Direct Indexing: Personalized Index Investing for Taxable Portfolios

Published January 2026

For decades, investors seeking diversified market exposure have relied on mutual funds and ETFs to track major indexes like the S&P 500. These vehicles are simple, efficient, and cost-effective—but they treat every investor the same.
Direct indexing changes that.

At its core, direct indexing allows an investor to own the individual securities that make up an index, rather than owning a pooled fund that tracks it. This seemingly small shift unlocks a powerful set of benefits that were historically available only to large institutions.

How Direct Indexing Works

Instead of purchasing a single fund, a direct indexing portfolio holds the underlying stocks of an index (or a representative subset), managed in a separately managed account (SMA).

For example:

• Rather than buying an S&P 500 ETF, an investor owns hundreds of individual stocks designed to closely track the S&P 500’s risk and return profile.
• Technology continuously monitors the portfolio to keep it aligned with the index while allowing for customization and tax management.

The result is index-like performance with investor-specific personalization.

Why Investors Are Moving Toward Direct Indexing

Direct indexing isn’t about beating the market. It’s about owning the market more intelligently.

Here are the key advantages:

1. Tax Efficiency Through Tax-Loss Harvesting

Because the portfolio holds individual securities, losses can be harvested at the stock level throughout the year—not just at the fund level.

This allows investors to:

• Offset capital gains elsewhere in their portfolio
• Potentially improve after-tax returns over time
• Maintain market exposure while realizing tax benefits

Importantly, this is done systematically and continuously, not opportunistically or manually.

2. Personalization and Customization

No two investors are exactly alike. Direct indexing allows portfolios to reflect individual preferences and constraints, such as:

• Excluding specific companies or industries
• Aligning with ESG or values-based objectives
• Managing concentrated positions from legacy holdings or executive compensation
• Coordinating with charitable giving or estate planning strategies

Traditional funds can’t do this. Direct indexing is built for it.

3. Transparency and Control

With direct indexing, investors see exactly what they own—every security, every day.

This transparency:

• Improves understanding of portfolio risk
• Enables tighter coordination with financial, tax, and estate planning
• Provides greater confidence during periods of market volatility

There’s no “black box” fund structure, just ownership.

4. Institutional-Quality Implementation

Historically, direct indexing was operationally complex and expensive. Advances in portfolio management technology, trading automation, and tax-aware optimization have changed that.

Today, direct indexing can be implemented efficiently, with:

• Tight tracking to the chosen benchmark
• Scalable customization
• Disciplined rebalancing and risk management

What was once exclusive to pensions and endowments is now accessible to high-net-worth investors and institutions.

Direct Indexing vs. ETFs: Not Either/Or

It’s important to note: direct indexing is not a replacement for ETFs in every situation.

ETFs remain excellent tools for:

• Smaller accounts
• Tax-advantaged accounts (IRAs, retirement plans)
• Tactical or short-term exposures

Direct indexing shines in taxable portfolios where customization and after-tax outcomes matter most. In practice, many investors use a combination of both.

Is Direct Indexing Right for Every Investor?

Not necessarily.

Direct indexing is most compelling for:

• Taxable investors
• Investors seeking to earn index-like returns
• Larger portfolios where customization adds value
• Clients with complex planning needs
• Investors interested in personalize an index for their preferences

The key question isn’t “Is direct indexing better than an ETF?”

It’s “Can this portfolio be managed more intelligently for this specific investor?”

The Bottom Line

Direct indexing represents a shift from one-size-fits-all investing to personalized, tax-aware portfolio construction, without giving up the discipline of index investing. Owning the individual securities that represent an index, provides investors with the opportunity to harvest tax losses, which is not possible by owning a pooled investment like a mutual fund or ETF.

As technology continues to evolve, direct indexing is becoming a foundational building block for modern wealth management—aligning portfolios not just with markets, but with investors themselves.

_{^{by CEO / Founder John Crosson, MainStreet Advisors.}}