Do you use direct indexing (e.g., at Wealthfront)?

[TypicalVillain]

I'll be getting about 300k in inheritance at some point this year and I was looking into direct indexing - the idea of buying individually every stock in the S&P500 in order to get maximum tax loss harvesting. I know Wealthfront does this for accounts at 500k, so in a few years I could be at that level. My question is, is this worth the hassle? I can imagine owning that many stocks, with frequent rebalancing, could invite hell from the IRS (just filling out the schedule D would drive me mad...). Have you done it?

[GGNoob]

According to this blog post, in 2015 you will be able to invest in the top 100 stocks in the S&P 500 with direct indexing when you have $100k or more. I think it's a very interesting idea and would probably do it myself if I had a big taxable account. For the tax hassle, you might be able to just import everything into TurboTax. Betterment allows a simple import, never looked at Wealthfront.

You didn't give much information in your post, but there are some other ideas for your inheritance...

1. Pay off debt
2. Set up emergency fund
3. Max IRA/HSA
4. Invest in a taxable account
5. If you are not already maxing your 401k (or similar), max it from now on while withdrawing an amount equal to the reduction of pay from your taxable portfolio each month
6. If you cannot afford to max IRA/HSA in future years, withdraw from taxable

[tj]

I don't like the Direct 100 idea. I might do the direct indexing if I had the 500k for all of the S&p 500 stocks. Of course, by the time that happens, Wealthfront probably will run out of its venture capital.

[forummm]

Some caveats with this approach:

1) Note that wealthfront charges a 0.25% annual fee for their service plus 0.02%. If you just bought all the stocks yourself from a discount broker like Vanguard, it would be $2 per trade for balances over $500k. Even if you bought or sold every single stock each year (which I don't recommend), your trade fees would be lower than wealthfront.
2) If you wanted to do this, I would actually recommend a buy and hold strategy, with only occasional rebalancing just to save the fees. This can be your alpha. You aren't paying the 0.05% for Vanguard's fund, but you are paying occasional (or even no fees) for trading. If you have over $1M, Vanguard gives you free trades each year.
3) Note that the equalweight strategy has done well for about the same period of time that wealthfront's analysis is using (weird that they would use those favorable numbers). If you look back at the prior decade, equalweighting lagged the cap weighted approach. Other than the possible tax loss harvesting, you can get essentially the same performance as the EQW with the Vanguard Mid Cap Index Fund. http://www.forbes.com/sites/rickferri/2013/04/29/no-free-lunch-from-equal-weight-sp-500/
4) The tax loss harvesting is only likely to work well for the first several years. Once the stocks have appreciated, even a significant hit to their price is unlikely to result in a large enough drop to fall below what you paid for it. And if you plan to have a small income in retirement (like many here do), the longterm benefit of loss harvesting will be substantially limited. Note that wealthfront uses a very high earning couple in California as their example for tax loss harvesting purposes (weird that they would use the most favorable scenario to their analysis).

I think the benefits of doing this are questionable, and the downside is seriously complicated taxes and a lot of tracking error from the cap weighted index. I would consider doing it myself (buying the stock myself and not wealthfront doing it) when I had the money, but I'd have to really believe in the strategy. Not sure I do at this point.

[Heckler]

I'd stick to biophysics.  Sounds simpler.

[Cathy]

It would be a relatively simple exercise to implement your own program that makes HTTPS requests to your broker's website in order to implement the direct indexing algorithm. You would potentially have to pay trade fees, but with a $500,000 portfolio, the commissions (if any) will be significantly less than Wealthfront's fee. I would not use Wealthfront for this feature, because as soon as you stop using Wealthfront, you have a very hard to manage portfolio unless you have the technical skills to automate the administration of it -- and if you have those technical skills, you might as well just use them in the first place.

[tj]

It would be a relatively simple exercise to implement your own program that makes HTTPS requests to your broker's website in order to implement the direct indexing algorithm. You would potentially have to pay trade fees, but with a $500,000 portfolio, the commissions (if any) will be significantly less than Wealthfront's fee. I would not use Wealthfront for this feature, because as soon as you stop using Wealthfront, you have a very hard to manage portfolio unless you have the technical skills to automate the administration of it -- and if you have those technical skills, you might as well just use them in the first place.

A fair point...Direct Indexnig if you ever abandon the strategy sounds like a nightmare to exit from.

[TypicalVillain]

Yeah actually that would be a really cool project that I absolutely don't have time for :). Maybe that would be a good open-source project. But anyway, yeah, part of my concern about Wealthfront is that they use market-cap weighting and I'd prefer to do equal weighting. Something to think about I suppose...

[superannuationfreak]

part of my concern about Wealthfront is that they use market-cap weighting and I'd prefer to do equal weighting.

One thought if you want to do equal weighting or some sort of value-weighting (like RAFI - fundamental indexing).

In the US the ETF structure is very efficient at avoiding capital gains incurred while rebalancing (my understanding is that, in the accounting, low-cost-basis shares tend to be "redeemed" by the market-makers when they buy units to earn the spread).  With any approach that isn't cap-weighting (requiring significant rebalancing) the advantage of avoiding those capital gains may outweigh the advantages from holding individual shares (such as the ability to harvest individual share losses).  You'd need to do some more calculation to be sure.