Mar 6, 2024

Financial planning

The power of tax direct indexing: tax-loss harvesting and customization

The power of direct indexing
The power of direct indexing

Overview: Direct indexing offers a cost-effective approach to investing in stocks and index funds, providing the advantages of tax-loss harvesting and enhanced customization without the need for manual intervention. By engaging in direct investing, an investor has the potential to attain a higher annual return compared to not participating in direct indexing.


Tax-loss harvesting is a strategy designed to minimize taxes by employing capital losses to counterbalance taxes owed on capital gains. This is a manual process that demands a considerable degree of organization. However, with direct investing, tax-loss harvesting gets done for you.


As tax season is underway, let's delve into the workings of tax-loss harvesting and its implications for your tax filing. Basic tax-loss harvesting is something that’s straightforward to do on your own.


As your income increases (esp. over $80k when you need to start paying capital gains taxes), more advanced techniques are available and it’s increasingly common to pay a portfolio management fee for this. 


Basic tax-loss harvesting 


Each year, the government allows you to “realize” up to $3,000 in losses and reduce your taxable income by that amount. That reduces the amount of taxes you owe. Say you invested $10,000 in a stock that went down to $7,000. You could realize it by selling all the shares valued at $7,000 before December 31st, in order to use that to lower your income.


How advanced tax-loss harvesting works 


Advanced tax-loss harvesting works differently. It can’t be used to reduce your income, but it can be used to reduce your investment capital gains.


If you bought a stock for $70,000 and sold it for $100,000, you would have a realized capital gain of $30,000. You now have tax to pay on the difference between the sale price of the stock and its cost basis. 


If the stock was held for less than a year, short-term capital gains tax rate would apply which is equal to the tax you pay on your regular income (your marginal federal income tax rate to be precise). However, if the holding period is longer than one year, the long-term capital gains tax rate comes into play–it’s typically much lower than your marginal federal income tax rate.


To reduce the amount of capital gains taxes you may owe, you can use an IRS-endorsed strategy known as tax-loss harvesting. This involves identifying and selling a stock that went down, to ‘cancel out’ the capital gains on your stock that went up. There is no limit on how much in gains you can ‘offset’ with ‘realized losses’. Once you sell a stock, you can’t rebuy it for a 30 day time period (called the ‘wash’ rule).


Of course, if you believe your investments might rebound, selling stocks just to minimize your capital gains tax might not be the best approach, as it could be premature.


When to use tax-loss harvesting


In the above example, to offset the $30,000 in capital gains, you'd need to sell securities at a loss within the same calendar year. The crucial deadline for realizing these capital losses is December 31, ensuring they can be used to offset capital gains for that specific year.


In other words, if you had $30,000 in capital gains in 2023, selling stocks in 2024 with $30,000 in losses wouldn’t eliminate the $30,000 in capital gains from 2023. The capital gains tax on that amount would still be applicable when filing your 2023 taxes.


If you're considering taking action in 2024 to reduce your 2023 capital gains, unfortunately, it's too late for the 2023 tax year. However, since you plan to be around for another year, you can implement tax-loss harvesting this year to counteract capital gains or potential capital gains from selling stocks.


While the optimal holding period for stocks may be forever, occasional selling can be beneficial to fund your desired expenses. Stocks by themselves may not provide utility or joy, but they can serve a positive purpose when sold to finance purchases or experiences. Tax-loss harvesting aims to minimize capital gains tax, which can enhance your overall return and provide more post-tax buying power from your sales.


The higher your income tax bracket, the more advantageous tax-loss harvesting becomes.


Your marginal federal income tax bracket directly impacts your tax liability. In other words, shielding your capital gains from taxes is typically more beneficial in higher tax brackets.


For instance, let’s say you fall into the 37% federal marginal income tax bracket because your household makes $800,000 a year. If you had a $10,000 short-term capital gain from selling Google stock, you would owe $3,700. If you had a $10,000 long-term capital gain from selling Google stock, the long-term capital gains tax rate you would face is 20% or $2,000. 



Now let's use a middle-class household income as an example to demonstrate the effectiveness of tax-loss selling.


If your married household income amounted to $75,000 and you sold $10,000 worth of Google stock, realizing a long-term profit, your long-term capital gains tax rate would be 0%. This zero tax liability stems from the fact that married couples filing jointly, earning less than $94,050 in 2024, are subject to a 0% long-term capital gains tax rate.


In this situation, there is no need for tax-loss harvesting. However, if you think your stock investment will continue to decline, selling might still be a reasonable choice, notwithstanding the tax shield benefits.



Some restrictions and rules for tax-loss harvesting 


Here are some other rules to follow if you plan to conduct some tax-loss harvesting.


1) Annual tax deduction carryover limit is $3,000


Let's consider a situation where you have $20,000 in capital loss and $15,000 in total capital gains for the year. You can utilize $15,000 in capital losses to offset the corresponding amount in capital gains. This results in $5,000 in remaining capital loss.


Now, what happens with the remaining $5,000 in losses? You can carry over the $5,000 in losses and use it against future capital gains indefinitely. In future years when you don't have a capital gain, you can use your capital loss carryover to deduct up to $3k against your income (aka basic tax loss harvesting).


2) No expiration date on capital losses


Let's say you have $90,000 in capital losses because you sold stocks during a bear market. And let’s also say you have zero capital gains that year.You can use the $90k against future income (aka basic tax loss harvesting) or future capital gains (aka advanced tax loss harvesting) in the many years to come.Luckily, there is no expiration date for capital losses. 

3) The wash sale rule nullifies tax-loss harvesting benefits


A loss is disallowed if, within 30 days of selling the investment (either before or after) you or even your spouse invest in something that is identical (the same stock or fund) or, in the IRS’ words, “substantially similar” to the one you sold.


4) Losses must first offset gains of same type


In other words, short-term capital losses must first be used to offset short-term capital gains. And long-term capital losses must be first used to offset long-term capital gains. Not only can capital losses offset capital gains, but—if losses exceed gains that year—you could also use the remaining capital-loss balance to offset personal income (up to a limited amount). Please check with a tax professional for detailed advice on this. 


Direct investing benefit: tax-loss harvesting for you


If tax-loss harvesting seems like a daunting task that’s because it can be. You must pay close attention to your investments and track your gains and losses. By December 31, you also need to determine which underperforming stocks are worth selling to counterbalance any capital gains and minimize taxes.


Rebalancing your portfolio annually or semi-annually can be beneficial because it can keep your investments in line with your objectives and risk tolerance. 


For example, over time, a single stock or sector may grow to represent 35% of your portfolio due to strong performance. However, based on your risk tolerance and objectives, your preference is no more than 20% exposure. To get your current asset allocation back in line with your preferences, selling becomes necessary.


For do-it-yourself investors, the challenge with all this lies in potentially lacking the time, skills, or knowledge needed for effective investing. This is where Direct Indexing can be highly beneficial for the average investor.


Illustration depicting tax forms and documents, symbolizing tax-related concepts and strategies in wealth management.


Source: Fidelity Investments


How direct indexing helps investors manage taxes


What’s direct indexing? Check out this video by Plenty co-founder and CEO Emily Luk.



Direct Indexing operates by utilizing technology and advanced algorithms to replicate the performance of a specific index. Managers can leverage this technology for tax optimization within an investor's portfolio. According to a 2023 MorningStar study, direct indexing portfolios may yield an average additional return (tax alpha) of 1.08% per year due to tax management; at income levels above $100k, we’ve estimated that the benefit could range between 2-4%.


The potential performance boost stems from the tax-loss harvesting process discussed earlier. Technology, algorithms, and investment managers of direct-indexing funds handle the tax-loss harvesting on behalf of the investor. If the retail investor pays a lower fee than the benefit derived from tax-loss harvesting, it becomes advantageous for the investor.


The snapshot below from MorningStar in 2023 highlights the top money managers offering direct indexing for clients. Observe the starting fee ranges between 0.23% to 0.4%, which is below the estimated 1.08% additional return projected through direct indexing tax management.



In comparison, at Plenty, our minimum investment is only $100, making direct indexing available to almost anybody. In the past, direct indexing was usually only available for high net worth individuals. You’ll also appreciate our fee of only 0.2% starting on March 1, 2024. 


Customization is also a benefit of direct indexing


Another less-discussed benefit of direct investing is customization. When you invest in an ETF, you do not have a say in what is included in the ETF. When you invest directly in underlying stocks, you have much more control over what your money goes towards.


For investors who appreciate investing according to their values, taxsummaries.pwc.com, direct indexing offers such a beneft. Although, as you can see from the investment minimums above, not everybody can gain access–until now with Plenty. 

Direct indexing with Plenty


At Plenty, we plan to offer automatic direct indexing, with the help of AI, giving you the ability to fully personalize your investments based on what’s important to you, aka values-based investments. Again, with only a $100 minimum and a 0.2% fee, almost anybody can get started on March 1, 2024. 


Invest for the long term with Plenty


The best way to avoid paying capital gains taxes is to refrain from selling. However, when the time comes to sell some stocks to enhance your life, remember the advantages of tax-loss selling. It can significantly reduce your tax liabilities.


We hope you’ll join us at Plenty where you can benefit from maximized tax-loss harvesting across your portfolio. We’ll automatically look for tax-loss harvesting opportunities every week, adding potentially an extra 2-4% on top of your portfolio’s after-tax returns.* That means lower taxes and more money in your pocket.


Start your free trial now and explore everything we have to offer.


– Team Plenty



* Actual returns may differ. The estimated 2-4% is based on households earning at least $80k. Tax-loss harvesting benefits higher-income earners even more.


This information is for general informational purposes only. It is not intended to constitute investment advice or any other kind of professional advice and should not be relied upon as such. Before taking action based on any such information, we encourage you to consult with the appropriate professionals. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any investment or other financial decisions. We do not endorse any third parties referenced within the article. Portions of the information and opinions contained in this material are obtained from third parties and other sources believed to be reliable,however the accuracy and completeness of the information cannot be guaranteed. Market and economic views are subject to change without notice and may be untimely when presented here. Do not infer or assume that any securities, sectors or markets described in this article were or will be profitable. Past performance is no guarantee of future results. There is a possibility of loss. Historical or hypothetical performance results are presented for illustrative purposes only.



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Plenty was founded to democratize access to financial products and tools that accelerate wealth building. Plenty Financial and affiliated entities. (“Plenty Financial”) provide a web, mobile, personal financial management and educational platform to consumers; some of these tools are freely accessible to all consumers, others require a fee-based subscription. Advisory services are provided in the form of software-first financial planning and investment advisory services for fee-based Subscribers. Plenty Financial RIA, LLC is an SEC-Registered Investment Advisor. All investments made are legally owned by you. Investing is inherently risky and Plenty does not guarantee positive performance. Investments are held in accounts at BNY Mellon | Pershings, the world's largest securities servicing company and are SIPC insured. Investing involves risk, including the possible loss of principal, and there is no assurance that the investment will provide positive performance over any period of time.


Brokerage services are provided by Atomic Brokerage LLC "Atomic Brokerage", member FINRA and SIPC. Clearing and custody services are provided by Brokerage firm BNY Mellon Pershing, member SIPC. Plenty Financial RIA, LLC has a relationship with Atomic Brokerage to manage and execute investments on behalf of customers. Subadvisory services are offered through Atomic Invest LLC ("Atomic Invest"), an SEC-registered investment advisor, member SIPC. Atomic Invest was formerly known as Helium Advisors LLC.


Return data used in the interactive tool are hypothetical performance data which contains inherent limitations and is not a substitute for actual investment returns derived from a live portfolio. There are numerous risk factors related to trading and markets which cannot be fully accounted for when depicting Hypothetical Performance. Consequently, future returns are not guaranteed, and a loss of principal may occur. THIS IS FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE RELIED UPON AS INVESTMENT ADVICE. This site/application has been prepared by Plenty and is not intended to be (and may not be relied on in any manner as) legal, tax, investment, accounting or other advice or as an offer to sell or a solicitation of an offer to buy any securities of any investment product or any investment advisory service. The information contained in this site/application is superseded by, and is qualified in its entirety by, such offering materials. This site/application may contain proprietary, trade-secret, confidential and commercially sensitive information.


By accessing this site, you signify your agreement with and understanding of the following Terms of Use and Legal Information pertaining to both this site and any material in it. Plenty owns and maintains this site. No act of downloading or otherwise copying from this site will transfer title to any software or material at this site to you. Anything that you transmit to this site becomes the property of Plenty, may be used by Plenty for any lawful purpose, and is further subject to disclosure as deemed appropriate by Plenty, including to any legal or regulatory authority to which Plenty is subject. Plenty reserves all rights with respect to copyright ownership of all material at this site, and will enforce such rights to the full extent of the law.


Plenty was founded to democratize access to financial products and tools that accelerate wealth building. Plenty Financial and affiliated entities. (“Plenty Financial”) provide a web, mobile, personal financial management and educational platform to consumers; some of these tools are freely accessible to all consumers, others require a fee-based subscription. Advisory services are provided in the form of software-first financial planning and investment advisory services for fee-based Subscribers. Plenty Financial RIA, LLC is an SEC-Registered Investment Advisor. All investments made are legally owned by you. Investing is inherently risky and Plenty does not guarantee positive performance. Investments are held in accounts at BNY Mellon | Pershings, the world's largest securities servicing company and are SIPC insured. Investing involves risk, including the possible loss of principal, and there is no assurance that the investment will provide positive performance over any period of time.


Brokerage services are provided by Atomic Brokerage LLC "Atomic Brokerage", member FINRA and SIPC. Clearing and custody services are provided by Brokerage firm BNY Mellon Pershing, member SIPC. Plenty Financial RIA, LLC has a relationship with Atomic Brokerage to manage and execute investments on behalf of customers. Subadvisory services are offered through Atomic Invest LLC ("Atomic Invest"), an SEC-registered investment advisor, member SIPC. Atomic Invest was formerly known as Helium Advisors LLC.


Return data used in the interactive tool are hypothetical performance data which contains inherent limitations and is not a substitute for actual investment returns derived from a live portfolio. There are numerous risk factors related to trading and markets which cannot be fully accounted for when depicting Hypothetical Performance. Consequently, future returns are not guaranteed, and a loss of principal may occur. THIS IS FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE RELIED UPON AS INVESTMENT ADVICE. This site/application has been prepared by Plenty and is not intended to be (and may not be relied on in any manner as) legal, tax, investment, accounting or other advice or as an offer to sell or a solicitation of an offer to buy any securities of any investment product or any investment advisory service. The information contained in this site/application is superseded by, and is qualified in its entirety by, such offering materials. This site/application may contain proprietary, trade-secret, confidential and commercially sensitive information.


By accessing this site, you signify your agreement with and understanding of the following Terms of Use and Legal Information pertaining to both this site and any material in it. Plenty owns and maintains this site. No act of downloading or otherwise copying from this site will transfer title to any software or material at this site to you. Anything that you transmit to this site becomes the property of Plenty, may be used by Plenty for any lawful purpose, and is further subject to disclosure as deemed appropriate by Plenty, including to any legal or regulatory authority to which Plenty is subject. Plenty reserves all rights with respect to copyright ownership of all material at this site, and will enforce such rights to the full extent of the law.


Plenty was founded to democratize access to financial products and tools that accelerate wealth building. Plenty Financial and affiliated entities. (“Plenty Financial”) provide a web, mobile, personal financial management and educational platform to consumers; some of these tools are freely accessible to all consumers, others require a fee-based subscription. Advisory services are provided in the form of software-first financial planning and investment advisory services for fee-based Subscribers. Plenty Financial RIA, LLC is an SEC-Registered Investment Advisor. All investments made are legally owned by you. Investing is inherently risky and Plenty does not guarantee positive performance. Investments are held in accounts at BNY Mellon | Pershings, the world's largest securities servicing company and are SIPC insured. Investing involves risk, including the possible loss of principal, and there is no assurance that the investment will provide positive performance over any period of time.


Brokerage services are provided by Atomic Brokerage LLC "Atomic Brokerage", member FINRA and SIPC. Clearing and custody services are provided by Brokerage firm BNY Mellon Pershing, member SIPC. Plenty Financial RIA, LLC has a relationship with Atomic Brokerage to manage and execute investments on behalf of customers. Subadvisory services are offered through Atomic Invest LLC ("Atomic Invest"), an SEC-registered investment advisor, member SIPC. Atomic Invest was formerly known as Helium Advisors LLC.


Return data used in the interactive tool are hypothetical performance data which contains inherent limitations and is not a substitute for actual investment returns derived from a live portfolio. There are numerous risk factors related to trading and markets which cannot be fully accounted for when depicting Hypothetical Performance. Consequently, future returns are not guaranteed, and a loss of principal may occur. THIS IS FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE RELIED UPON AS INVESTMENT ADVICE. This site/application has been prepared by Plenty and is not intended to be (and may not be relied on in any manner as) legal, tax, investment, accounting or other advice or as an offer to sell or a solicitation of an offer to buy any securities of any investment product or any investment advisory service. The information contained in this site/application is superseded by, and is qualified in its entirety by, such offering materials. This site/application may contain proprietary, trade-secret, confidential and commercially sensitive information.


By accessing this site, you signify your agreement with and understanding of the following Terms of Use and Legal Information pertaining to both this site and any material in it. Plenty owns and maintains this site. No act of downloading or otherwise copying from this site will transfer title to any software or material at this site to you. Anything that you transmit to this site becomes the property of Plenty, may be used by Plenty for any lawful purpose, and is further subject to disclosure as deemed appropriate by Plenty, including to any legal or regulatory authority to which Plenty is subject. Plenty reserves all rights with respect to copyright ownership of all material at this site, and will enforce such rights to the full extent of the law.