{"id":17973,"date":"2025-12-03T16:08:28","date_gmt":"2025-12-04T00:08:28","guid":{"rendered":"https:\/\/www.wealthfront.com/blog\/?p=17973"},"modified":"2025-12-03T16:08:30","modified_gmt":"2025-12-04T00:08:30","slug":"value-of-direct-indexing","status":"publish","type":"post","link":"https:\/\/www.wealthfront.com/blog\/value-of-direct-indexing\/","title":{"rendered":"How Direct Indexing Helps You Keep More of What You Earn"},"content":{"rendered":"\n

Back in 2013 when Wealthfront coined the term \u201cdirect indexing,\u201d the strategy (which had been around for decades) was fairly exclusive. Companies like Parametric and Aperio had long offered direct indexing to wealthy clients, but Wealthfront was an early pioneer in offering the strategy for a low cost and low minimum to everyday investors.\u00a0<\/p>\n\n\n\n

At Wealthfront, we believe that direct indexing is a powerful way to help maximize your after-tax returns, and that\u2019s why we\u2019re so passionate about making it more widely available to investors.<\/strong> In this post, I\u2019ll break down how this strategy works and why it can make such a big difference in helping you keep more of what you earn. Direct indexing might seem complicated, but you should know that Wealthfront makes it incredibly simple\u2014we design our direct indexing products, including Wealthfront\u2019s S&P 500 Direct<\/a> and Nasdaq-100 Direct<\/a>, to help lower your tax bill with no extra effort on your part.<\/p>\n\n\n\n

How direct indexing works<\/h2>\n\n\n\n

Let\u2019s start with the basics of the strategy. Direct indexing gets its name from the fact that investors directly own the stocks that comprise an index instead of owning an index-based ETF or mutual fund. As a result, you get exposure to the stocks in the index (like you would with an ETF) but it\u2019s also possible to conduct tax-loss harvesting<\/a> (strategically selling investments at a loss and replacing them with similar investments) using those individual stocks. Conducting tax-loss harvesting with individual stocks means you could get opportunities to harvest losses even on days when the index as a whole is up, which means more chances to help lower your tax bill. In this way, direct indexing offers some of the same benefits as owning an index-based ETF plus something you can\u2019t get just from holding a single ETF: the ability to generate future tax savings.\u00a0<\/strong><\/p>\n\n\n\n

Here\u2019s an example that illustrates how this works. Let\u2019s say you use a direct indexing product to hold the 200 largest market cap stocks that make up an imaginary index. On a day when the index is up 1%, Coca-Cola (which we\u2019ll say is part of that imaginary index) might have announced poor earnings and declined 10%. If you only held an index-based ETF, there would be no loss to harvest. But if the 10% decline in Coca-Cola brings the stock\u2019s price below its purchase price, you can sell it at a loss and temporarily replace it with a combination of other highly correlated alternative stocks in the index (for example, stocks in the same industry like Pepsi) to keep the portfolio tracking the index closely. When you sell Coca-Cola at a loss, you \u201charvest\u201d that loss and can use it to offset other gains and up to $3,000 of ordinary income each year. After 30 days, to comply with the wash sales rule<\/a>, you can sell Pepsi (and any other stocks you bought) and repurchase an equivalent amount of Coke.<\/p>\n\n\n\n

At the same time, the risk profile and pre-tax return of your portfolio generally remain the same with direct indexing (as compared to owning the corresponding index-based ETF) because the performance difference relative to the benchmark index should be fairly low. But your after-tax<\/em> return has the potential to be better with direct indexing because you should be able to harvest losses that you can then use to lower your tax bill. And after-tax return is what really matters<\/strong><\/a>, because that\u2019s what you get to keep<\/strong>. <\/strong>Saving on taxes is also valuable because it means more money to reinvest, with the potential to grow and compound in the future.<\/p>\n\n\n\n

If direct indexing sounds labor-intensive, that\u2019s because it can be. A human advisor would need to carefully track the performance of hundreds of individual stocks on a near-daily basis in order to execute this strategy successfully. Software, on the other hand, is ideally suited to this kind of rules-based task\u2014and that\u2019s exactly why Wealthfront automates it.\u00a0<\/p>\n\n\n\n

What do you do with the losses?<\/h2>\n\n\n\n

Harvested losses are valuable because they can be used to lower your tax bill.<\/strong> You can offset capital gains and, if you still have losses left over after that, up to $3,000 of ordinary income (like money you earn as your salary) in a given year. Any losses you have left over after that<\/em> can be rolled over to future years to offset future capital gains and\/or ordinary income.\u00a0<\/p>\n\n\n\n

Let\u2019s illustrate this with an example. To start, imagine you harvested $4,000 of losses last year and realized $500 of capital gains. We\u2019ll also imagine you have a salary of $150,000. Here\u2019s what you could do with those losses:<\/p>\n\n\n\n