Direct Indexing Examples and Use Cases

Advisor testimonials highlight ways to help clients with personalized indexing

man siting at a conference table around a group of coworkers


Recurring capital gains

Use Case No. 1: High-tax-bracket client with recurring capital gains

Our researchers crunched the numbers to quantify the hypothetical tax benefit that a client with a $4 million taxable portfolio could realize over five and 10 years with a 30% allocation to personalized indexing with Vanguard.*

Personalized indexing’s impact on $4 million taxable portfolio (no future deposits/withdrawals)
 

VPI impact chart at 5 and 10 year

Sources: Vanguard Investment Advisory Research Center, Vanguard Personalized Indexing.

Notes: Pre-tax and after-tax returns based on the following assumptions: municipal bond return, 4.0%; active equity, 8.3% (1.8% for dividends, 1.0% for short-term capital gains, 4.5% for long-term capital gains, and 1.0% for unrealized gains); index equity, 8.3% (1.8% for dividends, 0.0% for short-term capital gains, 0.5% for long-term capital gains, and 6.0% for unrealized gains); private equity, 10.0% ( 8.0% for long-term capital gains, 2.0% for unrealized gains); hedge funds, 6.5%(6.5% for short-term capital gains); Vanguard Personalized Indexing (VPI), 8.3% (1.8% for dividends, 6.5% for unrealized gains). VPI tax-loss harvesting (TLH) amounts were calculated using the Vanguard Tax Alpha Calculator and are based on the average losses, as a percentage of starting VPI allocations, incurred each year for years 1 through 10 given rolling 10-year simulations starting in 1982 through 2013. For instance, for the 2013 starting year, the simulation includes the time period from January 1, 2013, to December 31, 2022. Each simulation starts with an investment on day 1 of the simulation which has a cost basis equal to 100% of the initial investment. Withdrawals are not made from the portfolio at any time during the simulation. Please see Tax Alpha Calculator for full methodology and assumptions. For tax rates, this analysis uses a marginal U.S. income tax rate of 37.0% for income and short-term capital gains, a 3.8% Medicare tax on investment income, a 20.0% tax on long-term capital gains, and a 4.95% state tax for Illinois residents. This hypothetical example does not represent the return on any particular investment and the rate is not guaranteed. Any future changes in the tax treatment of investment earnings or a rate of return that is lower than the assumed rate of return may further impact the comparison. Investors should consider their time horizon and current and expected future tax rates before making an investment decision.

*Portfolio allocations before VPI: 30% equity ETFs, 30% active mutual funds, 20% municipal bonds, 10% private equity, 10% hedge funds. Portfolio allocations with VPI: 30% VPI, 30% active mutual funds, 20% municipal bonds, 10% private equity, 10% hedge fund.

 

Advisors explain how they’re using direct indexing

Wondering whether adding direct indexing to your offerings could help you build your business? See what your fellow advisors who already use the strategy have to say:

Longtime direct indexing user Matt Shibata, managing partner of Morling Financial Advisors, has been using the strategy to manage recurring capital gains. In this one-minute video, Matt explains how his firm marries Vanguard Personalized Indexing with other private investments to create better outcomes for clients.

Matt Shibata is an advisory client of Vanguard.

 

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Something we did a lot in 2020 and 2021, when the IPO market was going and a lot of people had some pretty large exits from real estate and other types of private assets, is we could roll those gains into an opportunity zone. And then you can take the basis and you could roll that into direct indexing. So, you’re able to manage the portfolio, you defer that capital gain through the opportunity zone for many years into the future—at that point, it was about five or six years, now it’s a little bit shorter. We could harvest losses in the meantime, through the personalized indexing strategy, to offset current gains or to carry those gains forward to when that tax liability would be due in 2026, 2027. So, there’s a lot of great benefits of personalized indexing by itself, but really marrying it with other alternative investments and other tools that you have, we’re able to create even better outcomes.*

 

*This is an opinion, and your results may vary

“We're never surprised by the degree to which people hate paying taxes. Oftentimes, we have clients who are in high brackets, they're selling a property, they're selling a business—they have a need for losses to minimize their tax burden. So, from a planning perspective, [direct indexing] fits in really, really, well.”

Josh joffe headshot

“If you’re used to talking about performance and quantitative numbers [with clients]—get that out of your lexicon. Because what you can talk about here are the benefits to investing. You get to talk about tax savings, you get to talk about ways you can customize a portfolio. You get to talk about the things that they care about, which is what they keep at the end of the day. So, [direct indexing] brings in this qualitative discussion that we really like.”

dave murdoch headshot


The experiences of these Vanguard clients may not be representative of the experience of other Vanguard clients and are not a guarantee of future investment performance or success.

Future sale of business

Use case No. 2: Investor anticipating a large future capital gain

Say you have a client or prospect who plans to retire in five years following the sale of a personal business. The sale will generate a $2M long-term capital gain.* Our researchers calculated the significant hypothetical impact VPI could have on sale proceeds in the following scenario:

  • Immediately fund a VPI account with $1M in cash.
  • Make additional $250,000 VPI investments at the start of each year for the next four years.

VPI impact on sale of business proceeds at year 5

client outcome for VPI cbar chart including tax benefit

Sources: Vanguard Investment Advisory Research Center, Vanguard Personalized Indexing.

Notes: Vanguard Personalized Indexing (VPI) account contributions are $1M today, and $250K at the start of each year for years 2 through 5. Client-owned business sale is expected to take place in year 5 and result in a $2M long-term capital gain. VPI tax-loss harvesting (TLH) amounts are based on the average losses, as a percentage of starting VPI allocations, incurred each year for years 1 through 5 given rolling 5-year simulations starting in 1982 through 2013. For instance, for the 2013 starting year, the simulation includes the time period from January 1, 2013, to December 31, 2017. Over the 5-year analysis period, VPI harvested $558,939 in losses to partially offset $2 million in capital gains. For tax rates, this analysis uses a marginal U.S. income tax rate of 37.0% for income and short-term capital gains, a 3.8% Medicare tax on investment income, a 20.0% tax on long-term capital gains, and a 4.95% state tax for Illinois residents. VPI fees assumed to be 0.20%. This hypothetical example does not represent the return on any particular investment and the rate is not guaranteed. Any future changes in the tax treatment of investment earnings or a rate of return that is lower than the assumed rate of return may further impact the comparison. Investors should consider their time horizon and current and expected future tax rates before making an investment decision. VPI tax-loss harvesting (TLH) amounts were calculated using the Vanguard Tax Alpha Calculator and are based on the average losses, as a percentage of starting VPI allocations, incurred each year for years 1 through 10 given rolling 10-year simulations starting in 1982 through 2013. For instance, for the 2013 starting year, the simulation includes the time period from January 1, 2013, to December 31, 2022. Each simulation starts with an investment on day 1 of the simulation which has a cost basis equal to 100% of the initial investment. Withdrawals are not made from the portfolio at any time during the simulation. Please see Tax Alpha Calculator for full methodology and assumptions. 


Concentrated positions

Use case No. 3: Investor with concentrated positions, or positions with large, embedded capital gains

Say a new client's portfolio has a concentrated position or a large amount of highly appreciated stock. Vanguard Personalized Indexing can serve as a tax-efficient way to transition to a diversified portfolio. As your client's concentrated position is gradually sold into a more diversified direct indexing portfolio, you can use automatically harvested losses to offset the capital gains generated by those sales.


Customization

Use Case No. 4: Clients who want enhanced personalization

For investors who want to overweight their portfolios toward companies with certain characteristics (factors) such as value, quality, or momentum, prepackaged ETFs can often be a good option. However, some clients may have customization needs that prohibit using off-the-shelf ETFs. In those cases, direct indexing could be the solution.

Other clients might feel passionate about seeing their personal preferences reflected in their investments. With Vanguard Personalized Indexing, you can apply screens and tilts to tailor portfolios for these clients to precisely reflect their choices.

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Learn more about Vanguard Personalized Indexing

  • What is direct indexing?

    Advisor testimonials highlight ways to help clients with personalized indexing

  • Disclosures and footnotes

    • Vanguard Personalized Indexing Management, LLC (“Vanguard Personalized Indexing Management”), formerly Just Invest, LLC, an SEC-registered investment advisor, is an independently operated wholly-owned subsidiary of The Vanguard Group, Inc. (“Vanguard”). Vanguard Personalized Indexing is an asset management technology that has been developed and is offered solely by Vanguard Personalized Indexing Management.
    • For more information on Vanguard Personalized Indexing Management and Vanguard Personalized Indexing, and to access Vanguard Personalized Indexing Management’s Form CRS and Form ADV Part 2A disclosure brochure, please visit the Vanguard Personalized Indexing topic page. 
    • All investing is subject to risk, including possible loss of principal. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
    • Vanguard Personalized Indexing Management cannot guarantee a profit or protect against a loss.
    • Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and could introduce portfolio tracking error into your accounts. There may also be unintended tax implications.  Prospective investors should consult with their tax or legal advisor prior to engaging in any tax-loss harvesting strategy.  Neither Vanguard Personalized Indexing Management nor Vanguard provide tax or legal advice.
    • The information contained herein does not constitute tax advice and cannot be used by any person to avoid tax penalties that may be imposed under the Internal Revenue Code. Each person should consult an independent tax advisor about their individual situation before investing in any security.
    • Factor investing is subject to investment style risk, which is the chance that returns from the types of stocks selected will trail returns from U.S. stock markets. Factor investing is subject to the risk that poor security selection will cause underperformance relative to benchmarks or funds with a similar investment objective.
    • ESG portfolios are subject to ESG investment risk, which is the chance that the stocks or bonds screened by the data provider for ESG criteria generally will underperform the market as a whole or, in the aggregate, will trail returns of other portfolios screened for ESG criteria. The data provider’s assessment of a company, based on the company’s level of involvement in a particular industry or the data provider’s own ESG criteria, may differ from that of other portfolios or of the advisor’s or an investor’s assessment of such company. As a result, the companies deemed eligible by the data provider may not reflect the beliefs and values of any particular investor and certain screens may not exhibit positive or favorable ESG characteristics. The evaluation of companies for ESG screening or integration is dependent on the timely and accurate reporting of ESG data by the companies. Successful application of the customized investment strategy will depend on the data provider’s proper identification and analysis of ESG data.
    • Private investments involve a high degree of risk and, therefore, should be undertaken only by prospective investors capable of evaluating and bearing the risks such an investment represents. Investors in private equity generally must meet certain minimum financial qualifications that may make it unsuitable for specific market participants.