Strategy
Direct indexing: the index, held one stock at a time.
Direct indexing holds the stocks of an index directly in your account instead of through a fund, so the ones trading below cost can be sold to realize losses while the portfolio keeps following the index. It pays off for taxable dollars with real gains to shelter, since each dollar of loss offsets a dollar of gain that would otherwise be taxed at 15%, 20%, or 23.8% with the surtax, and it fades as the account appreciates. We tell clients when it fits, and when an index fund does the job.
The situation
It usually arrives as a pitch.
A custodian, a brokerage app, or a new advisor proposes replacing the index fund in a taxable account with a separately managed account that holds the same several hundred stocks. The presentation shows losses harvested year after year while the portfolio tracks the index, and the fee looks small next to the tax it claims to save.
The mechanism is real. A fund cannot pass its internal losses through to shareholders, but an account that owns the stocks directly can sell the ones below cost, replace them with similar names to keep the index exposure, and hand you a realized loss for your return. What the presentation rarely shows is who that loss is worth something to, how quickly the supply of losses runs down, and what the account looks like ten years in.
That is the question we answer before any account is opened: whether your taxable dollars, your expected gains, and your bracket make the tool worth its fee and its complexity, or whether a low-cost index fund and a gain budget do the same job with less to manage.
Why it’s complex
Five trade-offs the brochure leaves out
A harvested loss is a deferral, not a discount
Every loss you realize lowers the basis of what replaces it, so the gain returns when the account is eventually sold. The deferral becomes permanent only if the lots are held until death, where basis resets under IRC §1014, or given to charity. The exit plan decides what the losses were really worth.
How the step-up worksThe supply of losses runs down
In the first years many lots sit below cost and harvesting is busy. As the market rises, most lots move above basis and the account has little left to sell without realizing gains. Without new cash, a direct-indexed account can settle into a locked portfolio of appreciated stock that is expensive to leave.
When tax leads the portfolioWash sales cross account lines
A loss is disallowed if substantially identical stock is bought within 30 days before or after the sale, and the IRS counts purchases by your spouse and purchases inside your IRA. The manager sees only its own account. If a 401(k), an employee stock plan, or a spouse’s brokerage holds the same names, the harvest can be quietly undone.
The wash-sale rule in fullA concentrated position changes the math
The best use of harvested losses is often a stock you already hold too much of. The index sleeve realizes losses while the position is sold in stages, and the index itself can be built without the company or its sector so the household is not doubling up. Sequencing the two is the work.
The concentrated-stock toolkitTracking, and the exit
Each exclusion and each harvested lot moves the account away from the index it is meant to follow, and the gap widens with the number of rules. Leaving means owning hundreds of lots with different holding periods and embedded gains. The transfer, the tax reporting, and the unwind schedule belong in the plan on day one.
Diversified or overengineered?Sources: IRC §1091; IRC §1211(b) and §1212(b); IRS Rev. Proc. 2025-32, §3.03; IRC §1411; IRS Publication 550, Wash Sales.
Our approach
Decided in the order the value arrives
We are not paid by any indexing platform and do not run one of our own. The decision starts with your gains and your bracket, moves to the sleeve and its rules, and ends with an exit already written down. Most of the value is in the order.
Inventory the gains
We list what you expect to realize over the next five to ten years: equity compensation sold at vest, a business or property sale, rebalancing out of legacy funds, and the ordinary rebalancing inside the plan. Those gains are then placed against the 2026 brackets, the 20% rate above $613,700 of joint taxable income, and the 3.8% surtax. If the list is short, an index fund wins and we say so.
Size the sleeve and the funding
Direct indexing is a decision about specific taxable dollars, not the whole plan. We decide which account, which benchmark, what moves in kind from existing holdings and what is sold, and how new contributions will keep the harvest alive after the early years. Retirement accounts stay in funds; there is nothing to harvest inside them.
Write the rules
Exclusions, a tracking tolerance, a minimum loss size worth the trade, and the household wash-sale map: every account that could buy the same names, including a spouse’s brokerage, IRAs, workplace plans, and employee stock purchase plans. The manager receives the map before the first trade.
Plan the exit before the entry
How the account ends decides what the losses were worth. Lots held until death take a stepped-up basis; appreciated lots can fund charitable gifts at fair market value; anything else unwinds over years inside a gain budget. We write that plan with your CPA before the account is funded.
Review it in the Quarterly Rounds
Each quarter we reconcile losses realized against gains sheltered, check tracking against the benchmark, and confirm the account still earns its fee. When it stops earning it, the plan already says what happens next.
The work
What you’ll work through with us
- A gains inventory for the next several years: equity compensation, a business or property sale, and portfolio changes
- A written decision on whether direct indexing beats an index fund for your taxable dollars, and why
- The transition plan for existing holdings: what moves in kind, what sells, and in which tax year
- A household wash-sale map covering spouse accounts, IRAs, and workplace plans
- Exclusion and tracking rules, including any company or sector you already hold too much of
- The exit plan: the step-up, charitable gifts of appreciated lots, or a staged unwind
- Coordination with your CPA on Form 8949 reporting and loss carryforwards
- A quarterly review of losses realized against gains sheltered, tracking, and cost
Portfolio construction at the firm is led by Theo Halbardier, CFP®, CIMA®, CAIA®, the firm’s founder. The CIMA® curriculum covers after-tax implementation and manager evaluation, which is the ground direct indexing is judged on. We are fee-only: no commissions, no product sales, and no revenue from any indexing platform. About Theo
Questions
Common questions about direct indexing
What is direct indexing?
Direct indexing is owning the individual stocks of an index in a separately managed account instead of owning a fund that tracks it. Because each stock is held directly, positions that fall below cost can be sold to realize a loss and replaced with similar holdings while the account keeps following the index. It also allows specific companies or sectors to be excluded. It is used almost entirely in taxable accounts.
Is direct indexing worth it?
It is worth it when three things are true: the dollars are taxable, you expect meaningful capital gains to offset in the coming years, and the account is large enough that the losses matter against the added fee and complexity. Without gains to shelter, harvested losses reduce ordinary income by only $3,000 a year under IRC §1211, while the account still carries its cost. For many households an index fund and a gain budget do the same job with less to manage.
How much money do you need to direct index?
Platform minimums vary, and fractional shares have lowered them. The better test is whether the taxable account is large enough that its harvested losses are worth something against your expected gains after the manager’s fee. A small account with no gains to offset gets the complexity without the benefit. We size it against the gains inventory, not against a platform’s minimum.
Does direct indexing work in an IRA or 401(k)?
No. Gains and losses inside an IRA or 401(k) are not reported on your return, so there is nothing to harvest, and exclusions can be handled more cheaply with fund choices. Direct indexing belongs in taxable accounts. The retirement accounts still matter to the strategy: a purchase of the same stock inside an IRA within the wash-sale window disallows the loss in the taxable account, and IRS Publication 550 confirms that loss is not added to any basis, so it is gone.
What happens to losses I cannot use this year?
They carry forward. Net capital losses offset capital gains first, then up to $3,000 of ordinary income per year ($1,500 if married filing separately), and the remainder carries to future years without a time limit under IRC §1212(b). A loss bank built in a down year can shelter a business sale or a stock sale several years later, which is why the timing of the gains matters more than the timing of the losses.
Does the wash-sale rule apply if my spouse or my IRA buys the stock?
Yes. The rule disallows a loss when substantially identical stock is bought within 30 days before or after the sale, and IRS Publication 550 extends it to purchases by your spouse, by a corporation you control, and inside your IRA or Roth IRA. A manager harvesting in one account cannot see the others, so the household map of who holds what is part of the setup, not an afterthought.
What happens when I want to stop direct indexing?
You own several hundred individual lots, each with its own basis and holding period, and most will carry gains after a few years. The account can be transferred in kind to another custodian, unwound over several years inside a gain budget, held for the step-up in basis, or used as the source of appreciated shares for charitable gifts. The exit is far easier when it was planned at the start.
Reviewed by Theo Halbardier, CFP® · Updated September 2026 · Figures current for 2026
Bring the gains you expect. We will tell you whether it fits.
The first conversation is 30 minutes. If direct indexing is not the right tool for your taxable dollars, we will say so and name what is.
Meet with us