Direct Indexing

There is an investment concept that has been around for many years, but as of late, has been increasingly brought up in conversation and use. It is called direct indexing, and we wanted to share not only how it works, but why it can be valuable in certain situations; mainly for those who hold concentrated publicly traded stock positions with a low cost-basis.

So, let’s say Mrs. Client has $1,000,000 of a stock that was purchased over many years. During that time, she invested a total of $250,000 and that is her cost basis. If she sold the shares today, she would have a taxable gain of $750,000. Ouch! In addition, this represents a large amount of her assets, and she would like to diversify some of this concentration risk away. She would also like to invest for income in retirement. Direct indexing is something that could provide significant value in this situation. Here’s how it works.

Mrs. Client opens a brokerage account and transfers her shares into it. She also provides some cash on hand for investment purposes. Let’s say $250,000. We then seek an investment goal for diversification such as the S&P 500, or other type of market objective. The custodian then invests the cash in a portion of that index which doesn’t buy every holding but provides enough diversification to be representative of the overall index. For example, we may buy 150 companies in the S&P. Over a period, such as monthly, weekly or even daily, losses in the portfolio are harvested, and during that period, the shares of stock are sold to match to losses, thereby achieving two objectives: diversifying the portfolio and doing it with little or no tax liability on the stock sales.

Recent advances in technology have reduced costs and simplified the processes available in direct indexing, making it available to larger audiences. There are many folks out there that have accumulated large amounts of single positions and look to diversify over time, especially as they reach retirement. This may be a good tool to re-direct some of that wealth into different and more diversified strategies, all in a tax-efficient manner.

This article represents a basic illustration of direct indexing and the opportunity for its use. There are other advanced uses that can be used, and additional details that are beyond the scope of this article.

Investing involves risk. No investment strategy can guarantee positive results. Loss, including loss of principal, may occur. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax or legal advice. Keep in mind that current and historical facts may not be indicative of future results. Diversification is an investment strategy that can help manage risk within a portfolio, but it does not guarantee profits or protect against loss in declining markets.

This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. (C) Twenty Over Ten