Direct Indexing: How to be Tax Efficient with Money Outside of Your 401k

Welcome to EWA’s FinLyt podcast. EWA is a fee -only RIA based at Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you.

And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. In today’s episode, we’re going to talk about a new strategy called direct indexing.

I think the best analogy I have for direct indexing is this is a technology that makes wealth management much more tax efficient. And the analogy I have is imagine a surgeon that now has the ability to operate with robotic arms.

So the robotic arms are not replacing the surgeon. You still have a surgeon doing surgery on you. But the robotic arms are not replacing the surgeon. They allow them to be more precise and get to angles that the human hand could not otherwise.

So direct indexing is simply a technology that does not replace the human touch. It really enhances the human touch. So a financial advisor like ourselves can do the best possible job for you. So we’re going to talk first, what is it?

And then Jameson’s going to talk about what it’s not. Then we’re going to talk about benefits of it. And then we’re going to close this podcast episode out with some direct applications for specific clientele that we work with, like physicians, executives, et cetera.

So to get right into it, what is direct indexing? So if you think about a portfolio, like in your 401k Roth IRA, typically you have a portfolio that holds funds. And those are either mutual funds or ETFs and generalities.

And those mutual funds or ETFs generally hold hundreds of companies. And the purpose of those are to ask that allocate to Versify. Jameson’s going to get into that in a second, because direct indexing is not replacing any of that.

But specifically in a way that’s tax deferred account like a 401k Roth IRA, it doesn’t matter if you move between a fidelity or a Vanguard fund. There’s no tax consequences in a tax deferred account.

However, if you’re a high -income earner, there are very strict limits on what you can put into a 401k. If you’re under age 50 in 2023, the total it’s called a 415C limit is 66 ,000 a year. So that’s obviously something smart to do.

Roth IRA, if you’re under 50, it’s 6 ,500 a year. HSA, if you’re married, you know, filing jointly, it’s a little bit over 7 ,000 years. So these different buckets, if the government puts a limit on it, generally speaking, you should be maxing it out.

But, you know, if you’re, for example, make it a half a million to a million or $2 million a year, there’s a lot of cash flow that you’re going to need to save to keep up with your lifestyle later in life.

And most of this money is going to end up going in what’s called a non -qualified account. So just to be really clear, direct indexing, in our opinion, is a tax strategy. that’s not replacing any of our other investment principles, but it only works in a non -qualified account from a tax perspective.

You could direct index in a 401k or Roth IRA, but to get the actual benefits of it, this has to be a non -qualified account, which is just after tax money that goes into brokerage account and then purchases things like stocks, ETS, mutual funds, et cetera.

So specifically what direct indexing is, now that we have that background, is if we look at each category, so our three rules of thumb for investing principles are asset allocation, which just simply means we want to take the lowest amount of risk to get the highest amount of return, so it’s the marriage between high returns and low risk, which does limit the returns on the upside, it does limit the risk on the downside.

It means you basically own six to eight asset classes, and the second principle is diversification, so inside each asset class, you have to have at least 25 companies to remove 80% of a risk of a company going down, and then 100 companies to remove 90% of that risk.

So direct indexing is essentially you owning the companies directly that a fund would otherwise own for you. So if you own S &P 500 index, you own one fund, but really you own the 500 companies inside of that fund.

If I’m a direct indexer, and hypothetically I would just directly go purchase those 500 companies myself. So that’s just very high level what it is. We’ve found that you need at least 100 to 150 companies to get within a 2% tracking error of, for example, our large cap, we want 40% of the portfolio to be in large cap, hypothetically, we would need at least 100 to 150 companies that are in the large cap category to get the tracking error within 2% return of what the S &P 500 would do.

And the reason we’ve set this to 2% tracking error is because generally speaking, there’s a 1% or 2% tax benefit per year to this. So worst case scenario, if you’re on the low end of that return, you’re still making it up from the tax benefits.

And most years we found you’re still going to be ahead of the game with even or even better returns with being a direct indexer, although that is obviously not guaranteed. So Jameson talked to us because we’ve now, I think 95% of our clients that are high net worth clients, high income runners have adopted this model with a non -qualified account done in 2022 in the market drop, which is amazing timing because tax law start -up is one of the purposes of direct indexing.

But first, let’s talk about what is it not? Let’s be clear on what does it not accomplish? Yeah, I think it’s important to understand that it’s not any different of an investment strategy. So like you said, we always follow whether we’re investing in ETFs, mutual funds, stocks, bonds.

main principles of asset allocation, diversification, long -term investing, asset location strategies. So this is not any type of, we’re shooting for a really high rate of return. We’re trying to say that, you know, this stock’s balance sheet looks really great.

We’re looking to outperform the indexes. We’re actually trying to mirror the indexes exactly and get within a 2% tracking error, like you said, of that index. So shoot for the exact same, almost returns.

And in doing so, the main benefit is the tax efficiencies. And I think a lot of high net worth individuals, like you said, there’s only so many tax favored, so much money that can go into tax favored account.

There’s a reason the government limits how much you could put into. So they’re always asking for new tax strategies of where they can put their money, save on taxes, because most of their income’s getting hit, you know, at the 37% tax bracket.

So anything that they can save on is generally what they wanna do. But I think you told me this quote the other day, that Warren Buffett said that he has only picked like seven good stocks or something in his lifetime.

So it’s like being able to pick a company is almost impossible anyway. So just to reiterate, that’s not what we’re trying to do, to try to mirror the index and the funds that we would already be invested in.

Yeah, this is not a stock picking strategy. This is we’re trying to mirror the index. We’re trying to invest with the market, not trying to time the market, not trying to beat the market. We’re just trying to invest with the market.

But instead of being a buy and hold ETF, mutual fund, this is a buy and hold. We actually own the companies that otherwise ETF are mutual funds. So essentially we’re just removing another middleman, because then you remove completely the cost of the internal fees that a mutual fund or ETF would have that you’re getting charged for on top of whatever your advisor is charging you for.

So it’s a much more cost effective strategy as well. Okay, so let’s talk about the benefits. And let’s just go back and forth, because I know we’ve had hundreds of conversations. conversations in the last 12 months as we’ve rolled this out.

I’m going to talk about, as far as benefits go, in 2021, we actually have this brochure. We’ll put this in the show notes. It’s a good, well -thought -out brochure that EWA team created. Put this right on our website.

So generally, tax loss harvesting, if you have a brokerage account, this can be done with mutual funds or ETFs. So you have a fidelity fund in large cap that goes down. And you sell it. Let’s say you have $100 ,000.

It goes down to $90 ,000. You sell it and buy it. Not an identical, but a similar large cap fund, let’s say a Vanguard fund, because you don’t want to ever go out of the market at a time. As the market recovers, you’re in the same place.

But that $10 ,000 loss in that example, you’re able to now carry forward up to $3 ,000 per year, actually, against your income. And you’re able to carry that forward forever. until the loss carry forward is used.

But you’re also able to carry forward those losses to offset gains. So short term or long term losses doesn’t matter, offset short term or long term gains. And so if you think about when you retire, if you have a 401k and you’re taking requirement of distributions out, you have social security, you know, whether you like it or not, whether your expenses are high or not, when you retire, you’re gonna show income between RMDs and your social security, maybe if, you know, depending on your age, if you have a pension or not, then if you have a Roth IRA that’s tax free, but typically, you know, high net worth person would have a large amount of their money and equities or private equity.

When that stuff starts getting unwound, there are capital gains that have to be paid. And so if you’re a direct indexer and you’ve done tax loss harvesting, you know, diligently your whole life, all those losses, which are just subtle fun switches and you can’t go back into the original holding stock or fun within 30 days, and then there’s also be a wash sale, you gotta carry those forward with you for life and potentially offset all the gains you have when you’re distributing.

So it’s an incredibly tax efficient way later to distribute your money. So that’s one of the major benefits. And the reason the direct indexing really puts this on steroids is 2021, this is in the brochure, the Russell 3000 index, which, you know, US stocks in general, so 3000 companies, the index went up 25 .7% that year.

And so if you held the Russell 3000 fund, you put a hundred grand in, it would have gone up, down a little bit, up, down, up, down, but there was really little opportunity to tax loss service because 2021 was a really good stock market year.

However, let’s say I was the fund holder, let’s say Jameson didn’t hold the fund, he just went out and purchased the 3000 companies directly, which would take a lot of time. a lot of effort. Out of those 3 ,000 companies, 992 of the 3 ,000 companies actually had a loss instead of a gain.

So typically in index, some of the companies are really well if it’s a good year, but a lot of them are still at a loss. And so you would have had the opportunity to sell those 992 companies by replacements, get similar returns within a tracking error margin, but all those losses if you didn’t go back to the original state within 30 days, you’d have in your back pocket for the rest of your life, whereas I would not.

So just tremendously, in that example, maybe we got the same exact returns in 2021, you know, within a tracking error of 2%, give or take. But Jameson now has an incredible tax advantage over what I would have had as a just a regular fund investor.

So that’s really In my opinion, the first benefit of direct indexing. But James, give us some more thoughts. Yeah, a couple of things on the taxes. So first, just to fundamentally break that down. If you have 300, just overly simplify this, you have 3 ,000 stocks in that index, you need 10% of it to be within a 2% tracking error.

So let’s say we need at least 300, hypothetically, in this example, to get within that return. And so that gives so much flexibility of, okay, we have 300, but 900 of them were down. So just to make that overly simple, you basically, what we do is we take the same, think of like, say if you’re, for example, investing in an Apple stock and techs getting crushed and you sell Apple at a loss and you purchase something that ideally would perform very similar.

I don’t say you buy Amazon. And that’s not a wash sale, because it’s a different stock. But they should, again, this is where the technology comes in and some of the math behind the scene, should perform the same way and then they’ll rebound in the next 30 days.

And you can either buy back to Apple or keep Amazon. So the first thing is just buying a similar performing equity and having that, we have a lot of leeway by only needing 10% to get within the 2% tracking error.

That gives you optionality when a company goes down, you have a replacement ready to go. Because typically, the amazing thing about the technology is if we did this by hand, it would take tons of reports, tons of, but the technology really just makes the human touch much more efficient because it gives us the data.

And there is artwork here. So I wouldn’t want a robot doing surgery on me. I want the surgeon controlling the robot because there are decisions that have to happen on the fly. So for example, if Apple drops and the technology is saying, hey, you can buy Amazon, but the tracking error is 3%, well then we have the artwork to determine, is the tax benefit really worth that much when we’re putting the integrity of the risk?

We’re allowing that to be higher than our philosophy, which is that 2% cap, and the answer is no. Whereas the robot, the technology would say, trade, trade, trade, trade, because it’s just looking at the taxes.

where we have to set those boundaries and artwork to make sure that the fundamentals of the investing strategy are kept in place, which are, again, asset allocation, diversification, and making sure you have a time frame of at least five years for equity investing.

So that’s a great point, Jameson. Give us some other examples of the benefits. Yeah, as I say, one other thing with taxes, too. A lot of, just as we’ve really done this at a high scale over the last year implementing this, but a lot of high net worth individuals have, like if you look at their tax returns, it’s very complicated.

They’re probably not just a W -2 income earner. They may have multiple K -1s, 1099 income, business ownership, whatever that is. And so if any of that, like I’m thinking of one example of someone I work with, had some private equity payout, it was a big gain, but we had, we working with a substantial non -qualified account that we had flipped into direct indexing in 2022.

So the market was getting crushed. I think we realized like 200 ,000 of losses didn’t sacrifice a return of the portfolio because we sold out of the ETFs that he was in and then purchased the exact same companies in individual stocks.

So the same return risk of the portfolio, but doing that, we were able to realize like 200 ,000 of losses and that offset his private equity payout. So, what he’s in the same, the portfolio is in the exact same spot it would have been if you’d just let it sit there.

And he saved $50 ,000 in taxes. The capital gains on the $200 ,000 gain. Yeah, that’s huge. That’s a good example. For high net worth people that have more, they’re not everything’s just taxed at an income rate like a W -2 employee, they’re having private equity, real estate, different things payout and this is a great strategy to capitalize on.

Absolutely. So, other benefits are also just simple control. So if you have a company that you have strong affiliation to, let’s say you held a certain stock for the last 50 years, and it’s just really like, it’s more heart based that you wanna keep it than or feeling based than a logic based.

And this happens all the time. The technology will work around that. So let’s say you have a million dollar portfolio and you have $100 ,000 in one stock and we mark that as never trade this, the decision making of you and I enter direct indexing at the same day and I wanna add the $100 ,000 that I never wanna sell, the companies that would buy around that to get that tracking error down to 2% to mirror the indexes would be totally different, not totally different, would be different than yours.

So at the end, I get to keep my stock, I have a 2% tracking error, I be direct index and so would you. But it provides a lot of flexibility for legacy holdings as well. And not just to say, oh, we’re gonna hold that in a separate account, let’s forget about it, well that people don’t know, that your risk profile may be thrown out of whack.

This takes all of that into consideration and allows the, again, what I call the artwork of the financial planning to really take place. Yeah. And I think, like you said, there is a huge, you feel tied to a stock or psychology behind it, but a lot of executives at large corporations, a lot of their compensation is through equity payouts.

So we’ve worked with some executives that they’re getting a bunch of stock options in our SUs and maybe like politically they don’t, it’s in their best interest to the stock, but they may want to keep it for political reasons within the company, rightfully so.

And so we’re able to get that concentrated position into the direct indexing portfolio and then do exactly what you just said, de -risk everything else around it and that satisfies that asset class holding.

Absolutely. So I’m going to, there’s this graph we have in this brochure that, hypothetically, if you had a million -dollar portfolio and over 20 over 20 years, you got a, you know, just normal returns after taxes of 6% versus if you were direct index and able to save 1% per year in taxes, have a 1% year higher return, that million dollar portfolio, in the 7% return example net of taxes, you’d have a $662 ,000 more than you would in the 6% return.

That’s what direct index does. There’s actual academic research that shows, I think it’s a little over 1%, 1 .08% of the actual value of alpha, value add in your portfolio if you’re a direct index or versus not direct index.

Yeah, that study is super interesting. They looked at, since 1930, I believe, I think it was last 90 years, the S &P 500 performance versus if you just bought the S &P 500 index those 90 years or if you owned the 500 companies and tax loss harvest, and that’s what the study shows, is that 1, a little over 1% benefit.

So, yeah, very interesting. I was going to say, long lines of control, Matt, talk a little bit about, you know, if you’re in an ETF or mutual fund, you have zero control over the taxes, they’re kicking off to you on your…

The S &P 500, so you share this statistic, actually over 1, James, and so the S &P 500 tell us, like, what was the average time frame a company stayed in the S &P 500 in the past and now, and what that’s trending to now?

Because that’s going to lead into helping me answer my question. Yeah, this is really interesting. So, if you look at just like lifespan of a corporation, it’s about 30, between like 30 to 40 years. So, a company lasts about 30 to 40 years.

The S &P 500, if you look at, you know, what is the S &P 500, the S &P 500 is an index of the 500 largest companies in the United States, and those companies may… move all the time. Whenever that report comes out by standards and poor, they could say, totally make this up.

Google’s out and Amazon’s in, whatever that is. That lifespan of being in that S &P 500 index right now is 12 years. So the average company is in that top 500 for 12 years. It used to be in the, in 1950, yeah, it was seven, which is even lower, but data is showing now that it’s actually declining.

So 12, I don’t know what it was the year before, but it’s trending backwards, back towards that seven, that seven years. There’s, there’s, I mean, so much polarizing differences and political beliefs.

There’s leadership differences. Even like in technology, right? 20 years ago, I mean, think about like the biggest players, what just looked like this Apple was like, fundamentally the largest company in the world, like they’re, you know, the market value.

Yeah. 20, I don’t say the 1990s, like Apple was not the largest company in the world, like nobody. Maybe some people would have predicted that, but it’s the industry’s change, technology’s change that yeah, it revolves all the time.

Okay, so thank you for that background. Let’s help me now answer the question you have for me, which was if you just hold an index, which is generally very tax efficient, when those companies change the fund, you’re paying a fee to a manager to make sure that you actually have the S &P 500, which isn’t a change every year, which means the companies get sold out of it and companies get bought into it.

When you hold, even if you’re not selling your fund, when there’s turnover in a portfolio, the tax liability goes to you and every other person that holds the fund. And a mutual fund, that’s like the worst thing in the world if you’re a non -qualified investor because there’s, I mean, the turnover is crazy.

Some funds have 10, 15% turnover and maybe you even lost that year, like you put 100 ,000, it’s less, but you actually have tax liability because of that turnover. And direct indexing, there’s taxes that help work for you, meaning there’s losses that can carry forward and there’s tax that work against you, which means you didn’t have a gain, but you’re still paying taxes if you did.

And so direct indexing not only gives you tax benefits on the upside, they more importantly, I’ll say more importantly, just as importantly, they avoid the tax liability, you have the downside if you were a mutual fund or a tax liability.

Thank you. If you’re a high net worth individual and then another layer of that is like dividends get paid out. If you’re holding an ETF or mutual fund and they’re in a bunch of like dividend stocks, that’s immediately, everything’s getting clipped at 37%.

Whereas direct indexing, we can selectively, okay, well in the non -qualified account, maybe we’re not going to hold companies that are paying high dividends for that reason. We can be much more selective and have control over tax situation for your individual situation versus just a fund as a whole.

Yeah, and just to clarify, qualified dividends should be the highest tax back at 23 .8, capital gains 23 .8 and then non -qualified dividends are short term. term loss would be the 37. But regardless, it is incredibly important to be as tax efficient.

If you have a couple million dollars in non -qualifying account and you’re direct indexing, and hypothetically you’re able to limit your tax liability versus if you’re on mutual fund, a couple million dollar portfolio, your tax turnover may be a couple hundred grand a year.

And if you’re capping, paying a 23 .8% tax on, let’s say, I mean, that’s over 70 ,000 of tax you’re paying on something you didn’t even sell or you’re not even using. And that just is every year that’s $70 ,000 that’s not, instead of getting reinvested, that’s going to Uncle Sam.

And that can be completely avoided by putting money in the right places, so prioritizing 401ks, Roth IRAs, HSAs, all the tax deferred investments. But then after that, if you’re a high net worth person, you’re going to have to put the majority of your wealth in a non -qualified account and being able to avoid that tax liability through tax less starves and through a direct indexing strategy.

So essential yeah to protecting your wealth. So last benefit we’re gonna talk about here And there’s a couple real quick hits like donor advice fund step up and bases at death James You talk about those in a second, but just from a cost perspective so Michael Kitch is a well renowned Financial advisor expert.

He does has a blog courses. So not only financial advisor described you to stuff But the general public does as well Actually a friend of myself and EWA’s great guy He did a research on the average portfolio cost Not what you’re paying to financial advice.

So let’s say in general it’s 1% it’s a little bit higher than that for most financial advisors the average portfolio cost on top of the advisor cost is 0 .65% Which is just absurd. That’s a lot of fees on a million dollar port for that’s $6 ,500 in fees if you’re a Passive investor, you know, you should be able to get that down to 15 to 30 basis points.

So a half or if not a third of the Standard which is you know in general our philosophy ride with the market not against it active management most of the time will not Be just general index investing The direct indexing eliminates that you own the company’s outright.

There are no soft. There are no internal cost So no wait we layer in a small cost because the technology is expensive We have the higher additional manpower and more important if you’re a direct indexer, you know a big Custodian like Fidelity Charles Schwab our two main ones that we use They for international trades charge for 95 a trade.

It doesn’t matter how big your account is and so we sponsor a wrap program That covers all of those commissions. And so if you have a buy 100 international stocks at $5 a trade, that’s That’s 500 bucks and then if you you know have the tax loss tariff set That’s another 500 bucks.

So we cover all that so we have this figured out where we’re gonna have, you know the direct indexing Cost is lower more than half lower the average industry standard of a Soft cost of a portfolio and it’s all inclusive So we you know commissions all that kind of stuff you try to do this on yourself the technology the tracking or all that stuff Is it is included which is really cool.

So The cost reduction of a direct indexing is incredible Then any so that point six five if you’re in ETF from mutual fund portfolio that never changes whether you have a million or ten million Not scalable and so with talk about a little bit how we have it as the you know The account goes down that’s gonna slide down just like the advisor.

Yeah, absolutely So the bigger account is it goes in half it goes down a third So I mean it almost becomes you know, I think the lowest the lowest year we have is like ten basis points for that so Talk to us about just some couple quick hits on ancillary benefits such as you know step up in basis or donor advice funds how a direct indexing could Benefit you more than just a regular investment.

Yeah, dinner advice funds is a good one. There’s a lot of tax savings and a lot of a Lot of high net worth people that we work with they’re very Mission -driven they’re very they like to be philanthropic, you know, they there’s They’re working because they really care about some Matter something that’s what they you know, they’re doing something for purpose And so a lot of them are charitable inclined and although we want to give Two charity for the charitable reasons if we’re gonna do it we might as well be as tax -efficient as possible So a big benefit is if you let’s just high level if you donate into a donor advice fund you take a hundred thousand dollars You donate it you get to deduct that against your taxes that year So if you’re in the highest tax bracket save 37% oversimplified example if you donate In appreciated stock, however, some charities can accept an appreciated stock some cannot If you donated an appreciated stock into the donor advice fund, so let’s just say Again oversimplified example, maybe there’s a zero in this hundred thousand dollar example Maybe the stock was gifted to you or something.

There’s a zero basis and there’s a hundred thousand of gains If you donate that if you sell the stock and give it to the charity you’re paying capital gains taxes on it so twenty three point eight and Then you obviously get to deduct the donation But if you donate the appreciated stock into the donor advice fund you get to avoid the capital gains tax So you’re saving that twenty three point eight plus you’re getting the the deduction against your income for the charitable donation so a hundred thousand dollar best You’re getting over sixty thousand dollars immediately.

I can tax savings. Yeah, so don’t you know being a direct induction I don’t realize you to do that The technology will also immediately adjust integrity the portfolio and say okay, we’re no longer holding So let’s say in that example.

It was like a Tesla that you bought before it became Tesla and you’ve donated a hundred thousand Tesla Now this offers a recommend buys and sells to get the tracking are right back within 2%. If you were a mutual fund or ETF holder, you can’t take that big of a sniper shot into a little basis holding.

You’re not threatening the integrity of the portfolio, you’re having probably to sell off a little bit of each fund to stay asset -allocated, stay diversified. So the direct index, I can’t stress enough, provides the flexibility to be extremely tax -efficient, which is amazing.

Absolutely. Okay, let’s go into, we’re going to close this out and let’s go into direct application. So the application number one, if you’re in the highest tax bracket, which I don’t know, Mary Fine jointly is over 600 ,000.

I think it’s like 690 for 2023, went up quite a bit. Went up with inflation. That means you’re in the highest capital gain rate. So just talking about Pennsylvania, we’re talking about 23 .8% plus a 3 .07% Pennsylvania tax on any capital gains.

Direct indexing, if we can avoid that. It’s a protection of your wealth. You’re keeping more money rather than paying it to taxes as your non -qualifying accounts grow. In states like California where state tax is even higher and higher, the tax benefits are even bigger.

So anyone that’s a high income earner, anyone that’s dollar -cost averaging, we found this to be extremely effective. If you’re putting in five or 10 ,000 a month or quarterly, and being on how cash flow works, you’re purchasing all these stocks throughout the year and dollar -cost averaging high and low points, which is a safe entry point into the market versus being worried my investing too high and my investing too low, et cetera.

So my favorite application, though, or two favorite applications, asset location, we can put on steroids through direct indexing. So, but asset location is basically essentially, if you have a football team and you have a quarterback, you don’t want your quarterback on the defensive line, you want him as a quarterback, right?

So a lot of investment portfolios we see these mistakes. You don’t want to put a high turnover, real estate investment trust into a taxable account where you’re paying all kinds of taxable events or a high turnover mutual fund and emerging markets, generally speaking, or a higher turnover.

But if you stick those kind of holdings inside of a Roth, inside of a 401k, it doesn’t matter, that’s all tax deferred, you can really stick your blue chip companies, individual companies, a direct indexing model that you can oversee all of this together.

So instead of viewing each account as a football team, your entire portfolio, your 401k Roth, HSA, taxable account, everything’s one account. We’re sticking the investments to mitigate miscan get the corresponding highest returns possible for the lowest amount of risk, the asset allocation, we’re doing that the most tax efficient manner on top of the individual benefits of direct indexing and how tax efficient that is.

So that’s benefit number, that’s the application. My favorite application is the asset allocation aspect of this. My second one is for executives or for any person that has a… you RSUs or company stock.

And so a lot of times what we find is if you work at a tech company, if you’re an executive, generally speaking, we’ve seen up to about half of your compensation on a yearly basis is going to be their stock.

And so as an actual example, let’s say someone has a salary of $300 ,000 and then as a cash bonus, but then they get given $300 ,000 of restricted stock and then those get taxed when they vest. So three years later, typically those get taxed.

And a lot of clients that come to us after doing this for 10 years, I mean, they’re literally their balance sheet is like 80% company stocks. Not only is the company that’s paying them their paycheck a risk because they have such a high lifestyle, such a high cash flow based upon one company, their entire balance sheet and almost their entire balance sheet is also predicated on the success of this one company.

So politically. Lot of times executives will need to keep one or two times their salary in the company stock So if we instead of we have a couple million dollars in the company stock And we want to first recommend to start diversifying that we can move all of that into a direct index portfolio So some of it keep some of it so then the decision making and Process of what companies are built around that are all predicated on that staying forever and that is Risk management technique that I cannot speak highly of because there are some companies I mean James and speak to you can speak to one of your clients You know the stock was literally over $300 a share and we recommended to sell it and and that client was like oh You know the CEO says it’s going to 500 Well sitting today This is two years later the stocks that under 10 bucks a share and so it was millions of dollars of Saving the exam and that one luckily we just wasn’t an exact there was no requirement for this client to hold the You know the one or two times salary so luckily it was all sold but it literally saved millions of dollars But you you looked like you had something to say what I was talking about so With the asset allocation I say one other application is clients in distribution phase so if you’re oh, yeah a lot of advisors and just speaking from like previous term We’re at a lot of advisors depending on your platform They’re maybe in like a model portfolio And so if you’re selling and say you’re retired or you’re taking some sort of distribution They may have to sell across every asset class So they may be properly asset allocated with an ETF or mutual fund within each asset class But if they want to send you money back they have to sell a little bit of each category essentially That could be good if the markets up But if the market’s not doing well you may be choosing to sell losers versus only selectively selling the winners Direct indexing takes that another layer deeper so we could not only would we have all the asset classes?

is covered. Let’s say within large cap for example, maybe large caps performing as a whole asset class down, but maybe tech’s doing really well. So within the large cap asset class, tech stocks are still positive and we can take that sniper shot of, okay let’s sell these tech stocks in a year that the market is down 20% at a gain to eliminate locking in any losses, which will obviously be a huge benefit to the portfolio long term.

So if you’re in distribution or taking any type of withdrawals from the portfolio, this can eliminate a lot of risk to that as well. Yeah, and I think the nice thing about, you know, behind that worth financial freedom is there is really is no time frame.

I mean, it’s literally there’s going to be enough for you to live off, there’s going to be enough for your kids, so the time frame is very, very long. And so having an approach where you never accept losses and only take out at a gain provides a lot of just not only flexibility, but the you know, probabilities for success go up tremendously.

And just to, just to, just because we talked about selling losses a lot, if we are selling losses, we’re buying back into the market. This would be sell again to take actual cash out. It would be the difference.

So yeah, you’re, you’re, you’re selling one stock, you’re buying it, something similar to keep that tracking. You’re immediately, yeah, same day. So well, thanks for tuning in to our podcast. Hopefully you found this helpful.

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