Why is Direct Indexing More Expensive Than ETFs?

Part 5 of  "Absolutely, Positively, Yes! Direct Indexes Make Sense for Investors Worth Less Than $1MM and Over $5MM"

This is a continuation of our responses to Jerry Michael's and Brent Sullivan's conversation on LinkedIn.

Objection: Cost above a comparable ETF

Jerry’s Response: Competitively priced direct indexes are currently running in the 15 - 20 bps range (if you're paying more, you're probably paying too much). This is greater than the cost of comparable ETFs, but the price difference is dwarfed by the tax savings (see tax alpha discussion above). It's true that the cost of direct indexing is more visible than the cost of ETFs (where the management fees are buried in the net asset value), but this issue with direct indexing is not confined to small accounts. 

GMAM’s Response: While it's true that Direct Indexing (DI) typically runs higher than many passively managed ETFs—the value derived from DI can justify the cost, especially when you consider the broader advantages:

• Tax Alpha: Jerry rightly points out that the tax savings outweigh the price difference. Through tax-loss harvesting, DI provides an ongoing opportunity to offset not only current gains but also carry forward losses to offset portfolio gains as well as other gains such as the sale of a business or real estate.
• Personalized Portfolio Management: Unlike ETFs, which are "one-size-fits-all" products, DI enables investors to tailor their portfolios. Whether an investor wants to exclude specific sectors, avoid individual stocks, or incorporate their ESG preferences, DI allows for a level of customization that ETFs simply cannot match. This personalization helps investors align their portfolios more closely with their personal financial goals, risk tolerance, and ethical considerations.
• Ownership of Individual Securities: With DI, investors directly own the underlying stocks, providing more transparency and control compared to owning a share in an ETF, which is a pooled product. This can make it easier to implement specific strategies, such as charitable giving or multi-generational estate planning, where gifting appreciated stock directly can yield additional tax benefits.
• Transparency and Control: The fees in ETFs are indeed embedded in the net asset value (NAV), making them less visible.        DI offers greater transparency and direct ownership of individual stocks, providing greater flexibility in managing positions. 

        In conclusion, while DI fees may be more visible and slightly higher than those of ETFs, the greater flexibility, tax efficiency, and control it offers can significantly enhance long-term wealth creation. For investors with taxable accounts or complex wealth management needs, these benefits far outweigh the cost difference.