The rise of direct indexing: Why investors are moving on from ETFs

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In recent years, ETFs have been recognised as the gold standard for passive investing. And it’s not hard to see why: they offer a simple, low-cost way for anyone to own a slice of the market. Yet a growing number of investors are moving in a different direction. They aren’t going back to expensive mutual funds; rather, they are avoiding the fund structure entirely in favour of owning the underlying stocks themselves.

This strategy is called direct indexing. Once reserved for the ultra wealthy, direct indexing is now becoming a standard tool for the modern retail investor.

What is direct indexing?

With a traditional index ETF, you buy one asset that represents a basket of stocks. You own the fund, but the fund owns the stocks.

With direct indexing, you leverage technology to buy all of those stocks directly in your own brokerage account. The increased availability of fractional shares and zero-commission trading have made this possible for portfolios of almost any size. The goal is the exact same — to track an index — but the ownership model is fundamentally different.

The problem with ETFs

While ETFs are convenient, they are “locked” products. For the sophisticated investor, this creates three problems:

1. Trapped tax losses: In an ETF, you can only harvest a tax loss if the entire fund’s price drops below what you paid for it. With a direct index however, you can easily sell off the individual “losers” within the index to offset capital gains elsewhere, even when the overall market is up.

2. Inflexible holdings: You cannot choose to remove a single company from an ETF. If you have a portfolio consisting of both ETFs and individual stocks, this can lead to concentration if you don’t have an ETF x-ray tool and are not checking for concentration risk on a regular basis.

3. Management fees: Even low fees add up over time. By owning the stocks directly, you eliminate the expense ratio of the fund provider.

The advantages of direct indexing: Tax alpha and customisation

One of the main reasons investors are “abandoning” ETFs in favour of direct ownership is the pursuit of tax alpha. Vanguard research suggests that active tax-loss harvesting at the individual stock level can enhance an investor’s after-tax return by between 1% and 2%, for example.

Today’s investors are also looking for the ability to customise their portfolios. Whether this means excluding certain industries for ESG reasons or shifting their portfolio toward a trending sector like AI, direct indexing gives investors a level of control that an ETF cannot match.

Not everyone is a good candidate for direct indexing

All of that being said, direct indexing is not for everyone. Moving from holding one ETF to investing in 500 individual stocks creates complexity from an admin and performance tracking perspective, and that should not be underestimated.

Unfortunately, most brokerage platforms are not built to show you the full picture of a direct-indexed portfolio. When your assets are spread across hundreds of individual tickers — and maybe even multiple brokerage accounts — it becomes impossible to answer basic questions about your portfolio. For example:

• What is my total exposure to the energy sector?
• Is my personal index actually tracking the benchmark, or has it drifted too far?
• How much did I save in taxes this year across all my accounts?

This is where many investors struggle, as they gain control but lack clarity.

Removing the complexity

If you’re considering moving towards a direct ownership model, tracking your shares via your brokerage platform isn’t enough. What you need is a dedicated portfolio tracking tool like Sharesight that allows you to track all of your investments in one place, even if you invest via multiple brokers.

Key features include:

• Benchmarking: Automatically compare your custom collection of stocks against the index of your choice to ensure you aren’t underperforming or drifting away from your target.
• Exposure reporting: Avoid hidden concentration risk by running a report to uncover your portfolio’s exposure to different industries, sectors, geographies and more.
• Comprehensive portfolio view: See your direct holdings alongside your remaining ETFs, crypto, precious metals and more, all in one place.

Choosing the right strategy for your portfolio

Neither direct indexing nor ETFs are inherently “better”, they simply serve different investor needs. For the investor who is looking for a simple, “hands off” solution, ETFs are an efficient choice to gain instant market exposure. If you’re a more sophisticated or high-net-worth investor seeking tax alpha and customisation, then direct indexing could provide some advantages.

Ultimately, the best strategy is one that you can properly track and manage. Whether you hold a few broad-market ETFs or hundreds of individual stocks, you can’t optimise what you don’t measure. The complexity of modern investment portfolios — especially those using a hybrid of ETF investing and direct indexing — require a dedicated portfolio tracking solution to ensure your investment decisions are grounded in a complete and accurate view of your total wealth.

Track your performance with Sharesight

Ready to see your true performance? Sharesight was built to provide you with one single view of all your investments. By aggregating your holdings across multiple brokers and accounts, Sharesight automatically tracks your performance, dividends and tax obligations — giving you the clarity you need to make informed decisions.

Sign up for a free Sharesight account to get started tracking your performance and tax today.

FURTHER READING

• Why Sharesight is the best multi-asset portfolio tracker
• Red flags: When should you avoid investing in an asset?
• See what’s inside your ETFs with Sharesight’s exposure report