Direct Indexing? Schwab's Next Big Thing
Direct Indexing? Schwab's Next Big Thing
https://riabiz.com/a/2021/11/4/charles- ... sed-assets
I'm having a hard time understanding the benefits of owning every stock individually in an index instead of just owning the index itself. The only real advantage I can discern is TLH, but at the expense of having a portfolio of thousands of tickers requiring constant management and vigilance? Seems like a novel idea to over complicate what should be the simplest form of investing - indexing. Am I missing something?
I'm having a hard time understanding the benefits of owning every stock individually in an index instead of just owning the index itself. The only real advantage I can discern is TLH, but at the expense of having a portfolio of thousands of tickers requiring constant management and vigilance? Seems like a novel idea to over complicate what should be the simplest form of investing - indexing. Am I missing something?
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Re: Direct Indexing? Schwab's Next Big Thing
This blogpost lays out a few uses cases.
That said, do you (or does anyone) need this? Probably not. Could it be useful in some cases? Sure.
Next big thing seems strong to me, but we will probably see it in more places. Plus it is something that can be sold to an investor. So it is being sold. Should add direct indexing has been around for a while. So this is more it going mainstream.
From the forum perspective, there are people that show up with a mess of shares that they would like to clean up after having tried this. Sadly the answers are sell them (and eat the taxes), donate them, or just let them sit there (particularly if they are a small portion of the overall portfolio). Ideally one could hand these shares to a company and get a total market ETF back (without triggering taxes). Though it seems no one is really providing that (at least not AFAICT). Rick Ferri has been asking for that for years.
That said, do you (or does anyone) need this? Probably not. Could it be useful in some cases? Sure.
Next big thing seems strong to me, but we will probably see it in more places. Plus it is something that can be sold to an investor. So it is being sold. Should add direct indexing has been around for a while. So this is more it going mainstream.
From the forum perspective, there are people that show up with a mess of shares that they would like to clean up after having tried this. Sadly the answers are sell them (and eat the taxes), donate them, or just let them sit there (particularly if they are a small portion of the overall portfolio). Ideally one could hand these shares to a company and get a total market ETF back (without triggering taxes). Though it seems no one is really providing that (at least not AFAICT). Rick Ferri has been asking for that for years.
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Re: Direct Indexing? Schwab's Next Big Thing
Yup. Also, making a giant complicated mess out of your portfolio incentivizes you to stay at Schwab where they're able to babysit the beast, instead of taking your portfolio elsewhere someday - and the more unrealized capital gains your monster portfolio accumulates the "stickier" it gets, too.tomsense76 wrote: ↑Fri Nov 05, 2021 2:06 am Plus it is something that can be sold to an investor. So it is being sold.
Re: Direct Indexing? Schwab's Next Big Thing
Fidelity recently sent its clients an email about this as well. Pardon me for being skeptical. https://www.fidelity.com/learning-cente ... _weekly_AT
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Re: Direct Indexing? Schwab's Next Big Thing
If Schwab makes direct indexing easier and more accessible, it could be great news for US expats in Europe. It gets around the US/EU regulation nightmare making it hard to own ETFs or mutual funds. And Schwab is one of very few brokerages that welcome US expats to begin with.
Re: Direct Indexing? Schwab's Next Big Thing
That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.sarabayo wrote: ↑Fri Nov 05, 2021 2:21 amYup. Also, making a giant complicated mess out of your portfolio incentivizes you to stay at Schwab where they're able to babysit the beast, instead of taking your portfolio elsewhere someday - and the more unrealized capital gains your monster portfolio accumulates the "stickier" it gets, too.tomsense76 wrote: ↑Fri Nov 05, 2021 2:06 am Plus it is something that can be sold to an investor. So it is being sold.
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Re: Direct Indexing? Schwab's Next Big Thing
Sounds like they took something simple and made it complicated so they can charge a fee. Lucky for them there is a market for almost everything.
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Re: Direct Indexing? Schwab's Next Big Thing
Can't you just transfer in kind?Jags4186 wrote: ↑Fri Nov 05, 2021 4:14 amThat’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.sarabayo wrote: ↑Fri Nov 05, 2021 2:21 amYup. Also, making a giant complicated mess out of your portfolio incentivizes you to stay at Schwab where they're able to babysit the beast, instead of taking your portfolio elsewhere someday - and the more unrealized capital gains your monster portfolio accumulates the "stickier" it gets, too.tomsense76 wrote: ↑Fri Nov 05, 2021 2:06 am Plus it is something that can be sold to an investor. So it is being sold.
Re: Direct Indexing? Schwab's Next Big Thing
Why can't you leave Schwab? There's no tax nightmare.Jags4186 wrote: ↑Fri Nov 05, 2021 4:14 amThat’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.sarabayo wrote: ↑Fri Nov 05, 2021 2:21 amYup. Also, making a giant complicated mess out of your portfolio incentivizes you to stay at Schwab where they're able to babysit the beast, instead of taking your portfolio elsewhere someday - and the more unrealized capital gains your monster portfolio accumulates the "stickier" it gets, too.tomsense76 wrote: ↑Fri Nov 05, 2021 2:06 am Plus it is something that can be sold to an investor. So it is being sold.
Re: Direct Indexing? Schwab's Next Big Thing
If you transfer 500 stocks out of Schwab, how do you rebalance without their service? You essentially can’t, so you have to sell everything to go back to an ETF.AlohaJoe wrote: ↑Fri Nov 05, 2021 6:05 amWhy can't you leave Schwab? There's no tax nightmare.Jags4186 wrote: ↑Fri Nov 05, 2021 4:14 amThat’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.sarabayo wrote: ↑Fri Nov 05, 2021 2:21 amYup. Also, making a giant complicated mess out of your portfolio incentivizes you to stay at Schwab where they're able to babysit the beast, instead of taking your portfolio elsewhere someday - and the more unrealized capital gains your monster portfolio accumulates the "stickier" it gets, too.tomsense76 wrote: ↑Fri Nov 05, 2021 2:06 am Plus it is something that can be sold to an investor. So it is being sold.
Ok, so maybe not a tax nightmare, but a forced sale.
Re: Direct Indexing? Schwab's Next Big Thing
Seems like a fair description of what it is. Perhaps appealing to those concerned about the top ten holdings in a total market index? Or those who want to implement their own definition of socially-responsible investing?calwatch wrote: ↑Fri Nov 05, 2021 3:28 am Fidelity recently sent its clients an email about this as well. Pardon me for being skeptical. https://www.fidelity.com/learning-cente ... _weekly_AT
Re: Direct Indexing? Schwab's Next Big Thing
I always think it’s funny when someone creates an unrealistic benchmark just to say hey look how good we are compared to that!
The average fee for passive index funds stands at 13-basis-points today; whereas average mutual fund expense ratios stand at 59-basis-points for equities, and 42-basis-points for bond funds, according to data from the Investment Company Institute.
How many bogleheads use portfolios consistently largely of funds with expense ratios of 42-59 basis points?
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Re: Direct Indexing? Schwab's Next Big Thing
FYI, Vanguard has also jumped onto the "Direct Indexing" wagon, ostensibly to serve affiliated advisors rather than DIY'ers... https://advisors.vanguard.com/insights/ ... ngsolution
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Re: Direct Indexing? Schwab's Next Big Thing
Vanguard, Blackrock, Fidelity, Goldman Sachs, Morgan Stanley, and Franklin have all said they will offer the same exact service. And no doubt others will also start adding it in the future.Jags4186 wrote: ↑Fri Nov 05, 2021 6:39 amIf you transfer 500 stocks out of Schwab, how do you rebalance without their service? You essentially can’tAlohaJoe wrote: ↑Fri Nov 05, 2021 6:05 amWhy can't you leave Schwab? There's no tax nightmare.Jags4186 wrote: ↑Fri Nov 05, 2021 4:14 amThat’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.sarabayo wrote: ↑Fri Nov 05, 2021 2:21 amYup. Also, making a giant complicated mess out of your portfolio incentivizes you to stay at Schwab where they're able to babysit the beast, instead of taking your portfolio elsewhere someday - and the more unrealized capital gains your monster portfolio accumulates the "stickier" it gets, too.tomsense76 wrote: ↑Fri Nov 05, 2021 2:06 am Plus it is something that can be sold to an investor. So it is being sold.
So you'd transfer to them and ask them to rebalance for you.
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Re: Direct Indexing? Schwab's Next Big Thing
Interestingly, I would have thought bond funds would have higher expense ratios. I always figured they were more difficult to manage. In case anybody is curious, I believe this is the source for the ER's, figure 5. They are using the average asset weighted ratio.muffins14 wrote: ↑Fri Nov 05, 2021 7:02 amI always think it’s funny when someone creates an unrealistic benchmark just to say hey look how good we are compared to that!
The average fee for passive index funds stands at 13-basis-points today; whereas average mutual fund expense ratios stand at 59-basis-points for equities, and 42-basis-points for bond funds, according to data from the Investment Company Institute.
How many bogleheads use portfolios consistently largely of funds with expense ratios of 42-59 basis points?
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Re: Direct Indexing? Schwab's Next Big Thing
You may be right but we should tackle the regulation nightmare instead. Not that you are suggesting otherwise.wineandplaya wrote: ↑Fri Nov 05, 2021 3:53 am If Schwab makes direct indexing easier and more accessible, it could be great news for US expats in Europe. It gets around the US/EU regulation nightmare making it hard to own ETFs or mutual funds. And Schwab is one of very few brokerages that welcome US expats to begin with.
I have gone to the international boards here and looked at a few threads and it is ridiculous what some people have to do when they are abroad to invest.
Re: Direct Indexing? Schwab's Next Big Thing
I think the case for direct indexing is pretty strong - TLH is basically a risk free return. You know how we obsess over basis points in our index funds? TLH is likely worth a lot more than a few basis points. The downside though is exactly what has been pointed out here — it’s a tax nightmare if and when you want to get out of the portfolio. A secondary downside is that filing yearly taxes is also a huge pain — I had an early version of a direct index account and received a 200+ page 1099 every year.
Re: Direct Indexing? Schwab's Next Big Thing
Rick Ferri has also talked about direct indexing being the next big thing. Should be interesting.
Re: Direct Indexing? Schwab's Next Big Thing
For historical reasons, many of my relatives in their 80s and up have a big chunk their investments in low-basis individual stocks in taxable accounts.
( During their early to mid working years, they had no access to tax-advantaged accounts, since those were either not created or not widely available until late in their careers. The mutual fund industry was small and expensive. Neither Vanguard nor index funds yet existed. Brokerage commissions were high. Middle class investors tended to save up, pay the commission to buy a chunk of an individual stock, then put it on a DRIP that avoided further brokerage commissions, then "buy and hold".)
As the original investors get older, the tax reporting and management of those individual stock portfolios starts falling on younger relatives (me), and I've noticed a few things.
I don't know about "nightmare," but those individual stock portfolios are a lot of work compared to a mutual fund:
1. Even if you don't sell anything, those individual companies don't just sit there calmly. They generate unpredictable taxable amounts at unpredictable times by having babies (spin-offs) and cannibalizing one another (mergers, buy-outs, etc.). And the "corporate actions" can be structured many different ways, so to do your taxes every year you need to get deep into the IRS Forms 8937 "Report of Organizational Actions Affecting Basis of Securities" filed by the relevant companies, plus deep into your cost basis records, plus deep into various IRS publications relevant to cost basis.
Maybe it is simpler with covered shares ... if you really trust your brokerage to get cost basis adjustments right. (I've certainly had to contact brokerages to tell them about errors in their cost basis adjustments.) But, even then, there are some structures for corporate actions where even the brokerage doesn't have enough information to know what your taxable amount might be.
I have no idea whether the "direct indexing" platforms somehow take some work out of this or not. But if you fire the direct indexing platform, I assume it then falls all in your lap.
2. This may be an individual thing, but ... filling out annual proxy voting cards for even a 30-50 individual stock portfolio is getting to be like nails on a blackboard to me. (And you can't ignore them unless you want to be buried under reminder emails.) I can't imagine dealing with the proxy voting for an individual stock portfolio of 100s of stocks that originated in a direct indexing product.
I have no idea if the "direct indexing" platforms somehow deal with the proxy voting workload. But if you fire the direct indexing platform at some point, I assume it then falls all in your lap.
Re: Direct Indexing? Schwab's Next Big Thing
Alternatively, I think they are simply attempting t to build a better mouse trap to satisfy a perceived need…investors wanting to make their own “secret sauce” portfolio with the offer of greater precision.GoldenFinch wrote: ↑Fri Nov 05, 2021 4:45 am Sounds like they took something simple and made it complicated so they can charge a fee. Lucky for them there is a market for almost everything.
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Re: Direct Indexing? Schwab's Next Big Thing
There are the problems with portability and tax consequences--and how many pages long is your schedule D if you have capital gains on five hundred stocks? I assume they've solved that already? And do they can avoid wash sales in tax-loss harvesting if they don't have a complete access to every other stock transaction you are making in other accounts?
But in addition, the devil's in the details of how you can pick the indexes and what kind of customization you can do. I'm not interested enough to dig into exactly what they actually provide. Fidelity's blurb makes it sound like only sector-level granularity?
The index providers these days calculate and sell, for a license fee, literally hundreds of thousands of indexes, most of which are not tracked by any mutual fund or ETF. It might be mildly intriguing to be able to choose your own index. For example, ESG investors might have particular concerns and might want to invest in the S&P 500 Catholic Values Index (wait... there IS an ETF for that... well, you get the idea).
The problem here is that they charge license fees, so how would that work? Indeed, who pays to license the plain old S&P 500 index with S&P 500 direct indexing?
One wonders if they have a clever enough selection screen to allow you to express ideas like "global midcaps ex-BRICS" or "the Bloomberg Barclay's aggregate index but without securitized mortgages and also with TIPS, and lets include BB-rated bonds?"
I assume that the typical "customization" will be something like "the S&P 500 but without this short list of stocks I don't want." (As FANG becomes FAANG becomes GAFAM becomes MAGA becomes MAMAA, how do you "reconstitute" the "short list of stocks I don't want?")
It's a pretty good gimmick, though. Without the ability to direct index to a professional index from an index provider--to effectively give you access to many hundreds of thousands of ETFS instead of only thousands--I don't see how it's more than that.
But in addition, the devil's in the details of how you can pick the indexes and what kind of customization you can do. I'm not interested enough to dig into exactly what they actually provide. Fidelity's blurb makes it sound like only sector-level granularity?
The index providers these days calculate and sell, for a license fee, literally hundreds of thousands of indexes, most of which are not tracked by any mutual fund or ETF. It might be mildly intriguing to be able to choose your own index. For example, ESG investors might have particular concerns and might want to invest in the S&P 500 Catholic Values Index (wait... there IS an ETF for that... well, you get the idea).
The problem here is that they charge license fees, so how would that work? Indeed, who pays to license the plain old S&P 500 index with S&P 500 direct indexing?
One wonders if they have a clever enough selection screen to allow you to express ideas like "global midcaps ex-BRICS" or "the Bloomberg Barclay's aggregate index but without securitized mortgages and also with TIPS, and lets include BB-rated bonds?"
I assume that the typical "customization" will be something like "the S&P 500 but without this short list of stocks I don't want." (As FANG becomes FAANG becomes GAFAM becomes MAGA becomes MAMAA, how do you "reconstitute" the "short list of stocks I don't want?")
It's a pretty good gimmick, though. Without the ability to direct index to a professional index from an index provider--to effectively give you access to many hundreds of thousands of ETFS instead of only thousands--I don't see how it's more than that.
Last edited by nisiprius on Fri Nov 05, 2021 7:41 am, edited 2 times in total.
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Re: Direct Indexing? Schwab's Next Big Thing
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Re: Direct Indexing? Schwab's Next Big Thing
Almost every "wealth management" firm offers this. They claim an extra .4% or so per year due to more granular tax loss harvesting even if you tell them to match an S&P500 index.
Then they wrap an AUM over the "direct indexing" offering. I wouldn't expect you will get this for less than an index fund/etf in cost.
Then they wrap an AUM over the "direct indexing" offering. I wouldn't expect you will get this for less than an index fund/etf in cost.
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Re: Direct Indexing? Schwab's Next Big Thing
I just don't see the need for 99% of people.
Creating a solution for a problem that doesn't exist. If any investor or advisor is wonderful enough to exclude companies and still perform to a benchmark (let alone outperform), that person should be actively running a fund and charging even more. Better, become a long/short HF manager. This is, to me, repackaged active management. If done in a rules-based way and relatively inexpensive, no issues there. But this feels like stock excluding, no better than stock picking. If people are okay with that underperformance, again, it would work. But I don't believe most people will be okay with it.
I do think it is a great idea for salespeople, and an efficient way to create a moat around assets being moved from one advisor to another. I also think that it would help those people whose portfolios are so large, and gains can become so big, that loss offsets represent a large absolute amount of money. But that would qualify as my 1% from above.
Creating a solution for a problem that doesn't exist. If any investor or advisor is wonderful enough to exclude companies and still perform to a benchmark (let alone outperform), that person should be actively running a fund and charging even more. Better, become a long/short HF manager. This is, to me, repackaged active management. If done in a rules-based way and relatively inexpensive, no issues there. But this feels like stock excluding, no better than stock picking. If people are okay with that underperformance, again, it would work. But I don't believe most people will be okay with it.
I do think it is a great idea for salespeople, and an efficient way to create a moat around assets being moved from one advisor to another. I also think that it would help those people whose portfolios are so large, and gains can become so big, that loss offsets represent a large absolute amount of money. But that would qualify as my 1% from above.
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Re: Direct Indexing? Schwab's Next Big Thing
Actually I see a good one. The investor who, for whatever reason, feels they are stuck with large positions in individual stocks, e.g. the stock of their employer. In such a case, it would be perfectly sensible to put their "discretionary" investments into "the S&P minus the company I work for."
Although, wait, not really. Even the biggest company is only 6% of the S&P 500, and 487 of the S&P 500 are less than 1%. So in reality if you buy an S&P 500 or a total stock market index fund you are only buying a tiny bit more of your employer's stock.
Sounds good but probably not worth it. Never mind.
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Re: Direct Indexing? Schwab's Next Big Thing
You can also short the company you work for to cancel your exposure, which has the advantage of seeming slightly evil.nisiprius wrote: ↑Fri Nov 05, 2021 7:50 amActually I see a good one. The investor who, for whatever reason, feels they are stuck with large positions in individual stocks, e.g. the stock of their employer. In such a case, it would be perfectly sensible to put their "discretionary" investments into "the S&P minus the company I work for."
Although, wait, not really. Even the biggest company is only 6% of the S&P 500, and 487 of the S&P 500 are less than 1%. So in reality if you buy an S&P 500 or a total stock market index fund you are only buying a tiny bit more of your employer's stock.
Sounds good but probably not worth it. Never mind.
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Re: Direct Indexing? Schwab's Next Big Thing
(Decided this particular post belongs better in a different thread)
Last edited by nisiprius on Fri Nov 05, 2021 8:02 am, edited 1 time in total.
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Re: Direct Indexing? Schwab's Next Big Thing
It's a solution to the decline in fees lost from the ongoing shift from active funds/active management to index funds/passive management. It's a hybrid way to actively manage a passage strategy for the individual investor. At least my take on it so far.donaldfair71 wrote: ↑Fri Nov 05, 2021 7:50 am I just don't see the need for 99% of people.
Creating a solution for a problem that doesn't exist. If any investor or advisor is wonderful enough to exclude companies and still perform to a benchmark (let alone outperform), that person should be actively running a fund and charging even more. Better, become a long/short HF manager. This is, to me, repackaged active management. If done in a rules-based way and relatively inexpensive, no issues there. But this feels like stock excluding, no better than stock picking. If people are okay with that underperformance, again, it would work. But I don't believe most people will be okay with it.
I do think it is a great idea for salespeople, and an efficient way to create a moat around assets being moved from one advisor to another. I also think that it would help those people whose portfolios are so large, and gains can become so big, that loss offsets represent a large absolute amount of money. But that would qualify as my 1% from above.
Edit: Instead of paying a premium to a manager to hopefully outperform peers in a customized portfolio due to skill, it's shifting to pay managers a premium for their technology and automation to customize a portfolio for potential tax savings. I mean how can you know how well they are doing if the benchmark is obfuscated?.
Re: Direct Indexing? Schwab's Next Big Thing
Assuming you can make an in kind transfer into that type of service, sure. But my guess is you won’t be able to do that.AlohaJoe wrote: ↑Fri Nov 05, 2021 7:05 amVanguard, Blackrock, Fidelity, Goldman Sachs, Morgan Stanley, and Franklin have all said they will offer the same exact service. And no doubt others will also start adding it in the future.Jags4186 wrote: ↑Fri Nov 05, 2021 6:39 amIf you transfer 500 stocks out of Schwab, how do you rebalance without their service? You essentially can’tAlohaJoe wrote: ↑Fri Nov 05, 2021 6:05 amWhy can't you leave Schwab? There's no tax nightmare.Jags4186 wrote: ↑Fri Nov 05, 2021 4:14 amThat’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.sarabayo wrote: ↑Fri Nov 05, 2021 2:21 am
Yup. Also, making a giant complicated mess out of your portfolio incentivizes you to stay at Schwab where they're able to babysit the beast, instead of taking your portfolio elsewhere someday - and the more unrealized capital gains your monster portfolio accumulates the "stickier" it gets, too.
So you'd transfer to them and ask them to rebalance for you.
I’ve been known to be wrong before.
Re: Direct Indexing? Schwab's Next Big Thing
What could go wrong) . Sales gimmick to suck away more in commissions for brokerage - buy stocks that go up only! lOl6NDone wrote: ↑Fri Nov 05, 2021 1:55 am https://riabiz.com/a/2021/11/4/charles- ... sed-assets
I'm having a hard time understanding the benefits of owning every stock individually in an index instead of just owning the index itself. The only real advantage I can discern is TLH, but at the expense of having a portfolio of thousands of tickers requiring constant management and vigilance? Seems like a novel idea to over complicate what should be the simplest form of investing - indexing. Am I missing something?
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Re: Direct Indexing? Schwab's Next Big Thing
Or not. Those in the position that they're stuck w/ company stock might find that their company prohibits them from shorting or holding derivatives in the companies' stock.whodidntante wrote: ↑Fri Nov 05, 2021 7:56 am You can also short the company you work for to cancel your exposure, which has the advantage of seeming slightly evil.
Re: Direct Indexing? Schwab's Next Big Thing
You could omit the company stock from your custom index. Or the sector. Or rejigger the factor load in your portfolio to balance the factors driving your company’s stock.random_walker_77 wrote: ↑Fri Nov 05, 2021 10:11 amOr not. Those in the position that they're stuck w/ company stock might find that their company prohibits them from shorting or holding derivatives in the companies' stock.whodidntante wrote: ↑Fri Nov 05, 2021 7:56 am You can also short the company you work for to cancel your exposure, which has the advantage of seeming slightly evil.
There are excellent options out there.
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Re: Direct Indexing? Schwab's Next Big Thing
The part I boldfaced above is a deal-killer for me.Afty wrote: ↑Fri Nov 05, 2021 7:21 am I think the case for direct indexing is pretty strong - TLH is basically a risk free return. You know how we obsess over basis points in our index funds? TLH is likely worth a lot more than a few basis points. The downside though is exactly what has been pointed out here — it’s a tax nightmare if and when you want to get out of the portfolio. A secondary downside is that filing yearly taxes is also a huge pain — I had an early version of a direct index account and received a 200+ page 1099 every year.
If there is a glitch somewhere, I do not want a mess of IRS correspondence sorting it out down the road, especially in the event that I am no longer competent to stay on top of my own financial affairs. The thought of my eventual PoA trying to make sense of a 200+page 1099 every year really bothers me. (Even just me trying to double-check the accuracy of the 200+page 1099 gives me pause.)
My mantra/guiding principle these days is Marie-Kondoing my tax return, keeping my taxes increasingly simple and transparent as I get older.
There has been a long-term consistent decreasing ability of the IRS to manage its correspondence flow (greatly exacerbated by the Pandemic of course, but a pre-existing trend before then.) No reason to think things will improve any time soon.
On top of that, it seems like there are increasing reports on this forums with problems involving custodians not tracking basis properly.
Direct indexing--no thanks! Not for me.
Re: Direct Indexing? Schwab's Next Big Thing
If you are familiar with a parametric equalizer for audio (the user has continuous adjustment over bandwidth, center frequency, and gain), I think a similar concept applied to creating user-customized indexes might appeal to some.nisiprius wrote: ↑Fri Nov 05, 2021 7:37 am There are the problems with portability and tax consequences--and how many pages long is your schedule D if you have capital gains on five hundred stocks? I assume they've solved that already? And do they can avoid wash sales in tax-loss harvesting if they don't have a complete access to every other stock transaction you are making in other accounts?
But in addition, the devil's in the details of how you can pick the indexes and what kind of customization you can do. [...]
For example, take the S&P 500, just to use an example. The user interface would start out by listing each of the 500 individual components and their individual weighting out of 100%. It would be less of a recordkeeping pain if this were done on the last closing price rather that real-time prices.
Let's say the top 20 holdings represent 25% of the index value and you'd rather reduce that to 15% and put more weighting in #21-50. So, from the user interface you'd bracket the top 20 in the listing, reduce the weighting to 15%, then bracket #21-50 and increase whatever their latest weighting is by 10%.
That would be a simple example, but the user interface would allow you to create as many of these bands of stocks in the list of 500 as you want, and whatever "bandwidth" and "gain" for each band. It could even total more or less than 100% if you want.
And of course they'd want to provide tools so you could do backtesting on different bands, band sizes, and gains, so you'd have some rationale for choosing what you choose.
The more they can make equity investing and especially the user-interface have "game-like" qualities to it, the more interest they generate among a certain group of people.
The logistics of doing this is a separate question, but I think it might have some appeal conceptually.
Re: Direct Indexing? Schwab's Next Big Thing
Direct Indexing will work because we have powerful computers and software and thus can optimize the tax efficiency of the portfolio. Sampling can be used to replicate an index and also when a stock is sold for tax reasons, the software can pick a very similar stock and maintain the character of the index. A company like Schwab could use a proprietary Index very similar to the S&P 500 and not have to pay licensing fees. The seeming complexity of having hundreds of stocks in your portfolio can easily be managed by computer, little if any human intervention is necessary.
I don't see a reason for using this service myself but there are people who might want to use it for tax efficiency. Not sure the minimum investment needed. Another factor is the getting the best price when trading, computers excel at that too.
I don't see a reason for using this service myself but there are people who might want to use it for tax efficiency. Not sure the minimum investment needed. Another factor is the getting the best price when trading, computers excel at that too.
A fool and his money are good for business.
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Re: Direct Indexing? Schwab's Next Big Thing
Isn't this what people did manually with DRIPS and going after dividends pre-index passive mutual funds? The "next big thing" seems like a big step backwards in bogleheadland (unless you are extremely motivated to exclude some specific stocks which are included in the broad indices). Considering fees on passive index funds are essentially zero, I don't see how it could be cheaper. Could it be as simple as being a new flavor of sales gimmick? Surely not.
Re: Direct Indexing? Schwab's Next Big Thing
2 things.Mike Scott wrote: ↑Fri Nov 05, 2021 12:08 pmThe "next big thing" seems like a big step backwards in bogleheadland (unless you are extremely motivated to exclude some specific stocks which are included in the broad indices). Considering fees on passive index funds are essentially zero, I don't see how it could be cheaper. Could it be as simple as being a new flavor of sales gimmick? Surely not.
First, the theory that a market cap weighted index is the best passive portfolio to meet your specific risk tolerance and goals is weak. Yes, it is very efficient and robust. Yes, the next step up is nuanced and complex. This does not mean the next step is silly or a marketing gimmick.
Second, yes costs would be higher. What do I care about costs? I don't, nor should you. What you should care about is after tax performance. In this case specifically can you expect that the tax savings will be greater than the fee charged?
It can be done, I have seen it done. I was tangentially involved with this 25 years ago. It was much cruder back then. Fees were higher. So this raised the bar. Taxes were higher. The portfolios had some serious low cost basis issues. This lowered the bar - low enough that it was like shooting fish in a barrel.
Not sure if the value is there today, but it is a possibility.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Direct Indexing? Schwab's Next Big Thing
I disagree that the costs will be higher given that: 1) free fractional share trading is widely available and 2) custom indices that mimic protected indices are already offered at no cost at multiple brokers.
For example, wealthfront already offers direct indexing at no additional cost (albeit with investment size limitations and a wealthfront fee):
https://support.wealthfront.com/hc/en-u ... -Indexing-
(My main issue with wealthfront's approach is that it's opaque but this will change as more discount "trading-centric" brokers release automated portfolio models/products.)
I expect that direct indexing will follow the trend towards zero fees/ER seen with funds/ETFs. I'm personally salivating at the prospect of direct indexing given that there is a demonstrable benefit from tax loss harvesting 500 stocks over an index-based mutual fund/ETF. I'm also salivating at the prospect of model-based direct indexing in that it may allow improved factor-based investing (e.g. US, international, and emerging market small cap value).
For example, wealthfront already offers direct indexing at no additional cost (albeit with investment size limitations and a wealthfront fee):
https://support.wealthfront.com/hc/en-u ... -Indexing-
(My main issue with wealthfront's approach is that it's opaque but this will change as more discount "trading-centric" brokers release automated portfolio models/products.)
I expect that direct indexing will follow the trend towards zero fees/ER seen with funds/ETFs. I'm personally salivating at the prospect of direct indexing given that there is a demonstrable benefit from tax loss harvesting 500 stocks over an index-based mutual fund/ETF. I'm also salivating at the prospect of model-based direct indexing in that it may allow improved factor-based investing (e.g. US, international, and emerging market small cap value).
Last edited by prioritarian on Fri Nov 05, 2021 2:24 pm, edited 1 time in total.
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Re: Direct Indexing? Schwab's Next Big Thing
Yes...direct indexing utilizes low-cost or free automated portfolio models and free fractional share trading. TLH will likely be algorithmic initially but may become investor customizable at some point.6NDone wrote: ↑Fri Nov 05, 2021 1:55 am https://riabiz.com/a/2021/11/4/charles- ... sed-assets
I'm having a hard time understanding the benefits of owning every stock individually in an index instead of just owning the index itself. The only real advantage I can discern is TLH, but at the expense of having a portfolio of thousands of tickers requiring constant management and vigilance? Seems like a novel idea to over complicate what should be the simplest form of investing - indexing. Am I missing something?
Last edited by prioritarian on Fri Nov 05, 2021 2:57 pm, edited 1 time in total.
Re: Direct Indexing? Schwab's Next Big Thing
This seems to be a version of the "folio" idea that was floated in 2000 (back when "everyone" wanted to invest and micro-manage their investments). The folio folks are still around as a business, too ... but seem to have stopped with folios?6NDone wrote: ↑Fri Nov 05, 2021 1:55 am https://riabiz.com/a/2021/11/4/charles- ... sed-assets
I'm having a hard time understanding the benefits of owning every stock individually in an index instead of just owning the index itself. The only real advantage I can discern is TLH, but at the expense of having a portfolio of thousands of tickers requiring constant management and vigilance? Seems like a novel idea to over complicate what should be the simplest form of investing - indexing. Am I missing something?
https://www.folioinvesting.com/folioinvesting/home/
Re: Direct Indexing? Schwab's Next Big Thing
Why rebalance at all?
A cap-weighted portfolio requires no rebalancing to remain cap-weighted. You know, like, index funds.
Re: Direct Indexing? Schwab's Next Big Thing
Wealthfront's direct indexing automation is their primary selling point so it seems odd to disassociate their general fee, which amounts to 25 basis points, from the direct indexing service they provide.prioritarian wrote: ↑Fri Nov 05, 2021 2:08 pm For example, wealthfront already offers direct indexing at no additional cost (albeit with investment size limitations and a wealthfront fee)
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Re: Direct Indexing? Schwab's Next Big Thing
prioritarian wrote: ↑Fri Nov 05, 2021 2:08 pm For example, wealthfront already offers direct indexing at no additional cost (albeit with investment size limitations ***and a wealthfront fee***)
Re: Direct Indexing? Schwab's Next Big Thing
If your portfolio is 60% SP 500 direct index, 40% bonds and the 500 individual stocks increase to 70% of your portfolio, how do you sell off 10% to buy 10% more bonds if you no longer have access to the service?
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Re: Direct Indexing? Schwab's Next Big Thing
Yes, I read your post. My point is that saying there's "no additional cost" for direct indexing is meaningless when the only reason you're paying their general "wealthfront fee" in the first place is to get their direct indexing service. Practically speaking, the "wealthfront fee" is a direct indexing fee.prioritarian wrote: ↑Fri Nov 05, 2021 2:52 pmprioritarian wrote: ↑Fri Nov 05, 2021 2:08 pm For example, wealthfront already offers direct indexing at no additional cost (albeit with investment size limitations ***and a wealthfront fee***)
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Re: Direct Indexing? Schwab's Next Big Thing
They offer conventional boglehead portfolios as well so the extra fee is not a "direct indexing" fee but a let the robots manage my investments according to my risk tolerance fee.sarabayo wrote: ↑Fri Nov 05, 2021 2:57 pmYes, I read your post. My point is that saying there's "no additional cost" for direct indexing is meaningless when the only reason you're paying their general "wealthfront fee" in the first place is to get their direct indexing service. Practically speaking, the "wealthfront fee" is a direct indexing fee.prioritarian wrote: ↑Fri Nov 05, 2021 2:52 pmprioritarian wrote: ↑Fri Nov 05, 2021 2:08 pm For example, wealthfront already offers direct indexing at no additional cost (albeit with investment size limitations ***and a wealthfront fee***)
Last edited by prioritarian on Fri Nov 05, 2021 3:01 pm, edited 1 time in total.
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Re: Direct Indexing? Schwab's Next Big Thing
Hopefully you also saw the concerns I raisednisiprius wrote: ↑Fri Nov 05, 2021 7:50 amActually I see a good one. The investor who, for whatever reason, feels they are stuck with large positions in individual stocks, e.g. the stock of their employer. In such a case, it would be perfectly sensible to put their "discretionary" investments into "the S&P minus the company I work for."
Although, wait, not really. Even the biggest company is only 6% of the S&P 500, and 487 of the S&P 500 are less than 1%. So in reality if you buy an S&P 500 or a total stock market index fund you are only buying a tiny bit more of your employer's stock.
Sounds good but probably not worth it. Never mind.
"Anyone who claims to understand quantum theory is either lying or crazy" -- Richard Feynman
Re: Direct Indexing? Schwab's Next Big Thing
All their marketing pushes the fact that the robots managing your investments do tax loss harvesting for you. None of this makes sense except in some kind of direct indexing framework (i.e. break up your portfolio into smaller pieces without affecting the broader allocation so that you can do fine grained tax loss harvesting). So I don't understand the distinction you're making between direct indexing and a conventional boglehead portfolio that the robots are "managing". But I suppose at the end of the day it's a matter of semanticsprioritarian wrote: ↑Fri Nov 05, 2021 2:59 pmThey offer conventional boglehead portfolios as well so the extra fee is not a "direct indexing" fee but a let the robots manage my investments according to my risk tolerance fee.sarabayo wrote: ↑Fri Nov 05, 2021 2:57 pmYes, I read your post. My point is that saying there's "no additional cost" for direct indexing is meaningless when the only reason you're paying their general "wealthfront fee" in the first place is to get their direct indexing service. Practically speaking, the "wealthfront fee" is a direct indexing fee.prioritarian wrote: ↑Fri Nov 05, 2021 2:52 pmprioritarian wrote: ↑Fri Nov 05, 2021 2:08 pm For example, wealthfront already offers direct indexing at no additional cost (albeit with investment size limitations ***and a wealthfront fee***)