Direct Indexing Examples and Use Cases
Advisor testimonials highlight ways to help clients with personalized indexing
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)
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.
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.”
“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.”
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
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.
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.
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