Key Highlights
- Market drops are no fun, but they can sometimes create tax-saving opportunities instead of just heartburn.
- Tax loss harvesting can help offset gains, reduce taxable income, and carry extra losses forward for future years.
- Direct indexing takes that same idea and gives larger taxable portfolios a bigger, more precise tax toolbox.
One of the more common conversations we have with clients sounds like this:
“The market is down. Is there anything useful we can do with that?”
Sometimes, yes. Market drops are never fun, but they can create opportunities. One of the biggest potentially is tax loss harvesting, which is something we try to help many clients take advantage of when the timing and tax situation line up. For some clients, there is also a more advanced version of that idea called direct indexing.
Start with tax loss harvesting
Tax loss harvesting means selling an investment that is down, realizing the loss for tax purposes, and reinvesting in something similar so your portfolio stays aligned with your long-term plan.
Those losses can offset capital gains. If losses exceed gains, up to $3,000 can be used each year against ordinary income, and unused losses can carry forward into future years. That is why volatility is not always just a nuisance. Sometimes it creates a tax asset.
We keep an eye on this for our clients with taxable accounts. Not every market dip creates a worthwhile opportunity, but when the setup is there, it can be a smart way to improve after-tax results over time.
Why this matters more than people think
As we talked about in our Red Dot Chart article, market pullbacks happen all the time. Even in years when the market finishes positive, there are often some uncomfortable drops along the way. In taxable accounts, those declines can create opportunities for tax-loss harvesting. In other words, the market’s bad mood can occasionally do something useful.
So what is direct indexing?
Direct indexing takes the tax loss harvesting concept and gives it a bigger toolbox. Instead of owning one ETF or mutual fund that tracks an index, you own most of the individual stocks inside that index. That creates more flexibility and often more chances to harvest losses at the stock level.
With a traditional index fund, the fund itself may be up even if several stocks inside it are down. With direct indexing, the manager can be more precise and laser-focused on those opportunities while still keeping the portfolio aligned with the intended market exposure.
It is not just about the S&P 500
When people hear direct indexing, they often think only of the S&P 500. That is one option, but it is not the only one. Depending on a client’s desired allocation, direct indexing can also be built around several other indexes, including large-cap value, global, or international indexes. That flexibility can make the strategy more useful, depending on how a client’s portfolio is built and where the best opportunities lie.
When direct indexing tends to make the most sense
Tax loss harvesting can help a wide range of taxable-account clients when the opportunity is there. Direct indexing is a bit different. Because of account minimums and the way we generally prefer to size the strategy within an overall portfolio. Like a lot of things involving money, the more you have in taxable accounts, the more room there may be to benefit from the strategy.
One downside worth mentioning
Direct indexing does not stay equally productive forever.
Over time, as more of the stocks held in the account recover and grow, there may be fewer positions in the account that have a loss to harvest. That is one reason the ideal setup is often a client who expects to keep adding new money to the strategy over time. New contributions can create new tax lots and potentially new harvesting opportunities down the road.
The bottom line
We spend a lot of time helping clients think about what to do during market volatility instead of just reacting to it. Tax loss harvesting is one of the more practical tools we can sometimes use in taxable accounts. Direct indexing builds on that idea and can be a very effective strategy for the right client, especially for those with larger taxable portfolios and an ability to keep adding new dollars over time.
Like most planning strategies, this is not about chasing complexity for complexity’s sake. It is about looking for smart ways to improve what you keep after taxes. If you have a sizable taxable portfolio and want to know whether regular tax loss harvesting or direct indexing belongs in your plan, let’s talk. This is exactly the kind of conversation we have with clients when markets get choppy, and headlines start acting like the sky is falling again.
Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James.
