The ETF Killer: Direct Indexing & Tax-Loss Harvesting
The ETF Killer: Direct Indexing & Tax-Loss Harvesting
Why buy the SPY ETF when you can buy the 500 stocks directly? How to generate “Tax Alpha” by harvesting losing stocks daily while the index goes up.
Executive Summary
- The ETF Limitation: When you buy an S&P 500 ETF (like SPY), you own a bundle. Even if 200 stocks inside the bundle are down, you cannot sell them to claim a tax loss unless you sell the *entire* ETF (which triggers gains on the winners). You are trapped in the average.
- The Solution (Direct Indexing): Instead of buying the ETF, software automatically buys all 500 individual stocks for you.
👉 The Magic: If Tesla drops 10% but Apple rises 10%, the software **sells Tesla immediately** to “harvest” the tax loss, then buys a substitute (e.g., Rivian) to stay invested. - The Tax Alpha: This creates a constant stream of “Capital Losses” that you can use to:
1. Offset unlimited Capital Gains from other investments (e.g., Real Estate sale).
2. Offset $3,000 of Ordinary Income annually.
👉 Result: An extra **1.0% to 2.0%** annual return purely from tax savings.
The “Wash Sale” Algorithm
The Constraint: You cannot sell a stock for a loss and buy it back within 30 days (Wash Sale Rule).
👉 The Automation: Direct Indexing software handles this automatically. It sells Coke and buys Pepsi (highly correlated but not “substantially identical”) for 31 days, then swaps back. Humans cannot do this manually; robots do it effortlessly.
Mechanic: Unbundling the Index
Unbundle
Buy Stocks Direct
Harvest
Sell Losers Daily
Offset
Cancel Other Gains
Min $100k
Acct Minimum
Simulation: S&P 500 Investing ($1M Portfolio)
After-Tax Return Comparison
| Feature | ETF (Exchange Traded Fund) | Direct Indexing (SMA) |
|---|---|---|
| Ownership | 1 Share of the Fund | 500 Shares of Stocks |
| Tax Management | Passive (Fund Level) | Active (Individual Level) |
| Customization | None (Take it or leave it) | High (e.g., “No Oil Stocks”) |
“Volatility is risk for an ETF investor, but opportunity for a Direct Indexer. Every dip in a stock price is a chance to harvest a tax asset (loss) that can shield your future wealth from the IRS.”
Essential Resources
INTERNAL
BMT Playbooks
tlh, wash-sale, tax-alpha, sma
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