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The Ultimate Guide to Direct Indexing

Learn everything you need to know about direct indexing,
tax-loss harvesting, and why investors are increasingly considering direct indexing strategies.

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What is Direct Indexing?

Direct indexing is a personalized investment strategy that enables investors to directly own the individual securities that make up a benchmark index instead of buying into a traditional mutual fund or exchange-traded fund (ETF).

This approach replicates the performance of an index while offering greater customization, tax efficiency, and control.

Also known as custom indexing in some contexts, direct indexing allows for tailored portfolios based on specific financial goals, values-based investing (e.g., ESG), or tax-loss harvesting strategies.

Direct Indexing vs. Custom Indexing

Direct Indexing:
Direct indexing involves constructing a portfolio by directly purchasing the underlying stocks of a benchmark index in their respective weightings. The goal is to mirror the performance of the index as closely as possible while enabling personalization and tax optimization.

Custom Indexing:
custom indexing goes a step further by allowing the investor or advisor to design a bespoke index based on specific rules or criteria. These could include excluding certain sectors, incorporating ESG filters, or overweighting certain factors like dividends or growth.

Benefits of Direct Indexing for Financial Advisors

Direct indexing for advisors, including Registered Investment Advisors (RIAs) and portfolio managers, provides a modern and flexible toolset to optimize and personalize client portfolios.

Key benefits include:

Personalization:
Align portfolios with individual client goals, values, or restrictions.

Tax Efficiency:
Enable tax-loss harvesting at the individual stock level to offset gains and reduce tax liability.

Enhanced Control:
Greater transparency and control over asset allocation and trading.

Cost Management:
Avoid fund-level fees and gain more flexibility in managing trading costs.

Client Education:
Foster deeper client engagement by demonstrating customized portfolio construction With the support of direct indexing platforms, advisors can offer these advantages within separately managed accounts (SMAs), delivering a high-touch, value-added service.

Direct Indexing Technology and Software Solutions

Modern direct indexing software platforms streamline the portfolio construction and management process, making the strategy more accessible and scalable.

Index One is a leading direct indexing platform offering a comprehensive and customizable solution for RIAs, wealth managers, and institutional investors, with capabilities including:

  • Dynamic portfolio rebalancing

  • Tax-loss harvesting algorithms

  • ESG integration tools

  • Real-time reporting and analytics

Index One empowers advisors to deliver cutting-edge, tax-optimized, and personalized investment experiences to clients.

Direct Indexing vs. ETFs: Understanding the Key Differences

With the growing popularity of direct indexing and exchange-traded fund strategies, it has become increasingly important for investors and financial professionals to understand the key differences between these two investment vehicles.

While both aim to provide diversified market exposure, they differ significantly in structure, customization, tax management, and investor control.

Direct Indexing vs. ETFs: Comparison Overview

Direct Indexing vs ETFs

Why Direct Indexing?

Thanks to advances in technology and fractional share trading, direct indexing platforms now make it possible for investors and advisors to implement highly personalized, tax-optimized investment strategies.

Direct indexing is particularly appealing for:

  • High-net-worth individuals seeking tax efficiency

  • Financial advisors and RIAs looking to deliver tailored portfolios

  • Investors with ESG or personal values-based preferences

Examples of Direct Indexing

Several RIAs and portfolio managers are increasingly adopting direct indexing solutions as a core part of their investment strategy.

The growing appeal of this approach is driven by its ability to deliver personalized portfolios and tax-efficient investing, which are often difficult to achieve through traditional index funds or ETFs.

The Ultimate Guide to Direct Indexing

Benefits of Direct Indexing for Investors and Advisors

With the rising demand for direct indexing and the emergence of powerful direct indexing technology platforms, investors and financial advisors now have an unprecedented opportunity to create custom index portfolios with enhanced efficiency, personalization, and tax optimization, all in a cost-effective manner.

Customization:

With direct indexing, investors gain direct exposure to each underlying security in an index. This enables a high level of customization, such as:

  • Excluding specific companies or sectors

  • Overweighting preferred industries or asset classes

  • Integrating thematic investment strategies (e.g., tech, clean energy)

View all custom indices here.

Tax-Loss Harvesting:

One of the biggest advantages of direct indexing is the ability to implement tax-loss harvesting at the individual security level. This means investors can strategically sell stocks at a loss to offset capital gains, reducing their overall tax liability.

  • Harvest losses in real time throughout the year

  • Offset gains from other asset sales

  • Reinvest proceeds to maintain market exposure

Personalization and ESG Integration:

Direct indexing allows for full customization of the portfolio. Investors can exclude specific stocks or sectors, overweight others, and even apply ESG (Environmental, Social, and Governance) filters to align with their values.

For example, an investor interested in ESG-focused tech companies can build a custom portfolio that mirrors a technology index, while removing companies that don’t meet their ethical standards.

Example: Trust 200 ESG Index

Full Transparency and Control:

Direct indexing portfolios are often managed through Separately Managed Accounts, giving investors:

  • Full visibility into individual holdings

  • Greater flexibility in managing gains/losses

  • Customized rebalancing strategies

Customized Rebalancing:

Unlike traditional index funds, direct indexing supports customized rebalancing strategies based on individual investor profiles and market conditions. Advisors can:

  • Maintain specific sector or risk exposures

  • Optimize for tax efficiency during rebalancing events

  • Implement rules-based or manual rebalancing preferences

Index One offers a flexible and intuitive platform to:

  • Create and maintain custom index portfolios

  • Automate tax-loss harvesting and ESG filters

  • Offer scalable personalization within separately managed accounts.

  • Integrate directly into client-facing platforms and workflows

Whether you're an investor seeking tax optimization or an advisor delivering high-touch, personalized services, Index One enables you to harness the full potential of modern direct indexing.

Drawbacks of Direct Indexing

While direct indexing offers significant advantages in terms of customization, tax efficiency, and values alignment, it also introduces certain challenges, especially when managing personalized index portfolios at scale.

Complexity:

Unlike traditional index funds or ETFs, direct indexing involves owning and managing individual securities.

For advisors and individual investors alike, managing these elements manually can be time-consuming and operationally intensive.

Higher Costs:

For smaller portfolios, the need to trade multiple individual securities may lead to:

Higher transaction costs and operational inefficiencies in execution, especially without automation tools

These costs can reduce the potential tax and performance benefits if not carefully managed.

Stock-Specific Risk:

Unlike broad index funds that offer built-in diversification, direct indexing involves direct exposure to individual stock performance.

Fortunately, today’s direct indexing platforms such as Index One remove much of the complexity traditionally associated with building custom indexes.

With advanced automation, fractional share capabilities, and real-time portfolio tracking, investors can now:

  • Build a custom, rules-based index portfolio

  • Automate tax-loss harvesting and rebalancing

  • Maintain personalized diversification at a fraction of the historical cost

This empowers both advisors and investors to construct and maintain “do-it-yourself” custom indexes easily and efficiently

Direct Indexing for Tax-Loss Harvesting

Tax-loss harvesting is a tax-efficient strategy where investors intentionally sell investments that have declined in value to offset gains elsewhere in their portfolio.

With direct indexing, investors can easily identify and sell underperforming individual stocks to generate tax losses, helping to reduce their overall tax liability.

How does Direct Indexing work​?

To implement direct indexing:

Select an Index

Choose the benchmark index you want to replicate, or create a custom index.

Build the Portfolio
Portfolio Management
Consider Tax Strategies

Index One has partnered with a number of direct indexing platforms that enables investors to deploy tax-loss harvesting in direct indexings strategies. Learn More.

Passive Index Investing

Passive index investing involves buying and holding a diversified portfolio that closely mirrors a specific market index.
It aims to capture the overall market's performance, typically with low costs and minimal turnover.

Direct Indexing Strategies

Direct indexing strategies can vary based on an investor's goals, but common approaches include:

Factor Investing:
Overweighting or underweighting stocks based on specific factors lik e value, growth, or dividend yield.

ESG Integration:
Constructing a portfolio with companies that align with environmental, social, and go vernance principles.

Tax Optimization:
Focusing on tax-efficient trading strategies, like tax loss harvesting and tax-efficient asset location.

How to Get Started with Direct Indexing

To get started with direct indexing:

Define Your Objectives

Determine your investment goals, risk tolerance, and any specific preferences.

Select an Index
Choose a Platform
Build Your Portfolio
Monitor and Rebalance

Direct indexing offers investors a unique approach to portfolio construction, allowing for greater customization and tax optimization, but it also requires active management and a solid understanding of the stock market. Before proceeding, consult with a financial advisor to ensure it aligns with your financial goals and risk tolerance.

List of Direct Indexing Strategies

Index One powers a diverse range of direct indexing strategies. Explore some of the innovative, custom-calculated strategies delivered through the Index One platform.

Strategydescriptioni1 Indices
Momentum StrategiesMomentum strategies focus on stocks with upward price momentum, typically aiming to outperform by riding trends.BX US Large Cap Momentum Index
BX US SMID Momentum Index
BX Triple Screen Momentum Index
Trend Capture StrategiesTrend capture strategies use technical signals to identify and capitalize on short- to medium-term market trends.BX Fantastic Five Trend Capture
BX US Equity Focus 10 Index
Value & Fundamental StrategiesValue based strategies select stocks believed to be undervalued relative to their fundamentals.BX Smart Alpha US Large-Cap Value Strategy
BX/FT American Disciplined Small Cap Index
Volatility & Risk-Based StrategiesVolatility & risk-based models focus on managing or optimizing portfolio risk through volatility targeting or dynamic adjustments.BX/FolioBeyond Dynamic Volatility Fixed Income Index
Sector Rotation StrategiesThese strategies rotate exposure across sectors based on market or economic signals.BX/Dynalogic Sector Rotation Index
Thematic StrategiesThematics strategies typically involve forward-looking themes like innovation, disruptive tech, or new economy sectors.BX/Thor Next Gen Stock Index
Tactical Allocation StrategiesTactical allocation models include strategies that dynamically adjust allocations across asset classes, sectors, or factors based on market conditions, quantitative models, or signals.BX/AI Funds Tactical Growth

Frequently Asked Questions

Index construction refers to the process of creating and maintaining a market index, which is a hypothetical portfolio of securities that represents a specific segment of the overall market.

While direct indexing requires you to choose amongst pre-packaged solutions, custom indexing allows for unlimited customization within different factors, allowing investors to build a portfolio that truly reflects their unique investment goals and preferences.

While active investing strategies focus on individual securities and a more hands-on approach, passive investing strategies tend to focus on purchasing shares of index funds or ETFs in an attempt to mirror or beat the performance of market indexes.

A security is the ownership or debt with value. A stock is a type of security that gives the holder of the stock ownership or equity of the publicly-traded company.

A share is a unit of ownership measured by the number of shares you own, whereas a stock is a unit of equity, measured by the percentage of ownership of the company.

A portfolio manager handles investments and other financial products that make up a portfolio. An asset manager may also manage portfolios, but they mainly handle cash and assets, which a portfolio manager does not.

While a benchmark only serves as a standard to measure index performance against, an index is created for a variety of reasons, and one of its purposes is to act as a benchmark. In other words, a benchmark is usually always an index, but an index doesn’t necessarily have to be a benchmark.

Rebalancing is a more automated process where price and market-cap weighted indices are rebalanced automatically. Reconstitution, on the other hand, requires the manual adding and removal of securities from an index, based on whether or not these securities are meeting index criteria.

An index fund is a mutual fund which tracks an index, while an ETF is an exchange traded asset tracking the performance of an index.

An index is a hypothetical basket of stocks. In order to invest in an index, it would need to be an investable product that tracks an index. A few examples of an investable product are mutual funds and ETFs.

Index rebalancing refers to the process of adjusting the composition and weights of securities within an index. It is typically done periodically to maintain the index's target representation and desired characteristics. Index rebalancing helps maintain the integrity of the index and ensures that it continues to accurately reflect the targeted market segment. It allows for adjustments to account for changes in market conditions, company fundamentals, and other factors that may affect the composition and weights of the index components.

Creating a stock index involves several steps and considerations, including defining the index objective, selecting the index components, determining the weighting methodology, setting the initial index values, establishing the index calculation methodology, regular maintenance and rebalancing, index calculation and dissemination and index governance and oversight.

Constructing an index for research purposes involves a tailored approach to meet specific research objectives. This includes defining research objectives, selecting the relevant securities, determining inclusion and exclusion criteria, determining weighting methodology, setting the index universe, establishing index calculation methodology, data collection and management, performing backtesting and validation, documenting index construction methodology and analyzing and interpreting results.

Creating your own index requires careful consideration of various factors, including your investment objectives, the availability of data, and the resources needed to maintain and calculate the index. It may be beneficial to seek professional advice or consult with experts in index construction to ensure the integrity and accuracy of your self-created index.

Creating your own index fund involves several steps and considerations: define the investment objective, select the index components, determine the weighting methodology, set the initial fund composition, establish a rebalancing strategy, implement the fund's portfolio, track and monitor performance, consider legal and regulatory requirements, consider administration and custody, develop a distribution strategy, and comply with reporting and governance.

Commonly Used Terms

custom indexing is the process of setting specific parameters on the stocks you’d like to invest money in, allowing you to personalize your investments based on your individual values, goals, preferences, risk tolerance and tax positioning.

direct indexing is an investing strategy that involves purchasing the individual stocks within an index, maintaining the same weights in the index.

active management involves an investment manager making investment decisions by tracking the performance of an investment portfolio.

passive management involves a fund’s portfolio mirroring a market index, by selecting stocks to be included in a portfolio, unlike active management.

A market index is a hypothetical portfolio that contains investment holdings. The value of a market index is based on the prices of the underlying holdings.

EHM, or efficient market hypothesis is a theory coined by Eugene Farma, which states that active managers can beat the market only for a given period of time, as their success is simply a matter of chance. EHM suggests that long-term passive management delivers better results than asset management.

active investing involves the ongoing buying and selling of securities by monitoring market index.

passive investing is a long-term strategy that involves buying securities that mirrors a market index.

thematic investing focuses on investing in long-term or macro-level trends. Examples of thematic investment themes include water, robotics & AI, gaming & e-sports, and space exploration.

ESG investing emphasizes on investments that prioritizes optimal environmental, social and governance outcomes.

factor investing is a type of portfolio management strategy that targets quantifiable metrics or factors that can explain differences in stock returns. These factors often include value, size, volatility, momentum, and quality.

exchange traded funds, or ETFs refer to a type of investment fund that is traded on a stock exchange. An ETF usually tracks a generic market index and allows an investor to potentially lower risks and exposure, while diversifying their portfolio.

A registered investment advisor, or RIA, is an individual or firm that advises clients on investment decisions and manages their investment portfolios.

backtesting allows an investor to test an investment strategy using historical data to assess how it would have performed before earning actual returns.

rebalancing involves the process of realigning the weightings of assets within a portfolio, by buying or selling the assets to maintain the original or desired level of asset allocation or risk.

a systematic portfolio contains securities that maintains a price higher than the predetermined level by a systematic manager. A systematic portfolio strategy invovvles trading decisions based on market price trends.

a rules-based investment strategy follows smart investment rules and aims to deliver active returns in a cost-efficient manner.

an active return is the percentage difference between a benchmark and the actual return.

an index provider is a firm that creates, calculates and maintains market indices based on any given investment strategy.

sustainable investing is a type of investment strategy that prioritizes environmental, social and corporate governance impacts before investing in a particular company, venture or fund. It is also called ESG investing or SRI.

an investment strategy is a set of principles that guide an investor to make sound investment decisions based on their financial goals, values, risk tolerance and preferences.

alpha strategies are active investment strategies that choose investments that have the potential to beat the market. Alpha is also known as “excess returns” or “abnormal rate of return.”

benchmarking is the process of setting a standard against which the performance of an investment strategy can be measured.

reconstitution is the re-evaluation of a market index to ensure that an index reflects up-to-date market cap and is balanced.

a bond is a type of security where the issuer of a bond owes the holder of the bond a debt, and the issuer is obligated to repay the principal of the bond at the maturity date, as well as interest on the bond.

asset allocation is the process of dividing an investment among different types of assets, such as stocks, bonds and cash.

quant, or quantitative analysis, is the process of using mathematical and statistical methods to make investment decisions.

index funds are a type of mutual fund or exchange-traded fund (ETF) that aim to replicate the performance of a specific market index.

a mutual fund is a type of investment fund that pools money from several investors to purchase securities.

derivative structured products are financial instruments that combine derivatives with other underlying assets to create investment products with unique risk and return characteristics.

similar to mutual funds, a hedge fund is a type of pooled investment fund that trades in relatively liquid assets. Hedge funds primarily use portfolio construction, complex trading and risk management techniques in an attempt to improve performance.

traders who watch market prices know when an index fund will update its components, allowing them to front-run the trade by buying or selling the shares to get ahead of the market and gain an edge. This is not considered illegal because it rewards individuals who pay close attention to information that already exists in the market. However, SEC Rule 17(j)-1 prohibits insiders from taking advantage of their knowledge of client trades for personal gain.

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