Direct Indexing

In this announcement, EWA is introducing a new Direct Indexing platform for its clients. The key principles of asset allocation, diversification, and long-term equity investing will remain unchanged. Direct Indexing involves holding individual companies rather than ETFs or mutual funds, ensuring greater control and tax benefits.

With Direct Indexing, clients will own a diversified portfolio of at least 125 individual companies within each asset class, reducing diversification risk and offering more opportunities for tax loss harvesting. The goal is to match an index within a 2% tracking error and strategically manage tax implications.

The benefits of Direct Indexing include potential tax alpha of about 1.8%, capital gain avoidance, and lower internal portfolio costs compared to traditional mutual funds and ETFs. EWA plans to scale the cost structure based on the size of the investment, making it cost-effective for clients.

Overall, this new offering aims to provide EWA clients with greater control over their portfolios, tax efficiency, and cost savings while adhering to the core principles of sound wealth management. Clients can expect a seamless transition to this platform with potential cost reductions.

Video Transcript

Excited to announce as EWA continues to provide the best in class service for you as our clients, our direct indexing platform that’s now available to you as a client. So direct Indexing, I want to break this down into what principles we follow.

As wealth managers in general and how those will not change with this new offering. Secondly, the what and the how of direct indexing. And then third, we’re going to talk. Specifically about the benefits and why would this benefit you?

Why will this benefit you as a EWA client? So first of all, the principles that will never change under our firm are that we follow asset allocation diversification and anything that we do, long term equity.

Investing has to have the right time frame attached to it. So asset allocation is really just the. Marriage between taking on the lowest amount of risk but also getting the highest return in the process.

So how to find the artwork between high returns with low risk and then also directly underneath each asset class is. Having a diversified portfolio. So holding at least 25 to 100 companies in large cap, in mid cap, in small cap, in each category, a bundle of pencils you can’t break, but one company you could break in half.

A diversification makes the strength in numbers. And then the third thing is long term equity investing. Number one rule of wealth managing is. Never take a loss. So as long as the time frame. Is matched, any equity investing that you do has a time frame that’s appropriate attached to it.

You’re never going to be in a position where you have to take a loss because you have the failsafe for short term time frames and there’s volatility and then obviously the equities are there for long term wealth accumulation and preservation to keep up with inflation.

So with this new offering, just quick review, those principles will not change whatsoever. And. Direct Indexing. What is it? Right now, the majority of EWA portfolios hold largely in part ETFs and a couple mutual funds, International Space.

So an ETF typically holds a couple hundred companies. What Direct Indexing does is you as an individual investor, instead of holding the ETF, you now hold the companies yourself. So instead of having a, for example, vanguard Large Cap Growth Fund, you would not see that fund.

You would see 100 companies that make up that fund. So just a quick review. Diversification is the importance here. 25 companies owned in one asset class reduces 80% of the diversification risk. 100 companies reduces 90% of the diversification risk.

In our model, we have chosen for 125 companies. The reason behind that is it’ll give us the greatest benefit, the greatest chances for tax benefits when we get to the tax loss harvesting conversation.

And this also improves our diversification risk. Anything above 100 really doesn’t improve diversification based upon studies. But going a little bit above 100 does present us with more less tracking error and more tax loss harvesting benefits.

So if we own these companies, the benefit of this is really to be able to decide when a capital gain is realized and then if there’s a loss. So, for example, if Pepsi drops and we go to Coca Cola, as long as we go back to Pepsi within a 30 day time period, that loss that we took in Pepsi, we can offset up to 3000 per year off our ordinary income taxes each year.

And then we can also off that the rest of that carried forward into the future to offset any capital gains making our tax distribution system in the future hopefully a net zero if we follow this system.

So the decision making between when are we going to. Ah, decide to take a loss, what company do we switch to? So when doing direct indexing, we match an index and we have a technology that determines are we within a risk ratio that we want to be.

And so we’ve narrowed this down to a 2% tracking error. So for large cap we’ve chosen the S and P 500, mid cap, S and P 400, small cap, S and P 600, so on and so forth. So we always are going to stay within a 2% tracking error and as long as there’s a tax benefit to selling something that we’ve held for 30 days and we can stay within that tracking error for more than 30 days with a sufficient replacement, then there’s always going to be a sale made for tax benefit.

So the goal here is we’re getting the same, taking the same amount of risk for the same return, same diversification, same philosophy of staying long term, but we are going to have a minimum tracking error for what the portfolio is already, but lots of tax benefits that we’re going to explain in a second.

So the benefits from a tax perspective and a cost perspective are first owning the companies individually. In 2019, the S and P 500 index went over 25%. There really wasn’t a time frame in that year where you could have sold out of an ETF and jumped to another ETF because the industry as a whole went up.

However, a large amount of companies inside the index were negative. So if we held the companies instead of the index overall we’d have still gotten that above 25% return. But we could have gotten lots and lots of tax benefits by selling and replacing, selling and replacing along the way on average been done over the last nine decades.

What does that add up to be? It’s about 1.8% of a tax alpha which would completely eliminate your fee if someone’s actively doing this throughout the year by doing tax loss harvesting. If you own the individual companies instead.

The funds themselves just due to the number of opportunities you’ll have by holding hundreds of companies versus just holding a fund that tracks the index overall. The second benefit is there’s a capital gain avoidance and this is going to be, generally speaking, above 1% as well.

Typically in October and November, mutual funds will determine, here is our capital gain that’s expected for the year and whether you’ve held that mutual fund all year or whether you’ve hold that mutual fund for partial of the year.

When a mutual fund decides to change over the companies they hold, the capital gains get dispersed to you as a taxable event. So we don’t have to worry about a manager making those decisions. Maybe you have a Roth conversion you’re doing this year, a Medicare rate that we’re trying to stay under.

We now have control of that and we will never unexpectedly realize capital gains without your say or control. But we’ll certainly be helping eliminate those capital gains on the loss side along the way.

The other major benefit of owning the direct index or the companies versus the fund is the cost. So generally speaking, studies have shown one was done on Kitchen, a well known researcher in the financial advisory industry.

That the underlying cost, not the advisory cost because none of this is going to change the advisory cost of firm charges, but the internal cost of the portfolio that the mutual funds and ETFs charge on average average would be about zero point 65%.

Now, our firm average is right now zero point 32% large in part because of the custodian fidelity that we use. We’ve negotiated, hey, let us use the lowest cost institutional funds and pass those on to our clients, which we do.

So those are all clean shares, so we don’t take any of that. That just goes to the managers of the mutual funds. But if you’re an EWA client and that’s what you’re paying right now, that’s going to the.

ETFs and the mutual funds underneath the portfolio. However, this does not scale. So if you have $100,000 a million dollars, 10 million or 100 million, that zero point 32% would be the same across the board.

And the higher you are, obviously the more expensive that would become. In a direct indexing, there are no costs. We’re operating in a zero commission platform, and especially at EWA we offer what’s called a wrap program.

So any buy or sell, if a commission is charged, it gets billed to us, not to you. So you’ll never pay a trading fee to get in, you’ll never pay a trading fee to get out. There is no commissions. If anything is charged, it gets billed directly to us.

Second, there’s no cost of holding an individual company, so there’s no cost to get the individual company, there’s no cost to sell it and there’s no cost to hold it. There is a significant technology investment to monitor the opportunity for the tax loss harvesting and the tracking error to make sure that’s maintained.

And there’s significant manpower that needs to go in and trade the positions at a loss on a daily, sometimes weekly or monthly basis. So we plan on scaling this where it will start at 0.4% and drop all the way to 0.1%.

For existing clients, we want to make sure this is a cost neutral, actually a small decrease. So if you’re an existing client, this will start at 0.3 and then scale down to 0.1 the bigger you are. So there will be a small decrease for clients that are existing clients that transition to the direct index.

No cost to make the transition, small cost decrease. But then as you get bigger, the cost scales down versus it staying the same. We really look forward to answering the questions you have and helping you make the transition, which we believe is going to be a huge benefit to you as an EWA client to help manage your wealth with as little taxes in the future.

And also preserve and grow it for your financial independence goals.

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