Direct Indexing? Schwab's Next Big Thing

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
6NDone
Posts: 153
Joined: Tue Sep 28, 2021 5:01 am

Direct Indexing? Schwab's Next Big Thing

Post by 6NDone »

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?
100% US TSM
tomsense76
Posts: 1428
Joined: Wed Oct 14, 2020 1:52 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by tomsense76 »

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.
"Anyone who claims to understand quantum theory is either lying or crazy" -- Richard Feynman
User avatar
sarabayo
Posts: 722
Joined: Fri Jun 29, 2018 6:59 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by sarabayo »

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.
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.
calwatch
Posts: 1447
Joined: Wed Oct 02, 2013 1:48 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by calwatch »

Fidelity recently sent its clients an email about this as well. Pardon me for being skeptical. https://www.fidelity.com/learning-cente ... _weekly_AT
wineandplaya
Posts: 306
Joined: Fri Sep 14, 2018 9:42 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by wineandplaya »

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.
Jags4186
Posts: 8198
Joined: Wed Jun 18, 2014 7:12 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by Jags4186 »

sarabayo wrote: Fri Nov 05, 2021 2:21 am
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.
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.
That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.
GoldenFinch
Posts: 2728
Joined: Mon Nov 10, 2014 10:34 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by GoldenFinch »

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.
runninginvestor
Posts: 1796
Joined: Tue Sep 08, 2020 8:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by runninginvestor »

Jags4186 wrote: Fri Nov 05, 2021 4:14 am
sarabayo wrote: Fri Nov 05, 2021 2:21 am
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.
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.
That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.
Can't you just transfer in kind?
AlohaJoe
Posts: 6609
Joined: Mon Nov 26, 2007 1:00 pm
Location: Saigon, Vietnam

Re: Direct Indexing? Schwab's Next Big Thing

Post by AlohaJoe »

Jags4186 wrote: Fri Nov 05, 2021 4:14 am
sarabayo wrote: Fri Nov 05, 2021 2:21 am
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.
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.
That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.
Why can't you leave Schwab? There's no tax nightmare.
Jags4186
Posts: 8198
Joined: Wed Jun 18, 2014 7:12 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by Jags4186 »

AlohaJoe wrote: Fri Nov 05, 2021 6:05 am
Jags4186 wrote: Fri Nov 05, 2021 4:14 am
sarabayo wrote: Fri Nov 05, 2021 2:21 am
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.
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.
That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.
Why can't you leave Schwab? There's no tax nightmare.
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.

Ok, so maybe not a tax nightmare, but a forced sale.
Dantes
Posts: 431
Joined: Wed Feb 25, 2015 5:38 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by Dantes »

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
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?
muffins14
Posts: 5529
Joined: Wed Oct 26, 2016 4:14 am
Location: New York

Re: Direct Indexing? Schwab's Next Big Thing

Post by muffins14 »


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.
I always think it’s funny when someone creates an unrealistic benchmark just to say hey look how good we are compared to that!

How many bogleheads use portfolios consistently largely of funds with expense ratios of 42-59 basis points?
Crom laughs at your Four Winds
User avatar
sleepysurf
Posts: 887
Joined: Sat Nov 23, 2013 5:59 am
Location: Florida

Re: Direct Indexing? Schwab's Next Big Thing

Post by sleepysurf »

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
Last edited by sleepysurf on Fri Nov 05, 2021 7:05 am, edited 2 times in total.
Retired 2018 | currently ~64/33/3 (partially sliced and diced, with a slowly rising equity glide path)
AlohaJoe
Posts: 6609
Joined: Mon Nov 26, 2007 1:00 pm
Location: Saigon, Vietnam

Re: Direct Indexing? Schwab's Next Big Thing

Post by AlohaJoe »

Jags4186 wrote: Fri Nov 05, 2021 6:39 am
AlohaJoe wrote: Fri Nov 05, 2021 6:05 am
Jags4186 wrote: Fri Nov 05, 2021 4:14 am
sarabayo wrote: Fri Nov 05, 2021 2:21 am
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.
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.
That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.
Why can't you leave Schwab? There's no tax nightmare.
If you transfer 500 stocks out of Schwab, how do you rebalance without their service? You essentially can’t
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.

So you'd transfer to them and ask them to rebalance for you.
runninginvestor
Posts: 1796
Joined: Tue Sep 08, 2020 8:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by runninginvestor »

muffins14 wrote: Fri Nov 05, 2021 7:02 am

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.
I always think it’s funny when someone creates an unrealistic benchmark just to say hey look how good we are compared to that!

How many bogleheads use portfolios consistently largely of funds with expense ratios of 42-59 basis points?
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.

[Pdf link to report]
http://www.ici.org/pdf/per27-03.pdf
BitTooAggressive
Posts: 1085
Joined: Tue Jul 13, 2021 3:15 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by BitTooAggressive »

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.
You may be right but we should tackle the regulation nightmare instead. Not that you are suggesting otherwise.

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.
Afty
Posts: 2390
Joined: Sun Sep 07, 2014 5:31 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by Afty »

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.
User avatar
Nate79
Posts: 9373
Joined: Thu Aug 11, 2016 6:24 pm
Location: Delaware

Re: Direct Indexing? Schwab's Next Big Thing

Post by Nate79 »

Rick Ferri has also talked about direct indexing being the next big thing. Should be interesting.
cas
Posts: 2258
Joined: Wed Apr 26, 2017 8:41 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by cas »

runninginvestor wrote: Fri Nov 05, 2021 6:01 am
Jags4186 wrote: Fri Nov 05, 2021 4:14 am That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.
Can't you just transfer in kind?
AlohaJoe wrote: Fri Nov 05, 2021 6:05 am Why can't you leave Schwab? There's no tax nightmare.


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.
invest4
Posts: 1905
Joined: Wed Apr 24, 2019 2:19 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by invest4 »

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.
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.

Be the boss with an “index fund” smoothie of your own creation with any ingredients you like!
User avatar
nisiprius
Advisory Board
Posts: 52216
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Direct Indexing? Schwab's Next Big Thing

Post by nisiprius »

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.
Last edited by nisiprius on Fri Nov 05, 2021 7:41 am, edited 2 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
arcticpineapplecorp.
Posts: 15081
Joined: Tue Mar 06, 2012 8:22 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by arcticpineapplecorp. »

The most important financial innovation that I have seen the past 20 years is the automatic teller machine, that really helps people and prevents visits to the bank and it is a real convenience. How many other innovations can you tell me of that have been as important to the individual as the automatic teller machine, which is more of a mechanical innovation than a financial one?--Paul Volcker Dec 13, 2009.

source: https://nypost.com/2009/12/13/the-only- ... s-the-atm/
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
fortunefavored
Posts: 1425
Joined: Tue Jun 02, 2015 8:18 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by fortunefavored »

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.
donaldfair71
Posts: 1241
Joined: Wed Mar 06, 2013 3:15 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by donaldfair71 »

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.
User avatar
nisiprius
Advisory Board
Posts: 52216
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Direct Indexing? Schwab's Next Big Thing

Post by nisiprius »

tomsense76 wrote: Fri Nov 05, 2021 2:06 am ...This blogpost lays out a few uses cases...
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.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
increment
Posts: 1736
Joined: Tue May 15, 2018 2:20 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by increment »

nisiprius wrote: Fri Nov 05, 2021 7:37 am and how many pages long is your schedule D if you have capital gains on five hundred stocks?
It could be very short if all the transactions are covered, because then no Form 8949 is required.
User avatar
whodidntante
Posts: 13115
Joined: Thu Jan 21, 2016 10:11 pm
Location: outside the echo chamber

Re: Direct Indexing? Schwab's Next Big Thing

Post by whodidntante »

nisiprius wrote: Fri Nov 05, 2021 7:50 am
tomsense76 wrote: Fri Nov 05, 2021 2:06 am ...This blogpost lays out a few uses cases...
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.
You can also short the company you work for to cancel your exposure, which has the advantage of seeming slightly evil.
User avatar
nisiprius
Advisory Board
Posts: 52216
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Direct Indexing? Schwab's Next Big Thing

Post by nisiprius »

(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.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
runninginvestor
Posts: 1796
Joined: Tue Sep 08, 2020 8:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by runninginvestor »

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.
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.

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?.
Jags4186
Posts: 8198
Joined: Wed Jun 18, 2014 7:12 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by Jags4186 »

AlohaJoe wrote: Fri Nov 05, 2021 7:05 am
Jags4186 wrote: Fri Nov 05, 2021 6:39 am
AlohaJoe wrote: Fri Nov 05, 2021 6:05 am
Jags4186 wrote: Fri Nov 05, 2021 4:14 am
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.
That’s it in a nutshell. You can’t ever leave Schwab unless you want a tax nightmare.
Why can't you leave Schwab? There's no tax nightmare.
If you transfer 500 stocks out of Schwab, how do you rebalance without their service? You essentially can’t
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.

So you'd transfer to them and ask them to rebalance for you.
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.

I’ve been known to be wrong before.
Ed 2
Posts: 2692
Joined: Sat May 15, 2010 9:34 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by Ed 2 »

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?
What could go wrong) . Sales gimmick to suck away more in commissions for brokerage - buy stocks that go up only! lOl
"The fund industry doesn't have a lot of heroes, but he (Bogle) is one of them," Russ Kinnel
random_walker_77
Posts: 2212
Joined: Tue May 21, 2013 8:49 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by random_walker_77 »

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.
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.
alex_686
Posts: 13320
Joined: Mon Feb 09, 2015 1:39 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by alex_686 »

random_walker_77 wrote: Fri Nov 05, 2021 10:11 am
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.
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.
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.

There are excellent options out there.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
User avatar
dodecahedron
Posts: 6607
Joined: Tue Nov 12, 2013 11:28 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by dodecahedron »

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.
The part I boldfaced above is a deal-killer for me.

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.
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by Tamales »

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. [...]
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.

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.
User avatar
nedsaid
Posts: 19275
Joined: Fri Nov 23, 2012 11:33 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by nedsaid »

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.
A fool and his money are good for business.
Mike Scott
Posts: 3579
Joined: Fri Jul 19, 2013 2:45 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by Mike Scott »

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. :)
alex_686
Posts: 13320
Joined: Mon Feb 09, 2015 1:39 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by alex_686 »

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. :)
2 things.

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.
prioritarian
Posts: 485
Joined: Tue Jul 16, 2019 6:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by prioritarian »

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).
Last edited by prioritarian on Fri Nov 05, 2021 2:24 pm, edited 1 time in total.
prioritarian
Posts: 485
Joined: Tue Jul 16, 2019 6:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by prioritarian »

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?
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.
Last edited by prioritarian on Fri Nov 05, 2021 2:57 pm, edited 1 time in total.
MarkRoulo
Posts: 1198
Joined: Mon Jun 22, 2015 10:25 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by MarkRoulo »

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?
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?



https://www.folioinvesting.com/folioinvesting/home/
000
Posts: 8211
Joined: Thu Jul 23, 2020 12:04 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by 000 »

Jags4186 wrote: Fri Nov 05, 2021 6:39 am 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.

Ok, so maybe not a tax nightmare, but a forced sale.
Why rebalance at all?

A cap-weighted portfolio requires no rebalancing to remain cap-weighted. You know, like, index funds.
User avatar
sarabayo
Posts: 722
Joined: Fri Jun 29, 2018 6:59 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by sarabayo »

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)
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
Posts: 485
Joined: Tue Jul 16, 2019 6:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by prioritarian »

sarabayo wrote: Fri Nov 05, 2021 2:51 pm 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***)
Jags4186
Posts: 8198
Joined: Wed Jun 18, 2014 7:12 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by Jags4186 »

000 wrote: Fri Nov 05, 2021 2:48 pm
Jags4186 wrote: Fri Nov 05, 2021 6:39 am 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.

Ok, so maybe not a tax nightmare, but a forced sale.
Why rebalance at all?

A cap-weighted portfolio requires no rebalancing to remain cap-weighted. You know, like, index funds.
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?
prioritarian
Posts: 485
Joined: Tue Jul 16, 2019 6:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by prioritarian »

000 wrote: Fri Nov 05, 2021 2:48 pm You know, like, index funds.
Index funds and ETFs are constantly "rebalanced".
User avatar
sarabayo
Posts: 722
Joined: Fri Jun 29, 2018 6:59 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by sarabayo »

prioritarian wrote: Fri Nov 05, 2021 2:52 pm
sarabayo wrote: Fri Nov 05, 2021 2:51 pm 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***)
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
Posts: 485
Joined: Tue Jul 16, 2019 6:00 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by prioritarian »

sarabayo wrote: Fri Nov 05, 2021 2:57 pm
prioritarian wrote: Fri Nov 05, 2021 2:52 pm
sarabayo wrote: Fri Nov 05, 2021 2:51 pm 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***)
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.
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.
Last edited by prioritarian on Fri Nov 05, 2021 3:01 pm, edited 1 time in total.
tomsense76
Posts: 1428
Joined: Wed Oct 14, 2020 1:52 am

Re: Direct Indexing? Schwab's Next Big Thing

Post by tomsense76 »

nisiprius wrote: Fri Nov 05, 2021 7:50 am
tomsense76 wrote: Fri Nov 05, 2021 2:06 am ...This blogpost lays out a few uses cases...
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.
Hopefully you also saw the concerns I raised :wink:
"Anyone who claims to understand quantum theory is either lying or crazy" -- Richard Feynman
User avatar
sarabayo
Posts: 722
Joined: Fri Jun 29, 2018 6:59 pm

Re: Direct Indexing? Schwab's Next Big Thing

Post by sarabayo »

prioritarian wrote: Fri Nov 05, 2021 2:59 pm
sarabayo wrote: Fri Nov 05, 2021 2:57 pm
prioritarian wrote: Fri Nov 05, 2021 2:52 pm
sarabayo wrote: Fri Nov 05, 2021 2:51 pm 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***)
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.
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.
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 semantics 🤷
Post Reply