While most of us invest in passive portfolios for our IRA account, simply because we don’t have the time or resources to select the best portfolio managers to do it for us, there is a new investing product at our disposal that empowers us to start investing like professional portfolio managers without being one. You may have heard this term before: Direct Indexing. It is going to bring a new mini-revolution for the investing world and something you should consider for your wealth management strategy. Here’s an article on how to put Direct Indexing in place for your investment portfolio strategy.

What is direct indexing?

Direct indexing is an investment process in which an investor is able to own a basket of stocks outright instead of through a collective investment vehicle like an ETF or mutual fund. What that means is that if you were to hold the stocks as a collective investment vehicle, you would just see only one line item, one ticker symbol that would represent the security that holds all the underlying securities of the collective investment vehicle. This approach is said to be Indirect Investing.

In Direct Indexing, you hold a basket of stocks in an account based on an established portfolio index methodology. On the brokerage statement you would see as many different line item entries as there are securities in the index. You hold a direct interest in the companies instead of the ETF or mutual fund holding the fractional interest on your behalf.

For example, WealthVenue’s Direct Index, the WealthVenue US MidCap 500 Value Advantage, is a basket of 80 successful US MidCap stocks that tracks US listed companies that have a Value Advantage over the market. This means that those listed companies are expected to positively outperform their peers over the long run, which they have effectively been doing for a long time. As the index trades infrequently, there isn’t much trading of these securities other than to rebalance the portfolio to mirror any changes in the index that it is modeled after.

Why you should care

The major advantage of Direct Indexing is that the portfolio can be customized to the needs of the investor instead of just being a one-size-fits-all ETF.

The main advantage of Direct Indexing is to build extraordinary investment strategies or strategies with a very specific investment angle that is hard to find in any other ETFs. For example, a direct index portfolio can be customized to your own preferences if you are interested in ESG. Let’s say that you want to exclude all retailers who sell firearms. You’re able to do that within your Direct Index portfolio whereas in an ETF you’d be stuck holding shares of companies with whom you disagree morally.

Direct Indexing is basically an investing strategy that could let you manage the market like a professional, but can be executed automatically without your involvement.

How can it benefits you

In the past, direct indexing wasn’t as beneficial to small retail investors because it was costly to hire a professional manager to implement such a strategy and index licensing costs are prohibitive for investors with small portfolios.

The good news is that innovation has streamlined the investment processes of many digital advisors, (aka roboadvisors), and they are now able to deliver Direct Indexing Portfolios to their retail clients with far lower costs than in the past.

Active management, or “dynamic” investing, is investing through a skilled and professional manager who is paid to buy and sell securities based upon intelligent market research, and it tends to be more expensive than passive management. On the other hand, passive strategies track an index based on “static” or “dumb” portfolio selection rules and make costly trading minimal. Whether or not active management actually rewards investors is a subject of dispute; there’s no clear evidence that return on investment is higher than for passive management.

In contrast, Direct Indexing is a semi-passive strategy that combines the best of both worlds: the smart dynamics of the active investing and the low trading cost of passive investing. In that regard, Direct Indexing is “smart investing” without the cost associated with Active investing.

Where to go to implement a direct indexing approach

Investors who are looking for exposure to a smart portfolio without the high cost of managing one may set up a direct index in a variety of ways.

  • You could do it yourself if you can buy the licensing cost of the index provider. The amount of time required to manage your own money can be quite substantial given there are a significant number of companies you would need to follow in order to conduct proper monitoring of your portfolio.
  • You could hire a financial advisor. Financial advisor fees can be quite significant, from 1% or higher. Often the investment management services are bundled with others such as financial or tax planning that the investor may or may not require. One of the benefits of passive investing is the lower cost; the fees for a professional money manager would effectively make it counterproductive to try to save money this way.
  • You could use a roboadvisor platform.Technology has driven down the cost of setting up a direct indexing strategy through an automated platform. This is a great option for a do not disturb investor who does not have extensive needs. Make sure to select the right underlying Portfolio Indexes that will fit your risk and return expectations and learn more about the logic behind the Portfolio Index selection process to make sure it’s not invested in risky asset classes like illiquid SmallCaps or MicroCaps securities.

Going for our Direct Index

Direct Indexing is a revolutionary new tool for us now to go beyond passive investing and start investing like professional portfolio managers without being one. The WealthVenue US MidCap 500 Value Advantage is priced daily in real time on Reuters and Bloomberg under the tickers .WMVA and <WMVA Index>, respectively. We think this could change the game for the performance of your investment portfolios. If Direct Indexing through a roboadvisor is something you are ready to try, click below and see how our WealthVenue Index can make a difference in your investment portfolio.