Direct Indexing: The Smart Strategy Advisors Can’t Afford to Ignore in 2025

by Jack Van Dyke of Russell Investments, 12/6/24

Executive summary:

Direct Indexing is growing rapidly but only a small percentage of advisors are using it
We believe many advisors don’t know enough about this game-changing strategy and how it can be used to solve several investor issues
Our Direct Indexing resource center is designed to help advisors and their clients discover how the strategy can help minimize an investor’s capital gains taxes, reduce concentration risk and plan for future tax liabilities on financial windfalls

Over the past few years, I’ve written numerous articles and given numerous presentations on Direct Indexing. My biggest takeaway is that while most advisors have heard of the strategy, the vast majority have yet to implement it in their practices. According to Cerulli and Associates, only 14% of financial advisors are actively using direct indexing to help their clients with their specific needs. Cerulli also believes that direct indexing assets under management (AUM) will grow by 12.4% a year, faster than mutual funds, Exchange-Traded Funds (ETFs) or even retail separate accounts, and by the end of 2026, will reach $800 billion.¹

A recent survey of financial advisors by FTSE Russell helps explain that apparent discrepancy. The survey found that only 34% of the 631 advisors polled were “familiar” or “very familiar” with how direct indexing works. Additionally, the survey found that advisors “not using direct indexing revealed less knowledge of its value.” For example, a majority didn’t know that it was useful in tax-loss harvesting or tax-efficient transitions.

As the survey noted: “Those already deploying direct indexing have a far keener appreciation of its benefits around tax efficiencies and customization.”²

In a nutshell, advisors who understand the benefits of this growing strategy are using it, while those who don’t, aren’t. After one of my presentations on direct indexing, many advisors have the same response: “Why isn’t everyone doing this?” My answer generally is that most haven’t taken the time to learn and thus are losing out on a large segment of the market.

I firmly believe the concept of Direct Indexing is here to stay and will play a huge role in client portfolios in the years to come. I believe advisors who understand what Direct Indexing can do for their clients and implement it to help solve some of their key issues will be far ahead of those who don’t.

As we all know, January is about resolutions and setting new goals for the year ahead. Why not make 2025 the year you learn how Direct Indexing can be a help to your clients and your own practice? You can be on the leading edge of this smart strategy that is poised for significant growth.

What do you know about Direct Indexing?

How much do you and your clients know about Direct Indexing? Can you illustrate the benefits of Direct Indexing to manage potential tax liabilities or maintain tax budgets within limits?

We are here to help you. Russell Investments recently launched a webpage focused on Direct Indexing. The site contains short videos, blogs and articles designed to educate you and your clients on the power of Direct Indexing.

The following is a quick overview of the strategy and how to unlock opportunities with your clients and prospects.

What is Direct Indexing?

In its simplest form, direct indexing is a strategy in which an investor hires a portfolio manager to purchase a selection of the securities that make up a specific index and hold them in a Separately Managed Account (SMA). A Direct Indexing strategy can potentially earn a return similar to a chosen benchmark – while allowing the investor to customize a portfolio to fit their needs or preferences, or utilize various strategies to manage their tax liabilities.

Uncovering Direct Indexing opportunities: Questions to ask your clients

Are you expecting any significant financial windfalls, such as the sale of property or the sale of a business, in the foreseeable future?
Many high-net-worth individuals foresee substantial gains from business, property, or large stock sales down the line. However, the planning often falls short. This is where Direct Indexing emerges as a potential strategic solution. By proactively managing portfolios to minimize capital gain taxes through selective loss harvesting and tax-efficient trading strategies, advisors can bank losses to potentially offset these future capital gains.
Do you have mutual fund holdings that are generating capital gains taxes that could be mitigated through a strategy like direct indexing?
For investors facing capital gain taxes from mutual fund holdings, direct indexing offers an enticing alternative. Unlike mutual funds, these strategies encompass separately managed accounts, which can help eliminate the need for capital gains distribution—a significant advantage for those seeking to minimize tax liabilities.
Do you hold a concentrated stock position, possibly accumulated through equity grants or stock options, and need a tax-efficient plan to manage it?
Many high-net-worth investors hold concentrated stock positions accumulated over years. Often overlooked, these positions might sit unmanaged, posing financial risks and compliance liabilities. A Direct Indexing strategy can help the investor reduce that concentrated position without triggering capital gains taxes. Alternatively, a strategic reduction plan over several years can be executed, offsetting gains with tax-loss harvesting to help minimize associated taxes.

Bottom line

Start the year right—uncover the power of direct indexing to help elevate strategic tax planning and portfolio customization for your clients in 2025.

¹ Source: https://www.cerulli.com/press-releases/cerulli-associates-projects-direct-indexing-assets-to-top-800-billion-by-2026-while-outpacing-growth-of-etfs-mutual-funds-and-smas

² Source: https://www.lseg.com/content/dam/ftse-russell/en_us/documents/research/direct-indexing-fresh-wave-growth.pdf

Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

This material is not an offer, solicitation or recommendation to purchase any security.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Personalized Managed Accounts (“PMA”) is a program of Russell Investment Management, LLC (“RIM”) and offers customized portfolio management services.

Each Personalized Direct-Indexed Separately Managed Account is a product of Russell Investment Management, LLC (”RIM”) and offered through RIM’s Personalized Managed Accounts (“PMA”) program. It represents a direct indexed portfolio provided by RIM. PMA is a separately managed account program of individually owned securities that can be tailored to meet investor’s investment objectives. RIM offers diversified, single or multi-asset managed accounts that can be customized to the investor’s investment objectives, circumstances and preferences, such as (but not limited to), market exposure, risk management, tax management, category and theme-based restrictions, and return objectives. Excluding any allocations to pooled investment vehicles, if any, each investor’s account is managed separately from other investor accounts, allowing for a personalized experience to deliver unique investment outcomes.

The decision to use PMA in investors’ portfolios and related investment advice are provided through financial advisors and other financial intermediaries that are independent of RIM and its affiliates. Investors should consult with their financial advisor to determine which services and programs are appropriate to meet their investment objectives.

Russell Investments' ownership is composed of a majority stake held by funds managed by TA Associates Management L.P., with a significant minority stake held by funds managed by Reverence Capital Partners L.P.. Certain of Russell Investments' employees and Hamilton Lane Advisors, LLC also hold minority, non-controlling, ownership stakes

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.

The Russell logo is a trademark and service mark of Russell Investments.

Copyright © 2024 Russell Investments Group, LLC. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

RIM-03600

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.