Brett Harris

The Good Problem with Direct Indexing Direct indexing often creates a "good problem." While equity gains benefit investors, substantial embedded gains make tax-loss harvesting and portfolio rebalancing increasingly difficult. Over time, directly indexed portfolios often become "ossified," dominated by holdings with large unrealized gains. Here are some common strategies to address this ossification: 1. Acceptance: Recognize the tax cost as an unavoidable consequence of successful investing. 2. Charitable giving: Donate appreciated shares and use cash to replenish positions, resetting the cost basis. 3. Gain recognition: Strategically realize long-term gains to open up future short-term loss harvesting. 4. SMA to ETF conversion: It may now be possible to transfer an ossified separately managed account (SMA) to an ETF structure via a section 351 conversion. (See Brent Sullivan 💸 and his good work at Tax Alpha Insider for more insights on this). 5. Risk overlay strategies: Include an options overlay in an SMA as a potentially potent strategy for rejuvenating loss-harvesting potential by: - Creating tax benefits in rising or falling markets through paired long and short exposures. - Extending harvesting potential by matching notional exposure between long and short positions. - Refreshing tax lots through regular rebalancing, maintaining an ongoing pipeline of loss-harvesting opportunities. While "good problems" pose challenges, they also bring opportunities. How are you managing the tax friction in direct indexing?

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