America's Best Direct Indexing Buyers Guide 2024 - 13

2024 DIRECT INDEXING BUYERS GUIDE
those who favor passive management
or low-cost products like ETFs-may
hesitate at the higher costs. The
potential for alpha may be modest,
which could lessen the appeal for
some investors.
However, for advisors willing to cater to
lower-HNW clients, direct indexing can
create a more personalized experience,
taking into account risk exposures
and tax efficiency. While the process
feels custom, much of it is automated,
requiring less direct involvement from
portfolio managers compared to
UHNW clients. Your role is to add the
human element and make clients feel
valued.
For institutions and UHNW individuals,
the process becomes genuinely
tailored, much like how you already
handle your top clients: using
technology to capture investor
preferences, fine-tune holdings, and
incorporate personalized elements
while maximizing tax efficiency. At
this level, it's a collaborative effort,
where clients often work with family
offices filled with specialists rather than
individual advisors.
Certain types of investors stand to
benefit the most from direct indexing:
* Tax-sensitive investors
* Investors with a longer time horizon
who want to defer capital gains
* Investors with strong ESG or other
thematic preferences who want
those reflected in their portfolios
* Investors who already own individual
securities and seek a more taxefficient
portfolio structure
How Low Does Direct Indexing Go?
With innovations like fractional shares,
account minimums have dropped
to as low as $5,000 although they
typically range between $100,000
and $250,000. For a wealth manager,
an account of that size can generate
$10,000 to $25,000 in fees . . .
worthwhile as long as you manage
those assets effectively and provide
added value.
What about clients with less to work
with? Robo-advisors and digital
platforms offer an alternative, using
algorithms and automation to create
and manage customized portfolios.
Another option is model portfolios,
which can be tailored using technology
to automate construction and
rebalancing based on the client's
objectives and risk tolerance. This
allows direct indexing-like solutions
to be offered across various asset
levels, without the need for deep
customization.
Remember, fractional share trading
and other technologies have helped
lower the costs of implementing direct
indexing, making it more accessible for
building diversified portfolios.
Scalability improves when you combine
active and passive strategies, providing
low-cost " core " market exposure
while allowing active direct indexing
strategies to deliver customization and
the potential for alpha generation.
What About Retirement Accounts?
Tax sensitivity is often overlooked in
the retirement market, where relatively
small account balances and the ability
to defer taxes make discussions of " tax
alpha " seem trivial or irrelevant.
However, for truly affluent investors,
taxable accounts offer significant
advantages and can complement taxdeferred
investments. By spreading
savings across both account types,
your top clients may unlock additional
tax benefits before retirement and gain
greater flexibility in managing taxes
during retirement and legacy planning.
Expanded Investment Options:
Company-sponsored retirement
plans often limit investment choices
by type, asset class, and provider. A
taxable account allows more freedom
in selecting investments based on
preferences. Clients can switch
providers and set up multiple taxable
accounts as needed, giving them more
control over their portfolios.
Offsetting Gains and Income with
Losses: Losses within retirement
accounts can't be used to offset gains
or regular income. In contrast, losses
in taxable accounts can offset capital
gains and up to $3,000 of ordinary
income annually, helping to reduce
overall tax liabilities.
Tax-Free Growth Opportunities:
With careful portfolio design, taxable
portfolios can be structured to minimize
taxable capital gains, dividends, or
income. Broad-market stock index
funds, ETFs, tax-efficient mutual funds,
or separate accounts can help longterm
investors avoid generating large
tax liabilities. Additionally, municipal
bonds are exempt from federal income
tax and often from state taxes, making
them a tax-efficient choice in fixedincome
allocations.
This strategy isn't limited to the
accumulation phase. Retired investors
can benefit by drawing from both taxable
and tax-deferred accounts, enjoying
flexibility in managing tax impacts and
distribution requirements over time.
Estate Planning Advantages:
Taxable accounts also offer significant
estate planning benefits. When clients
pass on assets in taxable accounts,
their heirs receive a " step-up " in basis,
effectively wiping out capital gains
accumulated during the client's lifetime.
Heirs only pay taxes on gains between
the value of the assets at the time of
inheritance and their eventual sale
price. This can lead to much lower tax
liabilities compared to taxes calculated
from the original purchase date.
From Direct to Dynastic: Get
Ahead of the Succession
As generational wealth passes to new
heirs, direct indexing plays a key role
in supporting those transitions. Unlike
static index funds that only adjust
in extreme cases or at scheduled
intervals, direct indexing offers
flexibility, allowing portfolios to adapt in
real-time to life changes.
Direct indexing also enhances
estate planning by allowing clients to
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America's Best Direct Indexing Buyers Guide 2024

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