If 2022 taught us anything, all asset classes can and will go down from time to time. That's no news flash! What is relatively new is that, through improvements in technology, assets can now more easily be managed in a tax-efficient manner. Investors taking advantage of losses and capturing them was one of the most significant value adds of 2022.
For decades, mutual funds have afforded clients access to professionally managed portfolios—many with the goal of outpacing their indexes. Some have succeeded, while others have failed; even if you were lucky enough to find that All-Star manager, it was not always the most efficient way to invest from a tax standpoint. For example, if an investor bought a mutual fund in 2018, but the fund invested in the stock of a successful company in 2014 and sold it in 2020, the investor owned the mutual fund for only two years, they absorbed the portion of the 2014 cost basis passed on at the end of 2020 as a capital gain.
Over the last two decades, Exchange Traded Funds’ assets have exploded to almost $6.5 trillion at the end of 2022. ETFs were created to mimic all types of indexes that now represent all asset classes. If you were looking for diversification and believed active managers generally do not outperform their indexes, ETFs give investors a low-cost option to diversify and trade on the open market. Unlike a mutual fund that calculates its NAV at the end of the day, an ETF can be bought and sold intraday. Investors pay taxes, but only on the price of the ETF they purchased not on the underlying companies in the fund. It is a way to invest efficiently and add diversification at a low cost.
Direct Indexing is relatively new to the scene—at least in terms of its availability to all but the largest investors, with roughly $460 billion in total investments at the end of 2022. Direct Indexing allows customized, professionally managed portfolios that can take advantage of selling losing positions in a portfolio and swapping them out for similar positions long enough to capture the loss then rebuying the original position if the manager still believed in his thesis. In plain speak, they are essentially buying their first cousin long enough to avoid the wash sale.
Technology now allows smaller accounts to take advantage of what customized portfolios have had for quite some time.
In any given year, an index such as the S&P 500 has multiple component companies that could be positive or negative for the year. No one wants to sell a winner, but we do want to take advantage of selling the losers, even if it is temporary. While capital gains taxes are also possible through a Direct Indexing investment, through algorithms, they buy a similar position and hold it long enough to capture the loss but still provide the ability to closely mimic the desired index—largely mitigating those taxes. It is not what you make, but it is what you keep.
Direct Indexing allows you to take advantage of gains and losses at any time and has been a successful tax-efficient strategy that may add value to your situation.
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This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be suitable for all types of investors. Recipients should not consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report. For investment advice specific to your situation, or for additional information, please contact us and/or your tax or legal advisor. Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index