How Direct Indexing Can Be a Smarter Way to Invest

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published 5 June 2025

For long-term investors, tracking the market has been a reliable way to build wealth. Over the past 30 years, the S&P 500 has delivered average annual returns of about 10%, even during periods of volatility.

That’s why many investors turn to index funds, typically exchange-traded funds (ETFs), to mirror broad market performance in a simple and efficient way.

But what if you could maintain that same market exposure while unlocking meaningful tax advantages and gaining more control over your portfolio?

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That’s where direct indexing comes in.

The Kiplinger Building Wealth program handpicks financial advisers and business owners from around the world to share retirement, estate planning and tax strategies to preserve and grow your wealth. These experts, who never pay for inclusion on the site, include professional wealth managers, fiduciary financial planners, CPAs and lawyers. Most of them have certifications including CFP®, ChFC®, IAR, AIF®, CDFA® and more, and their stellar records can be checked through the SEC or FINRA.

Unlike ETFs, which bundle the entire index into a single fund, direct indexing involves owning the individual stocks that make up the index. This opens the door to a powerful strategy called tax-loss harvesting.

Once reserved for ultrawealthy investors, direct indexing is now more accessible than ever, thanks to technology that makes it easy to implement and manage.

Direct Indexing 101

Direct indexing allows you to invest in the market by holding the individual stocks that make up an index, rather than buying a single fund, such as an ETF. This structure gives you more flexibility and control, particularly when it comes to taxes.

Because you own each stock separately, you can take advantage of losses at the individual stock level, even when the broader index is performing well. This creates more opportunities for tax-loss harvesting, a strategy where you sell securities that have declined in value to offset gains elsewhere and reduce your tax bill.

At Frec, where I am the founder and CEO, our research shows direct indexing of the S&P 500 can harvest tax losses on up to 40% of your portfolio over a 10-year period — and in some cases, even more, depending on the index you’re tracking.

That’s nearly double what traditional ETF-to-ETF tax-loss harvesting strategies typically deliver. For a $100,000 investment, you could generate about $40,000 in tax losses over a decade. If your tax rate is 33%, that's roughly $13,200 in potential tax savings.

Here are four benefits of direct indexing:

No. 1: Tax efficiency that outperforms

Direct indexing creates more opportunities for tax-loss harvesting than traditional ETFs. Because you own individual stocks, your portfolio has dozens — or even hundreds — of chances to capture losses, even when the overall market is up.

Instead of waiting for an entire ETF to decline, our platform continuously scans for underperforming stocks within your index and executes tax-loss harvesting trades when opportunities arise. This helps reduce your taxable gains and, in turn, your tax bill.

One of the key considerations in this process is the wash-sale rule, an IRS regulation that disallows a tax loss if you repurchase the same or a “substantially identical” security within 30 days before or after selling it.

Our latest innovation, strategic wash sales, allows investors who make frequent deposits to increase tax-loss harvesting by up to 16%. This approach enables customers to deposit as often as they'd like without worrying about wash-sale limitations affecting their tax efficiency.

Frec customers can also boost their returns through stock lending, allowing investors to lend their stocks to others for short selling, generating extra income while retaining ownership.

No. 2: Win despite market conditions

One of direct indexing's unique strengths is its ability to benefit investors in both bull and bear markets.

When markets are up, you capture the gains like any index investor.

When markets drop, you capture tax losses that create real economic value for years to come. It's like getting a consolation prize during market downturns.

No. 3: Customization for your needs

Unlike ETFs, which apply a one-size-fits-all approach, direct indexing gives you control over what you own — and what you don’t.

For example, if you work at a company like Microsoft and receive stock-based compensation, you might already be overexposed to that stock.

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Since Microsoft makes up a large portion of the S&P 500, buying an ETF could further concentrate your risk. Direct indexing allows you to adjust your exposure, all while keeping your overall index alignment.

You can also remove companies that don't fit your investment criteria, such as ESG preferences. With an ETF, you get everything. With direct indexing, you decide exactly what you own.

No. 4: Easy transfer from other platforms

Getting started is simple. When setting up a direct index with Frec, you can fund it with cash, existing stock or both. You can transfer stocks directly from other brokerages without selling, avoiding tax consequences.

This smooth process lets you upgrade your investment approach without triggering taxable events.

Is direct indexing right for you?

Direct indexing delivers the most value for investors who:

Have significant taxable investment accounts
Fall into higher tax brackets
Want more control over their portfolio makeup
Have substantial capital gains to offset

Even if you don't have capital gains to offset today, losses accumulated during the investment phase can offset gains during withdrawals, potentially delaying tax payments for years.

Worried it might be harder to exit a direct index than an ETF? While selling a basket of individual securities can be more complex than selling a single fund, the potential tax savings — both during the investment period and at withdrawal — often make that tradeoff worthwhile. And with modern platforms, the process is far more streamlined than it used to be.

Considerations before diving in

Direct indexing might not be a good fit for you, though. Be sure to consider:

If you aren't already maxing out contributions to your retirement accounts, you should absolutely do that before contributing to a direct index (or taxable account).
If you aren't ever going to have capital gains — for instance, you are planning to retire only on 401(k) or other tax-advantaged accounts — you might as well stick with a super-low-cost ETF since you cannot use the tax losses.
If you want to actively trade many positions within the index you are hoping to track (i.e. you could buy SPY/VOO ETF but actively trade a bunch of stocks in the S&P 500) or have retirement accounts trading individual stocks (no way to manage those wash sales).

Direct indexing, reimagined for today's investor

Direct indexing is a powerful strategy that’s changing the way people invest in indexes, offering a more efficient approach that can boost after-tax returns.

The strategy gives you the simplicity of index investing with the tax advantages previously available only through complex active management.

For self-directed investors looking to grow their wealth more efficiently, direct indexing puts powerful tax-saving tools in your hands with the ease of passive investing. All done automatically, without having to pay expensive fees to a human adviser.

Investing involves risk, including the risk of loss. Frec’s AUM fees range from 0.10% - 0.35% based on index. Brokerage services provided by Frec Securities LLC, member FINRA/SIPC and advisory services provided by Frec Advisers LLC, an SEC RIA. Both are subsidiaries of Frec Markets, Inc.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Mo Al Adham is a seasoned entrepreneur with extensive experience in building and growing companies. He founded and successfully scaled Twitvid, which led to an acquisition. Additionally, Mo served as the first adviser at Instacart and held product leadership roles at both Twitter and Microsoft. Now, as the founder of Frec, he's applying his expertise to redefine the direct indexing space.