Definition
Direct indexing is owning the individual stocks of an index directly rather than through a fund, which enables ongoing tax-loss harvesting.
How It Works
Instead of buying an index fund, the investor holds the underlying stocks in a separate account. This allows selling individual losers to harvest losses while maintaining overall index exposure, generating tax benefits a single fund cannot.
Example
In a down market, a direct indexing account sells specific declining stocks to harvest losses while staying invested in the broader index, offsetting gains elsewhere.
When It Works Best
It works best for investors with large taxable accounts and significant capital gains to offset, such as those with concentrated stock or frequent realized gains.
Who It Applies To
Higher-net-worth investors with taxable accounts.
Watch-Outs
It adds complexity and cost relative to a simple index fund, and the wash sale rule still applies to the harvesting.
