With index funds, investors can buy a bucket of investments that is made up of all 500 stocks in Standard and Poor’s famous index. This is great because you get access to 500 stocks with having to pay only one trade commission.
But with direct indexing, you are able to take advantage of tax-loss harvesting at a scale not possible with traditional funds. After all, with a fund, when you buy or sell, you are buying or selling the entire list of stocks. Many robo advisors, such as Betterment and Wealthfront, offer opportunities for tax-loss harvesting. Betterment takes care of tax-loss harvesting only at a fund level. But direct indexing (and Wealthfront) allows tax-loss harvesting at the individual stock level.
|Minimum to Open Account||$0||$500|
|Advice Options||Automated, Human Assisted||Automated|
|Socially Responsible Investing||true||true|
While you may end up paying more fees for a managed direct indexing portfolio than you would with a low-fee index fund, tax-loss harvesting benefits can make up for those costs and then some.
To see how the numbers fall into place for your portfolio, let’s look at an example. Let’s say you bought a handful of S&P 500 stocks at the start of the year. From January to October, one stock you hold falls by $4,000. If you want to keep building your portfolio and avoid selling, you get no tax benefit from this scenario in an index fund. But with direct indexing, you can sell the stock with a $4,000 loss and buy a comparable S&P 500 stock with the proceeds. This locks a $4,000 capital loss into your portfolio, offsetting a future capital gain. At the 25% tax bracket, that is worth $1,000 in tax savings.