Four reasons why direct indexing is so popular today
December 17, 2025
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4 min
After a webinar presenting the benefits of employing a direct indexing strategy for taxable investors, I received a note from one of the participants. He said, “I used what is now called Direct Indexing as early as 1996. Why do you think so much time passed in the industry before this became widely embraced?”
He makes a good point. Direct indexing and tax-managed strategies have certainly gained popularity recently. We’ve been in the business since 2002, with early marketing materials describing how we shelter gains and harvest losses in our “active indexing” strategy – now commonly known as direct indexing. Today, Cerulli estimates that 18% of advisors are using direct indexing – with assets topping $860 billion, up 22% annualized from 2021–2024.1 Here are my thoughts on that question:
- In 1996, passive investing was still new and just making it into retail portfolios. The $690 billion SPDR S&P 500 tracking exchange-traded fund (ETF) had just launched in 1993. The whole industry was built on beating the index. Then after the dust settled following the 2008 global financial crisis, I started to see passive investments show up in earnest in advisor portfolios. Data from our Portfolio Analysis & Consulting group shows the average advisor portfolio had just 5% in passive equity investments in Q1 2013, and ten years later in Q1 2023, it hit 20% and has consistently remained above that level. Now clients expect a portion, if not the majority, of their equity allocation (especially US large-cap stocks) will be in index-based investments, if nothing else, to keep the fees down. But in reality, the S&P 500® has been a formidable competitor for active managers. And that’s resulted in many DIY investors taking the passive approach. Once you accept passive investing, it becomes easier to embrace direct indexing for the additional tax benefits.
- Technological improvements and lower (near zero) trading costs have made the tax loss harvesting process better, cheaper, quicker, and therefore more accessible to individual taxable investors. Our minimum is typically $100,000 for a new direct indexing account. Some direct-to-consumer firms offer it for as little as $5,000, using fractional shares to help achieve diversification and more precise index tracking. Fractional shares are another innovation that didn’t exist in 1996. And corporations have been friendlier in splitting share prices to remain accessible to retail investors. After college, I remember saving up to buy a single share of Berkshire Hathaway Class B (about $2,300 at the time) so I could attend the annual meeting in Omaha. (It was awesome!) Berkshire later split B shares 50:1. I would argue that a $5,000 minimum for direct indexing is unnecessarily low, since the tax benefits accrue to those in the higher tax brackets, such as 32%–37%, where low minimums aren’t a hurdle. But certainly folks at a lower minimum can benefit from the customization options (e.g., build me the S&P 500® but exclude all alcohol-related stocks).
- Mutual funds continue to distribute taxable capital gains to investors, even in down years, which investors are becoming fed up with. The example I often point to is 2022. The S&P 500® shed 18% that year. Of the 300+ active large-cap blend funds, 100% had negative performance during the year, ranging from 3% to -38%. Even worse, though, was 83% distributed a net capital gain to shareholders. Negative performance combined with a tax bill is a bad recipe to keep taxable investors on board. Especially with ETFs being so tax efficient: rarely distributing taxable gains aided by investor inflows, in-kind redemptions to purge low-basis securities, and heartbeat trades to aid efficient index rebalancing. More focus on taxes has bolstered the story for tax-efficient investing and direct indexing – where harvested losses in the investor’s separately managed account flow through to their tax return to offset other realized gains, offset up to $3,000 in ordinary income, or carry forward to the next calendar year.
- Investors are looking for help taking the bite out of big tax bills from selling concentrated, low-basis stock positions in Magnificent 7 names – and systematic tax loss harvesting can help deliver that tax savings. Biting the bullet and paying the tax is the least popular option among clients, and advisors have an armamentarium of solutions to help mitigate the tax cost. Direct indexing tends to be the simplest and cheapest to implement. It’s relatively easy to understand – track the index with a subset of index holdings and systematically tax loss harvest them – and it’s simple to unwind and shut off. There are no lockups or early-withdrawal penalties or commitments to sell the concentrated position. Just use the losses from the portfolio to enable gains to be taken in the concentrated position. Shares of a concentrated stock will be sold only when losses are generated elsewhere in the portfolio to achieve a tax-neutral result.
Overall, direct indexing combines tax efficiency, customization, and simplicity – three things investors value. With technology making this strategy more accessible, a heightened focus on taxes, and outstanding performance from indices such as the S&P 500®, it’s no surprise direct indexing is having its moment.
If I were to anticipate what this advisor might ask me a decade from now (circa 2035), it would be: “Why did it take so long for tax-aware, long-short strategies to become mainstream?” And “Why did we struggle so long with complicated and expensive ways to reduce concentrated stock risk?”
