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Is Direct Indexing the Next Evolution of Wealth Management?

You’ve likely been hearing a lot in the financial news lately about direct indexing and its potential to disrupt the wealth management world. We’d like to shed a little light on what direct indexing is, how it differs from ETFs and mutual funds, and how it can benefit your clients and your business.

What is direct indexing?

Direct indexing allows advisors to build personalized, transparent portfolios of individual securities for clients based on indexes or model portfolios. In other words, advisors can either create a portfolio of securities that are the component parts of an index or which financially reflect an existing index, like the S&P 500, or construct a unique compilation of individual securities that include or exclude particular industries, stocks, sectors, geographies, preferences, and values. For example, if an investor has a significant amount of concentrated stock from an employer, that stock could be excluded from a direct index, but stocks in industries which reflect the investor’s values, like solar and alternative energy companies, could be specifically included. Generally, direct indexing is employed for high net worth clients, but it does not have to be: as long as there are no or low account minimums, with the right technology, investors of most asset levels could take advantage of direct indexing.

Direct indexing versus ETFs and mutual funds

ETFs and mutual funds are essentially “wrappers” with a predetermined number of prescribed stocks, chosen by company analysts. With direct indexing, investors own the individual stocks directly, not a wrapper from an intermediary. Purchasing and selling ETFs and mutual funds is simple, quick, and easy, since one transaction takes care of investing in hundreds of companies. While it may take more time and effort to build a portfolio based on an index from scratch, once built, direct indexing offers the ability to give clients exactly what they want, still have diversified holdings and, on the Folio platform, use one easy transaction to take care of investing in all the securities in the index you construct.

The advantages of direct indexing

The primary benefits of direct indexing revolve around three factors: customization, tax efficiency, and cost effectiveness.

Consumers in general, especially high net worth investors, are looking for more personalization, eschewing cookie cutter solutions for everything from hair care products to debit cards, and technology is allowing this high level of customization. Investing is no different. Direct indexing offers the ability to tailor investment choices for a variety of factors, as well as the ability to choose any weighting, including market cap weights, for each holding, and this investing technology, while incredibly complex, is becoming more scalable and accessible. This allows advisors to use their financial acumen and expertise to advise clients and differentiate their practice.

Direct indexing also offers tax efficiency. Investors can harvest tax losses or gains on individual stocks within the direct index, according to their personal needs. In this regard, direct indexing allows for a more distinct level of granularity and transparency. With an ETF or mutual fund, advisors and investors have no control over what gets bought or sold within the portfolio, allowing for fewer opportunities for tax optimization.

Cost efficiency is another result of direct indexing. Typically, mutual funds and ETFs have expense ratios, sales loads, and other fees associated with them, which can be a drawback, especially for those investing large amounts. With direct indexing, investors only pay a fee on the trades they make, which may be beneficial, especially with commission-free trading or a low asset-based fee that includes trading.

Index investing has long been considered the best path to investing success. Direct indexing allows firms to up their advisory alpha while providing clients with the bespoke portfolios they are beginning to expect. It is the next evolution in wealth management.

And by the way: Folio Financial was built for direct indexing, with two decades of experience, way before recent trends. Visit to learn more.

Direct Indexer