The After-Tax Advantages of Direct IndexingTheAfter-TaxAdvantagesofDirectIndexing

Robert Holderith, who leads PGIM’s direct indexing business, joined PGIM Investments President and CEO Stuart Parker for the latest episode of The Inside Track to discuss how direct indexing can help advisors manage tax impact for high-net-worth clients via tax-loss harvesting.

Below is an excerpt from their conversation. 

Stuart Parker: Bob, we're going to talk today about taxes and direct indexing. I heard a statistic the other day that 95% of high-net-worth individuals and their advisors are concerned about minimizing taxes at the end of every year. 

Bob Holderith: We're always concerned about minimizing costs to clients. Clearly, we talk a lot about expense ratios. We talk a lot about spreads, and we used to talk a lot about commissions. Those are all measured in basis points. Taxes are measured in percentage points, so it's an important focus. 

Parker: And with budget deficits at an all-time high, I've got to believe that the only direction that taxes are going to go is up. Direct indexing is a way of being able to minimize one's taxes at the end of the year. Can you talk a little bit about how that works? 

Holderith: Sure. Direct indexing is the process of breaking down an index into component parts. Owning those parts independently allows you to customize or to tax-loss harvest. Tax-loss harvesting is the process of selling a security that's gone down in value in order to realize a capital loss. Those losses may have value if you have gains that you need to offset. 

Parker: Right. So, if you have gains either in the portfolio or outside the portfolio, you can use these losses to be able to offset those gains. 

Holderith: That's correct. 

Parker: At the end of the day though, you are trying to match the performance of a particular index. Why not just buy an index fund? 

Holderith: You could buy an index fund, but the ability to capture losses that an index fund doesn't provide because it's one big component part is the reason we like to do direct indexing and break the index up into pieces. 

Parker:  There's trillions of dollars that have gone into index funds, particularly over the last several years. But I did see that the direct indexing business is one of the fastest growing strategies in the separate account world. Literally over $400 billion has gone into direct indexing strategies. I mean, taxes have been an issue for a long time. Why do you think that it's become so popular today? 

Holderith: Well, I think taxes are becoming an increasing burden, as we said before, on high-net-worth clients. They're just top of mind. And like you said before, there is some risk that taxes go up from here, so the time to focus on saving tax money is now. 

Parker:  If I'm a high-net-worth advisor or an investor, what type of account would I need to have? What would make me the ideal client for someone who wanted to go into a direct indexing strategy? 

Holderith: Most investors that use direct indexing have $100,000 in taxable money to invest. They may have a concentrated securities position that they'd like to sell as well, and that can become part of the portfolio. 

Learn more about PGIM Custom Harvest SMAs.