Why it makes sense to open a direct indexing account early in the year.
When it comes to tax-loss harvesting, many investors wait until year-end.
But the advantage of beginning the process as early as possible in the year is that an investor can realize roughly 11 months of losses during the year, allowing them to increase the time available to realize losses or offset taxable gains from the sale of a security or securities. For example, if an investor sells a stock position in January for a gain and transfers the assets to a direct indexing portfolio, they have the remainder of the year to harvest losses they can use to offset the gain. By waiting to harvest losses until later in the year, they have less time to accomplish their goal.
We believe tax-loss harvesting using a direct indexing portfolio can be a powerful tax-planning tool. Investors who plan on selling a business or property in the future may want to consider investing in a direct indexing portfolio now and begin the tax-loss harvesting process as soon as possible, thus increasing the potential tax offset when they eventually realize their taxable gain.
Indeed, that is the process we follow at Russell Investments. When you partner with us for non-IRA accounts, you’re getting access to a time-tested process that is much more than just tax-loss harvesting at year-end. Our trading desk is staffed 24 hours a day by traders averaging more than 15 years of experience across the investment spectrum. Our team is systematically looking for opportunities to harvest losses all year long, while balancing risk and index tracking. Depending on the individual investor, these losses can then be carried forward and used to offset any future gains in that portfolio, elsewhere in the investor’s account or even in another part of the household’s portfolio—such as the sale of a property or business. Other investors may use these tax losses to help diversify a concentrated position.
How does direct indexing help reduce a concentrated stock position?
Divesting part or all of a concentrated stock position in a tax-efficient manner is challenging. In some cases, the original cost of the shares could be a small fraction of the current price, which would trigger a significant capital gain and a massive tax bill.
As noted earlier, direct indexing allows the investor to directly hold a basket of stocks that replicates an index. That means the investor can offset the capital gains from selling a concentrated stock position with capital losses generated from selling other securities in the direct indexing portfolio. When the transition is done through a program such as our Personalized Managed Accounts (PMA), using a direct indexing strategy, investors can determine how much they want to take in capital gains annually until the position is whittled down to a more manageable percentage of the portfolio. Alternatively, the exposure to the concentrated stock position can be pared down by taking gains over a period anywhere from three to five years. And with a PMA strategy, those capital gains will be offset with tax-loss harvesting, keeping any related taxes as low as possible.
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As you can see, direct indexing can be a beneficial tax-planning tool. Whether to harvest losses today to offset a future gain or to reduce a concentrated stock position, direct indexing through our Personalized Managed Account program can provide you with options to help your clients reach their financial goals.