Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
The majority of financial professionals seem to have reacted with a shrug to advances in direct indexing. Cerulli Associates recently found just 14% of advisors recommend direct indexing strategies to their clients. Those who are not familiar with this strategy may be missing out on an opportunity for their clients.
Why? From where I sit, it has been an effective answer to a very compelling question advisors hear from clients: “How do I minimize my tax bill?” This investing strategy warrants a closer look now.
Direct indexing is a strategy that creates a customized portfolio by directly purchasing individual stocks that aim to track an index (like the S&P 500 or a sector index) with some modifications, rather than buying a traditional index fund or exchange-traded fund (ETF). This allows for greater flexibility and control over the investments in the portfolio. Advantages include tax efficiency by facilitating tax-loss harvesting and great ability to customize the portfolio.
The idea of direct indexing is not new. However, it has yet to see broad adoption, even after technological advances that have made it feasible for advisors to deploy the strategy outside the realm of the ultra-wealthy.
On the bright side, those who do adopt direct indexing are securing an early advantage in client service over the adopters I believe will come later.
It’s useful to compare direct indexing with the trajectory of ETFs. State Street Global Investors launched the first U.S. ETF in 1993. By now, ETFs are widely recognized as a fundamentally more efficient, flexible, and versatile investment vehicle than mutual funds.
Similarly, direct indexing, like ETFs, brings important efficiencies to the end investor and is likely to experience a similar growth pattern. Direct indexing solves compelling challenges for investors. Modern direct indexing tools, using sophisticated technology, can identify tax loss opportunities on a daily or even minute-by-minute basis. As time progresses, I believe more advisors will see the potential of direct indexing. At the end of 2023 there were $615.3 billion in direct indexed assets, and analysts expect the market to hit $1.1 trillion by the end of 2028.
