The Rise of Direct Indexing: How Smart Investors Are Beating ETFs and Index Funds

For decades, ETFs and index funds have been the go-to investment vehicles for anyone seeking low costs, diversification, and long-term market performance.

They simplified investing by giving people an easy way to “buy the market” without picking individual stocks. But in the last few years, a new strategy has emerged—one that offers even more customization, tax efficiency, and potential for higher returns. This strategy is known as direct indexing, and it’s quickly becoming one of the fastest-growing trends in modern investing.

As technology, zero-commission trading, and fractional shares continue to advance, everyday investors—not just the ultra-wealthy—are beginning to use direct indexing to outperform traditional ETFs and index funds. Here’s how smart investors are taking advantage of this powerful approach.

What Is Direct Indexing?

Direct indexing is an investment strategy where you build your own index by purchasing individual stocks that replicate the performance of a market index—like the S&P 500—rather than buying an ETF that tracks the index.

Instead of owning just “one fund,” you own each stock directly in your portfolio.

This allows for powerful customization that traditional ETFs simply cannot offer, including:

• Choosing which stocks to include or exclude
• Adjusting the weight of certain sectors
• Harvesting tax losses strategically
• Aligning the portfolio with personal values (like ESG or religious preferences)
• Managing risk in a more flexible way

Thanks to fractional shares and automated portfolio tools, direct indexing is now accessible even for portfolios as small as $5,000 to $25,000, depending on the platform.

Why Direct Indexing Is Growing So Fast

The investment landscape is changing rapidly. Here are the main reasons direct indexing is taking off:

1. Fractional Shares Have Changed Everything

In the past, to replicate an index like the S&P 500, you needed hundreds of thousands of dollars. Buying one share of every stock was simply impossible for average investors.

But with fractional shares, you can buy as little as $1 worth of a company. This makes it practical for smaller accounts to build a diversified basket of stocks.

2. Technology and Automation Make It Easy

Modern platforms automatically:

• Rebalance your holdings
• Optimize for taxes
• Replace underperforming positions
• Track index changes

This automation means you don’t need to manually manage hundreds of stocks.

3. Tax-Loss Harvesting Gives Direct Indexing a Major Advantage

This is one of the biggest reasons investors are shifting away from ETFs.

With ETFs, you can only harvest losses on the entire fund.
But with direct indexing, you can harvest losses on individual stocks inside your portfolio—even if the overall index is doing well.

This creates:

• Lower taxable income
• Higher after-tax returns
• More flexibility in down markets

Studies from major investment firms show that tax-loss harvesting alone can add 1% to 2% in additional returns annually for some investors.

4. Customization Outperforms Generic Index Funds

Traditional index funds treat every investor the same. Direct indexing tailors the portfolio to your goals.

You can:

• Build a portfolio around certain industries
• Exclude companies with poor ESG scores
• Reduce exposure to volatile sectors
• Increase weight in industries you believe in

This customization allows smart investors to use direct indexing as both a risk-management and performance-enhancing tool.

How Smart Investors Are Beating ETFs and Index Funds

Direct indexing isn’t automatically better—but it gives smart investors more control, tax efficiency, and opportunities to outperform. Here’s how they’re doing it:

1. Tax Savings Directly Boost Returns

Investors use loss harvesting during market dips to reduce their tax burden while keeping their portfolio aligned with the index. Over time, the tax savings compound.

It’s like getting “bonus returns” that ETF investors never see.

2. Avoiding Overvalued or Unwanted Stocks

Indexes include every stock in the market—even those that are overpriced or risky.

With direct indexing, you can leave out:

• Companies with weak fundamentals
• Businesses you don’t believe in
• Stocks that clash with your values

This selective filtering gives investors a chance to outperform the index.

3. Personalized Sector Weighting

If you believe certain sectors (e.g., AI, clean energy, biotech) will beat the market, you can overweight them while still mirroring the overall index.

ETFs don’t give you this flexibility.

4. Replacing Stocks Without Triggering the “Wash Sale” Limitation

Direct indexing platforms can automatically replace sold stocks with similar alternatives, maintaining exposure while staying compliant with tax rules.

This gives investors continuous market participation with optimized tax benefits.

Who Should Consider Direct Indexing?

Direct indexing is ideal for investors who:

• Want more control than ETFs provide
• Are in higher tax brackets
• Plan to invest for the long term
• Prefer personalized portfolios
• Want to use advanced tax-loss harvesting strategies
• Have at least $5,000–$25,000 to invest

It’s especially powerful for investors using taxable brokerage accounts, not just retirement accounts.

Direct Indexing vs. ETFs: Which Is Better?

Here’s a quick comparison:

Feature	ETFs	Direct Indexing
Diversification	Excellent	Excellent
Tax Efficiency	Good	Excellent
Customization	None	High
Control Over Holdings	Low	High
Minimum Investment	Very Low	Moderate
Potential to Outperform	Low	Moderate to High
Best For	Beginners	Intermediate & advanced investors

While ETFs are still great for many investors, direct indexing offers a clear upgrade for anyone who wants more flexibility and smarter tax strategies.

The Future of Investing: Why Direct Indexing Is Here to Stay

Wall Street experts predict that direct indexing will grow faster than ETFs over the next decade. As platforms improve and costs drop, it’s quickly becoming the new standard for personalized wealth management.

Major firms like Vanguard, Fidelity, Schwab, and BlackRock are investing heavily in direct indexing technology—proof that this strategy is not a passing trend.

Smart investors are already using it to:

• Boost returns
• Lower taxes
• Build portfolios that match their goals and values

If you want more control over your investments—and the potential to beat traditional index funds—direct indexing is one of the most powerful tools available today.