With tax season upon us, one of our clients, whom we’ll call “John,” had built a substantial portfolio but faced large annual capital gains tax liabilities. A successful entrepreneur in his mid-50s, John had previously worked with another advisor who actively managed his portfolio. However, despite the high-touch approach, the results didn’t meet expectations—returns were underwhelming, and taxes were still eating into his gains.
John came to us with the question, “What can you do to reduce my tax burden without sacrificing performance?”
We pivoted the non-retirement part of his portfolio to a newer strategy called “Direct Indexing.”
One of the big advantages here is tax-loss harvesting. In this case, John offset over $100,000 in gains in just one year by strategically selling stocks in the red to offset gains from winners. This allowed him to reinvest savings into both equities and real estate, compounding his wealth while minimizing tax drag.
So, what is Direct Indexing? Hang tight, and you’ll learn how we helped John customize his portfolio while realizing returns at (and sometimes above) the S&P index and saved on taxes as well … Imagine That!™
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What Is Direct Indexing? Example 2
I’m so glad you asked!
Direct Indexing is one of the most exciting innovations in modern investment planning. The very, very short definition? It’s a method of growing your portfolio and, at the same time, mitigating your taxes.
Here is an example of another client situation …
“Sarah,” a 52-year-old tech executive, had a significant portion of her wealth tied up in her company’s stock through restricted stock units (RSUs) and an employee stock purchase plan (ESPP). This created tax inefficiencies and a “concentration risk” (owning too much of a single company stock) that her previous advisor had not addressed. Through Direct Indexing, we helped her diversify while using tax-loss harvesting to offset gains from stock vesting. Over two years, she reduced her concentrated stock risk while optimizing her tax liabilities—both outcomes made her very happy!
This innovative strategy allows investors to own individual stocks that make up a specified index (commonly the S&P 500 Index) rather than purchasing a mutual fund or exchange-traded fund (ETF) that tracks that specific index. The result? Greater customization, tax efficiency, and increased control over your portfolio.
Traditionally, investors looking for broad market exposure turned to index funds or ETFs. But thanks to advancements in technology and the availability of fractional shares, individuals can now replicate an index by owning its underlying securities directly.
It is a powerful approach for those looking to optimize taxes, personalize their investments, and align their portfolios with their values.
How Direct Indexing Works - Example 3
“Michael,” the 37-year-old son of one of our long-time clients, wanted his investments to reflect his passion for sustainability. He disliked that his previous portfolio included fossil fuel companies and businesses with poor labor practices. Direct Indexing allowed us to construct a portfolio mirroring the S&P 500 while excluding companies misaligned with his values. We also tilted his investments toward renewable energy and corporate social responsibility. Now, his wealth supports companies that share his mission.
Rather than buying a fund that mimics an index—such as the S&P 500—Direct Indexing allows you to directly own a customized basket of stocks that aligns with it. These holdings are managed by portfolio managers or automated platforms to track index performance, with the flexibility to tailor the portfolio to your preferences.
Direct indexing is buying individual stocks to mirror an index, allowing more control and tax benefits.
Side Note: You don’t have to own all 500 companies that make up the S&P 500. It’s all about customization. You could own the top-performing 150 or 200 if that works better for you.
Direct Indexing works by:
- Portfolio Customization – Exclude companies or sectors that don’t align with your values or investment thesis.
- Tax-Loss Harvesting – Maximize tax efficiency by realizing losses on underperforming stocks to offset gains elsewhere.
- Optimized Asset Location – Strategically place investments across taxable and tax-deferred accounts for maximum benefit.
- Factor-Based Investing – Tilt your portfolio toward factors like growth, value, or dividend income while maintaining index-like exposure.
Who Benefits Most from Direct Indexing?
Direct Indexing is particularly well-suited for:
- High-Net-Worth Individuals – Those in higher tax brackets benefit from enhanced tax-loss harvesting and strategic asset location.
- Investors with Large Taxable Accounts – Direct Indexing’s tax efficiencies are best realized outside retirement accounts.
- Values-Based Investors – Customize your portfolio to align with ESG goals or avoid companies that don’t match your beliefs.
- Individuals with Concentrated Stock Holdings – Balance existing exposures while staying aligned with overall market performance.
- Investors Seeking More Control – Enjoy flexibility in managing sector weightings, risk exposure, and individual holdings.
Implementing Direct Indexing: Next Steps for Investors
If you’re a high-income or high-net-worth investor looking for more tax efficiency, flexibility, or values-based investing, Direct Indexing could be a game-changer. Here’s how to get started:
- Assess Suitability – Using our ten-question checklist, we’ll help determine whether Direct Indexing aligns with your goals and tax situation.
- Define Customization – Identify any stocks, sectors, or industries to include or exclude.
- Design for Tax Optimization – Implement a customized strategy for tax-loss harvesting and asset location.
- Ongoing Management – We rebalance and optimize typically every 31 days to ensure performance and tax efficiency remain on track. We will monitor your portfolio daily for opportunities and meet quarterly to review progress.
Beyond the Index: Making Your Investments Work Smarter
Direct Indexing represents the next generation of personalized investing. Enabling tax-efficient strategies, increased customization, and greater control provides high-net-worth and sophisticated investors with a superior approach to index-based investing.
Direct Indexing offers a compelling alternative to traditional ETFs and mutual funds as the financial industry shifts toward personalized wealth management. If you—or someone you know—are interested in learning more, we invite you to schedule a complimentary consultation to explore how this strategy can work for you.
A strategy that can build wealth and lower your taxes? Imagine That!™
Imagine That!™ is a complimentary bi-monthly newsletter provided by Wealth Legacy Group®, Inc. that addresses various topics of interest for high-net-worth and high-income business owners, professionals, executives and their families. Sign up to receive our monthly newsletter here.
R. J. Kelly, Wealth Legacy Group®, Inc. – March / April 2025
Header image on Canva, one design use license
