Is Direct Indexing Right for Your Portfolio? The Tax Strategy That's Changing Wealth Management

Tired of watching your investment returns get eaten up by taxes? Direct indexing might just be the strategy that changes the game for how you think about portfolio management.

What Makes Direct Indexing Different

Think of direct indexing as the customized cousin of ETFs and mutual funds. Instead of holding a basket of securities through a fund, you own the actual individual stocks or bonds that make up your chosen index. This might sound like a small distinction, but it opens the door to a level of control that traditional index investing simply can’t match.

The real magic happens when you take full ownership of your investment decisions. You decide the timing of when to crystallize gains and losses—not some fund manager on a predetermined schedule. This timing flexibility is where the tax benefits come in, potentially adding 1% to 2% to your after-tax returns over time.

The Tax-Loss Harvesting Advantage

One of the most powerful features of direct indexing is tax-loss harvesting. When holdings drop in value, you can sell them to lock in losses, then immediately pivot those proceeds into similar securities rather than sitting in cash. Those realized losses offset your capital gains—potentially from other investments entirely. In a traditional mutual fund or ETF, you get hit with whatever capital gains the fund itself realizes, taking away your control.

Want to exclude tobacco stocks from your portfolio on ethical grounds? With direct indexing, that’s entirely within your control. You’re building an index that reflects your values and risk tolerance, not one-size-fits-all fund structures.

The Catches You Need to Know

Here’s where direct indexing gets complicated. First, the “wash sale rule”—if you sell a security at a loss, you can’t repurchase the identical security within 30 days. The workaround? Buy a substitute with similar factor scores to stay aligned with your benchmark while respecting the rules.

Second limitation: short-term losses can’t offset long-term gains. And here’s the kicker—if you’re holding most of your wealth in a retirement account, those tax benefits largely disappear since those accounts are already tax-deferred anyway.

Who Should Actually Use Direct Indexing

Yes, direct indexing is becoming more accessible thanks to lower trading costs and better technology platforms. But let’s be real: it’s most valuable for investors in higher tax brackets, those with large concentrated positions, and those playing the long game with multi-year holding periods.

The bottom line? Direct indexing gives you precision control over your taxes, but you need to match the strategy to your actual situation.