Wait. You say you can customize an index?


Do you know what I miss? I miss equalizers on stereos. For all millennials, there was a set of six, 10, or sometimes even more levers that let you adjust the sound quality of the music you were listening to, sometimes at very subtle intervals. You couldn’t edit the recording itself, but you could, for example, boost the bass. Basically, you can take a mass-produced album and customize it to work better for you. Dude, I loved that.

But I’m not here just to get nostalgic for old records and old ways. Regular readers of this column will know that I am a firm believer in the power of technology and how it has (mostly) improved the way we live our lives and interact with our friends and colleagues – and, yes, build, manage and analyze investment portfolios. As I wrote in my last column, advances in technology have had a major effect on the construction of indices, which are used as a basis and/or benchmark for many different types of investments.

In particular, the major effect we are talking about today is what is called direct indexing. Direct indexing essentially allows a wealth manager or advisor working with an individual investor to offer customized versions of existing indices; essentially, the advisor refines them based on a number of criteria to achieve specific results. An important difference between direct indexing and, say, mutual funds is that, rather than buying shares in a fund that tracks a particular index, investors directly own the individual securities of the index. Now, I know, it’s starting to get a little complicated, but let me see if I can break it down for you.

Tell me what you want

Take the example of an investor looking to invest in a way that reflects their views on the importance of reducing carbon emissions or increasing diversity on corporate boards…or both. . Climate and ESG considerations are becoming increasingly important components of many investors’ goals. At the same time, our investor would like to have a way to reduce risk, increase global exposure and work to reduce the tax impacts of their investments.

Once the goals are clear, the advisor can select a particular index and customize it based on what the client wants to achieve. Ultimately, an advisor can help provide an index specifically tailored to the investor.

Let’s not make it too hard

I feel like most of the customizations I’ve included in the example are pretty straightforward: climate and ESG, reduced risk, and worldwide investing. But we should devote some time to tax management and the so-called “tax optimization”, which is really just a way to simultaneously achieve various investment goals in the most efficient way. efficient as possible, including tax considerations. . Tax optimization can be very useful because many advisers deal with tax-related issues in a very manual, sometimes cumbersome way.

Tax optimization is an efficient, rule-based method of minimizing taxes by offsetting portfolio losses with portfolio gains. The tax optimizer also works efficiently by not trading in many cases, avoiding unnecessary taxes and trading costs. Of course, in our example, tax efficiency is only one of the investor’s objectives and will be weighed against his overall strategy. Throughout this time, the investor maintains exposure to the index of their choice, which helps them achieve their investment objectives.

Could it be the great equalizer?

The truth is, I could provide any number of examples of what different forms of direct indexing might look like, with as many or as few variables or goals as you can imagine. And that’s the point: The approach is based on an index that is selected, customized and personalized for the individual investor by a financial advisor.

I’ve written before about how one of the great benefits of technology is accessibility. What was once the domain of a privileged and wealthy handful is now accessible to a much wider audience. Direct indexing is no exception. In fact, in many ways it brings more of us an updated, index-based version of what are called separately managed accounts, which most people outside of the investing that the non-privileged rich may never have heard of. I won’t go into detail here, because that’s only a bit related to what we’re talking about. And the thing is, direct indexing does for investors what the equalizer in my old stereo did for me. I didn’t have to be a sound engineer to make the albums in my vinyl collection sound exactly the way I wanted.


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