Are Direct Index Investments the Next Big Thing?

Written By: John Drachman The Twitter world erupted in laughter recently when a presidential candidate referred to a “record player” during a debate – a term familiar to hipsters and boomers but few others. Will investors someday regard “mutual funds” and “ETFs” with similar mockery? The answer may be “yes,” if a new retail kid on the block, Direct Index Investing, continues to gain ink and traction with rising numbers of return-focused, expense-minded investors and advisors.

A Look Back

Morningstar Research has steadily documented the torrent of outflows from mutual funds, an investment vehicle founded nearly a century-ago. For the present, the popularity of ETFs (Exchange Traded Funds) continues to shine brightly, as they reached almost $4 trillion this past March, according to the Investment Company Institute. After the launch of the original passive, index-based ETFs, a plethora of active/passive hybrids, smart beta solutions, rules-based algorithms and liquid alternative products quickly followed. Now, it may be time for Direct Index Investments to have their close-up. Formerly an exclusive offering to large institutions and HNW investors, Direct Index Investing provides smaller retail investors with access to fractional shares, asset-based pricing, digital innovations and benefits like these:
  • Lower Expenses Direct Indexing can lower expenses though benefits like tax‑loss harvesting, which allows a security that has fallen below its purchase value to be resold and replaced with another. In this manner, you can use the tax loss to off-set the tax payable on a potential future capital gain – while still staying invested in the market.
  • Added Measure of Personalization ETF investors can’t exclude companies they dislike from their portfolio models. With a Direct Index Investment, you can specify what to leave in – or out. Trading in fractional shares has become increasingly common, too. This is good news if you want exposure to pricier stocks at more affordable levels.
Are you more interested in weapons and oil? Or green technologies? Direct Index Investing can facilitate portfolio construction based on your sector and company interests, while still letting you rebalance your assets periodically to optimize expenses based on rules you select.

Wanted: Validation

While avid do-it-yourselfers may relish committing their own time toward managing these expense-optimized vehicles, you might prefer some help in validating your assumptions and keeping your portfolio model aligned with long-term objectives. Fortunately, increasing numbers of advisors are climbing the Direct Index Investing learning curve to put this emerging retail vehicle to work for their clients. John Drachman is a contributing writer to, the premier matchmaker between investors and advisors.  Related: The Reality of Financially and Emotionally Supporting Aging Parents