Direct indexing: Tax-loss harvesting in any market weather
by Hiren B. Patel, Head of Advisor Solutions
Key takeaways
- Market returns and valuations will continue to vary, whether the environment is broadly negative, neutral, or positive.
- Ongoing volatility and sector dispersion show that opportunities for tax-loss harvesting persist across market cycles.
- Advances in direct indexing and technology have made these strategies more desirable and accessible than ever.
It’s basically a myth that tax-planning season dawns in the fourth quarter each year. The truth is that tax loss harvesting opportunities can be pursued year-round, in any market weather, especially with a systematic approach available through direct indexing strategies.
That’s certainly one reason driving the increasing popularity of these approaches, and the rise of direct indexing shows little sign of slowing. In our most recent Annual Client Survey, 37% of respondents expressed interest in using direct indexing in 2025—second only to the percentage of clients (57%) citing model portfolios on the 55ip platform as central to their practice. Direct indexing strategies stood at $864 billion by year-end 2024—compared to $9.4 trillion for ETFs and $6.6 trillion for U.S. mutual funds—and industry estimates have suggested that direct indexing may continue to see robust growth.*
Despite being employed broadly in manager-traded strategies, where they accounted for 37.6% of assets reported by SMA asset managers at the end of 2024, the tax-optimization potential of direct indexing remains underappreciated. While mutual funds and ETFs provide investors with efficient, diversified market exposure, they offer limited flexibility when it comes to realizing potential tax advantages. By contrast, direct indexing allows investors to own the individual securities that comprise an index, and whether markets are rising or falling, it can enable more precise tax-loss harvesting at the security level in virtually any market weather.
Market conditions will always evolve, but opportunities to harvest losses typically persist across cycles—creating potential to enhance after-tax returns while maintaining exposure to overall market performance. With direct indexing, investors can more readily identify and act on those opportunities, finding a silver tax-loss lining regardless of the market outlook.
Variances can persist in up and down markets
In broadly rising or falling markets, performance among individual stocks can vary widely. During sharp downturns, it may appear that all stocks are declining in tandem; in stronger environments, broad macro or sector trends can lift most securities. Yet beneath the surface, valuation dispersion often reveals meaningful differences—and potential opportunities for tax-loss harvesting.
Valuation dispersion reveals opportunity
Valuation dispersion today continues to revolve around the gravity well of the “Magnificent 7” (or Mag 7) mega-cap tech names (Microsoft, Amazon, Apple, Meta, Alphabet, Nvidia, and Tesla) and the fact of their being levered to the artificial intelligence theme. According to Barron’s, five of the Mag 7 are currently trading at higher forward price-to-earnings valuations than their five-year averages.** What’s more, these valuations are significantly higher than the forward P/E ratio for the rest of the S&P 500 Index, which was around 26x as of September 30, 2025.
For investors using direct indexing, this valuation unevenness is valuable: It means there could well be holdings trading below their purchase price even when the index itself is positive. Those individual losses can be harvested to offset realized gains elsewhere, improving after-tax returns without sacrificing overall market exposure. In other words, dispersion turns diversity of outcomes into a steady source of tax-management opportunity. To a lesser extent, these same benefits can be applied to separately managed accounts (SMAs) and model portfolios.
| Market type | What’s happening | Why TLH opportunities persist |
|---|---|---|
| Up markets | Broad indices rise, but dispersion remains—some stocks or sectors still underperform. | Even in strong periods, a sizable percentage of names may be in negative territory. Rotating into similar exposures can capture losses without losing market exposure. |
| Down markets | Widespread declines push many securities below cost basis. | Obvious time to harvest losses broadly and reset cost basis lower for future gains. |
| Sideways markets | Indices churn with sharp rotations across sectors, styles, and factors. | Frequent pullbacks and rebounds create repeated short-term loss pockets—perfect for systematic TLH through direct indexing or automated tools. |
Volatility creates ongoing tax-loss harvesting opportunities
Because performance numbers will always be in flux, having a systematic approach to realizing TLH opportunities is critical, as are the benefits of a direct indexing strategy. TLH should be considered a continuous, emotion-free, opportunistic strategy—not a reactive one that comes to mind only when the market weather is stormy.
Automate the opportunities
There is no tax-loss harvesting season. That’s because tax-loss harvesting is an always-on activity. Today it’s possible to access harvesting opportunities with increased frequency and ease, whether through direct indexing or actively managed SMAs. While many advisors rely on a manual process at year-end to identify tax-loss harvesting possibilities for clients, 55ip’s ActiveTax TechnologySM enables advisors to automate this process on a perpetual basis. It reviews the potential for tax-loss harvesting in client portfolios so that any intra-year dislocations in stock prices’ can be identified and acted on.
*Direct Indexing Assets Close Year-End 2024 at $864.3 Billion,” Cerulli Associates, April 2025.
**Tech Earnings Are Right Around the Corner. What to Look for This Time,” Barron’s, October 8, 2025.
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