Utilizing investment strategies only institutional or ultra-high-net-worth investors have access to in the past. Increase your after-tax investment portfolio. Build your own index fund to invest in what’s important to you. It’s tempting to dismiss these marketing claims as hyperbole, except they come from some of the best-known and most respected names in the investment world, including Fidelity, Schwab and even Burton Malkiel, author of investment classics. A Random Walk Down Wall Street.
The fanfare is about a controversial trend: A growing number of investment firms now offer Main Street investors a strategy called “personal” or “direct” indexing that typically requires buying and trading stocks directly, mimicking an index. Investment firms and advisors have long offered this strategy to the wealthy for an annual management fee that often exceeds 1% of the portfolio’s value. But now, enabled by trading no commission, a smart supercomputer program with the ability to buy fractions of shares, at least three firms-Fidelity, Schwab and Wealthfront-are repackaging services for cost-conscious index investors. The new offer allows you to index your personal and portfolio for as little as $1, for fees ranging from $4.99 a month to 0.4% a year (see table below).
There are two main types of this new program. One focuses on personalizing your portfolio by allowing you to invest in a thematic basket of individual stocks-green energy companies, for example—or to adjust the broader index by eliminating companies that you may dispute or that you have large positions elsewhere. Other types, which typically allow less personalization, all about tax efficiency, focus on harvest investment losses to offset profits or income and reduce your bill by April 15.
Why not just pick your own stocks? Few average investors have the time and expertise either to buy and manage potentially hundreds of stocks by repeating the index or to continually trade money-losing stocks for similar issues to lock in tax losses.
Healthy Skepticism For Direct Indexing
Any new Wall Street offering should be scrutinized. And here’s a lot of criticism: Rick Ferri, a financial advisor and president of the John C. Bogle Center for Financial Literacy, questions the cost and wonders whether customized portfolios might make it harder to transfer assets from privately built providers. index.
As for tax efficiency, investors must weigh the advantages against the increased complexity of their tax returns: Schwab (which requires potential new clients to have a no-cost consultation with one of its advisers) warns that Personalized Investor Indexing expects tax 1099 forms that may exceed 50 glass, for example. And some individual investors may consider the minimum investment at Schwab and Wealthfront — $100,000 — to be on the high side.
Reasons to Invest
Even boosters—including the research-blind Morningstar fund, which plans to launch a direct index program for sale through advisers as late as 2022—admit that the new index isn’t for everyone. Daniel Needham, president of Morningstar’s Wealth Management Solutions, urges investors to protect core savings by building an emergency fund and using a profitable retirement savings account to invest in a tried-and-true mix of low-cost stocks and bonds. index funds. Once that’s done, he says there are three main reasons an investor might consider a personal index:
Interest. Although there are more than 10,000 mutual and exchange-traded funds with almost every imaginable mix of stocks, some investors may prefer to create individual stock portfolios to address ethical or other issues. Customization can be limited, though. Customers of Fidelity-managed FidFolios can exclude up to five stocks or two industries from Fidelity’s preset portfolio; for now, Schwab’s clients can bar only three stocks after choosing a portfolio.
Balance. Employees of companies that offer significant stock compensation (tech companies, for example) may want to limit their exposure to technology elsewhere. It could create a private index that avoids the tech stocks that make up more than one-fourth of the S&P 500, a diversification that can reduce overall portfolio risk.
Tax. The above investors tax brackets who hope to reap significant capital gains can use personal indexing to turbocharge the loss of harvest tax in the taxable brokerage account. The technique involves selling an investment that has decreased in value and using the loss to offset taxes on capital gains from other investments (or up to $3,000 in income if losses exceed gains). To stay fully invested, investors use the proceeds to buy similar things.
This requires skill, because the IRS’s “wash sales” The rule penalizes you for switching to an investment that looks “substantially identical” to anything you sold in the past 30 days. You can’t sell and then buy back GM stock in the next month, for example. But you can sell GM and buy Ford
|Name||costs||Minimum investment||Primary purpose||Account type|
|Loyalty Solo FidFolis||$4.99/month||$1||Personalization||Taxes and some IRAs|
|FidFolios Managed Loyalty||0.4%/year||$5,000||Harvest tax-loss||Taxable|
|Schwab Personal Indexing||0.35%-0.4%/year depending on the invested assets||$100,000||Harvest tax-loss||Taxable|
|Wealthfront US Direct Indexing||0.25%/year||$100,000||Harvest tax-loss||Taxable|
There are a lot of losses these days in mutual funds and ETFs, of course, but the promoters of direct-indexing claim that holding individual shares allows you to cash in on losses that may be obscured by the return of all broad index funds. “Even in a good year, 20% to 30% of stocks will fall,” explains DJ Tierney, a senior portfolio strategist for Schwab Asset Management Solutions.
The boosters say tax loss harvesting can be worth the work. Wealthfront research says that over the five-year period ending April 30, the after-tax returns of the firm’s U.S. Direct Index clients were typically 0.4 to 0.8 percentage points a year ahead of where they would have stuck with ETFs and used them. standard tax-loss harvesting strategy.
Malkiel, Wealthfront’s chief investment officer, says that tax loss harvesting is the only exception he makes to passive-index-investment advice: “I really believe in direct indexing. It’s really helpful in times like this, when the market has been down a lot.”
But other cost-conscious investment advisers say most investors do not pay enough tax to make the strategy worthwhile, unless they expect large capital gains. It should come as no surprise that sophisticated tax strategies pay off the most for those with high tax bills. For everyone else, personal indexing is, perhaps, like hiring a tailor to make a custom-made shirt. Creating a dedicated stock portfolio for a fee can be a luxury to invest only after taking care of the necessities.