{"id":18303,"date":"2026-07-07T10:05:05","date_gmt":"2026-07-07T17:05:05","guid":{"rendered":"https:\/\/www.wealthfront.com/blog\/?p=18303"},"modified":"2026-07-07T10:41:07","modified_gmt":"2026-07-07T17:41:07","slug":"direct-indexing-better-than-etf","status":"publish","type":"post","link":"https:\/\/www.wealthfront.com/blog\/direct-indexing-better-than-etf\/","title":{"rendered":"Why Direct Indexing Is Better Than an ETF"},"content":{"rendered":"\n

We recently asked an LLM (a large language model) a question we know our clients have from time to time: Which is better, investing in an index-based ETF or a direct indexing product that tracks the same index? <\/strong>We think the answer is pretty straightforward, which is why we were surprised to see the LLM provide guidance that we believe was clearly incorrect. That guidance was based on some common misconceptions about direct indexing rather than data, and we wanted to clear things up.\u00a0<\/p>\n\n\n\n

First, a quick refresher: Direct indexing<\/strong><\/a> is a strategy that involves directly holding individual stocks that make up an index in your brokerage account (thus the name <\/strong>direct<\/em><\/strong> indexing) instead of an index-based ETF. <\/strong>You can then conduct tax-loss harvesting with those individual stocks, which provides more opportunities to harvest losses than you\u2019d get with an ETF because individual stocks are far more volatile than broad index funds (even on a day when the index is up, many of its component stocks will be down). As a result, direct indexing provides a similar return as an index-based ETF (return of the index) with an added benefit: the potential to generate tax savings. Skeptics sometimes say those tax savings are not worth the supposed downsides of the strategy, but the data clearly tells a different story.<\/p>\n\n\n\n

In this post, we\u2019ll explain why we believe direct indexing, as implemented by Wealthfront, is nearly always superior to holding an ETF that tracks the same index for investors who have at least $5,000 to invest in a taxable account<\/strong>. <\/strong>We\u2019ll focus our argument primarily on our standalone direct indexing products: S&P 500 Direct<\/a> and Nasdaq-100 Direct<\/a>.<\/p>\n\n\n\n

Myth: The tax benefit from direct indexing \u201cdecays\u201d or dwindles to nearly nothing over time<\/strong><\/h2>\n\n\n\n

Reality: Index turnover, dividends, and add-on deposits provide new tax lots to keep harvesting losses<\/strong><\/h2>\n\n\n\n

We\u2019ll tackle what is arguably the most consequential misconception first: Some investors mistakenly believe the tax benefit from our standalone direct indexing products wanes over time to the point where it no longer justifies the fees we charge for them, even though these fees are very low. While it\u2019s true that Tax-Loss Harvesting can become more challenging over time when no additional deposits are made, reinvesting proceeds from harvested investments tends to lower the portfolio’s cost basis. In an upward-trending market, this lower cost basis means it can be harder to find losses to harvest in the future.<\/p>\n\n\n\n

While you might not maintain the exact same high level of benefit year after year, we believe even without add-on deposits our standalone direct indexing products should continue to generate more than enough estimated benefit to cover their fees, which are shown in the table below. Few other direct indexing services charge such a low price with such low minimums, and even ETFs like QQQ and QQQM have a higher price than Nasdaq-100 Direct.<\/p>\n\n\n\n

Annual advisory fees for Wealthfront\u2019s standalone direct indexing products<\/th><\/tr>
Product<\/th>Index tracked<\/th>Annual advisory fee<\/th>Expense ratio for cheapest ETF tracking the same index<\/th><\/tr><\/thead>
S&P 500 Direct<\/td>S&P 500\u00ae Index<\/td>0.09%<\/td>0.02% for SPYM<\/td><\/tr>
Nasdaq-100 Direct<\/td>Nasdaq-100 Index\u00ae<\/td>0.12%<\/td>0.10% for QNDX<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

While neither S&P 500 Direct nor Nasdaq-100 Direct yet have a long-enough history for us to share results over longer periods of time, we can look at the performance of our US Direct Indexing product to see how the estimated tax benefit changes over time. US Direct Indexing is an upgrade available within our globally diversified Automated Investing Account to replace the ETF that represents the US equities asset class. For clients with the US Direct Indexing upgrade, when their account reaches $100,000 in value, our software will purchase up to 100 individual large- and mid-cap US stocks (and certain ETFs to cover the remainder of the CRSP US Total Market Index) and conduct tax-loss harvesting with those stocks. <\/p>\n\n\n\n

Because of this, US Direct Indexing is useful for understanding how much potential tax benefit S&P 500 Direct and Nasdaq-100 Direct can provide over time. In the table below, we show \u201charvesting yield<\/a>\u201d for the US stocks portion of US Direct Indexing portfolios that have not benefited from any add on deposits post account creation (harvesting yield measures the quantity of losses harvested as a percentage of portfolio value), and we apply assumed tax rates to demonstrate the potential value of those losses. This table shows only<\/em> <\/em><\/strong>the results for clients who used US Direct Indexing for at least a year with no add-on deposits.<\/p>\n\n\n\n


Year<\/th>		Average annual harvesting yield<\/th>Range of estimated after-tax benefit, assuming 25-50% marginal tax rate<\/th><\/tr><\/thead>
1<\/td>8.26%<\/td>2.07% – 4.13%<\/td><\/tr>
2<\/td>4.14%<\/td>1.04% – 2.07%<\/td><\/tr>
3<\/td>2.72%<\/td>0.68% – 1.36%<\/td><\/tr>
4<\/td>0.55%<\/td>0.14% – 0.28%<\/td><\/tr>
5<\/td>1.06%<\/td>0.27% – 0.53%<\/td><\/tr>
6<\/td>0.27%<\/td>0.07% – 0.13%<\/td><\/tr>
7<\/td>0.46%<\/td>0.12% – 0.23%<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Source: Wealthfront<\/em>1<\/sup><\/p>\n\n\n\n

As you can see, in nearly every case, that estimated after-tax benefit is still <\/em>enough to cover the fee for S&P 500 Direct or Nasdaq-100 Direct over a period of many years when clients have gains and ordinary income to offset. And the numbers above actually understate the estimated after-tax benefit for four reasons:\u00a0<\/p>\n\n\n\n

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  1. Tax rate assumptions: <\/strong>A 25% marginal combined federal and state tax rate is a very conservative assumption that we think applies to very few of our clients using these products. The low end of the tax benefit range is likely not applicable.<\/li>\n\n\n\n
  2. Use of dividends to rebalance other asset classes: <\/strong>Wealthfront uses dividends to rebalance our Automated Investment Account portfolios, intelligently reinvesting dividends generated by US Direct Indexing and ETFs to buy more of the underweighted asset classes in the portfolio. This reduces (but does not eliminate) the need to rebalance by selling asset classes that have exceeded their target, which in turn reduces taxable gains. US stocks have outperformed in recent years, which means dividends from US Direct Indexing were likely reinvested in other<\/em> asset classes in order to rebalance the portfolio and help keep clients close to their target allocations rather than reinvested in the US Direct Indexing portion of the portfolio, which would have created more tax-loss harvesting opportunities.\u00a0<\/strong><\/li>\n\n\n\n
  3. Total number of stocks: <\/strong>US Direct Indexing employs up to 100 stocks whereas S&P 500 Direct employs up to 500 stocks. More stocks create more harvesting opportunities.<\/li>\n\n\n\n
  4. Add-on deposit behavior: <\/strong>While the analysis above excludes accounts with any add-on deposits for the sake of argument, this is not reflective of actual client behavior. In fact, almost all our clients follow best practices for building long-term wealth and continue to add to their portfolios over time. It is extremely rare for them to only make one deposit.<\/li>\n<\/ol>\n\n\n\n

    We think the data above should give investors confidence about the ongoing potential tax benefits of our direct indexing products, especially given that we believe they significantly understate the actual benefit, though final benefit may vary.<\/strong><\/p>\n\n\n\n

    So how can direct indexing products generate tax savings without add-on deposits, even as tax-loss harvesting lowers your cost basis? The answer is primarily twofold: index turnover and dividend reinvestment in the underlying indices, both of which are significant in the S&P 500\u00ae index and the Nasdaq-100 Index\u00ae.<\/p>\n\n\n\n