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

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

30 January, 2023 4:29 PM

Here’s a definition from Morgan Stanley: “Direct indexing seeks to replicate an existing stock index, such as the S&P 500 or the Russell 3000, in a taxable account … Using optimization software, the manager typically includes a sample of the index constituents, which allows for close mirroring of the index’s performance.”

An article by Morningstar Canada suggests direct indexing is “effectively… the updated version of separately managed accounts (SMA). A generation ago, SMAs were that era’s hot commodity: “As with direct indexing, SMAs were modified versions of mutual funds, except the funds were active rather than passive with SMAs.” However, it added, separately managed accounts disappointed, in part because in the early 2000s they charged an average of 2.05% a year. It also said that for do-it-yourself investors, “direct indexing is much cheaper than the early SMAs. Direct indexing through financial advisors is of course pricier because of the second layer of fees, but total annual expenses will still be well below 2%.”