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The Democratization of Direct Indexing

Once confined to the world of the ultra-wealthy, Direct Indexing has come down to the masses with all of the benefits and opportunities that it entails. With the power of passive indexing combinedwith greater tax-loss harvesting opportunities and fine-tuned to your values, goals, and needs, many Americans have a new and potent tool in their hands.

Traditionally High Barriers

If you’re not familiar with Direct Indexing, let’s start by understanding some basics using the S&P 500 index and its associated ETF, SPY, as examples. The S&P 500 is an index that represents the performance of the 500 largest publicly traded companies in the United States. On the other hand, SPY is an Exchange-Traded Fund (ETF) designed to mimic the S&P 500 by holding a basket of stocks that closely resembles the composition of this index.
We use the S&P 500 and SPY as examples because they are well-known. However, we can reproduce any index using Direct Indexing – not only the S&P 500.

Costs

In contrast to SPY, Direct Indexing involves actually buying the individual stocks that make up the S&P 500. Of course, purchasing varying amounts of 500 different stocks would be prohibitively costly for the vast majority of Americans – which is why it was, until recently, solely the domain of the ultra-wealthy.

Complexity

Managing a portfolio is difficult. Now imagine managing a massive portfolio comprising the stocks associated with the S&P 500 index or Russell 3000 index. That’s why these kinds of ETFs or Mutual Funds have their own fund managers and administrative staff to do so. Even then, drifting and tracking errors can occur.
Setting up your own index fund meant not just an enormous sum of money to purchase the stocks but also hiring a full-time manager to constantly rebalance the portfolio to keep it in line with the index, also bearing a sizeable cost.

Barriers Torn Down

Fortunately for modern investors, leaps in technology have significantly reduced the barriers to entry into the world of indexing.

Fractional Ownership

As we mentioned, the cost of setting up a Direct Indexing portfolio has been one of its major drawbacks. However, fractional shares significantly lower this financial barrier. Now, for a fraction (pun intended) of the cost, investors can enjoy the benefits of owning a diverse range of stocks.

Portfolio Rebalancing

Maintaining a portfolio that accurately tracks a specific index is an ongoing task, one that involves constant rebalancing. This was traditionally labor-intensive and error-prone when done manually. Technology has streamlined this process considerably. Cutting-edge software can now automatically adjust the holdings in real-time to keep the portfolio aligned with the target index, significantly reducing tracking errors.

Automated Tax-Loss Scanning

One of the most complex aspects of managing an individualized portfolio is identifying tax-loss harvesting opportunities. When it comes to an enormous portfolio mirroring an index, it would require a dedicated team of professionals perpetually scrutinizing the market and your portfolio. Just like portfolio rebalancing, sophisticated software can now scan for positions where selling would be advantageous from a tax perspective, optimizing your tax obligations and enhancing the overall portfolio performance.

Cost Efficiency

Perhaps one of the most significant benefits of technology is cost efficiency. The fees usually associated with frequent trades are significantly diminished, making the ongoing operation of an index portfolio more affordable.
In essence, technology has revolutionized Direct Indexing, making it more efficient, accessible, and affordable. It’s another step toward a more equitable financial landscape, where high returns and strategic investing are not just the playground of the wealthy but are accessible to all.

The Role of Financial Advisors

While the advancement of technology certainly has democratized Direct Indexing, the expertise of a seasoned financial advisor remains invaluable.
Firstly, not many state-of-the-art indexing tools are readily available to the general public. Blackrock’s Aperio and Vanguard Personalized Indexing are two popular examples of platforms only available to advisors. And perhaps there’s a good reason for it.
Having a tool and knowing how to use it effectively are two very different things. Financial advisors bring years of education and experience to the table. With a deep understanding of market nuances and the expertise to interpret data, they can make better-informed decisions while using sophisticated software than a layperson can.
Also, no technology is foolproof. If something does go wrong, an advisor can provide a crucial layer of human oversight, making necessary manual adjustments to ensure that the portfolio remains aligned with the client’s goals and risk profile.
And as always, it always takes time. Even with automated help, it still requires a significant time investment for monitoring and adjustments. Most people have other responsibilities and can’t afford to dedicate the time needed to manage their portfolios properly.
Lastly, Direct Indexing doesn’t exist in a vacuum; it’s part of your overall financial portfolio. A financial advisor can integrate it seamlessly with your other assets and liabilities, retirement plans, and long-term financial goals, creating a balanced and optimized financial strategy.

In Conclusion

The democratization of Direct Indexing is indeed a groundbreaking advancement in investment, making it more equitable, efficient, and accessible. However, the value of professional guidance can’t be overstated.
As fiduciary financial advisors and Certified Public Accountants (CPAs), our dual background allows us to take a holistic approach to your financial planning, such as integrating Direct Indexing into your overall financial strategy and ensuring it aligns seamlessly with your other assets, liabilities, and long-term goals.
So, while technology has indeed made Direct Indexing more accessible to the average investor, the expertise and comprehensive services we offer make us the go-to professionals for maximizing the benefits of this powerful investment tool.
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About the Authors

  • Douglas Walters

    Doug is the Managing Partner of Walters Strategic Partners, LLC, a licensed Registered Investment Advisory firm. Doug is a licensed Certified Public Accountant (CPA) in the state of Florida and holds a Series 65 Investment Advisor Representative securities license. He is also a member of the AICPA. With over 28 years of experience as a CPA, he believes investment decisions should be based on decades of peer-reviewed research rather than relying on the latest “hot tip” from media outlets. This empirical evidence puts the science of investing to work for his clients.

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  • Jose Joia

    Jose M. Joia is a Wealth Advisor at Walters Strategic Advisors, LLC. As a member of the team, Jose’s responsibilities involve comprehensive wealth management, planning and customer service. He has over 6 years of industry experience specializing in planning and solving unique issues his clients encounter. Jose has experience serving individual clients, business owners and non-profit organizations.

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