Direct Indexing

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Gaston
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Direct Indexing

Post by Gaston »

A lot of investment firms are rolling out Direct Indexing (DI) products these days, with a lot of marketing about the merits of such products. If you are interested in DI and would like to hear about the potential downsides, check out the May 9 episode of the Sara Grillo podcast.

And if you are a fan of Rick Ferri, he was a guest on the April 11 episode.

The podcast is targeted at financial advisors, but we laymen can listen too.
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nedsaid
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Re: Direct Indexing

Post by nedsaid »

Direct Indexing is an idea that has merit but the benefits for most of us regular folk are pretty small. The one thing about Direct Indexing is that you own the stocks directly and you are not subject to potential Capital Gains Distributions triggered by people who panic sell out of an Index Fund. With Vanguard, many of their Index Funds have an ETF that is a share class of the index fund, so Vanguard has ways on minimizing the tax impacts from panic selling.

Another benefit of Direct Indexing is that the managers can utilize tax loss harvesting to accumulate capital losses that you can use to offset future capital gains.

Index Funds and particularly ETFs of the broad Indexes are pretty tax efficient already. Most of us need not sweat this but it is an interesting concept. Where I very wealthy, I would give such a product consideration.
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Mardoc01
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Re: Direct Indexing

Post by Mardoc01 »

nedsaid wrote: Sun Jul 17, 2022 3:19 pm Direct Indexing is an idea that has merit but the benefits for most of us regular folk are pretty small. The one thing about Direct Indexing is that you own the stocks directly and you are not subject to potential Capital Gains Distributions triggered by people who panic sell out of an Index Fund. With Vanguard, many of their Index Funds have an ETF that is a share class of the index fund, so Vanguard has ways on minimizing the tax impacts from panic selling.

Another benefit of Direct Indexing is that the managers can utilize tax loss harvesting to accumulate capital losses that you can use to offset future capital gains.

Index Funds and particularly ETFs of the broad Indexes are pretty tax efficient already. Most of us need not sweat this but it is an interesting concept. Where I very wealthy, I would give such a product consideration.
How much to be considered Very Wealthy. .? In taxable ? That DI has merit?
livesoft
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Re: Direct Indexing

Post by livesoft »

Mardoc01 wrote: Sun Jul 17, 2022 3:29 pmHow much to be considered Very Wealthy. .? In taxable ? That DI has merit?
I'd say that you would have to be so Very Wealthy that you don't give a hoot about taxes, thus creating a paradox: So wealthy that you don't need Direct Investing in the first place.
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nedsaid
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Re: Direct Indexing

Post by nedsaid »

Mardoc01 wrote: Sun Jul 17, 2022 3:29 pm
nedsaid wrote: Sun Jul 17, 2022 3:19 pm Direct Indexing is an idea that has merit but the benefits for most of us regular folk are pretty small. The one thing about Direct Indexing is that you own the stocks directly and you are not subject to potential Capital Gains Distributions triggered by people who panic sell out of an Index Fund. With Vanguard, many of their Index Funds have an ETF that is a share class of the index fund, so Vanguard has ways on minimizing the tax impacts from panic selling.

Another benefit of Direct Indexing is that the managers can utilize tax loss harvesting to accumulate capital losses that you can use to offset future capital gains.

Index Funds and particularly ETFs of the broad Indexes are pretty tax efficient already. Most of us need not sweat this but it is an interesting concept. Where I very wealthy, I would give such a product consideration.
How much to be considered Very Wealthy. .? In taxable ? That DI has merit?
The scenario of an Index Fund having a large Capital Gains Distribution from panic selling by other shareholders IS a possibility but a remote one. How much are individual investors willing to pay to guard against this? My guess is not much. Is forty basis points yearly too much for an investor to pay in order to insure against a rare event?

The other issue is that Tax Loss Harvesting may over time increase the embedded capital gains within the fund over time as the fund would tend to sell losers and keep winners. Market downturns are a good opportunity to sell losers and winners at the same time and help reduce embedded capital gains within the portfolio. The key is how good will they be at this, supposedly the computers make this easy. What I am trying to say is that over time, the benefits from tax loss harvesting might not be as big as imagined. I would want to see how this actually works with real money and real investors.

My definition of very wealthy? Certainly wealthier than I am. I suppose having a few million in a taxable account would be enough were the tax benefit would be more than the fees. What I have seen so far, is that this service is offered for about 40 basis points a year. To me, that seems like a high hurdle. I would like to see some academic research on this.

I would NOT do Direct Indexing in a tax deferred account. Unwanted Capital Gains Distributions would not be an issue. Tax loss harvesting would not be an issue. All you would have is more fees and more portfolio turnover.
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nedsaid
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Re: Direct Indexing

Post by nedsaid »

livesoft wrote: Sun Jul 17, 2022 3:34 pm
Mardoc01 wrote: Sun Jul 17, 2022 3:29 pmHow much to be considered Very Wealthy. .? In taxable ? That DI has merit?
I'd say that you would have to be so Very Wealthy that you don't give a hoot about taxes, thus creating a paradox: So wealthy that you don't need Direct Investing in the first place.
Warren Buffett is very wealthy and he fights the IRS tooth and nail over taxes.
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livesoft
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Re: Direct Indexing

Post by livesoft »

nedsaid wrote: Sun Jul 17, 2022 3:44 pmWarren Buffett is very wealthy and he fights the IRS tooth and nail over taxes.
And his spouse would be very wealthy all by herself if she survives him and we know what Buffett recommends for her portfolio. HInt: It ain't Direct Investing.
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squirrel1963
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Re: Direct Indexing

Post by squirrel1963 »

nedsaid wrote: Sun Jul 17, 2022 3:43 pm
Mardoc01 wrote: Sun Jul 17, 2022 3:29 pm
nedsaid wrote: Sun Jul 17, 2022 3:19 pm Direct Indexing is an idea that has merit but the benefits for most of us regular folk are pretty small. The one thing about Direct Indexing is that you own the stocks directly and you are not subject to potential Capital Gains Distributions triggered by people who panic sell out of an Index Fund. With Vanguard, many of their Index Funds have an ETF that is a share class of the index fund, so Vanguard has ways on minimizing the tax impacts from panic selling.

Another benefit of Direct Indexing is that the managers can utilize tax loss harvesting to accumulate capital losses that you can use to offset future capital gains.

Index Funds and particularly ETFs of the broad Indexes are pretty tax efficient already. Most of us need not sweat this but it is an interesting concept. Where I very wealthy, I would give such a product consideration.
How much to be considered Very Wealthy. .? In taxable ? That DI has merit?
The scenario of an Index Fund having a large Capital Gains Distribution from panic selling by other shareholders IS a possibility but a remote one. How much are individual investors willing to pay to guard against this? My guess is not much. Is forty basis points yearly too much for an investor to pay in order to insure against a rare event?

The other issue is that Tax Loss Harvesting may over time increase the embedded capital gains within the fund over time as the fund would tend to sell losers and keep winners. Market downturns are a good opportunity to sell losers and winners at the same time and help reduce embedded capital gains within the portfolio. The key is how good will they be at this, supposedly the computers make this easy. What I am trying to say is that over time, the benefits from tax loss harvesting might not be as big as imagined. I would want to see how this actually works with real money and real investors.

My definition of very wealthy? Certainly wealthier than I am. I suppose having a few million in a taxable account would be enough were the tax benefit would be more than the fees. What I have seen so far, is that this service is offered for about 40 basis points a year. To me, that seems like a high hurdle. I would like to see some academic research on this.

I would NOT do Direct Indexing in a tax deferred account. Unwanted Capital Gains Distributions would not be an issue. Tax loss harvesting would not be an issue. All you would have is more fees and more portfolio turnover.
I highly doubt the tax benefits would be meaningful in my case given the size of my portfolio and my low tax bracket, but what makes me suspicious is the lack of transparency. Promoters of this product should be able to very easily tell me "for investment of size X and marginal tax bracket of Y you should get a tax savings of around Z", but the only thing they tell you is how much they charge you.
Wealthfront has a white paper on this product but to be honest I didn't quite understand what the expected benefits would be.
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BF3000
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Re: Direct Indexing

Post by BF3000 »

I think the benefit is largely a function of (1) how fast the broad market goes up after your investment (decay of TLH opportunities will happen eventually, but how soon?), (2) recurring nature of investment (goes to decay issue) and (3) whether the investor has capital gains elsewhere (so that the tax loss benefit can be used soon rather than a trickle of $3,000 carry overs).

Suppose investor puts $1 million into DI, sets dividends to reinvest, and adds $200,000 per year for the next 10 years. Also, the market goes down and chops sideways for a long time. Also, the investor has lots of real estate property sales and hedge funds that distribute capital gains. This investor’s tax alpha would be well above 40 basis points.

ETFs rarely, if ever, distribute capital gains. For most investors, this attribute, combined with the ability to TLH at the ETF level, is adequate.

The downside is having to hold hundreds of individual stocks, with encyclopedia sized statements and tax forms, and potentially being locked into 40 basis points after TLH opportunities come to an end.

The “customization” possibility is appealing to some people I guess. That angle seems to be a recipe for sub-optimal investing (excepted in the case of an employee with concentrated position due to stock options who could use DI to skip the holding or maybe entire sector).
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Re: Direct Indexing

Post by Mike Scott »

All you have to do is read here to see how much work some people are willing to do to save a few cents. There is a market for this even if it is not really necessary.

What I think is the most potentially valuable application for direct investing is for individuals to build their own flavor of ESG type fund with some of the benefits of broad indexing. I believe this is a real and viable piece of the market if someone can get the service delivered at a reasonable cost.
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Re: Direct Indexing

Post by Valuethinker »

Mike Scott wrote: Sun Jul 17, 2022 6:04 pm All you have to do is read here to see how much work some people are willing to do to save a few cents. There is a market for this even if it is not really necessary.

What I think is the most potentially valuable application for direct investing is for individuals to build their own flavor of ESG type fund with some of the benefits of broad indexing. I believe this is a real and viable piece of the market if someone can get the service delivered at a reasonable cost.
Direct Investing is of greatest benefit, I think, to US individuals living abroad who are unable to access US mutual funds and ETFs. Residents in the UK & EU in particular.

PFIC rules basically mean you cannot buy European-listed mutual funds and ETFs. European fin services regs mean brokers won't sell you US-listed vehicles. Catch-22.
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nedsaid
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Re: Direct Indexing

Post by nedsaid »

squirrel1963 wrote: Sun Jul 17, 2022 4:20 pm
nedsaid wrote: Sun Jul 17, 2022 3:43 pm
Mardoc01 wrote: Sun Jul 17, 2022 3:29 pm
nedsaid wrote: Sun Jul 17, 2022 3:19 pm Direct Indexing is an idea that has merit but the benefits for most of us regular folk are pretty small. The one thing about Direct Indexing is that you own the stocks directly and you are not subject to potential Capital Gains Distributions triggered by people who panic sell out of an Index Fund. With Vanguard, many of their Index Funds have an ETF that is a share class of the index fund, so Vanguard has ways on minimizing the tax impacts from panic selling.

Another benefit of Direct Indexing is that the managers can utilize tax loss harvesting to accumulate capital losses that you can use to offset future capital gains.

Index Funds and particularly ETFs of the broad Indexes are pretty tax efficient already. Most of us need not sweat this but it is an interesting concept. Where I very wealthy, I would give such a product consideration.
How much to be considered Very Wealthy. .? In taxable ? That DI has merit?
The scenario of an Index Fund having a large Capital Gains Distribution from panic selling by other shareholders IS a possibility but a remote one. How much are individual investors willing to pay to guard against this? My guess is not much. Is forty basis points yearly too much for an investor to pay in order to insure against a rare event?

The other issue is that Tax Loss Harvesting may over time increase the embedded capital gains within the fund over time as the fund would tend to sell losers and keep winners. Market downturns are a good opportunity to sell losers and winners at the same time and help reduce embedded capital gains within the portfolio. The key is how good will they be at this, supposedly the computers make this easy. What I am trying to say is that over time, the benefits from tax loss harvesting might not be as big as imagined. I would want to see how this actually works with real money and real investors.

My definition of very wealthy? Certainly wealthier than I am. I suppose having a few million in a taxable account would be enough were the tax benefit would be more than the fees. What I have seen so far, is that this service is offered for about 40 basis points a year. To me, that seems like a high hurdle. I would like to see some academic research on this.

I would NOT do Direct Indexing in a tax deferred account. Unwanted Capital Gains Distributions would not be an issue. Tax loss harvesting would not be an issue. All you would have is more fees and more portfolio turnover.
I highly doubt the tax benefits would be meaningful in my case given the size of my portfolio and my low tax bracket, but what makes me suspicious is the lack of transparency. Promoters of this product should be able to very easily tell me "for investment of size X and marginal tax bracket of Y you should get a tax savings of around Z", but the only thing they tell you is how much they charge you.
Wealthfront has a white paper on this product but to be honest I didn't quite understand what the expected benefits would be.
The idea has merit. Bogle discussed individuals creating their own index with individual stocks but Bogle would ask investors why they would go through all that effort when Vanguard would do it all for them for a very few basis points. Not dismissing the idea but I think it has very limited benefit, if any, for the average retail investor. Let's see how the idea works in real life.
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whodidntante
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Re: Direct Indexing

Post by whodidntante »

Valuethinker wrote: Mon Jul 18, 2022 6:33 am Direct Investing is of greatest benefit, I think, to US individuals living abroad who are unable to access US mutual funds and ETFs. Residents in the UK & EU in particular.
That is an excellent point.

Prior to the availability of direct indexing, I imagined I would perform some sort of "sampling" approach with a couple of dozen stocks. Or maybe use futures or options. I still might if the cost is favorable. Either way, I hope the various nations of the world will get over themselves and stop their harmful and protectionist policies.
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nedsaid
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Re: Direct Indexing

Post by nedsaid »

livesoft wrote: Sun Jul 17, 2022 4:01 pm
nedsaid wrote: Sun Jul 17, 2022 3:44 pmWarren Buffett is very wealthy and he fights the IRS tooth and nail over taxes.
And his spouse would be very wealthy all by herself if she survives him and we know what Buffett recommends for her portfolio. HInt: It ain't Direct Investing.
I wouldn't be shocked if Buffett performs tax loss harvesting within the Berkshire-Hathaway portfolio but he isn't going to constantly sell and buy to generate tiny capital losses with add up to bigger losses. Buffett would likely take a slower and more measured approach. After all, he invests to MAKE money. I do think the tax loss harvesting concept is sometimes overdone.
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Re: Direct Indexing

Post by livesoft »

nedsaid wrote: Mon Jul 18, 2022 8:39 amI do think the tax loss harvesting concept is sometimes overdone.
I agree. For instance, I have no losses in my taxable account to harvest in quite a while, so I would not benefit from Direct Investing and any automated TLH algorithms. The reason I have no losses is that I have not made any buys in my taxable account in quite awhile since I am retired and use the dividends for expenses.
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skeptical
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Re: Direct Indexing

Post by skeptical »

nedsaid wrote: Sun Jul 17, 2022 3:43 pm
The key is how good will they be at this, supposedly the computers make this easy. What I am trying to say is that over time, the benefits from tax loss harvesting might not be as big as imagined. I would want to see how this actually works with real money and real investors.
.....

What I have seen so far, is that this service is offered for about 40 basis points a year. To me, that seems like a high hurdle. I would like to see some academic research on this.
I have asked several places who do this the following questions:
- Can you provide an aggregate of all of your portfolios (active and past) graphed with the x axis the year from start of portfolio, the y axis the % net savings (or % realized loss) for that year ?
- Can the lines be broken into segments, such as current/past accounts, account size, account size relative to new funds, etc ? Can you plot the amount of skew with regard to baseline over time due to TLH ?
- How do you determine TLH partners ? By stock, by sector ? If by stock, what do you partner with Google, FB, Amazon, Apple ?

It is funny the answers I get. On the question of results, first they say they have plenty of data to prove it works, but do not have the data by portfolio origin date. When I ask how they do analyze the results, they then say, oh we do, we just do not analyze it that way. Ok, how ? It is usually anecdotal, for example "last year, many of our customers saved x%". No one has offered a rigorous set of data to look at. When I point out how can I trust a system that has not been rigorously and comprehensively analyzed, they really do not have an answer, they just say their customers are happy with it.

On the question of TLH partners, they say it clearly cannot be perfect, but are unwilling/unable to provide data on how the portfolio skews over time from the baseline. Or what happens if you get locked out of a large company (say Apple), and the TLH partners plod along (no TLH opportunities) without getting into active stock analysis and picking.

One of those ideas that sound good in theory. I do think there are valid scenarios for this, but not for most people.
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Re: Direct Indexing

Post by Hola »

There could be a benefit to build your own index that excludes ones own profession/company/industry.
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Re: Direct Indexing

Post by edge »

Not worth the added expense and complexity. Major broker portability issues as well.
Statistical
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Re: Direct Indexing

Post by Statistical »

The costs are too high. 40 bps is a lot. Get it down to 10 and it would be more interesting. Share loaning and tax loss harvesting are useful but not 40 bps useful.
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Re: Direct Indexing

Post by cheapskate »

Beyond the complexity and the fee hurdle, any direct indexing algorithm will, by design, not own some percentage of stocks in the Index at all times (ones that have been sold for TLH, with the 31 day wait to buy it back). What's the guarantee these stocks won't viciously rally back when the portfolio is out of them, causing direct indexing to lag the index ? In many market rallies, a small portion of stocks account for the lions share of an index's gains.

The reason no direct indexing provider is willing to share multi-decade performance numbers publicly is likely because the results aren't all that great, compared to vanilla indexing with rock bottom costs and tax-impact. If the results were rosy, these guys would be jumping up and down to publicize the data and sweep up assets. 40bps should be very interesting to them compared to the 3bps they are forced to charge (to compete with Vanguard), especially because this is supposed to be completely automated.
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Re: Direct Indexing

Post by cheapskate »

skeptical wrote: Mon Jul 18, 2022 10:17 am On the question of TLH partners, they say it clearly cannot be perfect, but are unwilling/unable to provide data on how the portfolio skews over time from the baseline. Or what happens if you get locked out of a large company (say Apple), and the TLH partners plod along (no TLH opportunities) without getting into active stock analysis and picking.

One of those ideas that sound good in theory. I do think there are valid scenarios for this, but not for most people.
Agreed. These are the top 10 companies in the S&P500, accounting for nearly 30% of the Index. None of them has a TLH partner. If you sell AAPL for a loss, wait out 31 days, and AAPL rallies 10% while you wait, you are out of something like 0.7%-0.8% of return, just on that trade.

Apple (AAPL): 7.14%
Microsoft (MSFT): 6.1%
Amazon (AMZN): 3.8%
Tesla (TSLA): 2.5%
Alphabet Class A (GOOGL): 2.2%
Alphabet Class C (GOOG): 2.1%
NVIDIA Corporation (NVDA): 1.8%
Berkshire Hathaway Class B (BRK.B): 1.7%
Meta (META), formerly Facebook, Class A: 1.4%
Statistical
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Re: Direct Indexing

Post by Statistical »

cheapskate wrote: Mon Jul 18, 2022 12:59 pm
skeptical wrote: Mon Jul 18, 2022 10:17 am On the question of TLH partners, they say it clearly cannot be perfect, but are unwilling/unable to provide data on how the portfolio skews over time from the baseline. Or what happens if you get locked out of a large company (say Apple), and the TLH partners plod along (no TLH opportunities) without getting into active stock analysis and picking.

One of those ideas that sound good in theory. I do think there are valid scenarios for this, but not for most people.
Agreed. These are the top 10 companies in the S&P500, accounting for nearly 30% of the Index. None of them has a TLH partner. If you sell AAPL for a loss, wait out 31 days, and AAPL rallies 10% while you wait, you are out of something like 0.7%-0.8% of return, just on that trade.

Apple (AAPL): 7.14%
Microsoft (MSFT): 6.1%
Amazon (AMZN): 3.8%
Tesla (TSLA): 2.5%
Alphabet Class A (GOOGL): 2.2%
Alphabet Class C (GOOG): 2.1%
NVIDIA Corporation (NVDA): 1.8%
Berkshire Hathaway Class B (BRK.B): 1.7%
Meta (META), formerly Facebook, Class A: 1.4%
Well probably not that bad. First a TLH doesn't require you sell everything. In fact unless 100% of your position of AAPL was at a loss you wouldn't. You could limit yourself to just the losing lots and no more than 10% of position. You could also use the proceeds from the TLH to temporarily buy QQQ which has a pretty high correlation with the big tech names. So hypothetically you sell no more than 10% of AAPL position and buy QQQ. AAPL jumps 10%, QQQ rallies 5% meaning a net loss of 5% on 10% of Apple which is 7% of the portfolio = -5% * 10% * 7% = 0.04% net missed gain.

It isn't zero risk but I think there could be interest TLH oppertunities. However with 40 bps cost it is really hard to justify. That is a guaranteed continual cost right there.
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Re: Direct Indexing

Post by Broken Man 1999 »

If I hold individual stocks, and I sometimes do, I'll be the one picking them. Depending on others for this type of active equity management just doesn't appeal to me.

Besides, I just don't see myself holding individual stocks in a taxable account. As it is, when I hold individual stocks, they are held in my TIRA.

DW and I have one joint taxable investment account, with the balance of $5.01. In a few years when we have RMDs, whatever we can't spend of the RMD each year can be invested in something tax friendly like I-bonds from the start or gifted to family members or favored charities.

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nedsaid
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Re: Direct Indexing

Post by nedsaid »

skeptical wrote: Mon Jul 18, 2022 10:17 am
nedsaid wrote: Sun Jul 17, 2022 3:43 pm
The key is how good will they be at this, supposedly the computers make this easy. What I am trying to say is that over time, the benefits from tax loss harvesting might not be as big as imagined. I would want to see how this actually works with real money and real investors.
.....

What I have seen so far, is that this service is offered for about 40 basis points a year. To me, that seems like a high hurdle. I would like to see some academic research on this.
I have asked several places who do this the following questions:
- Can you provide an aggregate of all of your portfolios (active and past) graphed with the x axis the year from start of portfolio, the y axis the % net savings (or % realized loss) for that year ?
- Can the lines be broken into segments, such as current/past accounts, account size, account size relative to new funds, etc ? Can you plot the amount of skew with regard to baseline over time due to TLH ?
- How do you determine TLH partners ? By stock, by sector ? If by stock, what do you partner with Google, FB, Amazon, Apple ?

It is funny the answers I get. On the question of results, first they say they have plenty of data to prove it works, but do not have the data by portfolio origin date. When I ask how they do analyze the results, they then say, oh we do, we just do not analyze it that way. Ok, how ? It is usually anecdotal, for example "last year, many of our customers saved x%". No one has offered a rigorous set of data to look at. When I point out how can I trust a system that has not been rigorously and comprehensively analyzed, they really do not have an answer, they just say their customers are happy with it.

On the question of TLH partners, they say it clearly cannot be perfect, but are unwilling/unable to provide data on how the portfolio skews over time from the baseline. Or what happens if you get locked out of a large company (say Apple), and the TLH partners plod along (no TLH opportunities) without getting into active stock analysis and picking.

One of those ideas that sound good in theory. I do think there are valid scenarios for this, but not for most people.
My suspicion is that the reason you don't get more specifics is that everyone's situation is different. Things like tax brackets, whether or not their state has an income tax, if they already have embedded capital gains somewhere else that they would want offset someday. There was one poster here who was pretty high on tax loss harvesting because he was trying to offset dividend income, I think he or she was in the UK, where of course their tax laws are different from ours, as I recall the tax on dividends was pretty steep. Another factor is how states tax capital gains income, in my state capital gain income gets taxed at the same rate as everything else.

I suppose what you would have to do is to set up a computer program to model this and just let it rip with pretend trades and see what happens. Another factor is that the markets change, 2021 produced an unusual amount of capital gains and my best guess is that 2022 will not, that is unless there is an awful lot of panic selling.

So you would have to run a simulation, the best would be with real time data and look at what happens. I suppose you could also back test such strategies based on daily data but as you know both stocks and ETFs trade within a daily range that varies. The results would be affected somewhat by when you executed your trades. Also depends upon what indexes you are using.

So the concept has merit but I think it varies from client to client how much benefit they would get from this. Market conditions would also introduce some variability. So it isn't like you could just go to Portfolio Visualizer and run some back tests.
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Re: Direct Indexing

Post by squirrel1963 »

nedsaid wrote: Mon Jul 18, 2022 2:17 pm
skeptical wrote: Mon Jul 18, 2022 10:17 am
nedsaid wrote: Sun Jul 17, 2022 3:43 pm
The key is how good will they be at this, supposedly the computers make this easy. What I am trying to say is that over time, the benefits from tax loss harvesting might not be as big as imagined. I would want to see how this actually works with real money and real investors.
.....

What I have seen so far, is that this service is offered for about 40 basis points a year. To me, that seems like a high hurdle. I would like to see some academic research on this.
I have asked several places who do this the following questions:
- Can you provide an aggregate of all of your portfolios (active and past) graphed with the x axis the year from start of portfolio, the y axis the % net savings (or % realized loss) for that year ?
- Can the lines be broken into segments, such as current/past accounts, account size, account size relative to new funds, etc ? Can you plot the amount of skew with regard to baseline over time due to TLH ?
- How do you determine TLH partners ? By stock, by sector ? If by stock, what do you partner with Google, FB, Amazon, Apple ?

It is funny the answers I get. On the question of results, first they say they have plenty of data to prove it works, but do not have the data by portfolio origin date. When I ask how they do analyze the results, they then say, oh we do, we just do not analyze it that way. Ok, how ? It is usually anecdotal, for example "last year, many of our customers saved x%". No one has offered a rigorous set of data to look at. When I point out how can I trust a system that has not been rigorously and comprehensively analyzed, they really do not have an answer, they just say their customers are happy with it.

On the question of TLH partners, they say it clearly cannot be perfect, but are unwilling/unable to provide data on how the portfolio skews over time from the baseline. Or what happens if you get locked out of a large company (say Apple), and the TLH partners plod along (no TLH opportunities) without getting into active stock analysis and picking.

One of those ideas that sound good in theory. I do think there are valid scenarios for this, but not for most people.
My suspicion is that the reason you don't get more specifics is that everyone's situation is different. Things like tax brackets, whether or not their state has an income tax, if they already have embedded capital gains somewhere else that they would want offset someday. There was one poster here who was pretty high on tax loss harvesting because he was trying to offset dividend income, I think he or she was in the UK, where of course their tax laws are different from ours, as I recall the tax on dividends was pretty steep. Another factor is how states tax capital gains income, in my state capital gain income gets taxed at the same rate as everything else.

I suppose what you would have to do is to set up a computer program to model this and just let it rip with pretend trades and see what happens. Another factor is that the markets change, 2021 produced an unusual amount of capital gains and my best guess is that 2022 will not, that is unless there is an awful lot of panic selling.

So you would have to run a simulation, the best would be with real time data and look at what happens. I suppose you could also back test such strategies based on daily data but as you know both stocks and ETFs trade within a daily range that varies. The results would be affected somewhat by when you executed your trades. Also depends upon what indexes you are using.

So the concept has merit but I think it varies from client to client how much benefit they would get from this. Market conditions would also introduce some variability. So it isn't like you could just go to Portfolio Visualizer and run some back tests.
But the problem though is that absent any kind of hard data, we are simply left with a lot of speculation about the reasons they don't provide any - among them is that maybe the advantages are not that great compared to the 40 bps they charge.
Obviously they can't provide expected benefit for all tax and income situations, but providing at least the tax benefit in regard to federal taxes and by tax bracket should be doable. Or simply provide a tool where you enter basic information from your last tax return and estimate expected yield.
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squirrel1963
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Re: Direct Indexing

Post by squirrel1963 »

I have a lot reservations for this idea, mainly due to lack of transparency from the part of fund providers.

But the idea is great though. I wonder how doable would be to implement it on our own?
I would imagine the tracking error of owning the top 100-200 stocks of S&P500 would be small enough that it could be done. So then the problem becomes of how to select stocks for TLH.
It's probably easy to do this for Coke vs Pepsi, Exxon vs Shell, or AMD vs Intel, but I doubt it'd be so easy for the remaining stocks.
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shess
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Re: Direct Indexing

Post by shess »

Gaston wrote: Tue Jun 14, 2022 6:00 pm A lot of investment firms are rolling out Direct Indexing (DI) products these days, with a lot of marketing about the merits of such products. If you are interested in DI and would like to hear about the potential downsides, check out the May 9 episode of the Sara Grillo podcast.
The technology which enables direct indexing also enables other things to improve, like index ETFs. If you had come to me in 1995 with a direct indexing product charging 1% per year, I'd have been all over that because the fee was competitive with mutual funds and the product was arguably better. If you had come to me in 2005 with a direct indexing product charging .5%, I'd have probably taken you up on it because though there was a lot more choice in indexed funds, the fee was still in a reasonable ballpark. But at this point, VTI and VOO have expense ratios of .03%. MAYBE you can make up the fee delta in reduced tax drag due to TLH ... but I think it's debatable because the TLH advantage will decay over time, but the wrap fee probably won't. Maybe you can port all those assets elsewhere to avoid the wrap fee, perhaps at the cost of whatever tools they provide for making management palatable.

I once had a windfall to invest in taxable, and sat down and figured out whether it might be worthwhile to do a stratified sampling type approach using a place like FolioFN (or M1 these days). The problem is, if you multiply out the VTI fees against your portfolio size, it just doesn't add up to much! .03% on a $1M portfolio is is $300/year. I wouldn't even be willing to manage a fully invested direct-indexing portfolio for that much, where all you have to deal with is index changes from IPOs and privatizations and mergers and acquisitions. I wouldn't be willing to organize my records for my tax person for that amount. Or, really, for 10x that amount.

I might change my mind at $25M. At some point, you could do things like fund cash flow by selling of low-gains positions for low tax cost, leaving high-gains positions for heirs (step-up) or charities. Live off of that while doing Roth conversions, maybe. If you have enough, the resulting skew versus the index won't make that much difference to your lifestyle.
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Re: Direct Indexing

Post by Gaston »

shess wrote: Mon Jul 18, 2022 11:56 pm The technology which enables direct indexing also enables other things to improve, like index ETFs. If you had come to me in 1995 with a direct indexing product charging 1% per year, I'd have been all over that because the fee was competitive with mutual funds and the product was arguably better. If you had come to me in 2005 with a direct indexing product charging .5%, I'd have probably taken you up on it because though there was a lot more choice in indexed funds, the fee was still in a reasonable ballpark. But at this point, VTI and VOO have expense ratios of .03%. MAYBE you can make up the fee delta in reduced tax drag due to TLH ... but I think it's debatable because the TLH advantage will decay over time, but the wrap fee probably won't. Maybe you can port all those assets elsewhere to avoid the wrap fee, perhaps at the cost of whatever tools they provide for making management palatable.

I once had a windfall to invest in taxable, and sat down and figured out whether it might be worthwhile to do a stratified sampling type approach using a place like FolioFN (or M1 these days). The problem is, if you multiply out the VTI fees against your portfolio size, it just doesn't add up to much! .03% on a $1M portfolio is is $300/year. I wouldn't even be willing to manage a fully invested direct-indexing portfolio for that much, where all you have to deal with is index changes from IPOs and privatizations and mergers and acquisitions. I wouldn't be willing to organize my records for my tax person for that amount. Or, really, for 10x that amount.

I might change my mind at $25M. At some point, you could do things like fund cash flow by selling of low-gains positions for low tax cost, leaving high-gains positions for heirs (step-up) or charities. Live off of that while doing Roth conversions, maybe. If you have enough, the resulting skew versus the index won't make that much difference to your lifestyle.
Good comments, shess. I guess my biggest concern with DI is unwinding the structure. If, 10 years down the road, you want to exit DI and get back to a simple index ETF, I see no way to do this without a sizable tax bill. So once you start DI, it seems like you are in it for life. Make sense?
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shess
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Re: Direct Indexing

Post by shess »

Gaston wrote: Tue Jul 19, 2022 1:35 am Good comments, shess. I guess my biggest concern with DI is unwinding the structure. If, 10 years down the road, you want to exit DI and get back to a simple index ETF, I see no way to do this without a sizable tax bill. So once you start DI, it seems like you are in it for life. Make sense?
Absolutely, you'd have to sell things to make a change. But for all that I said I wouldn't want to manage things, I suspect it wouldn't be THAT bad, especially if you stop caring about diverging from the index (you can just let mergers and buyouts and stuff happen and not bother replacing things).

Of course, if you go with a broad-based index fund, after a few years you'd also have a sizable tax bill if you get tired of the simplicity :-).

It might be interesting if someday there were a way for individuals to participate in unit redemptions of some sort to get into an ETF. To prevent abuse, maybe it could be like exchange funds, where you have to lock your contributed assets up for seven years before you can get back out.
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squirrel1963
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Re: Direct Indexing

Post by squirrel1963 »

shess wrote: Tue Jul 19, 2022 1:46 am
Gaston wrote: Tue Jul 19, 2022 1:35 am Good comments, shess. I guess my biggest concern with DI is unwinding the structure. If, 10 years down the road, you want to exit DI and get back to a simple index ETF, I see no way to do this without a sizable tax bill. So once you start DI, it seems like you are in it for life. Make sense?
Of course, if you go with a broad-based index fund, after a few years you'd also have a sizable tax bill if you get tired of the simplicity :-).
Right and that's the other problem for people like me who have VTI with large capital gains. It makes it too expensive for me to switch to DI with existing funds :-(
No matter what once you have large capital gains on an investment, it is difficult to change.
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calwatch
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Re: Direct Indexing

Post by calwatch »

Interactive Advisors, the "advising" arm of deep discount Interactive Brokers, has been doing this for some time. They explicitly rebalance quarterly and don't do tax loss harvesting enhancement. The broad market portfolio comes pretty close to the Russell 1000 although they say they weight to reduce risk concentration in mega-cap securities and securities with large price appreciation. The cost is as low as eight basis points for this version. There are also other indexes available, such as the Russell based indexes, which cost 20 basis points due to the need to pay the licensing fee.

https://interactiveadvisors.com/portfolios/all

I think this is good for people who prefer to vote their own shares, and those who want to roll their own exclusions, which is easy to do with the IBKR software. I don't really care to exclude companies and am fine with tax loss harvesting at the ETF level, especially since there are many similar but not identical indexes for all the major categories (i.e. CRSP vs. Russell vs. S&P, different flavors of international, etc.) The risk of tax loss harvesting at the stock level is that if you decide to take losses in, say, Exxon by buying an alternate company in the same sector, like Chevron, you have risk when they start diverging. The diversion risk between the CRSP Broad Market Index and the Russell 3000 is much less significant.
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Re: Direct Indexing

Post by Gaston »

Mardoc01 wrote: Sun Jul 17, 2022 3:29 pm How much to be considered Very Wealthy?
I’d say at least an 8-digit portfolio.
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