Five myths financial professionals believe about direct indexing

What advisors can misunderstand about direct indexing

Direct indexing has experienced a rapid rise in popularity over the past few years. With that growth has come a flood of questions from clients and increasing pressure on advisors to develop a point of view.

As more providers have entered the space and simplified access to direct indexing, a few persistent myths have taken hold. These narratives often frame direct indexing as a niche product useful only for ultra-high-net-worth investors or as a pure tax-loss harvesting strategy.

In reality, direct indexing is a flexible, tax-aware solution with far broader applications. This post addresses the most common objections and misconceptions we hear from advisors and explains how direct indexing can be used to serve a broader range of clients more effectively.

Myth #1: Direct indexing is only for ultra-high-net-worth investors

It’s true that direct indexing began as a solution for clients with multimillion-dollar portfolios and complex tax situations. But that’s no longer the case.

Today, lower trading costs, fractional-share capabilities and technology-driven platforms have significantly reduced the minimums for direct indexing. Some solutions are now available for portfolios under $100,000. In fact, younger professionals with strong income potential and growing taxable exposure may be ideal candidates.

Younger investors may be looking for:

• Improved after-tax outcomes
• Security restrictions to account for existing financial exposures
• The opportunity to incorporate personal values into their portfolios

By offering direct indexing to a broader segment of your book—not just your wealthiest clients—you can create more customized, tax-aware portfolios while differentiating your advisory practice.

Myth #2: ETFs are already tax efficient—why pay more for direct indexing?

ETFs are tax-efficient, but they can’t harvest losses at the individual-security level.

Direct indexing offers a layer of tax management that surpasses the capabilities of ETFs. Even in a rising market, many individual stocks within an index will still have negative returns. With direct indexing, those losses can be harvested, potentially reducing your client’s current and future tax liability.

When comparing after-tax outcomes, direct indexing can sometimes be more cost effective than a traditional ETF model or actively managed strategy. How? A typical index ETF may only realize capital gains at the fund level, limiting tax loss harvesting opportunities. A direct-indexing strategy continuously harvests losses from individual securities, potentially boosting tax alpha.

Direct indexing may be a good fit for:

• Taxable investors with income to offset
• Clients preparing for a liquidity event
• Anyone in a high-tax bracket looking to improve after-tax returns without sacrificing diversification

In short, if you’re only comparing direct indexing to ETFs on management fees or pre-tax returns, you may be missing the bigger picture.

Myth #3: Tax alpha quickly disappears due to tax lock

Tax lock refers to the point when a portfolio has realized most of its available losses and can no longer generate meaningful tax benefits, especially in long-term bull markets.

While this is a real consideration, many studies evaluating tax lock do so in a vacuum. They often ignore the dynamic nature of how real portfolios are managed. In practice, several techniques are available to help delay the onset of tax lock and to refresh a portfolio’s cost basis over time.

Strategies to manage tax lock:

• Periodic deposits, where new cash is used to purchase fresh securities, often at higher basis levels.
• Dividend reinvestments similarly help establish new cost-basis positions.
• Annual tax budgets allow some turnover, maintaining index tracking while creating harvesting opportunities.
• Gifting appreciated securities can help remove low-basis holdings without triggering gains.
• Client-specific harvesting aggressiveness enables you to tailor the strategy to each client’s unique income situation and goals.

Tax alpha doesn’t have to be a one-time benefit. With the right approach, it can be a long-term advantage, particularly for clients with evolving tax profiles or those making ongoing contributions.

Myth #4: Direct indexing is too complex for clients or advisors

This might have been true in the past, when direct indexing required custom portfolios and active management. But today’s technology has made the process remarkably streamlined. Modern platforms handle everything from tax harvesting and index tracking to portfolio customization. Advisors can set tax budgets, apply security restrictions or align a portfolio to a client’s values—all with a few clicks.

Here’s what it might look like in practice:

A newly onboarded client comes to you with a $300,000 taxable account holding a mix of ETFs and individual stocks. They want to reduce their tax bill, avoid investing more in their employer’s industry and integrate some ESG screens.

With direct indexing, you can potentially:

• Harvest losses from underperforming holdings
• Build a diversified portfolio that avoids overexposure to their industry
• Apply ESG filters to match the client’s values
• Avoid triggering large gains when repositioning their legacy assets

You can accomplish all of this through a single, unified solution.

Myth #5: Direct indexing is just about taxes

While tax efficiency is a compelling feature, it’s not the only reason to consider direct indexing. This strategy also provides potential benefits across several other areas of portfolio design and financial planning.

What else can direct indexing do?

• Enable factor tilts or active overlays for clients who want to go beyond market-cap-weighted exposure
• Manage risk exposures, especially for clients who already hold concentrated stock positions or own businesses
• Integrate values-based preferences at the individual-security level
• Generate potential income with options overlays without having to sell appreciated securities

Direct indexing provides a higher level of control, allowing for more opportunities to align a portfolio with what matters most to each client.

When direct indexing makes sense

Direct indexing isn’t the right solution for every client, but it fits far more situations than many advisors realize.

You might consider it for:

• Clients with taxable accounts and meaningful income
• High earners preparing for an exit or liquidity event
• Clients with specific risk exposures (like concentrated stock positions)
• Investors transitioning from legacy holdings
• Anyone seeking a more customized, flexible portfolio-construction process

By thinking beyond account size and focusing on client needs instead, you’ll discover far more opportunities to use direct indexing effectively. The key is to position direct indexing not as a niche strategy or tax trick, but as a core part of your portfolio-construction toolkit.

Here are a few ways to start the conversation:

• “Let’s talk about how to make your portfolio more tax aware.”
• “Would you like to align your investments with your values?”
• “We can help reduce your tax liability while keeping you fully invested.”

Real-life examples (like donating appreciated stock, managing legacy positions or customizing for risk) help bring the value to life. Framing direct indexing in terms of the outcomes clients care about (lower taxes, better alignment, more flexibility) makes it easier for them to say yes.

Direct indexing is not just a tool for the ultra-wealthy. It’s a flexible, modern solution that suits clients at various wealth levels, particularly those with taxable exposure or complex needs. In a world where personalization is expected and after-tax outcomes are increasingly important, direct indexing allows advisors to stand out, deepen relationships and grow their businesses with greater impact.