Direct Indexing: The Ultra Wealthy’s Secret Edge
If not, you may be leaving significant performance gains on the table. Let's dive into why.
You cannot tax-loss harvest an index-tracking fund because you own interests in the fund, instead of the individual securities. But with Direct Indexing, you can.
Direct Indexing enables you to build a separately managed account that replicates a stock index, such as the S&P 500 or the Russell 3000, enabling you to directly own the individual stocks that make up the chosen index.
For example, if you are environmentally conscious, direct indexing allows you to selectively avoid companies with high carbon emissions. Or perhaps you believe you are overexposed to a certain stock or sector that you view as risky; direct indexing can allow you to diversify around that position to help mitigate the risk.
After selling an underperforming stock, the proceeds can be strategically reinvested in a correlated stock, ensuring you remain exposed to the index's potential upside.
Traditional ETFs vs. Direct Indexing: Tax Alpha & Tax Loss Harvesting
Morgan Stanley's extensive backtest, spanning events like the DotCom crash, the 2008 crisis, and the 2010s, reveal a compelling narrative. Direct Indexing has the potential to outperform passive ETF investing by approximately 2%, especially in bear markets. The magic of compounding this 2% over time? Substantial.
Under this: Advisors can sell underperforming stocks, realizing a tax loss. And to stay compliant of the "wash sale" rule, they may repurchase the same securities after a 30-day window.
Benefits: The realized losses can offset capital gains, reducing the current year's tax burden.This is especially useful for those with unexpected capital gains, like from a property sale. Unused losses can often be carried forward, offsetting future capital gains.
In essence, TLH is a proactive approach to manage potential tax bills, enabling investors to improve their overall returns.
Investor facing substantial capital gains tax
Scenario A: The ETF Path
Investment Method: Holding an ETF mirroring the S&P500.
Tax Season Reality: No losses to harvest despite underperformers due to overall positive index performance.
Tax Implication: A 15% tax on the full $300,000 gain, equating to a $45,000 tax bill. No mitigation strategy in place.
Scenario B: The Direct Indexing Path
Investment Method: Utilizing Direct Indexing, holding a basket of individual securities mirroring the S&P500.
Advantage: The Direct Indexing software sells underperforming securities during the year, realizing losses of $60,000, and buys similar ones to maintain index tracking.
Tax Season Reality: The $60,000 loss is strategically offset against your $300,000 capital gains, reducing taxable income to $240,000.
Tax Implication: A 15% tax on the reduced $240,000 gain, lowers the tax bill to $36,000, saving you $9,000.
Navigating Concentrated Stock Holdings for Entrepreneurs and Early Employees
Even post-IPO, employees at tech giants like Facebook and Microsoft face the risk of overexposure to tech. With Direct Indexing, they can create a portfolio that reduces tech stock exposure, ensuring diversification and lower tech sector volatility while tracking the index.
Harness immediate tax savings and enjoy the potential of long-term wealth creation.
Whether it's aligning values, sidestepping sector risks, or capitalizing on tax rate shifts, Direct Indexing adapts to your financial goals.
Your Next Step: In the current market environment of sudden rate hikes and volatility the opportunity is ripe to deploy Direct Indexing into your portfolio. We're eager to hear your thoughts and discuss how it can be tailored to your unique financial journey.Consider joining our waitlist, by pressing the button below, if you are ready to explore this opportunity for your portfolio.
The Lumida Advantage
Beyond the Ordinary
Qualified Clients can click below to learn more:
Ram, has 20+ years of experience in management and investments. He founded Cross River Crypto, was CEO of PeerIQ (acquired by Cross River Bank), and held executive roles at Bank of America and Merrill Lynch. Ram is a CFA Charterholder with a BA in Philosophy and Economics from Columbia College.
Justin, has 18+ years of experience in corporate operations, finance, legal, compliance, and investments. He co-founded Reserve Trust, served as Managing Director at PennAve One, and practiced law at Dentons and Kilpatrick Townsend. Justin holds a JD from The George Washington University Law School and a BA in Business Administration from the University of Florida.