Personalization and customization are becoming increasingly important for investors. If you find that mutual funds and ETFs aren’t addressing your client’s investing goals, then direct indexing may be an option.
Direct indexing allows advisors to select individual stocks for a client’s portfolio rather than opting for the bundled-stock style of a fund. This active management option has several distinct benefits, including tax efficiency, customization, risk management, and charitable giving.
Benefit #1: Help reduce the impact of taxes
Direct indexing allows investors to use a common tax-saving strategy called tax-loss harvesting. Because you’re directly buying and selecting individual stocks, you have more control over when you choose to sell positions. Tax-loss harvesting refers to selling positions in taxable investment accounts that have lost value (in other words, “harvesting” them) and using the losses to offset the capital gains of other positions. You can lower your tax bill by offsetting gains with losses.
With mutual funds or ETFs, you still can sell and buy shares — but you’re doing so at the fund level. That means that you’re also selling off stocks that are potentially performing well, along with any losses. Direct indexing allows you to hone in on the underperforming positions and offload them to take advantage of the loss.
Benefit #2: High level of customization
One of the most notable benefits of direct indexing is the ability to customize and personalize your client’s portfolio. Build the portfolio based on their desires to invest in specific companies or sectors of the market (like energy, health care, e-commerce, etc.) or even make value-based investment choices.
ESG – Environmental, Social, and Governance – investing is growing more popular each year. People want to make a difference in how they spend and invest their money. If your clients have a specific cause in mind, such as climate change or diversity and inclusion, direct indexing allows them to pick and choose which companies best align with those values. Mutual funds or ETFs are bundles of stocks, which means some included in the bundle may not align with your clients’ ESG investing goals or personal values.
Benefit #3: Risk management
When you have total control over what stocks are included (or not included) in your client’s portfolio, you can reduce their risk exposure. If a particular sector or company is performing poorly or expecting to perform poorly, you can adjust as needed. Having this more significant control over your clients’ investments allows you to develop and maintain a portfolio based on their tolerance for risk and long-term goals.
Benefit #4: Charitable giving
If your clients are charitably minded or want to incorporate philanthropy into their investment strategy, direct indexing can help. Clients may donate individual stocks to charities. Or, if they have established a donor-advised fund (DAF), they may donate stocks to the DAF. Donating appreciated assets (like individual stocks) is an effective way to give to a deserving cause and reduce your clients’ tax liability.
When stocks are donated directly to charity (or to your client’s DAF), they can bypass capital gains tax. Plus, your client may be able to deduct the stock’s fair market value from their income taxes.
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Direct indexing is an effective way to create an ultra-customized, tax-focused portfolio for your clients. intelliflo redblack is designed to empower RIAs of all sizes by providing digitally-driven rebalancing and trading capabilities that allow your firm to scale without sacrificing client service.