What Is Direct Indexing?
Direct indexing is an approach to index investing that involves buying the individual stocks that make up an index, in the same weights as the index.
This is in contrast to buying an index mutual fund or index exchange-traded fund (index ETF) that tracks the index.
In the past, buying all of the stocks needed to replicate an index, especially a large index such as the S&P 500, required dozens to hundreds of transactions, which quickly could become overly expensive in terms of commissions and fees. However, with the advent of zero-commission stock trading on several online brokerage platforms, this concern has largely gone away.
Still, because direct indexing requires an investor to know exactly how many shares of each index component to buy, and to reweight accordingly from time to time (especially when the makeup of an index changes), several financial companies now offer automated direct indexing services for individual investors.
KEY TAKEAWAYS
Direct indexing is an index investing strategy that involves directly purchasing the components of an index at the appropriate weights.
Direct indexing can provide greater autonomy, control, and tax advantages to certain investors over owning an index mutual fund or an index exchange-traded fund (index ETF).
Once reserved for wealthy investors, the rise of zero-commission trading and fractional shares has made direct investing available to many smaller investors.
Because it can still be time-consuming to build an index one stock at a time, many brokers have begun offering direct indexing services to their customers.
Understanding Direct Indexing
Until recently, direct indexing made sense only for large investors and typically would be more costly to implement and maintain than owning an index fund. As stock trading fees have dropped to effectively zero, index investors are increasingly interested in taking some control and autonomy in their portfolios, self-replicating indexes that were previously only practical and cost-effective via index mutual funds or index ETFs. Additionally, with the increasing ubiquity of fractional shares, it is easier than ever to replicate even a large index with modest sums of investible funds.