Direct Indexing Adventure

[loghound]

This is a thread I intend to maintain for 2023 detailing my experience with using the Fidelity Direct Indexing service.

If you go back in my history you'll see I've been pretty active on threads that talked about direct indexing. The idea of direct indexing seemed to make a lot of sense to me and it appealed to me as possibly a clever way to optimize your portfolio while still keeping it indexed.

The main advantages of direct indexing (from people who are fans) are

• Tax Loss Harvesting (TLH) -- Sell Coke to buy Pepsi --> and enjoy the loss on your taxes this year while still being 'in cola'
• Ability to tilt the portfolio for either your morals (ESG) or to avoid stocks that you are already too concentrated in (for instance employer stock)

The main disadvantages that I've heard are:

• Overly complex.. Owning hundred of stocks makes taxes a mess
• High Fees compared to just buying the index.

I did an extensive analysis a while back and while the tilting the direct index away from areas you have concentration and TLH can be a real win, you normally can only TLH for a few years but you are stuck with the higher fees for as long as you hold the account. My walk away was that it was an interesting idea but it wasn't a clear enough win to pursue, especially my main brokerage is a Schwab account and Schwab wants a $100,000 minimum investment for their direct indexing product.

But a little over a month ago I was in my fidelity account (my company uses fidelity for managing HSA, 401K, retirement, the employee stock plan for buying stock at a discount, RSU's, etc.), I had some cash that I needed to do something with (I sold some of my company stock late last year to realize some gains to offset losses) -- Normally I would just transfer it to Schwab and then buy an index fund but I noticed fidelity offered a direct index program and their minimums were pretty low (maybe $5k?) -- after a little head scratching I decided to open an account and fund it with a nice round number of $10,000 and chronicle what happened.

I'll try to come in monthly (middle of the month) to update what is happening to the account. I'll also chronicle how things were at tax time next year

[loghound]

Month 1 (Feb 14-March 17)

Setting up the account was easy -- It already had most of my details (from the other work sponsored accounts) so really I had to just click through a few times, select the index I wanted to track (S&P500) and then I was given a chance to list 5 stocks to exclude. As it turns out I had 5 stocks that I'm overweight in so I typed them in, finished account setup, selected the funding source and waited three days.

After about 3 days it started buying. It ended up making 296 purchases of 252 unique stocks (for some reason it went back after it's first round of purchases and bought more of some companies?) -- It purchased fractional shares as low as .01 but that didn't happen too much. As an example I'm now the proud owner of 0.17 shares of Air BNB, 0.57 shares of Berkshire Hathaway, 1.43 shares of Cisco... you get the idea. Not surprisingly it did a pretty good job of getting me close to the S&P weighting for these individual shares.

Anyway after that initial flurry of activity not much has happened. I've received about $10 in dividends (and fidelity has very thoughtfully swept them into FDRXX) but no attempt at tax loss harvesting has occurred.

so here are my first months results:

• Initial Investment on 2/14/2023: $10,000
• Account Balance on 3/17/2023: $9,428.99 (down 5.7%)
• S&P 500 Index return (VOO): 380.48 -> 359.17 (down 5.6%)
• Total TLH : $0

[hammockhiker]

so here are my first months results:
--------snip------

Thanks for starting this thread. While it's probably not something I'd do myself, I find the subject of direct indexing fascinating and yours is the first explanation I think I've grasped as to the nuts and bolts of it. I'll be checking in periodically to see how you get along.

[tj]

Appreciate that you are the guinea pig

[David Jay]

In this thread, Allan Roth said that the tax document from his broker was 86 pages long: viewtopic.php?t=400137

[prd1982]

In this thread, Allan Roth said that the tax document from his broker was 86 pages long: viewtopic.php?t=400137

Assuming you don't own any other individual stocks that could cause a wash sale, i assume you just need to enter a few lines into schedule D?

[yatesd]

Thanks for the writeup and I will be following. Is there any management fee?

I kind of like the concept, except for two issues:

- I'm not trying to add/exclude stocks
- I would feel too constricted with just tracking the S&P 500, and if I did that...then what is the point again?
- tax loss harvesting doesn't mean anything to me since I am primarily invested in tax deferred accounts.

The main reason for me would be the ability to retain voting rights since I don't want an index to vote for woke policies that I believe are detrimental to the stock.

For now Schwab Intelligent Index seems like a better fit for me. I can exclude asset classes if I want...but haven't felt strong enough to object (2% in Gold was tempting, but I digress).

[CletusCaddy]

In this thread, Allan Roth said that the tax document from his broker was 86 pages long: viewtopic.php?t=400137

Assuming you don't own any other individual stocks that could cause a wash sale, i assume you just need to enter a few lines into schedule D?

Correct, the long 1099 objection is a red herring

[Scrooge McDuck]

Correct, the long 1099 objection is a red herring

Why? Doesn't schedule D need to list the individual stocks you sold, along with the cost basis and sales price?

[CletusCaddy]

Correct, the long 1099 objection is a red herring

Why? Doesn't schedule D need to list the individual stocks you sold, along with the cost basis and sales price?

No it doesn’t. All you need to enter are two summary figures:

Short term gain/loss
Long term gain/loss

[rkhusky]

Correct, the long 1099 objection is a red herring

Why? Doesn't schedule D need to list the individual stocks you sold, along with the cost basis and sales price?

No it doesn’t. All you need to enter are two summary figures:

Short term gain/loss
Long term gain/loss

As long as the transactions have already been reported to the IRS and no corrections are necessary.

[RosieQ]

So Schwab has this service with 100k minimum and 0.4% fee. Fidelity has their Fifolios and it looks like a 90 day free trial and then $4.99/mo which seems much more affordable, then the managed version which is also 0.4% and includes some more active management so more of a Schwab competitor. I think Wealthfront has the winner in terms of fees, at 0.25%. I haven't been all the impressed by the need to optimize tax loss harvesting especially as the extra accout fees add up over time while TLH benefit fades. I think just not worth the complexity but it's an interesting product overall.

[kxl19]

This is a thread I intend to maintain for 2023 detailing my experience with using the Fidelity Direct Indexing service.

…would just transfer it to Schwab and then buy an index fund but I noticed fidelity offered a direct index program and their minimums were pretty low (maybe $5k?) -- after a little head scratching I decided to open an account and fund it with a nice round number of $10,000 and chronicle what happened.

I'll try to come in monthly (middle of the month) to update what is happening to the account. I'll also chronicle how things were at tax time next year

Which fidelity direct indexing product has such a low minimum? I’ve been looking too and I thought it had to be the SMA with 100k minimum

[loghound]

There have been a few question -- let me try to answer them.

• Fidelity directing (they call it FidFolios managed) has a $5,000 minimum and an annual expense ratio of 0.4% (so my experiment will cost me $40 in fees for the one year I plan on running it) For comparison I could have purchased VOO at 0.03% fees (or $3 for the year) so the managed portion is definitely more expensive (but for this amount of money it's not a super material amount)
• The tax concern is Brought up a lot, but today when I do taxes I pretty much just sync up turbotax to my brokerage and do a. quick verify that the totals match -- even with hundreds of transactions I don't expect it to be especially more difficult from my point of view (assuming they get it right!) -- We'll see how it ends up being but I'm optimistic that taxes won't be difficult.
• wash sales don't concern me -- I mostly own mutual funds and the few stocks I own are appreciated and unlikely to be eligible to be sold for a loss.
• I believe Fidelity has a low minimum because they and Schwab lauched their products at basically the same time. Fidelity was trying to differentiate based on low fee (Schwabs response was 'it really doesn't make sense to direct index with less than $100,000')
• You don't have to track and S&P 500, they also have an Environmental focus and a international fund (ex-us) you can track.

[kxl19]

What I find interesting is that the Fidelity large cap direct index has about a 1% after tax "alpha" (additional return net of fees) than the index, which matches the academic research.

Even more interesting - the international index (developed ex-US) has a 4-5% annualized after tax (net of fees) alpha beyond the international index.

https://digital.fidelity.com/prgw/digit ... national/f

Annualized
3 Month YTD 1 Year 3 Year 5 Year 10 Year Life
Pretax composite
International Index Strategy³ (net of fees)
5.08% 5.39% -5.16% 5.50% -- -- 3.88%
Pretax benchmark return (Fidelity Developed ex North America Focus Index [Net])
5.72% 5.59% -3.40% 7.22% 3.16% 5.40% 7.42%
After-tax composite (taxable accounts)
International Index Strategy³ (net of fees)
5.37% 5.40% 0.40% 10.83% -- -- 8.88%
After-tax composite benchmark return
2.81% 5.34% -3.66% 5.89% -- -- 4.06%

[tj]

What I find interesting is that the Fidelity large cap direct index has about a 1% after tax "alpha" (additional return net of fees) than the index, which matches the academic research.

Even more interesting - the international index (developed ex-US) has a 4-5% annualized after tax (net of fees) alpha beyond the international index.

https://digital.fidelity.com/prgw/digit ... national/f

Annualized
3 Month YTD 1 Year 3 Year 5 Year 10 Year Life
Pretax composite
International Index Strategy³ (net of fees)
5.08% 5.39% -5.16% 5.50% -- -- 3.88%
Pretax benchmark return (Fidelity Developed ex North America Focus Index [Net])
5.72% 5.59% -3.40% 7.22% 3.16% 5.40% 7.42%
After-tax composite (taxable accounts)
International Index Strategy³ (net of fees)
5.37% 5.40% 0.40% 10.83% -- -- 8.88%
After-tax composite benchmark return
2.81% 5.34% -3.66% 5.89% -- -- 4.06%

Does The International FidFolio using exclusively ADR's have any effect on that ?

[kxl19]

What I find interesting is that the Fidelity large cap direct index has about a 1% after tax "alpha" (additional return net of fees) than the index, which matches the academic research.

Even more interesting - the international index (developed ex-US) has a 4-5% annualized after tax (net of fees) alpha beyond the international index.

https://digital.fidelity.com/prgw/digit ... national/f

Annualized
3 Month YTD 1 Year 3 Year 5 Year 10 Year Life
Pretax composite
International Index Strategy³ (net of fees)
5.08% 5.39% -5.16% 5.50% -- -- 3.88%
Pretax benchmark return (Fidelity Developed ex North America Focus Index [Net])
5.72% 5.59% -3.40% 7.22% 3.16% 5.40% 7.42%
After-tax composite (taxable accounts)
International Index Strategy³ (net of fees)
5.37% 5.40% 0.40% 10.83% -- -- 8.88%
After-tax composite benchmark return
2.81% 5.34% -3.66% 5.89% -- -- 4.06%

Does The International FidFolio using exclusively ADR's have any effect on that ?

The fidfolio holds the individual stocks directly, not etfs, since it’s a direct indexing product . My theory on the difference is maybe around TLH and avoiding non Qual. dividends since most international ETFs have lower portion of qualified dividends, which affects after tax return

[GTBuzz]

Correct, the long 1099 objection is a red herring

Why? Doesn't schedule D need to list the individual stocks you sold, along with the cost basis and sales price?

No it doesn’t. All you need to enter are two summary figures:

Short term gain/loss
Long term gain/loss

Does their direct indexing avoid stocks that are structured as partnerships? If not, I'd think that would require a Schedule K-1, which in my experience are a total PITA at tax time.

[tj]

Correct, the long 1099 objection is a red herring

Why? Doesn't schedule D need to list the individual stocks you sold, along with the cost basis and sales price?

No it doesn’t. All you need to enter are two summary figures:

Short term gain/loss
Long term gain/loss

Does their direct indexing avoid stocks that are structured as partnerships? If not, I'd think that would require a Schedule K-1, which in my experience are a total PITA at tax time.

What stocks are structured as partnerships? I've never heard of that.

[GTBuzz]

Here's a list of publicly traded partnerships:

https://stockmarketmba.com/listofmlps.php

Basically, the partnership passes through all income to unitholders and avoids paying any tax at the entity level. The downside is that very complicated tax considerations flow through to unitholders on Schedule K-1. I'd be interested in how direct investing handles these entities, or if they avoid them altogether. And if they do avoid, would that mean they're underweight in oil/gas?

[the_wiki]

I am tempted to try this at Wealthfront, but the biggest thing holding me back is:

A) I have a lump sum to invest and probably won't be contributing a lot to taxable in the future. Will there be anything to TLH after a few years? I guess there are always a few companies with losses if you own the whole index, and dividend reinvestments will create small lots. So maybe there will be some. But it feels like the greatest benefit is going to be to people regularly contributing.

B) I feel like I would be stuck forever because who wants to ACATS back a few hundred individual holdings and then manage them? And they would all be low basis because of all the TLH so you'd have a tax hit to unload any of them.

C) Taxes. Some are saying you just have to enter simplified figures. If that is true, I wish I knew how to do that. When I import trades into HR Block, it makes me confirm each and every one of them. I had about 80 last year due to liquidating some small broker accounts with multiple lots and that was bad enough. Can't imagine having to do that for a few thousand trades a year.

[prd1982]

.

C) Taxes. Some are saying you just have to enter simplified figures. If that is true, I wish I knew how to do that. When I import trades into HR Block, it makes me confirm each and every one of them. I had about 80 last year due to liquidating some small broker accounts with multiple lots and that was bad enough. Can't imagine having to do that for a few thousand trades a year.

You don’t import the data. You use the 1099-B form to enter the short and long term covered shares. This assumes you don’t sell any non-covered shares and don’t need to adjust the cost basis.

[tj]

.

C) Taxes. Some are saying you just have to enter simplified figures. If that is true, I wish I knew how to do that. When I import trades into HR Block, it makes me confirm each and every one of them. I had about 80 last year due to liquidating some small broker accounts with multiple lots and that was bad enough. Can't imagine having to do that for a few thousand trades a year.

You don’t import the data. You use the 1099-B form to enter the short and long term covered shares. This assumes you don’t sell any non-covered shares and don’t need to adjust the cost basis.

You can't add the wash sale adjustments on the summary? pretty sure I did.

[prd1982]

You can't add the wash sale adjustments on the summary? pretty sure I did.

I don't know. I just assumed you could not. Hopefully someone will respond.

[FreddieFIRE]

If I were pouring a bunch of new money into equities, and planned to die before pulling it out (i.e. my heirs would receive stepped up basis) or donating it to charity, then this would make a lot of sense. Otherwise, not so much.