Direct indexing is rapidly moving from niche to mainstream, offering a more modern and investor-aligned alternative to traditional fund-based strategies. While once limited to institutional and high net worth investors, recent advances in data and technology have made this approach accessible – and scalable – for a broader range of financial advisors and their clients.
As investors increasingly expect portfolios to reflect their unique values, goals and tax circumstances, direct indexing offers a compelling path forward. It blends the transparency of passive investing with the customization traditionally reserved for active strategies, all while minimizing the hidden costs that can quietly erode returns.
Why Direct Indexing Now?
The appeal of direct indexing stems from the growing demand for personalization in investing. Cerulli estimates that $105 trillion will pass to heirs between 2024 and 2048. These investors – Gen X, millennials and Gen Z – often want more than market exposure. They want portfolios aligned with their beliefs and lifestyles. Direct indexing makes this possible by allowing individuals to own the underlying securities of an existing index or personalized index directly, rather than investing through pooled vehicles like mutual funds or ETFs.
This direct ownership unlocks several advantages. Investors can exclude specific companies or sectors, overweight themes they care about and build portfolios that better reflect their tax, legacy or philanthropic goals. At the same time, the transparency and ease of access to different index methodologies gives advisors a clear and explainable way to align portfolios with client preferences.
The Hidden Cost In Investing: Negative Compounding
While fund expense ratios are often low, they’re not zero – and they’re not always obvious. This is especially true for strategies that go beyond basic market benchmarks. In traditional fund-based structures, fees are bundled and compounded over time. These “wrapper fees,” when combined with advisor costs, can materially affect long-term performance.
We ran an analysis internally that showed reducing an all-in fee from 1.25% to 1.0% over a 30-year back test period could preserve an additional $120,000 on a $100,000 investment – equal to 120% of the original capital. The difference isn’t just the savings in the direct fees paid, but also in the opportunity cost of lower compounding. Each dollar spent on fees is a dollar that no longer benefits from long-term market growth.
Direct indexing can help reduce or eliminate fund-level costs entirely.
Direct indexing can help reduce or eliminate fund-level costs entirely. When implemented efficiently, it allows investors to retain more of their returns while still benefiting from diversified, rules-based exposure.
Customization For Risk And Opportunity
Beyond fee savings, direct indexing also offers strategic flexibility for both defensive and thematic approaches. For example, in uncertain market conditions, advisors can use defensive equity models to reduce exposure to overconcentrated sectors like technology. A defensive index that tilts toward consumer staples, regulated utilities and healthcare – built from granular revenue data to improve security selection – can help mitigate downside risk without giving up long-term performance fundamentals.
On the flip side, clients seeking exposure to fast-growing sectors like AI can also benefit. For example, a thematic AI index, customized to track companies deriving significant revenue from AI-related technologies, has historically delivered impressive modeled returns. An index we created demonstrated that by outperforming a broad market benchmark by nearly 400 basis points annually over five years.
Better Outcomes Through Precision
Advisors can also use direct indexing to build portfolios that accommodate tax constraints, avoid duplication with legacy holdings, or reflect personal or religious values. When clients feel their portfolios are thoughtfully tailored rather than simply off-the-shelf, it strengthens trust and fosters greater engagement.
When clients feel their portfolios are thoughtfully tailored rather than simply off-the-shelf, it strengthens trust and fosters greater engagement.
As Christopher Hensley, President and CEO of Houston First Financial Group, put it: “Now that I’ve brought direct indexing into my practice, I can sit with a client, hear what matters to them, and actually build around it – whether that’s excluding certain sectors or customizing based on faith or personal beliefs. It’s not just a checkbox; it’s something we can shape together. That kind of flexibility gives me a real edge … clients appreciate that level of care and, frankly, they should expect it.”
This level of flexibility also allows advisors to pivot as markets evolve or client priorities change. Need more downside protection? Tilt toward defensives. Want to capture innovation? Add thematic exposure. Direct indexing gives you the control to do both – cost-effectively.
Rethinking The Role Of The Advisor
As investment products become more commoditized, what sets an advisor apart isn’t access to a particular fund – it’s the ability to offer tailored, transparent strategies that meet clients where they are. Direct indexing supports that shift. It empowers advisors to design portfolios that reflect what matters most to clients, and it gives clients a deeper sense of ownership and involvement.
Done well, this approach can strengthen relationships and improve outcomes. Clients feel seen and heard. Portfolios are more aligned with their goals. And the long-term benefits – better tax efficiency, lower fees and fewer unintended risks – compound over time.
The Bottom Line
Direct indexing represents a fundamental shift in how portfolios can be built, managed and explained. It replaces mass-produced fund strategies with custom, transparent and cost-efficient portfolios built around the individual investor.
As technology continues to remove friction and complexity, the barriers to adoption are falling quickly.
As technology continues to remove friction and complexity, the barriers to adoption are falling quickly. For advisors looking to stay competitive and relevant in a rapidly changing landscape, direct indexing isn’t just a trend – it’s a strategic imperative.
Patrick Shaddow is CEO of Syntax Data, a financial data and technology provider offering data-optimized custom indexing solutions.
