How to attract high net-worth investors with direct indexing

Executive summary:

  • Direct Indexing strategies may help differentiate your services from your peers
  • Direct Indexing strategies can offer high net-worth investors tax-effective ways to manage any potential future cash windfalls or reduce concentrated stock positions
  • High net-worth investors appreciate the value of customization in many goods and services, why not bespoke investments too?

A key element of most financial advisors' annual business plans is to grow their revenue. Barring acquisitions or mergers, there are three primary ways to achieve this goal:

One of my mentors once told me that "Hope is not a strategy" and since we can't predict the markets, I have decided to focus this blog on using Direct Indexing to attract new high net-worth clients.

Most advisors would agree they would rather generate the same amount of revenue from five clients rather than 20. The problem they face is that most high net-worth individuals or organizations already have an existing relationship with a financial professional and don’t realize that they may require your services.

So besides asking for referrals from your existing high net-worth clients, what is the best way to get in front of these individuals? My suggestion is having something unique to offer them.

This is where Direct Indexing can come into play. While many financial advisors have heard of Direct Indexing—a strategy that can be used to manage a client's investment tax liability while also allowing for personalization to reflect the client's unique values and preferences—most have yet to adopt it in their practices. And while many high net-worth clients may benefit from employing a DI strategy, it's possible that they don't know about this approach. By incorporating Direct Indexing into your offering, you can introduce a new idea to these prospects, which may result in you winning a new client.

How to start a conversation with high net-worth investors about the benefits of Direct Indexing

One of the advantages of Direct Indexing is that it is easily explained to clients and prospects. In its simplest form, DI allows an investor to own a basket of stocks that is designed to generate a benchmark-like return while allowing for customization and tax loss harvesting—with those losses available to offset gains elsewhere in the client's overall investment portfolio. The question some advisors struggle with is how to approach the conversation. In my experience, it's as easy as asking your client or prospect three key questions.

1. Are you expecting a large financial windfall in the future?

Many high net-worth individuals are planning on selling a business, property or large stock position in the future. These types of sales most likely will generate a significant capital gains tax liability that needs to be planned for years in advance. Unfortunately, many advisors are not helping clients look this far into the future and have yet to put a plan in place.

This is where you can introduce Direct Indexing. You can explain to the client that a Direct Indexing strategy can potentially earn a return similar to a chosen benchmark – while simultaneously harvesting losses that can be stockpiled to offset the future capital gain. Starting this process early gives the client (and you) plenty of time to adapt and adjust over time as the markets move—and as the investor's situation evolves.

By offering a solution, you may find yourself with a new high net-worth client who will likely be very relieved to have such a forward-thinking advisor by their side.

2. Do you currently own mutual funds that are generating capital gains taxes?

High net-worth individuals who own mutual funds that generate capital gains taxes are likely great prospects for Direct Indexing. Because DI strategies are separately managed accounts--not commingled vehicles like mutual funds--they are not forced to distribute capital gains. In addition, our DI portfolios employ active tax loss harvesting every month, with the goal of helping clients build tax assets they can use to offset any gains that year or in future years. A prospect whose advisor recommended mutual funds that generate capital gains is likely to be very intrigued by your investment idea.

You may also want to let the potential client know that Russell Investments can help put together a plan for how to most effectively transition out of their existing mutual fund into a DI strategy, with the lowest possible tax impact. The investor can decide whether they want to optimize using an annual tax budget or a transition timeline.

Personalized Managed Accounts with Russell Investments

3. Do you have a concentrated stock position?

Many high net-worth investors have a concentrated stock position that has accumulated over years. It may be a result of numerous equity grants, employee stock purchase plans or from exercising stock options. Often, financial advisors do not have a plan to work out of these positions in a tax-efficient manner. Many times, the position sits in an unmanaged, non-revenue-producing brokerage account, creating unnecessary financial risk for the client and a potential compliance liability for the advisor.

A Direct Indexing strategy can help the investor offset their estimated annual capital gains tax liability annually until the concentrated stock position is whittled down to a more manageable percentage of the portfolio. Alternatively, the exposure to the concentrated stock position can be pared down by taking gains over a period anywhere from three to five years. Those capital gains can be offset with tax-loss harvesting, keeping any related taxes to a minimum.

In summary, financial advisors looking to increase assets under management by attracting new high net-worth clients might be well served by exploring the advantages of direct indexing. Direct Indexing gives investors more control over where they put their money. And for a clientele which may be accustomed to bespoke suits and customized finishings on their private jet, having that level of control over their investment portfolio as well as having the option to potentially lower their tax bill (among other benefits), is likely to be appealing. Incorporating Direct Indexing to your practice can place you at the vanguard of an evolving financial landscape.