold at a loss and replaced with Stock B with a similar risk profile. The captured losses can then be used to offset gains of other stocks in the portfolio, potentially resulting in tax savings and enhanced performance. Now, consider the possibilities at scale. Tax-loss harvesting at the individual security level can offer opportunities to exploit volatility and generate tax alpha throughout the life of a portfolio, even in up-markets. This helps investors tap into a highly robust, year-round tax management program designed to help them keep more of what they earn. Next up, transparency. Direct indexing investors also have the benefit of high visibility into their portfolio holdings, helping them better understand how their money is being managed and providing the ability to make informed investment decisions. Finally, how about transition planning? Direct indexing can help ease portfolio transitions through detailed tax mitigation. Instead of selling entire positions, investors can manage individual holdings, reduce tax impact, and use harvested losses to offset gains—making the shift to a new strategy a more tax friendly experience. Now that we understand the benefits of direct indexing, let's talk about who can benefit the most. Thanks to advancements in trading technology and lower fees, direct indexing has become a much more viable and accessible strategy for many investors. Now, do any of these describe you or your clients? An investor seeking to maximize after-tax returns? Or those with large taxable accounts where tax-loss harvesting matters the most? What about investors seeking to align portfolios with faith-based values? Or those looking for control over specific securities held in their portfolios? And finally, how about owners of concentrated stock positions looking to mitigate concentration risk? Does that sound familiar? Then, consider how direct indexing can empower you and your clients to take control of investments with customization, tax efficiency, and transparency. At Allspring, direct indexing is all about choice—shaping your financial future in a way that's right for you. It's index investing, made personal.