What is direct indexing? Should you build your own index?

Then there’s the problem of how to exit this strategy: “Another 500 trades? Compare that against the cost of IVV iShares Core S&P 500 ETF; its MER is 0.03%. A small price to pay for simplicity I think.”

Finally, Ardrey sees issues for someone attempting this strategy through automatic savings plans. “How are they possibly going to allocate those funds monthly? To me, unless they are paying someone to do this, it does not make much sense … it would likely remove any fee savings they would receive.” Ardrey concludes direct indexing may be more useful for Canadian investors trying to allocate to a particular sector of the market (like Canadian financials), where “a person would have to buy a lot less companies and make the trading worthwhile.”


I would call this professional or advisor-mediated direct indexing, and I agree it seems to have severe drawbacks. However, that doesn’t mean savvy investors can’t implement their own custom approach to incorporate some of these ideas. 

Classic direct indexing seems similar but slightly different than a hybrid strategy many DIY Canadian financial bloggers have been using in recent years. They may target a particular stock index—like the S&P 500 or TSX—and buy some or most of the underlying stocks in similar proportions. Again, the rise of zero-commission investing and fractional share ownership has made this practical for ordinary retail investors.

Why would you want to do this? If you’re an investor with significant taxable (non-registered) investments, then the ability to customize your stock ownership may be a way of maximizing tax-loss harvesting. That is, you can pick and choose stocks to sell at year-end to trigger capital losses and reduce current year capital gains, or alternatively to carry back and offset capital gains from the previous three years. It’s also a way you can do your own version of ethical investing; declining to buy, for example, tobacco stocks or defense stocks or any other specialized type of stock that offends your sensibilities. Conversely, it’s a way to double-down on high-conviction stocks such as perhaps the tech giants or energy stocks.

With the S&P 500, you would endeavour to have the 11 major economic sectors represented and in similar proportions. But you wouldn’t have to slavishly imitate the index: after all, if that’s what you want, you can more easily just buy an index fund or ETF.

The Morningstar article linked above suggests DI ’s so-called ability to customize portfolios is mostly “spin.” It then implies that a version of the hybrid DIY approach to DI I believe many financial bloggers already espouse. “But there’s no point in doing so through direct indexing,” it argues, “Instead, buy an index fund to anchor the portfolio, then trade individual equities on the side. Using two investment buckets rather than one is both cheaper and cleaner.”

Indeed, many Canadian ETF enthusiasts, who also like to buy individual dividend-paying stocks, have been doing a DIY version of direct indexing all along. I’m thinking of blogger Mark Seed of My Own Advisor, who advocates a hybrid strategy that does just that. Former advisor Dale Roberts, who runs his own Cut The Crap Investing blog as well as writing for MoneySense and Seeking Alpha, often describes how he “skims” particular indexes to create concentrated high-conviction portfolios. 

Sumber: www.moneysense.ca

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