The Alpha of Loss: Direct Indexing & Harvesting
The Alpha of Loss: Direct Indexing & Harvesting
Unbundling the ETF: How to beat the benchmark not by picking winners, but by systematically harvesting losers.
Executive Summary
- Direct Indexing: Instead of buying an S&P 500 ETF (1 ticker), you buy the ~500 individual stocks. This allows you to sell specific losers while keeping the winners.
- Tax Loss Harvesting (TLH): You realize losses on declining stocks to offset capital gains elsewhere. This lowers your tax bill, effectively creating “Tax Alpha” (avg +1% return).
- Customization: Unlike rigid ETFs, you can exclude specific sectors (e.g., ESG filters) or concentrated positions (e.g., excluding Tech if you work at Google).
The Wash Sale Rule (30 Days)
If you sell a security at a loss and buy a “substantially identical” one within 30 days, the loss is disallowed. Algorithms automatically swap to a correlated substitute (e.g., Coke -> Pepsi) to preserve market exposure while booking the loss.
Mechanic: The Harvesting Engine
+1.1%
Tax Alpha
30 Days
Wash Sale
Daily
Scan Cycle
Auto
Execution
Simulation: 10-Year Growth (ETF vs. Direct Indexing)
After-Tax Wealth Accumulation ($10M Initial)
| Feature | Standard ETF (SPY/IVV) | Direct Indexing |
|---|---|---|
| Structure | Single Fund Wrapper | Separately Managed Acct (SMA) |
| Loss Harvesting | None (Locked Inside) | Individual Stock Level |
| Min Investment | 1 Share (~$500) | Typically $100k+ |
“In a down market, the ETF investor sees only red. The Direct Indexing investor sees ‘Green’—in the form of tax credits banking for the future.”
Essential Resources
INTERNAL
BMT Playbooks