# Direct indexing: the tax-loss harvesting case and its limits

URL: https://www.financialadvsr.com/guides/direct-indexing-explained
Updated: 2026-10-10
Publisher: Financial ADVSR (https://www.financialadvsr.com)

Direct indexing is a strategy in which an investor owns the individual stocks of an index, or a sample of them, in a separately managed account instead of buying an index fund or ETF. Because each stock is held directly, the manager can sell positions that have fallen below cost to realize capital losses, buy similar but not substantially identical stocks to stay close to the index, and use the losses to offset gains, subject to the IRS wash-sale rule. Those harvesting opportunities tend to shrink as a portfolio ages, and customizing the holdings can make returns drift from the benchmark.

Key points:
- Direct indexing holds index constituents individually in a separately managed account, which allows security-level tax-loss harvesting and customization.
- Under the wash-sale rule in IRS Publication 550, a loss is disallowed if substantially identical securities are acquired within 30 days before or after the sale; the disallowed loss is added to the basis of the new shares.
- Cerulli Associates reported that direct indexing assets closed 2024 at $864.3 billion, and MMI-Cerulli data put them at $1,155 billion at the end of 2025.
- Large asset managers bought into the business in 2021: BlackRock closed its $1.05 billion purchase of Aperio, Morgan Stanley acquired Parametric through Eaton Vance and Vanguard agreed to buy Just Invest.
- Schwab launched Schwab Personalized Indexing in 2022 with a $100,000 minimum and fees starting at 0.40%; Fidelity lists a 0.40% advisory fee and a $5,000 balance requirement for Managed FidFolios direct indexing strategies.
- A study by Chaudhuri, Burnham and Lo in the Financial Analysts Journal estimated loss-harvesting tax alpha of 1.08% a year before costs over 1926 to 2018, or 0.82% with wash-sale constraints.
- Harvesting opportunities decline as positions are reset to lower cost bases; AQR has written that the tax benefits decay to very low levels after a few years.

## What is direct indexing?

Direct indexing is a way to get index-like exposure by owning the underlying stocks themselves. Instead of buying shares of a mutual fund or ETF that tracks, say, the S&P 500, the investor holds the index's constituents (or a representative sample) in a separately managed account in their own name.

The account is typically run by a professional manager, often using software that keeps the portfolio close to the target index while making trades for tax or personal reasons. Providers such as Schwab, Fidelity and Vanguard pair direct indexing with automated tax-loss harvesting, according to their product materials.

Because the investor owns each stock, gains and losses on individual positions belong to the investor rather than being pooled inside a fund. That is the feature that makes the strategy useful for tax management and for tailoring holdings.

## How does tax-loss harvesting work in a direct index?

In any index, some stocks fall even in a year when the overall index rises. In a direct indexing account, the manager can sell those individual positions below their cost basis to realize capital losses, then buy other stocks with similar characteristics so the portfolio keeps tracking the index. The realized losses can offset capital gains elsewhere in the investor's portfolio.

A fund investor can harvest a loss only when the fund as a whole is down. A direct indexing account has many more chances because each stock has its own cost basis. Vanguard describes its Personalized Indexing accounts as scanned for harvesting opportunities and notes that clients can add cash to reset cost basis and make further losses more likely.

Academic estimates of the benefit vary with assumptions. A study by Shomesh Chaudhuri, Terence Burnham and Andrew Lo, published in the Financial Analysts Journal in 2020, estimated tax alpha of about 1.08% a year before costs using the 500 largest U.S. stocks from 1926 to 2018, falling to about 0.82% a year when the strategy was constrained by the wash-sale rule. Harvesting generally defers taxes rather than eliminating them, because replacement shares carry a lower cost basis.

## What is the wash-sale rule, and how does it apply?

The wash-sale rule limits loss harvesting. According to IRS Publication 550 (2025), a wash sale occurs when an investor sells stock or securities at a loss and, within 30 days before or after the sale, buys substantially identical stock or securities, acquires them in a fully taxable trade, or acquires a contract or option to buy them.

A wash sale does not erase the loss permanently in most cases. The IRS says the disallowed loss is added to the cost of the new shares, which becomes their basis, and the holding period of the sold shares carries over. The Schedule D instructions note an exception: if the replacement shares are bought in an IRA or Roth IRA, the basis is not increased.

Whether two securities are substantially identical depends on the facts and circumstances, the IRS says, but stocks or securities of one corporation are ordinarily not considered substantially identical to those of another. That is why direct indexing managers typically replace a sold stock with a different company in the same industry. Because the rule applies across an investor's accounts, purchases in other accounts, including IRAs, can trigger a wash sale.

## How can a direct index be customized?

Owning the stocks directly lets an investor exclude or underweight specific holdings. Fidelity said its Managed FidFolios strategies, which initially included U.S. Large Cap Index, International Index and Environmental Focus, could be customized by removing individual stocks or industries, according to ThinkAdvisor's 2022 coverage. BlackRock said its Aperio acquisition expanded personalization across tax-managed strategies, factors, broad market indexing and investor ESG preferences.

A second common use is managing a concentrated stock position, such as company stock from an employer. Parametric markets direct indexing as a way to help investors move out of concentrated positions, using losses harvested elsewhere in the portfolio to offset gains from selling the concentrated stock over time.

Customization has a cost in benchmark fidelity. Every stock or industry removed from the portfolio is one the index still holds, so returns can drift from the benchmark, and the effect generally grows with how much of the index a screen removes.

## Who are the main direct indexing providers?

Several of the largest firms in wealth management built or bought direct indexing businesses. Morgan Stanley completed its acquisition of Eaton Vance on March 1, 2021, and Parametric Portfolio Associates, a longtime direct indexing manager, became an indirect wholly owned subsidiary of Morgan Stanley, according to Morgan Stanley.

BlackRock completed its acquisition of Aperio on Feb. 1, 2021. The all-cash deal was valued at $1.05 billion when announced in November 2020, and Aperio had about $36 billion in assets under management, according to BlackRock. Aperio operates as a separately branded team in BlackRock's U.S. Wealth Advisory business.

Vanguard announced on July 13, 2021, that it would acquire Just Invest, an Oakland, California-based firm with about $1 billion in assets and a direct indexing platform called Kaleidoscope, according to InvestmentNews. Vanguard now offers Vanguard Personalized Indexing to advisors. Schwab launched Schwab Personalized Indexing in 2022, and Fidelity introduced Managed FidFolios for retail investors the same year.

## What are the minimums and fees?

Minimums and fees vary widely by provider and change over time, so figures should be checked against current disclosures. When it launched Schwab Personalized Indexing in 2022, Schwab set an account minimum of $100,000 and fees starting at 0.40%, and said most direct indexing offerings at the time typically started at $250,000 or higher.

Fidelity's Managed FidFolios page lists an advisory fee of 0.40% for its direct indexing strategies and 0.70% for actively managed strategies. Fidelity says there is no minimum to open an account, but the balance must reach $5,000 before it is invested according to the chosen strategy. Morningstar's Ben Johnson called the $5,000 level the lowest entry point he had heard of for a direct indexing product, according to ThinkAdvisor in 2022.

Advisory fees typically do not cover everything. Fidelity notes that certain trading and transfer charges are not included. Advisors who use direct indexing for clients also usually charge their own advisory fee on top of the manager's fee.

## What are the limits of direct indexing?

The biggest limit is loss decay. Each harvest resets positions to a lower cost basis, and as markets rise, fewer holdings sit below cost. Vanguard acknowledges that systematic harvesting can eventually exhaust the losing positions in a portfolio, and AQR has written that the tax benefits of direct indexing decline to very low levels after just a few years. Regular new contributions can extend the benefit by adding fresh cost bases.

Tracking error is the second. Replacement trades, exclusions and sampling mean a direct index will not match its benchmark exactly. Vanguard lists tracking error, along with the possibility of higher costs, among the risks of tax-loss harvesting.

The value also depends on the investor. Harvested losses matter most to investors who have realized gains to offset, so the benefit is generally larger for investors in higher tax brackets with gains elsewhere in their portfolios. Direct indexing also adds complexity, including many more line items on statements and tax forms. This guide is general information, not tax, legal or investment advice; investors should consult a qualified tax professional about their own situation.

## How big is the direct indexing market?

Cerulli Associates reported in April 2025 that direct indexing assets closed 2024 at $864.3 billion, compared with $9.4 trillion in index-tracking ETFs. Cerulli said direct indexing accounted for 37.6% of manager-traded assets reported by separately managed account managers, more than double its share in 2020, and that 18% of advisors reported using direct indexing strategies in 2024, up from 16% in 2023.

Quarterly data from the Money Management Institute and Cerulli showed direct index assets of $1,155 billion at the end of 2025, the largest manager-traded SMA category. The MMI-Cerulli series and Cerulli's year-end 2024 figure may differ in methodology, so the two should be compared with care.

Growth has outrun earlier forecasts. In December 2022, Cerulli projected direct indexing assets would reach $825 billion by 2026, a 12.3% compound annual growth rate, according to WealthManagement.com, which reported that the study was sponsored by Parametric.

## Questions

**What is direct indexing?** Direct indexing is owning the individual stocks of an index, or a sample of them, in a separately managed account instead of buying an index fund or ETF. It allows tax-loss harvesting on individual positions and customization of holdings.

**What is the wash-sale rule?** Under IRS Publication 550, a loss on a sale of stock or securities is disallowed if substantially identical securities are acquired within 30 days before or after the sale. The disallowed loss is generally added to the basis of the replacement shares.

**Does buying in an IRA trigger a wash sale?** It can. If the replacement shares are bought in an IRA or Roth IRA, the IRS Schedule D instructions say the basis of those shares is not increased by the disallowed loss.

**How much does direct indexing cost?** It depends on the provider. Schwab launched its program in 2022 with fees starting at 0.40% and a $100,000 minimum, and Fidelity lists a 0.40% advisory fee for its Managed FidFolios direct indexing strategies with a $5,000 balance requirement.

**Does tax-loss harvesting keep working forever?** No. Harvesting opportunities tend to shrink as positions are reset to lower cost bases and markets rise. AQR has written that the benefits decline to very low levels after a few years unless new cash is added.

**How large is the direct indexing market?** Cerulli Associates reported $864.3 billion in direct indexing assets at year-end 2024, and MMI-Cerulli data showed $1,155 billion at the end of 2025.

**Is this tax advice?** No. This guide is general information. Tax outcomes depend on individual circumstances, so investors should consult a qualified tax professional.

Sources:
- IRS: Publication 550 (2025), Investment Income and Expenses (https://www.irs.gov/publications/p550)
- IRS: Instructions for Schedule D (Form 1040) (2025) (https://www.irs.gov/instructions/i1040sd)
- Cerulli Associates: Direct Indexing Assets Close Year-End 2024 at $864.3 Billion (https://www.cerulli.com/press-releases/direct-indexing-assets-close-year-end-2024-at-864.3-billion)
- Money Management Institute: MMI-Cerulli Q4 2025 Advisory Solutions Data (https://www.mminst.org/insight/mmi-cerulli-q4-2025-advisory-solutions-data)
- WealthManagement.com: Build-Your-Own-Index Boom Could Hit $825 Billion in Four Years (https://www.wealthmanagement.com/equities/build-your-own-index-boom-could-hit-825-billion-in-four-years)
- BlackRock: BlackRock Completes Acquisition of Aperio (https://ir.blackrock.com/news-and-events/press-releases/press-releases-details/2021/BlackRock-Completes-Acquisition-of-Aperio/default.aspx)
- Morgan Stanley: Morgan Stanley Closes Acquisition of Eaton Vance (https://morganstanley.com/press-releases/morgan-stanley-closes-acquisition-of-eaton-vance)
- InvestmentNews: Vanguard to acquire Just Invest and offer direct indexing (https://investmentnews.com/industry-news/vanguard-to-acquire-just-invest-and-offer-direct-indexing/208761)
- Charles Schwab: Schwab Introduces Schwab Personalized Indexing (https://www.businesswire.com/news/home/20220331005263/en/Schwab-Introduces-Schwab-Personalized-Indexing)
- Fidelity: Fidelity Managed FidFolios (https://digital.fidelity.com/prgw/digital/msw/overview/z)
- ThinkAdvisor: Fidelity Readies the First Retail Direct Indexing Product (https://thinkadvisor.com/2022/01/20/fidelity-readies-the-first-retail-direct-indexing-product)
- Vanguard: Amp up tax-loss harvesting with direct indexing (https://advisors.vanguard.com/investments/personalized-indexing/amp-up-tax-loss-harvesting)
- CFA Institute (Financial Analysts Journal): An Empirical Evaluation of Tax-Loss-Harvesting Alpha (https://rpc.cfainstitute.org/research/financial-analysts-journal/2020/0015198x-2020-1760064)
- AQR: Improving Direct Indexing: 130/30 and 150/50 Strategies (https://www.aqr.com/Insights/Research/Tax-Aware-Investing/Improving-Direct-Indexing-13030-and-15050-Strategies)
- Parametric: Direct Indexing (https://www.parametricportfolio.com/direct-indexing)