How to Tell When Personalized Indexing Makes Sense: Vanguard

Clients enjoy choices when it comes to index investing. Index mutual funds and tax-efficient ETFs may be ideal for many, while others stand to benefit from the advantages, including tax-loss harvesting, available in direct, or personalized, indexing.

A personalized indexing portfolio, established in a separately managed account, or SMA, is tied to a benchmark index while allowing client customization. These accounts also offer opportunities to boost returns by selling certain holdings at a loss to reduce capital gains taxes, the Vanguard Group noted in a white paper posted this week.

How can a financial advisor tell which clients might be best suited to personalized indexing?

The investing giant outlined four ways to tell who could most benefit from “improved after-tax alpha” via direct indexing, suggesting financial advisors seek clients in higher tax brackets with at least one of the following:

Significant, recurring, realized capital gains. This includes clients with active equity, private equity and other hedge-fund-like investments, and retirees taking distributions to meet spending needs.

Estate plans that anticipate charitable bequests or a step-up in basis. Gifting highly appreciated assets to charity from taxable accounts can lower taxes, as nonprofits don’t pay federal income tax on gifts, Vanguard noted.