6 steps to tax-efficient onboarding of clients with direct indexing

Executive summary:

  • Financial advisors often face the challenge of transitioning a new client into their practice in a tax-efficient way
  • Direct indexing offers the ability to transfer existing stocks into a new portfolio without creating an immediate taxable event
  • A six-step process can help advisors leverage a direct indexing strategy while onboarding clients

A challenge many financial advisors face is transitioning a new client into their practice in a tax-efficient way. Most new clients own individual securities, ETFs and mutual funds that may require adjusting or liquidating in order to create a new portfolio. Many times, the investor is reaching out for help because they want the guidance of a financial professional and their current investment portfolio may reflect a lack of industry knowledge. They may be overweight in a particular stock or industry, or they may have investments that simply underperformed their expectations. Financial advisors often grapple with the tax challenge that repositioning some of the assets into a new solution presents. That is where a direct indexing portfolio may be beneficial.

Direct indexing is a strategy that allows investors to own individual stocks in an account that closely replicates the performance of a specific index, such as the S&P 500, rather than investing in a traditional mutual fund or exchange-traded fund (ETF). This approach offers several benefits, including the ability to transfer the existing stocks into the portfolio without creating an immediate taxable event

Financial advisors can leverage direct indexing to transition new clients into their practice by following these steps:

  1. Education: Start by explaining the concept of direct indexing to your clients. Discuss the benefits, and potential cost savings compared to traditional investment options. Emphasize how direct indexing allows for greater customization, tax efficiency and control over the portfolio. Check out our website, Russellinvestments.com, for industry-leading educational material, or reach out to us and we would be happy to meet with you.


  2. Portfolio Analysis: Evaluate the client's existing investment portfolio and identify any overlapping holdings, security or sector over/underweights, tax inefficiencies, and areas for improvement. Highlight how direct indexing can help address these issues and potentially enhance their after-tax returns.


  3. Customization: Leverage the flexibility of direct indexing to customize the client's portfolio to fit their situation. Possibly underweight or exclude certain industries or companies that the client wants to avoid because of a current equity overweight or values preferences.


  4. Tax Optimization: One of the main advantages of direct indexing is its potential for tax optimization. Guide your client through the process of strategically harvesting tax losses by selling individual securities that have declined in value to offset capital gains or reduce taxable income. Explain how this may lead to significant tax savings over time.


  5. Cost Analysis: Compare the costs associated with direct indexing to the fees of traditional investment options such as mutual funds. Highlight potential cost savings, especially for larger portfolios, as direct indexing may have lower management fees.


  6. Transition Plan: We can help you develop a transition plan to gradually move the client's existing investments into the direct indexing strategy in a tax-efficient way. This plan can be guided by a tax or time-based budget, ensuring a smooth and efficient transition managed by our experts

The bottom line

By effectively explaining the benefits of direct indexing and tailoring the strategy to the investor’s individual needs, you can successfully transition new clients into your practice and provide them with a personalized and tax-efficient investment solution. 

This can have multiple benefits, not just for the investor, but for you as well. Satisfied clients can provide the best referrals so you may find that the more successful transitions you conduct, the more arise. High-net worth investors especially are seeking customization and can have complicated portfolios that require careful transitions, so developing this expertise may attract more of that client cohort to your practice. And you may find you retain more assets as you move more clients into tax-efficient portfolios that can provide the potential for increased growth over time.