By Spencer Schamle
Financial Advisor at Investment Consulting Group

Published October 7th, 2026

Direct Indexing: A Tax-Aware Approach to Managing a Taxable Investment Portfolios

Investors have more choices than ever when it comes to managing a taxable investment account.

For decades, mutual funds and exchange-traded funds (ETFs) have provided investors with efficient ways to build diversified portfolios. But for some investors with larger taxable accounts, there is another approach worth understanding: direct indexing.

Direct indexing can provide investors with greater control over individual securities within a portfolio and, in certain circumstances, greater opportunities for tax management.

But direct indexing isn't simply "buying an index one stock at a time."

Its potential value comes from the combination of personalization, tax management, and portfolio construction.

So what is direct indexing, how does it work, and when might it make sense for an investor?

What Is Direct Indexing?

Direct indexing is an investment strategy in which an investor owns individual securities designed to track or represent the performance of a particular market index or investment strategy.

Instead of purchasing an ETF or mutual fund that owns the securities within an index, the investor directly owns a portfolio of individual stocks.

For example, rather than purchasing a single investment that tracks the S&P 500, a direct-indexing strategy may hold many of the individual companies within that index.

The portfolio can then be managed to maintain a desired level of exposure to the underlying index while potentially allowing for greater customization and tax management.

How Is Direct Indexing Different From an ETF?

Consider a simplified example.

An investor wants exposure to a broad U.S. stock-market index.

With an ETF, the investor purchases shares of the ETF.

The ETF owns the underlying securities.

With direct indexing, the investor owns individual securities that are designed to provide similar exposure.

This distinction is important because the investor has greater visibility and control over the individual securities.

That can create opportunities that aren't available in the same way when all of the securities are held inside a single pooled investment.

ETF

Investor owns:
Shares of the ETF

Underlying securities:
Owned inside the ETF

Tax-loss harvesting:
Generally occurs at the ETF level

Direct Indexing

Investor owns:
Individual securities

Underlying securities:
Owned directly by the investor

Tax-loss harvesting:
Can potentially occur at the individual-security level

Neither structure is universally better.

The appropriate approach depends on the investor's objectives, portfolio size, tax circumstances, costs, and other factors.

Why Is Direct Indexing Considered Tax Efficient?

One of the primary reasons investors consider direct indexing is the potential for tax-loss harvesting.

Imagine a portfolio holding 500 individual stocks.

During a market decline, some stocks may be down while others are up.

If the investor owns an ETF containing all of those companies, the investor generally owns a share of the entire fund.

With direct indexing, the investor owns the individual securities.

That may create opportunities to sell certain individual positions that have declined in value and realize capital losses while maintaining exposure to the broader market through other securities.

Those realized losses may potentially be used to offset capital gains elsewhere in the taxable portfolio, subject to applicable tax rules.

This can create a level of tax-management flexibility that isn't available in exactly the same way when owning a single pooled investment.

What Is Tax-Loss Harvesting?

Tax-loss harvesting involves selling an investment that has declined in value to realize a capital loss.

The loss can potentially be used to offset capital gains elsewhere in a taxable portfolio, subject to applicable tax rules.

For example:

• Stock A has a $10,000 unrealized gain.
• Stock B has a $10,000 unrealized loss.
• Stock B is sold, realizing the loss.
• The loss may potentially offset the gain from Stock A.

The investor can then purchase an appropriate replacement investment to maintain the desired portfolio exposure, while observing applicable tax rules such as the wash-sale rules.

Direct indexing can create more potential opportunities for this type of tax management because the portfolio consists of individual securities rather than one pooled investment.

Does Direct Indexing Guarantee Tax Savings?

No.

This is an important distinction.

Direct indexing may create opportunities for tax management, but it doesn't guarantee tax savings.

The potential benefit depends on factors such as:

• Market volatility
• The number of securities held
• The investor's existing gains and losses
• The investor's tax situation
• Portfolio size
• Investment turnover
• Trading costs
• The investment strategy
• The ability to use harvested losses

There can also be circumstances where harvesting a loss creates a tax benefit today but affects the tax consequences of future sales.

The strategy should therefore be evaluated based on its overall after-tax economic benefit, not simply the amount of losses harvested.

Why Does Portfolio Size Matter?

Direct indexing typically involves owning many individual securities.

That can make the strategy more complex to manage than simply owning an ETF.

For this reason, direct indexing has historically been more commonly associated with investors who have sufficiently large taxable portfolios to justify the additional customization and management.

There isn't one universal account-size threshold where direct indexing suddenly becomes appropriate.

The relevant question is whether the potential benefits justify the additional costs and complexity for the particular investor.

Factors to consider include:

• Account size
• Taxable assets
• Investment objectives
• Tax bracket
• Existing capital gains
• Desired level of customization
• Portfolio complexity
• Management fees
• Trading costs

A larger portfolio may provide more opportunities for tax management, but size alone doesn't make direct indexing appropriate.

Can Direct Indexing Help With a Concentrated Stock Position?

Potentially.

This is one area where direct indexing can become particularly interesting for investors who have accumulated significant appreciated assets.

Suppose an investor has a $1 million position in a single company with a $200,000 cost basis.

Selling the entire position could create a substantial capital gain.

At the same time, continuing to hold the entire position creates significant concentration risk.

A direct-indexing strategy could potentially be incorporated into a broader transition plan.

As the concentrated position is gradually reduced, the proceeds could be transitioned into a diversified portfolio of individual securities.

Over time, the investor may be able to move toward greater diversification while using tax-aware strategies to manage the transition.

Direct indexing doesn't eliminate the tax consequences of selling the concentrated position.

Instead, it may provide additional tools for managing the portfolio surrounding that position.

Can You Customize a Direct Indexing Portfolio?

Yes.

One of the potential benefits of direct indexing is customization.

Because the investor owns individual securities, the portfolio can potentially be adjusted to reflect individual preferences or circumstances.

For example, an investor may want to:

• Exclude certain companies or industries
• Reduce exposure to a particular sector
• Maintain an existing stock position
• Incorporate environmental, social, or other investment preferences
• Manage exposure to securities already held elsewhere
• Coordinate the portfolio with other taxable investments

Customization can be useful, but it can also create additional complexity.

The more customized a portfolio becomes, the more important it is to monitor the portfolio's overall risk and diversification.

Can You Use Direct Indexing to Avoid Capital Gains?

Not necessarily.

Direct indexing does not eliminate capital gains.

If appreciated securities are sold, the resulting gains may still be taxable.

However, direct indexing may provide greater flexibility in determining which securities are sold and when.

That distinction is important.

Tax-aware investing generally isn't about eliminating taxes at all costs.

It is about making thoughtful decisions about the relationship between:

Investment opportunity + risk + diversification + tax consequences.

What About Tax-Loss Harvesting in a Rising Market?

Tax-loss harvesting isn't limited to major market crashes.

Even in a generally rising market, individual securities can move in different directions.

For example, an index could be up 8% while some individual companies within that index are down 15%.

When individual securities are owned directly, those differences can potentially create opportunities to realize losses while maintaining exposure to the broader investment strategy.

This is one of the characteristics that makes direct indexing different from simply owning a broad-market ETF.

However, the availability and value of these opportunities will vary with market conditions.

How Does Direct Indexing Affect Rebalancing?

Rebalancing a taxable portfolio can create another tax consideration.

Suppose an investor needs to reduce exposure to an investment that has appreciated significantly.

Selling the position may create a capital gain.

With a portfolio of individual securities, there may be greater flexibility in determining which securities to sell, potentially allowing the investor to manage gains and losses more deliberately.

This doesn't eliminate the tax consequences of rebalancing.

It can, however, provide additional tools for managing those consequences.

What Are the Potential Drawbacks of Direct Indexing?

Direct indexing has potential benefits, but it isn't appropriate for every investor.

Greater complexity

Owning hundreds of individual securities is more complex than owning one or two broad-market ETFs.

More portfolio management

Individual securities must be monitored and managed.

Costs

Direct-indexing strategies have management fees and may involve trading costs and other expenses.

Tracking error

A direct-indexing portfolio may not perfectly replicate the performance of its target index.

Tax considerations

Tax-loss harvesting and other strategies must be managed carefully, including consideration of applicable wash-sale rules.

Minimum account sizes

Some direct-indexing solutions may have minimum investment requirements or may be more economically practical at larger account sizes.

Over-customization

Too much customization can potentially cause a portfolio to drift away from its intended diversification or investment objectives.

The potential tax benefits need to be weighed against these considerations.

Direct Indexing vs. ETF: Which Is Better?

There isn't a universal answer.

For many investors, a low-cost, broadly diversified ETF may provide an effective and straightforward way to invest.

For others—particularly investors with larger taxable portfolios and meaningful tax-management opportunities—the additional customization of direct indexing may be worth considering.

The better question isn't:

"Is direct indexing better than an ETF?"

It is:

"Does the additional tax management and customization provided by direct indexing justify its costs and complexity for this investor?"

That is a much more useful question.

How Does Direct Indexing Fit Into a Tax-Aware Investment Strategy?

Direct indexing should generally be viewed as one tool within a broader tax-aware investment strategy, rather than a strategy that stands on its own.

A comprehensive approach may consider:

• Asset allocation
• Diversification
• Tax-loss harvesting
• Capital-gain management
• Cost basis
• Concentrated positions
• Portfolio turnover
• Investment location
• Portfolio transition strategies
• Long-term financial objectives

For example, an investor may begin with a concentrated stock position.

A transition analysis could evaluate how to gradually reduce that concentration.

New proceeds might then be invested into a tax-aware direct-indexing strategy.

Over time, tax-loss harvesting opportunities could potentially help manage gains generated elsewhere in the portfolio.

The result is not simply "a direct-indexing portfolio."

It is a broader tax-aware approach to managing taxable wealth.

Direct Indexing Requires Ongoing Monitoring

One of the most important aspects of direct indexing is that it isn't a set-it-and-forget-it strategy.

The portfolio may need to be monitored for:

• Tax-loss harvesting opportunities
• Portfolio drift
• Concentration
• Changes in cost basis
• Investment changes
• Rebalancing needs
• Tax circumstances
• Changes in the investor's financial objectives

Market movements can change the tax characteristics of the portfolio over time.

A position that is attractive from a tax perspective today may look very different several years from now.

This is why ongoing monitoring is an important part of tax-aware portfolio management.

The Bottom Line

Direct indexing can provide investors with greater control over individual securities and may create additional opportunities for tax management within a taxable investment account.

Its potential benefits can include:

• Individual-security ownership
• Tax-loss harvesting opportunities
• Portfolio customization
• Greater control over realized gains
• Potential integration with portfolio transition strategies
  

But direct indexing isn't automatically better than an ETF or mutual fund.

It involves additional complexity, costs, and ongoing management.

For the right investor, particularly one with a meaningful taxable portfolio, the ability to combine diversification, customization, and tax-aware management may make direct indexing worth considering.

At ICG, we believe the question isn't simply which investment vehicle is most tax efficient.

The more important question is:

How can the taxable portfolio be managed in a way that balances investment objectives, diversification, risk, and after-tax wealth?

Direct indexing may be one tool that helps answer that question.

This article is provided for educational and informational purposes only and is not intended to provide individualized investment, tax, or legal advice. Tax laws and regulations are subject to change. Individual circumstances vary, and investors should consult their qualified tax, legal, and financial professionals regarding their specific situation.