Experience with Direct Indexing?

[jazz4cash]

Direct Indexing is an active strategy that involves buying a sample of stocks rather than the whole index. Stocks are bought and sold according to an algorithm to generate gains including tax loss harvesting.
DD is talking with a Merrill Lynch advisor and I believe they are pitching a Direct Indexing scheme. They mentioned 1% AUM fee and $100k mininum. I think I convinced her to lean away from ML and use her Roth IRA and/or HYSA instead.

I am looking for knowledgable input/discussion wrt pros, cons, suitability, etc. Please refrain from snark and uninformed opinions. TIA

 

[easysurfer]

The words Direct Indexing sounds like an oxymoron. Direct being active and Indexing being passive.

Seems to me like buzzwords put together o get your attention.

IMO (no snark attempted), I'd rather just go the DIY Indexing route, avoid the fee and minimum requirements.

 

[jazz4cash]

The words Direct Indexing sounds like an oxymoron. Direct being active and Indexing being passive.

Seems to me like buzzwords put together o get your attention.

IMO (no snark attempted), I'd rather just go the DIY Indexing route, avoid the fee and minimum requirements.

i agree but maybe suitable for specific situations. It is marketed as something “previously unavailable to individual investors”

 

[yakers]

Some discussion on the Bogleheads board, looks like a lot of smoke and mirrors to me. You end up with a complicatd portfolio which has to overcome trading/AUM fees. And if you ever want to move or liquidate your portfolio it gets complicated. An ETF like VOO, VTI, ot VT will on the average probably do better. But I'm sure we will hear about some good performance somewhere with this idea but seems not likely to be me and, afgain, I like a simple portfolio, this is the opposite.

 

[OldShooter]

One of the things I teach in my adult ed investing class is this rule:

Rule of Thumb: The more complicated an investment product is, the more likely it is that it was designed to make money for the seller, not to make money for you.

I don't give contraptions like this Merrill thing a second look. KISS.

 

[Sunset]

Seems like it would generate a lot of taxes, unless a person was "lucky" enough to just generate losses.

 

[ERD50]

I can maybe see some sense in the approach, but no way would I want someone else controlling it, and/or pay 1% annually.

The top 20 or so stocks in a something like SPY or VTI make up a large % of the total holdings, and would probably track pretty well if bought separately at their current ratios. It wouldn't even really take much effort to buy the top 50. Brokerages track your cost basis gain/loss now, so that's really not much work. And you would have the advantage of selling losers if you you need to generate cash flow.

I don't think you'd need to do much rebalancing, even if off a bit, it would probably still track well. But, I'm too lazy, not going to do it myself either.

 

[jazz4cash]

FYI, here is investopedia description of this strategy. It lists more cons tvan pros. I’m just curious when it might work well. It’s not a Merrill thing.

What Is Direct Indexing? How It Works, Benefits, and Downsides

Direct indexing involves purchasing the underlying shares of an index, rather than owning an index mutual fund or index exchange-traded fund.

www.investopedia.com

 

[ERD50]

Seems like it would generate a lot of taxes, unless a person was "lucky" enough to just generate losses.

Only if you did a lot of sell/buy to rebalance, but I don't think that would be that important.

 

[Koolau]

Letting ML or anyone else "manage" such a play for me would mean lots of fees. Doing it myself would require a lot of effort (well, "some" effort). Therefore, I see no appeal to such a "scheme" but perhaps it w*rks for some investors. YMMV

 

[SnowballCamper]

So it sounds like the direct indexing product costs 1% to invest in the index while VOO costs less than 0.05%. What index are they following?

 

[jazz4cash]

So it sounds like the direct indexing product costs 1% to invest in the index while VOO costs less than 0.05%. What index are they following?

I assume it’s 1% AUM fee PLUS trading fees. I think they might use just 50 or some subset of the SP500. They probably say “our AI enabled Smart Algos blah, blah, blah.

I know it’s been used for awhile with very large portfolios like mega wealthy or pension fund. The tax loss harvesting seems to be an integral part of the scheme so that rules out tax deferred funds.

 

[Koolau]

I assume it’s 1% AUM fee PLUS trading fees. I think they might use just 50 or some subset of the SP500. They probably say “our AI enabled Smart Algos blah, blah, blah.

I know it’s been used for awhile with very large portfolios like mega wealthy or pension fund. The tax loss harvesting seems to be an integral part of the scheme so that rules out tax deferred funds.

My thoughts on indexing are to maximize diversity - not pick and choose some number of "winners" or large contributors to the index. I guess I just don't understand the concept or rationale of direct indexing - unless, as someone mentioned, enriching your Financial "planner."

 

[Closet_Gamer]

The only value I would see in this is if you wanted to “delete” companies from your index because you think they are wildly over-valued. For example, when the Mag7 were flying super high, you may have wanted to not have anything invested on AAPL or TSLA.

Too much work and/or too much expense for my tastes.

 

[Koolau]

The only value I would see in this is if you wanted to “delete” companies from your index because you think they are wildly over-valued. For example, when the Mag7 were flying super high, you may have wanted to not have anything invested on AAPL or TSLA.

Too much work and/or too much expense for my tastes.

Yeah, it does seem like "w*rk" to me and I'm retired.

 

[TickTock]

So it sounds like the direct indexing product costs 1% to invest in the index while VOO costs less than 0.05%.

Costs are a constant drag on performance. So what about this strategy might produce 95 basis points above the index just to break even? I'd avoid it.

 

[OldShooter]

... DD is talking with a Merrill Lynch advisor and I believe they are pitching a Direct Indexing scheme. They mentioned 1% AUM fee and $100k mininum. ...

Schwab's quarterly magazine came last week. It appears that they have a similar product with the same $100K minimum but fee at 40bbps. I still have no interest but for those who do, 60bps is significant saving.

Charles Schwab

 

[jazz4cash]

Schwab's quarterly magazine came last week. It appears that they have a similar product with the same $100K minimum but fee at 40bbps. I still have no interest but for those who do, 60bps is significant saving.

Charles Schwab

I heard some guys on the radio say 40bps was typical but some are less. Somehow I assume the AUM fee is on top of the direct indexing fee. It makes sense that you could bypass the FA’s fee by going direct with schwab.

 

[SnowballCamper]

But if you're selling the index's laggards to offset capital gains, does that mean you'll never buy them back? What does the strategy say happens if one of the laggards has a comeback? Does it end up buying back the laggard as it's price comes back up? Or is this just a decumulation strategy?

 

[pjigar]

FYI, here is investopedia description of this strategy. It lists more cons tvan pros. I’m just curious when it might work well. It’s not a Merrill thing.

What Is Direct Indexing? How It Works, Benefits, and Downsides

Direct indexing involves purchasing the underlying shares of an index, rather than owning an index mutual fund or index exchange-traded fund.

www.investopedia.com

This is the real definition of "direct indexing". You buy the shares "directly" based on market caps represented in a given "index". But the way you described in your OP, Merrill product sounds more like "closet indexing" i.e. their algorithm defines what to buy or sell from the index (in other words, this is an active investing and not "indexing"). A true "direct indexing" will hold the exact numbers and weights of the shares dictated by an index composition (index has it's own "formula" to define shares and their weights). The only buy or sell events for a true "direct indexing" approach will be when a share is added/dropped from the index outside of changing market caps.

The advantage of direct investing is to save the cost charged by an index fund (e.g. VOO charges 0.03% annually). The disadvantage is that you have to track the index composition regularly and make trades accordingly. If Merrill charges 1% AUM which is way more than a typical index fund expense ratio then there is no advantage of getting "direct indexing" service from Merrill. Advantage only comes if you do it yourself (and cheaper). If I were to do it myself then I would create a pseudo-index where I would pick top 100 shares from S&P500 and adjust weights annually to minimize number of transactions. I think it would track the S&P500 pretty close since top 100 shares cover 72% of market cap as of today.

I actually tried to do "direct indexing" before it even became a well known word. I was investing in Indian stock market about 15 years ago. A typical Indian NIFTY50 index fund used to charge close to 1% expense ratio at the time. I could have done it way cheaper (because only 50 shares in NIFTY50 index) but I ran in to a roadblock when opening a brokerage account so I didn't follow through. But there was a clear advantage in this particular case since the costs were flipped upside down between index fund and direct indexing.

 

[frayne]

Direct indexing sounds like a marketing ploy by financial firms targeting people who don’t understand indexing in the first place. Next, they’ll be pushing indirect indexing or some other boneheaded financial product with a semi-sophisticated name to the unsuspecting consumer.

 

[jazz4cash]

Direct indexing sounds like a marketing ploy by financial firms targeting people who don’t understand indexing in the first place. Next, they’ll be pushing indirect indexing or some other boneheaded financial product with a semi-sophisticated name to the unsuspecting consumer.

It could be but there is a practical benefit if you can harvest losses on individual stocks in the index instead of only being able to TLH on the entire index. In DD’s case it could well be more sizzle than steak. I’m guessing a very large portfolio is required to get any bang for the buck.

 

[jazz4cash]

This is the real definition of "direct indexing". You buy the shares "directly" based on market caps represented in a given "index". But the way you described in your OP, Merrill product sounds more like "closet indexing" i.e. their algorithm defines what to buy or sell from the index (in other words, this is an active investing and not "indexing"). A true "direct indexing" will hold the exact numbers and weights of the shares dictated by an index composition (index has it's own "formula" to define shares and their weights). The only buy or sell events for a true "direct indexing" approach will be when a share is added/dropped from the index outside of changing market caps.

The advantage of direct investing is to save the cost charged by an index fund (e.g. VOO charges 0.03% annually). The disadvantage is that you have to track the index composition regularly and make trades accordingly. If Merrill charges 1% AUM which is way more than a typical index fund expense ratio then there is no advantage of getting "direct indexing" service from Merrill. Advantage only comes if you do it yourself (and cheaper). If I were to do it myself then I would create a pseudo-index where I would pick top 100 shares from S&P500 and adjust weights annually to minimize number of transactions. I think it would track the S&P500 pretty close since top 100 shares cover 72% of market cap as of today.

I actually tried to do "direct indexing" before it even became a well known word. I was investing in Indian stock market about 15 years ago. A typical Indian NIFTY50 index fund used to charge close to 1% expense ratio at the time. I could have done it way cheaper (because only 50 shares in NIFTY50 index) but I ran in to a roadblock when opening a brokerage account so I didn't follow through. But there was a clear advantage in this particular case since the costs were flipped upside down between index fund and direct indexing.

I see what you are saying but I don’t really like the investopedia definition. Yeah I know I linked it! It is very strict at the beginning but it is very flexible towards the end of the definition wrt how closely the index is replicated. At the end of the day I’m not a fan of more complication.

I really was looking for actual experience but it seems like we just have speculation which is OK too. It’s what we do!

 

[pjigar]

It could be but there is a practical benefit if you can harvest losses on individual stocks in the index instead of only being able to TLH on the entire index. In DD’s case it could well be more sizzle than steak. I’m guessing a very large portfolio is required to get any bang for the buck.

As they say, don't let the tax tail wag the investment dog. You can afford to pay A LOT of future taxes with 1% AUM saved annually. e.g.
Portfolio 1: 1M portfolio will grow to be 6.7M at 10% after 20 years.
Portfolio 2: 1M portfolio will grow to be 5.6M at 9% (-1% AUM) after 20 years.
The AUM fees saved from Portfolio 2 (1.1M) can practically pay the entire tax bill (1.14M @20%) of the Portfolio 1 after the end of 20 years.

Compounding is magical if it works for you. It is equally dangerous when it works against you.

 

[RetMD21]

I see what you are saying but I don’t really like the investopedia definition. Yeah I know I linked it! It is very strict at the beginning but it is very flexible towards the end of the definition wrt how closely the index is replicated. At the end of the day I’m not a fan of more complication.

I really was looking for actual experience but it seems like we just have speculation which is OK too. It’s what we do!

Are you looking for testimonials from people who invested in this ML program and have investment results to report?