Good Analysis of Direct Indexing by Allan Roth

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Northern Flicker
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Good Analysis of Direct Indexing by Allan Roth

Post by Northern Flicker »

My synopsis of Allan Roth's very good article on direct indexing follows.

1. Direct indexing has a higher expense ratio than a low cost equity index ETF or mutual fund (.03% vs .4% in his comparison with an S&P500 ETF).

2. The value of tax-loss harvesting opportunities is purported to more than offset the higher ER.

3. Eventually, gains in the stock market should lead the stocks held having embedded gains. The embedded gains would be amplified by past tax loss harvests.

4. The tax loss opportunities will dry up, and the investor will pay the higher ER for many years to come.

5. There may be some investor-specific benefits like reducing the correlated risk of holding the stock of one's employer by not holding it in the direct indexing portfolio.

6. The benefit of tax loss harvests could be diluted if capital gains tax laws are changed so that LTCG's are taxed less favorably.

I'll add my own additional one:

7. The possibility of customization may lead to the investor making some active decisions or stock picking decisions, for better or for worse.
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Northern Flicker
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Northern Flicker »

I have some observations.

Changes in tax laws that lead to LTCG's being taxed less favorably could go either way. Direct indexing will create more embedded gains and reduce TLH opportunities, but direct indexing also may overall enable more tax-efficient withdrawals to deal with a hypothetical less favorable tax rate on LTCG.

During accumulation, new contributions and reinvestment of dividends will re-seed TLH opportunities. But in decumulation, that will no longer be in play. Direct indexing may offer the opportunity for withdrawals that are not just a slice of the portfolio, but this may be unproven.

Direct indexing is a form of indexing by sampling. With sampling, an optimizer is used to find a portfolio other than a full replica that minimizes tracking error. I am not familiar with any of the direct indexing products, but the way I could see them working is just to enhance the optimizer to have a constraint on holding a given stock.

Suppose you wish to TLH Intel stock. Set the portfolio representation with the Intel holdings replaced with cash, and run the optimizer to invest the cash with an additional constraint of not holding Intel. This is just a simple example.

A concern I have is that after years of TLH and amplified embedded gains in assets held, could the portfolio anneal to a sample that once in decumulation cannot be modified without realizing embedded gains? This would mean that all withdrawals were just a slice of the portfolio (just like for a traditional index fund) and now the investor will have an ER drag on decumulation for no benefit. Moreover, changes in the behavior of individual stocks and the makeup of the market may then require realizing gains to track the market properly, but there would not be the techniques used by ETFs to manage the gains.

Companies offering direct indexing may have thought about these issues carefully, and may have simulated portfolios over years of direct indexing. I don't know how much of an issue these observations might be. But holding a low cost, tax-efficient index ETF seems like an easy, safe choice.
the_wiki
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by the_wiki »

I think the biggest reason that some advisors/brokers are pushing direct indexing is because you are effectively trapped once you get a few years into it with some solid gains. You'll have a few hundred individual holdings. Sure you can ACATS out at any time, but trying to unwind all those positions without blowing up your taxes and maintaining your asset allocation is going to be a bigger challenge than most would be willing to take on.
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Taylor Larimore
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Taylor Larimore »

Allan Roth, Northern Flicker and the_wiki:

Thank you for a good analysis of the latest attempt by the financial industry to tempt us into purchasing costly and complex strategies.

Best wishes.
Taylor
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Gaston »

Northern Flicker wrote: Wed Mar 15, 2023 2:52 pm I'll add my own additional one:

7. The possibility of customization may lead to the investor making some active decisions or stock picking decisions, for better or for worse.
I’ll add one more.

8. At present, it’s difficult to unwind, leaving the investor with potentially hundreds of individual stocks to manage, or a sizable tax bill if sold to invest the proceeds into a Boglehead-friendly ETF. Maybe one day it will be possible to move “in kind” from a direct indexed portfolio to an ETF with no adverse tax consequences.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by anil686 »

Gaston wrote: Thu Mar 16, 2023 2:29 pm
Northern Flicker wrote: Wed Mar 15, 2023 2:52 pm I'll add my own additional one:

7. The possibility of customization may lead to the investor making some active decisions or stock picking decisions, for better or for worse.
I’ll add one more.

8. At present, it’s difficult to unwind, leaving the investor with potentially hundreds of individual stocks to manage, or a sizable tax bill if sold to invest the proceeds into a Boglehead-friendly ETF. Maybe one day it will be possible to move “in kind” from a direct indexed portfolio to an ETF with no adverse tax consequences.

This x 1000 IMO…. It was the same (separate from Direct Indexing) with Wealthfront and others before with the continuous TLH portfolios. Those were a mess after a year….
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Gaston »

anil686 wrote: Thu Mar 16, 2023 9:54 pm This x 1000 IMO…. It was the same (separate from Direct Indexing) with Wealthfront and others before with the continuous TLH portfolios. Those were a mess after a year….
Interesting. Did not know that.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by the_wiki »

anil686 wrote: Thu Mar 16, 2023 9:54 pm
This x 1000 IMO…. It was the same (separate from Direct Indexing) with Wealthfront and others before with the continuous TLH portfolios. Those were a mess after a year….
I'd have a hard time calling any of them "a mess" when you just get the ETF portfolios. They are still a good portfolio of low cost index funds. Worst case you get like a 10 fund portfolio with most of the funds from Vanguard or iShares. I'm surprised you mentioned Wealthfront as their default portfolio is just VTI, VWO, VEA, BND and VIG.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by kxl19 »

I've been considering direct indexing, and reading the academic research on direct indexing, and I think it's a potentially valuable product for certain situations

1 - High tax bracket - increases the post-value of the capital losses
2 - Continuous capital gains from year to year (ie, FAANG-like employee with annual refreshes of options/RSU that have been held to LTCG), so you could use the capital loss offsets
3 - Already have a recurring periodic investment into an index fund - so that there'll always be new opportunities to TLH from direct indexing.

I share similar concerns about what happens in decumulation stage - you won't have new funds coming in, but will be making sales, so maybe there's still opportunities to capitalize on the losses.

Excellent paper by Andrew Lo's team (well known finance professor at MIT) - showing a roughly consistent 1% tax alpha for direct indexing during various market periods. Their sensitivity analysis shows tax alpha increases with greater periodic contributions (my point #3). and also increases with higher tax brackets (point #1).

https://alo.mit.edu/wp-content/uploads/ ... -Alpha.pdf

Even If there's a 40 bps expense ratio, direct indexing could still have positive alpha.

What's not known is if one did a monthly TLH strategy "by hand" of ETFs, how much more alpha is obtained by direct indexing?
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by aristotelian »

Tax loss harvesting is nice but it's a marginal benefit. Optimizing tax loss harvesting seems like a marginal optimization of the marginal. The maximum benefit to anyone is $3,000 deduction per year. Anyone who has enough money for direct indexing to make a difference is going to have big enough losses to max out the deduction through tax loss harvesting with ordinary index funds. Just seems like a solution in need of a problem.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by retiredjg »

Allan Roth wrote: The 1099 tax form on my little $5,000 direct indexing experiment is 86 pages!
Wow :shock:

Direct indexing is obviously not a good choice for someone who values simplicity.
CletusCaddy
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by CletusCaddy »

aristotelian wrote: Fri Mar 17, 2023 7:11 am Tax loss harvesting is nice but it's a marginal benefit. Optimizing tax loss harvesting seems like a marginal optimization of the marginal. The maximum benefit to anyone is $3,000 deduction per year. Anyone who has enough money for direct indexing to make a difference is going to have big enough losses to max out the deduction through tax loss harvesting with ordinary index funds. Just seems like a solution in need of a problem.
There are many other uses for tax losses than just the $3k ordinary income offset. I own a home in the Bay Area. With a very conservative assumption of 3% CAGR, the home will appreciate to a $1.5M capital gain in 20 years when I retire and might want to downsize or move to LCOL. Homestead exemption is $500k, leaving me a $1M taxable capital gain that I could wipe out if I had enough tax losses. Hardly marginal.
retiredjg wrote: Fri Mar 17, 2023 8:47 am
Allan Roth wrote: The 1099 tax form on my little $5,000 direct indexing experiment is 86 pages!
Wow :shock:

Direct indexing is obviously not a good choice for someone who values simplicity.
DIY tax loss harvesting is not simple. At least not for people who get paid twice a month and send their paychecks to their brokerage for immediate investing. It’s been my experience that you actually need to juggle as many as three separate funds:

1. Start out with VTI
2. Two weeks later, your paycheck deposits and VTI has experienced a loss. However you can’t just sell VTI because that would be a wash sale. You also can’t buy more VTI with your new paycheck because that would reset the clock on the wash sale. So you buy ITOT.
3. Two weeks later, you get another paycheck and the market has gone down even more. Now you can sell VTI for a tax loss. But you can’t buy or sell ITOT yet, again, that would reset the clock. So you buy SCHB.

What’s more complicated, monitoring all of the above every two weeks, or plowing in your regular paychecks into the direct indexing account, having the service TLH for you, and clicking a button at tax time for TurboTax to load in the 80 page 1099?
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by km91 »

CletusCaddy wrote: Fri Mar 17, 2023 9:37 am DIY tax loss harvesting is not simple. At least not for people who get paid twice a month and send their paychecks to their brokerage for immediate investing. It’s been my experience that you actually need to juggle as many as three separate funds:

1. Start out with VTI
2. Two weeks later, your paycheck deposits and VTI has experienced a loss. However you can’t just sell VTI because that would be a wash sale. You also can’t buy more VTI with your new paycheck because that would reset the clock on the wash sale. So you buy ITOT.
3. Two weeks later, you get another paycheck and the market has gone down even more. Now you can sell VTI for a tax loss. But you can’t buy or sell ITOT yet, again, that would reset the clock. So you buy SCHB.
This is quite extreme though, taking tax losses quarterly or yearly is much simpler to implement and doesn't require constant trading between multiple funds. Choose a pair of funds, like VOO and IVV and on a quarterly basis swap between them to lock in the tax loss
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by CletusCaddy »

km91 wrote: Fri Mar 17, 2023 12:24 pm
CletusCaddy wrote: Fri Mar 17, 2023 9:37 am DIY tax loss harvesting is not simple. At least not for people who get paid twice a month and send their paychecks to their brokerage for immediate investing. It’s been my experience that you actually need to juggle as many as three separate funds:

1. Start out with VTI
2. Two weeks later, your paycheck deposits and VTI has experienced a loss. However you can’t just sell VTI because that would be a wash sale. You also can’t buy more VTI with your new paycheck because that would reset the clock on the wash sale. So you buy ITOT.
3. Two weeks later, you get another paycheck and the market has gone down even more. Now you can sell VTI for a tax loss. But you can’t buy or sell ITOT yet, again, that would reset the clock. So you buy SCHB.
This is quite extreme though, taking tax losses quarterly or yearly is much simpler to implement and doesn't require constant trading between multiple funds. Choose a pair of funds, like VOO and IVV and on a quarterly basis swap between them to lock in the tax loss
How is this quite extreme? Literally everyone I know gets paid twice a month or every two weeks. Assuming you are investing in taxable at all then you should be investing with every paycheck. And if you do so then you are forced into the three fund approach I described above or else you would also find yourself in a wash sale situation.

If you lump sum your taxable investments once per month then you don’t have this problem I agree, but then what are you doing with your other paycheck mid month?
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by km91 »

CletusCaddy wrote: Fri Mar 17, 2023 12:27 pm How is this quite extreme? Literally everyone I know gets paid twice a month or every two weeks. Assuming you are investing in taxable at all then you should be investing with every paycheck. And if you do so then you are forced into the three fund approach I described above or else you would also find yourself in a wash sale situation.

If you lump sum your taxable investments once per month then you don’t have this problem I agree, but then what are you doing with your other paycheck mid month?
You don't need to TLH every two weeks, you could do quarterly TLH trades and achieve the same benefit. I make contributions every 2 weeks and have never needed to juggle between 3 funds
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by CletusCaddy »

km91 wrote: Fri Mar 17, 2023 12:41 pm
CletusCaddy wrote: Fri Mar 17, 2023 12:27 pm How is this quite extreme? Literally everyone I know gets paid twice a month or every two weeks. Assuming you are investing in taxable at all then you should be investing with every paycheck. And if you do so then you are forced into the three fund approach I described above or else you would also find yourself in a wash sale situation.

If you lump sum your taxable investments once per month then you don’t have this problem I agree, but then what are you doing with your other paycheck mid month?
You don't need to TLH every two weeks, you could do quarterly TLH trades and achieve the same benefit. I make contributions every 2 weeks and have never needed to juggle between 3 funds
Ok I see. You wouldn’t “achieve the same benefit” however, you’d miss out on all the TLH opportunities mid quarter if the market dips and then recovers.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by km91 »

CletusCaddy wrote: Fri Mar 17, 2023 12:57 pm Ok I see. You wouldn’t “achieve the same benefit” however, you’d miss out on all the TLH opportunities mid quarter if the market dips and then recovers.
Fair, but there's a trade off between operational complexity and TLH that needs to be made somewhere
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by CletusCaddy »

km91 wrote: Fri Mar 17, 2023 1:14 pm
CletusCaddy wrote: Fri Mar 17, 2023 12:57 pm Ok I see. You wouldn’t “achieve the same benefit” however, you’d miss out on all the TLH opportunities mid quarter if the market dips and then recovers.
Fair, but there's a trade off between operational complexity and TLH that needs to be made somewhere
But that’s the point with direct indexing. Zero operational complexity for the investor and maximal TLH benefit in exchange for the 0.4% expense ratio.
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Northern Flicker
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Northern Flicker »

retiredjg wrote: Fri Mar 17, 2023 8:47 am
Allan Roth wrote: The 1099 tax form on my little $5,000 direct indexing experiment is 86 pages!
Wow :shock:

Direct indexing is obviously not a good choice for someone who values simplicity.
Not to mention the increase in tax preparation cost.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by nedsaid »

retiredjg wrote: Fri Mar 17, 2023 8:47 am
Allan Roth wrote: The 1099 tax form on my little $5,000 direct indexing experiment is 86 pages!
Wow :shock:

Direct indexing is obviously not a good choice for someone who values simplicity.
I don't know, it just seems to me that you can do tax loss harvesting with a whole lot less turnover. I think the algorithms harvest a lot of small capital losses. I am sure there is a logic to this but I am not impressed with a tax statement with pages and pages and page of transactions. There is a point where it just seems like churning.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by tj »

Looks like Fidelity jacked up the fee from 40bps to 70bps since Allan published his article.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Vivbet »

tj wrote: Sun Jun 18, 2023 12:51 pm Looks like Fidelity jacked up the fee from 40bps to 70bps since Allan published his article.
Or once they have you trapped in a situation that is hard or expensive to undo, then they raise their rates. Works out well for them, doesn’t it?
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by grabiner »

CletusCaddy wrote: Fri Mar 17, 2023 9:37 am DIY tax loss harvesting is not simple. At least not for people who get paid twice a month and send their paychecks to their brokerage for immediate investing. It’s been my experience that you actually need to juggle as many as three separate funds:

1. Start out with VTI
2. Two weeks later, your paycheck deposits and VTI has experienced a loss. However you can’t just sell VTI because that would be a wash sale. You also can’t buy more VTI with your new paycheck because that would reset the clock on the wash sale. So you buy ITOT.
3. Two weeks later, you get another paycheck and the market has gone down even more. Now you can sell VTI for a tax loss. But you can’t buy or sell ITOT yet, again, that would reset the clock. So you buy SCHB.

What’s more complicated, monitoring all of the above every two weeks, or plowing in your regular paychecks into the direct indexing account, having the service TLH for you, and clicking a button at tax time for TurboTax to load in the 80 page 1099?
You don't have the delay in situation 2. If you sell the shares of a security which you purchased in the last 30 days, with or without any other shares, you eliminate the wash sale.

Thus, if you buy every two weeks, you can harvest a loss by selling your last two purchases of Fund A along with any other purchases. Your next two investments need to be in Fund B to avoid a wash sale. You could still need three funds if you sold Fund A to buy Fund B, and then Fund B declined significantly in 30 days or less.
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tj
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by tj »

tj wrote: Sun Jun 18, 2023 12:51 pm Looks like Fidelity jacked up the fee from 40bps to 70bps since Allan published his article.

I need to correct myself. The 0.70 bps is for actively managed FidFolios that try to outperform. The direct index is still 0.40 bps
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by EddyB »

Northern Flicker wrote: Fri Mar 17, 2023 11:56 pm
retiredjg wrote: Fri Mar 17, 2023 8:47 am
Allan Roth wrote: The 1099 tax form on my little $5,000 direct indexing experiment is 86 pages!
Wow :shock:

Direct indexing is obviously not a good choice for someone who values simplicity.
Not to mention the increase in tax preparation cost.
My tax preparer doesn’t charge any differently for importing a larger .csv.

I’ve said it elsewhere on this board, but I was very happy with index ETFs and started direct indexing only because of a specific non-US tax issue not relevant to the rest of you. Nonetheless, I’ve been more than satisfied with the US tax effects. Would I like it even more if it were less expensive? Yes.

The dismissals above also seem much less convincing for those of us with other capital gains (which, especially now, with some inflation and larger-than-normal real-estate price increases, seems likely to be a growing category). Stepped-up basis treatment also matters for those claims that one is going to realize the same gains eventually.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by FixedIncQuant »

CletusCaddy wrote: Fri Mar 17, 2023 9:37 am
aristotelian wrote: Fri Mar 17, 2023 7:11 am Tax loss harvesting is nice but it's a marginal benefit. Optimizing tax loss harvesting seems like a marginal optimization of the marginal. The maximum benefit to anyone is $3,000 deduction per year. Anyone who has enough money for direct indexing to make a difference is going to have big enough losses to max out the deduction through tax loss harvesting with ordinary index funds. Just seems like a solution in need of a problem.
There are many other uses for tax losses than just the $3k ordinary income offset. I own a home in the Bay Area. With a very conservative assumption of 3% CAGR, the home will appreciate to a $1.5M capital gain in 20 years when I retire and might want to downsize or move to LCOL. Homestead exemption is $500k, leaving me a $1M taxable capital gain that I could wipe out if I had enough tax losses. Hardly marginal.
retiredjg wrote: Fri Mar 17, 2023 8:47 am
Allan Roth wrote: The 1099 tax form on my little $5,000 direct indexing experiment is 86 pages!
Wow :shock:

Direct indexing is obviously not a good choice for someone who values simplicity.
DIY tax loss harvesting is not simple. At least not for people who get paid twice a month and send their paychecks to their brokerage for immediate investing. It’s been my experience that you actually need to juggle as many as three separate funds:

1. Start out with VTI
2. Two weeks later, your paycheck deposits and VTI has experienced a loss. However you can’t just sell VTI because that would be a wash sale. You also can’t buy more VTI with your new paycheck because that would reset the clock on the wash sale. So you buy ITOT.
3. Two weeks later, you get another paycheck and the market has gone down even more. Now you can sell VTI for a tax loss. But you can’t buy or sell ITOT yet, again, that would reset the clock. So you buy SCHB.

What’s more complicated, monitoring all of the above every two weeks, or plowing in your regular paychecks into the direct indexing account, having the service TLH for you, and clicking a button at tax time for TurboTax to load in the 80 page 1099?
Would VTI for ITOT to SCHB pass the substantially identical test ?
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Nonna »

I am 71 years old and just recently (3 months ago) signed up with an advisor who convinced me to invest in direct indexing using O’Shaughnessy and to buy bonds through Telemus. The advisor fees we agreed to are charged in advance, which are not easy to calculate. I am not happy with this at all, but now I realize I can’t terminate advisor without being stuck with owning 500 stocks, as O’Shaughnessy will not service the account for individuals. After reading these posts about direct indexing, I am wondering if I should just wait until the tax loss harvesting drops to zero and then just instruct the advisor to gradually sell out of the direct indexing?
Does that make sense. I feel sick about all this.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by tj »

Nonna wrote: Tue Jul 09, 2024 8:42 pm I am 71 years old and just recently (3 months ago) signed up with an advisor who convinced me to invest in direct indexing using O’Shaughnessy and to buy bonds through Telemus. The advisor fees we agreed to are charged in advance, which are not easy to calculate. I am not happy with this at all, but now I realize I can’t terminate advisor without being stuck with owning 500 stocks, as O’Shaughnessy will not service the account for individuals. After reading these posts about direct indexing, I am wondering if I should just wait until the tax loss harvesting drops to zero and then just instruct the advisor to gradually sell out of the direct indexing?
Does that make sense. I feel sick about all this.
Never heard of this service. No it does not make sense to wait. if it's not good value, pull the plug now.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by CletusCaddy »

EddyB wrote: Mon Jul 17, 2023 1:59 am The dismissals above also seem much less convincing for those of us with other capital gains (which, especially now, with some inflation and larger-than-normal real-estate price increases, seems likely to be a growing category).
This is exactly right. My Bay Area home increased in value by $300k this year alone.
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by finite_difference »

Nonna wrote: Tue Jul 09, 2024 8:42 pm I am 71 years old and just recently (3 months ago) signed up with an advisor who convinced me to invest in direct indexing using O’Shaughnessy and to buy bonds through Telemus. The advisor fees we agreed to are charged in advance, which are not easy to calculate. I am not happy with this at all, but now I realize I can’t terminate advisor without being stuck with owning 500 stocks, as O’Shaughnessy will not service the account for individuals. After reading these posts about direct indexing, I am wondering if I should just wait until the tax loss harvesting drops to zero and then just instruct the advisor to gradually sell out of the direct indexing?
Does that make sense. I feel sick about all this.
I would also pull the plug and then get advice on how to manage your investments from this site, for free, for example by using the three-fund portfolio.
The most precious gift we can offer anyone is our attention. - Thich Nhat Hanh
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by retiredjg »

Nonna wrote: Tue Jul 09, 2024 8:42 pm I am 71 years old and just recently (3 months ago) signed up with an advisor who convinced me to invest in direct indexing using O’Shaughnessy and to buy bonds through Telemus. The advisor fees we agreed to are charged in advance, which are not easy to calculate. I am not happy with this at all, but now I realize I can’t terminate advisor without being stuck with owning 500 stocks, as O’Shaughnessy will not service the account for individuals. After reading these posts about direct indexing, I am wondering if I should just wait until the tax loss harvesting drops to zero and then just instruct the advisor to gradually sell out of the direct indexing?
Does that make sense. I feel sick about all this.
Welcome to the forum. :happy

I would not stay in this situation if it makes you "feel sick". If you have only been there 3 months, you probably don't have a great deal of capital gains. The gains you have, though, are probably short term.

If this were my problem, I think I'd terminate the agreement before things get worse and move the stocks to a major brokerage such as Fidelity or Schwab. Then start selling them with as few gains as possible and replace the stocks with a broad index fund such as total stock index. This might take some time, but I think it is better than staying where you are.

Are you familiar with this process at all?

Are the bonds a bond fund(s) or individual bonds?

What is your tax situation....tax bracket? Single or married filing jointly?
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by bople »

FixedIncQuant wrote: Sun Apr 07, 2024 7:01 pm
CletusCaddy wrote: Fri Mar 17, 2023 9:37 am
aristotelian wrote: Fri Mar 17, 2023 7:11 am Tax loss harvesting is nice but it's a marginal benefit. Optimizing tax loss harvesting seems like a marginal optimization of the marginal. The maximum benefit to anyone is $3,000 deduction per year. Anyone who has enough money for direct indexing to make a difference is going to have big enough losses to max out the deduction through tax loss harvesting with ordinary index funds. Just seems like a solution in need of a problem.
There are many other uses for tax losses than just the $3k ordinary income offset. I own a home in the Bay Area. With a very conservative assumption of 3% CAGR, the home will appreciate to a $1.5M capital gain in 20 years when I retire and might want to downsize or move to LCOL. Homestead exemption is $500k, leaving me a $1M taxable capital gain that I could wipe out if I had enough tax losses. Hardly marginal.
retiredjg wrote: Fri Mar 17, 2023 8:47 am
Allan Roth wrote: The 1099 tax form on my little $5,000 direct indexing experiment is 86 pages!
Wow :shock:

Direct indexing is obviously not a good choice for someone who values simplicity.
DIY tax loss harvesting is not simple. At least not for people who get paid twice a month and send their paychecks to their brokerage for immediate investing. It’s been my experience that you actually need to juggle as many as three separate funds:

1. Start out with VTI
2. Two weeks later, your paycheck deposits and VTI has experienced a loss. However you can’t just sell VTI because that would be a wash sale. You also can’t buy more VTI with your new paycheck because that would reset the clock on the wash sale. So you buy ITOT.
3. Two weeks later, you get another paycheck and the market has gone down even more. Now you can sell VTI for a tax loss. But you can’t buy or sell ITOT yet, again, that would reset the clock. So you buy SCHB.

What’s more complicated, monitoring all of the above every two weeks, or plowing in your regular paychecks into the direct indexing account, having the service TLH for you, and clicking a button at tax time for TurboTax to load in the 80 page 1099?
Would VTI for ITOT to SCHB pass the substantially identical test ?
Yes, because the underlying number of stocks and which ones they are very different between them.

Since this thread got necroed, I want to add three additional points to the general discussion so far:

1. Aperio/Parametric are the OG direct indexers and they charge ERs of ~15bps at scale—you do have to go through an advisor to get them.

2. Frec https://frec.com/ is the new Fintech provider at 10bps ER and available directly—but they are Fintech so, make sure you do your research. I will note that Aperio and Parametric were startups once as well. ;)

3. Direct indexers can do some very cool things: How much can I withdraw without any STCG? How much can I withdraw without any LTCG? I want to withdraw X% with minimal LTCG and minimal tracking error, etc. There are so many threads/comments on BH that express the "I can't withdraw from my taxable accounts because of the tax cost" sentiment.
garlandwhizzer
Posts: 3588
Joined: Fri Aug 06, 2010 3:42 pm

Re: Good Analysis of Direct Indexing by Allan Roth

Post by garlandwhizzer »

Taylor posted:

Allan Roth, Northern Flicker and the_wiki:

Thank you for a good analysis of the latest attempt by the financial industry to tempt us into purchasing costly and complex strategies.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Fund marketers favor the fads that are in the momentary limelight, with the expectation that investors will take the bait."

1+

In my view this post hits the bull's eye. It it takes more than 3 sentences to explain why a complex portfolio is superior to ultra cheap broadly based index fund, it is unlikely to succeed long term. At least that is my personal experience. As Ben Graham observed: getting satisfactory investing returns is much easier than most investors believe, while getting better returns than that is much more difficult than most believe. This insight comes from a truly greatly value investor who had an outstanding career of outperformance when he picked bushels of low hanging value fruit in the erstwhile very inefficient mom-and-pop driven market. At the end of Graham's career the abundance of low hanging fruit was gone, and he came to believe that cheap broadly based index investing could not be reliably bested even by an expert of his skill level.

The financial media as well as much financial research constantly drives the narrative of "don't accept average returns" against index funds. What they carefully do not mention is that the overwhelming majority of their more complicated, more expensive approaches will underperform simple cheap index returns long term. These more complex approaches will reliably put money in the pockets of those who create and market them--that is in fact the major driving force that generates that output. But whether they put risk adjusted dollars not in the pockets of investors relative to simple index funds is an entirely different question. Some few do, most do the opposite, and on average alternate approaches underperform comparable indexes. Picking the few active winners from the more abundant losers prospectively on a consistent basis is somewhere between extremely unlikely and impossible.

Garland Whizzer
livesoft
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Joined: Thu Mar 01, 2007 7:00 pm

Re: Good Analysis of Direct Indexing by Allan Roth

Post by livesoft »

Nonna wrote: Tue Jul 09, 2024 8:42 pmI am ....
In the past 3 months the S&P500 is up about 8%, but it had dropped near the beginning of that time frame ago by almost 5%. Anyways you have a nice gain. I don't know what you mean by "tax loss harvesting drops to zero," I recommend you bite the bullet (rip off the band-aid) and just sell all the shares. However it would be helpful to know about the tax consequences of that for you.

Since you are paying for all this, your provider should be able to tell you exactly what the tax consequences would be for you, so please insist that they do this for you.
Wiki This signature message sponsored by sscritic: Learn to fish.
RosieQ
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Joined: Tue Sep 09, 2014 2:52 am

Re: Good Analysis of Direct Indexing by Allan Roth

Post by RosieQ »

Frec does sound interesting. Fee structure plus pledged asset line of credit for LIBOR + 1% is excellent. I would absolutely use them over one of the advisor options or Fidelity/Schwab at 0.4%

https://frec.com/
tj
Posts: 10060
Joined: Wed Dec 23, 2009 11:10 pm

Re: Good Analysis of Direct Indexing by Allan Roth

Post by tj »

RosieQ wrote: Wed Jul 10, 2024 3:46 pm Frec does sound interesting. Fee structure plus pledged asset line of credit for LIBOR + 1% is excellent. I would absolutely use them over one of the advisor options or Fidelity/Schwab at 0.4%

https://frec.com/
Can Frec realistically stick around at that cost though? They're going to burn through the VC eventually.
Lyrrad
Posts: 1048
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Re: Good Analysis of Direct Indexing by Allan Roth

Post by Lyrrad »

tj wrote: Wed Jul 10, 2024 6:47 pm
RosieQ wrote: Wed Jul 10, 2024 3:46 pm Frec does sound interesting. Fee structure plus pledged asset line of credit for LIBOR + 1% is excellent. I would absolutely use them over one of the advisor options or Fidelity/Schwab at 0.4%

https://frec.com/
Can Frec realistically stick around at that cost though? They're going to burn through the VC eventually.
No idea. I don't plan to consider using Frec until I'm comfortable that they have a sustainable product and they implement the features I want.

I hope they succeed.

Their growth can be monitored through their annual Form ADV filings. Once they hit $100 million in AUM, they should have quarterly Form 13F filings.
RosieQ
Posts: 165
Joined: Tue Sep 09, 2014 2:52 am

Re: Good Analysis of Direct Indexing by Allan Roth

Post by RosieQ »

At the very least Frec provides competition that drives down prices. If they get big enough it pushes for a similar competing product from Schwab etc. Just like Vanguard brought ETF fees down to earth and we find ourselves with the current status quo.
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