ESG-based direct indexing would let you buy 29 of the 30 Dow component companies but skip CVX.
Say you liked the DJIA but didn’t want to support oil and gas giant Chevron ( CVX), a DJIA component. If this sounds familiar, it’s probably because it’s part and parcel of ESG investing, a subset of socially responsible investing (SRI) that actively screens companies based on how well they score on third-party criteria related to their environmental, societal and governance policies and behavior.ĮSG-based direct indexing can allow you to personalize a major index, like the S&P 500 or the Dow Jones Industrial Average (DJIA). Faith-based investors may reject vice-based stocks, and environmental investors might turn green over a coal-based or nuclear power generator, for instance. Direct Indexing and ESGĭirect indexing offers you the ability to choose-or more commonly, reject-individual companies that don’t meet your personal standards, ethical or otherwise. Bloomberg reports that direct indexing providers estimate this kind of tax-loss harvesting could raise returns by about 1% a year. The benefits can be significant, even when the market’s on an overall upswing. However, it’s been established that the strategy works consistently across market conditions. For similar reasons, direct indexing is not relevant to tax-advantaged retirement accounts, like a 401(k) or an individual retirement account. Individual investors who earn $41,675 or less ($83,350 for married filing jointly). Not everyone can benefit from tax-loss harvesting. Meanwhile, you’ve generated a capital loss that you can use to reduce your overall tax liability. Take the cash from each tax-loss sale and buy shares in similar companies to balance your portfolio’s allocations. Maybe only a few stocks in a hundred are responsible for a fund’s sizable dip in performance, after all.ĭirect indexing portfolios make it simple to handle precise tax-loss harvesting, since it’s easy to sell underperforming individual stocks. You could harvest tax losses at the fund level-sell shares of an underperforming index fund or ETF and replace them with a different fund-but you can’t hone in on individual winning or losing securities within a fund. You may then replace the assets you sell with similar, but not identical, investments to position yourself for a rebound in the asset class.
Tax-loss harvesting is when you sell off assets that have fallen in value to offset current or future gains from other sources. Tax-Loss Harvesting Is Direct Indexing’s Superpower Building and managing a direct index portfolio is a time-consuming job that requires frequent rebalancing. Individual investors typically rely on big financial firms or financial advisors to provide them with direct indexing services. Since you’re buying individual securities rather than a fund, you get extra flexibility to customize your portfolio, enabling you to reap potential tax benefits and filter out unsavory or undesirable stocks you can’t when you buy a fund wholesale.
Here’s where the direct indexing strategy diverges from funds. Sound familiar? Direct indexing uses a similar approach to index funds and ETFs. How Direct Indexing Worksĭirect indexing involves purchasing the underlying securities that make up an index, with the goal of duplicating the index’s performance. This strategy is expected to grow 12.3% annually and reach $800 billion by 2026, according to a recent report from Cerulli Associates. Once the exclusive domain of wealthy clients, direct indexing has become cheaper and more accessible than ever thanks to better technology and ever-lower trading commissions. Rather than buying a mutual fund or exchange-traded fund, direct indexing allows investors to tailor their portfolio to their specific preferences and investment goals, and it’s especially useful for ESG investing. Direct indexing is the construction of a custom investment portfolio that mirrors the composition of an index.
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