Segment’s strategies are grounded in decades of experience of dealing with things as they are and not as we wish them to be. Sometimes this puts us twenty years ahead of the crowd.  With 2021 came a “new” trend: Direct Indexing!

Back in 2003, I attended a dinner meeting with an executive from one of the country’s largest money managers, which also happens to call Houston home. The executive explained how their management company had made a “big bet” by overweighing client accounts in a particular sector in their stock selection. The SP500 had allocated 16% in this sector, and their allocation was 17.5%. My mouth went agape as my mind raced in an epiphany. On average, stocks across any sector, like consumer cyclicals -vs.- industrials, for example, are more than 65% correlated to one another. Correlations to the broad market are much higher, pushing 90%. With rounding, this 1.5% overweight had a near-zero chance of producing significant over-performance.

My immediate thoughts: This company is an indexer in drag; I can do this, and my clients can keep their firm’s 1% fee.  

Performance Results

Within a year, I had fired all my clients’ money managers and sold nearly all of the active mutual funds on my books. It had dawned on me that controlling taxes and manager fees was infinitely more valuable than the sporadic and minimal outperformance of active managers, and those preferred advantages would repeat every year, with 100% certainty. Results improved dramatically. 

Since that time, I came to appreciate two other factors that supercharge results: 

1. Strategic Charitable Gifting – Instead of writing a check, give the best-performing stocks to a charity or donor-advised fund, which rinses the account of taxable gains. Rebuy the stocks with cash.
2. Permanent Hold Goal – Using the guarantee of our eventual mortality, plan to hold positions until death. Taxes are not inevitable; The IRS gives your heirs total forgiveness of taxes on all untaxed (unrealized) gains.   

From a results perspective, this protocol is like investing on an escalator and then climbing onto a rocket at the end of one’s life! Meanwhile, the active money manager (or unfocused investor) has frittered away these benefits with frequent trades and is stuck on a moving sidewalk of his own construct. Properly deployed, this requires great discipline, focus, and intentionality, along with thinking in decades and generations, not quarters.   

Direct Indexing: The “New” Trend

Direct Indexing is the intentional mimicking of an index in order to derive the alternate benefits I just described. We’ve been doing this for decades and are already well on our way to a potential tax-free triple for many clients!  

While Mr. Biden has taken aim at this forgiveness of taxes at death as an “unfairly advantaged” part of the tax code, Congress has already admitted defeat in getting the rules changed.  

Please see IMPORTANT DISCLOSURE information.