Since the first robo-advisors came on the market, I have been “robo-curious”. Robots could manage hundreds of individual positions while creating daily tax loss harvesting opportunities. But the fees were always so high. That has finally started to change. Direct Indexing with Tax Loss harvesting is now more accessible than ever.
Now the real question: how likely is the benefit dwarfed by the risk that the Evolves/Synapses these companies use will one day lock my funds up indefinitely, like Yotta did?
It’s a bit different when dealing with stocks. You own the actual shares and they are held with a clearing house, Apex Clearing in Frec’s case.
But it is definitely something to think about anytime dealing with fintech companies. It would be a good question for the Frec team during the fireside chat.
That is some of the magic Frec is doing under the hood. Here is my rudimentary explanation (Mo, Frec's CEO would be able to give you more details):
Frec will sell a position for a loss. The won't re-buy that same position for at least 30 days to avoid any issue with wash sales. During that time they may buy other company shares that are in the same industry and move in similar ways to the company sold, so they can still maintain that exposure.
Hmm, but that would deviate from the index - no? Let's say Apple is down 5% tomorrow so it sells some for TLH. Now, it can't buy Apple again for 30 days. But that means it will deviate from the index for at least 30 days. If Apple had backed up >5% during that time, the TLH would have been worthless.
1. They will temporarily park the proceeds from selling a loss-making stock into a similar stock (e.g., Sell Tesla and park the funds in Ford). But that can deviate from the index significantly in the short term, even though over a 10-year period, it would be immaterial.
2. Although very low, transaction costs (approx. 1.7 bps of trading volume) must be factored in before we can conclude that the effective expense ratio (compared to VOO) is 0.07%.
Stocks are free to trade at most major brokerages. Presumably Frec is able to trade client positions for free or they would have to disclose the additional fees.
How does direct indexing get by wash sale rules? Like lets say S&P Stock A goes down 1%, the loss is harvested, how does it get back into Stock A again?
Like mentioned in the other thread they will sell stock A, capture the loss, and if needed buy shares that are highly correlated with stock A prior to re-buying stock A.
I am watching closely in my own account how this works. On the day of the big drop last week NVDA was sold to harvest $1,500 in losses and MSFT for $1,700 in losses. They were replaced primarily by AMZN, META, APPL from my high level glance. This is likley a primary source of "drift" away from the index. Frec says it should end up at <1% drift over time. I am well below that at the moment.
since you have a lot in Uber (we have a lot on APPL and MSFT), have you looked into exchange funds like UseCache (has a much lower minimum). We don't REALLY need the loss harvesting but only to unwind big positions.
The fee's, holding period, limited actual diversification made exchange funds less appealing of an option for me.
I think the harvesting can also be powerful in the FIRE scenario where you have a large number of low income years. Even without having a single large position to unwind. I wouldn't sell VTI to buy a direct index. But with new funds that are continuously being invested, it could be a good option with a real tax alpha.
Does Frec integrate with any tax software? The real nightmare scenario that arises from investing like this is recording all of the trades at tax time.
All the core info is summarized in the 1099 consolidated. I’m sure the full document can end up running hundreds of pages, but I rarely have the individual trades entered these days.
If you have any wash sales you won't be able to use the summarized form. Frec should be able to avoid this scenario but in the past I used wealthfront and it would occasionally generate these which required me to list every trade in my taxes. Overall Frec looks really interesting, I might give it a shot myself.
A great feature would be the ability to split the direct index stocks between taxable and retirement accounts, with high-dividend stocks in retirement accounts.
I'm not sure why robo-advisors and direct indexers are so interested in TLH. It's easy to have zero gains and max out your $3000/year loss indefinitely with minimal manual effort. If Frec could reduce my taxable dividends, I'd be very interested!
Thanks for the research and write-up, Andre. Are you beholden to Frec's TLH algorithm, or do you have any control over the timing and magnitude of TLH?
As far as I know you are beholden to Frec's algorithm. That could be a good question for Mo (Frec's CEO) during the FIRE side chat. At least to see what their thoughts are on the future development and potential personalization.
Now the real question: how likely is the benefit dwarfed by the risk that the Evolves/Synapses these companies use will one day lock my funds up indefinitely, like Yotta did?
It’s a bit different when dealing with stocks. You own the actual shares and they are held with a clearing house, Apex Clearing in Frec’s case.
But it is definitely something to think about anytime dealing with fintech companies. It would be a good question for the Frec team during the fireside chat.
I'm confused about how they are able to TLH every day, despite the 30-day wash sale rule.
That is some of the magic Frec is doing under the hood. Here is my rudimentary explanation (Mo, Frec's CEO would be able to give you more details):
Frec will sell a position for a loss. The won't re-buy that same position for at least 30 days to avoid any issue with wash sales. During that time they may buy other company shares that are in the same industry and move in similar ways to the company sold, so they can still maintain that exposure.
Hmm, but that would deviate from the index - no? Let's say Apple is down 5% tomorrow so it sells some for TLH. Now, it can't buy Apple again for 30 days. But that means it will deviate from the index for at least 30 days. If Apple had backed up >5% during that time, the TLH would have been worthless.
Take a look at https://frec.com/resources/blog/direct-indexing-handbook and search the page for "Similar stocks", they are estimating that the tracking error from the underlying index will be <1% over 10 years.
Thanks. I just read through it. Two things:
1. They will temporarily park the proceeds from selling a loss-making stock into a similar stock (e.g., Sell Tesla and park the funds in Ford). But that can deviate from the index significantly in the short term, even though over a 10-year period, it would be immaterial.
2. Although very low, transaction costs (approx. 1.7 bps of trading volume) must be factored in before we can conclude that the effective expense ratio (compared to VOO) is 0.07%.
Stocks are free to trade at most major brokerages. Presumably Frec is able to trade client positions for free or they would have to disclose the additional fees.
How does direct indexing get by wash sale rules? Like lets say S&P Stock A goes down 1%, the loss is harvested, how does it get back into Stock A again?
never mind i see the thread above
Like mentioned in the other thread they will sell stock A, capture the loss, and if needed buy shares that are highly correlated with stock A prior to re-buying stock A.
I am watching closely in my own account how this works. On the day of the big drop last week NVDA was sold to harvest $1,500 in losses and MSFT for $1,700 in losses. They were replaced primarily by AMZN, META, APPL from my high level glance. This is likley a primary source of "drift" away from the index. Frec says it should end up at <1% drift over time. I am well below that at the moment.
since you have a lot in Uber (we have a lot on APPL and MSFT), have you looked into exchange funds like UseCache (has a much lower minimum). We don't REALLY need the loss harvesting but only to unwind big positions.
The fee's, holding period, limited actual diversification made exchange funds less appealing of an option for me.
I think the harvesting can also be powerful in the FIRE scenario where you have a large number of low income years. Even without having a single large position to unwind. I wouldn't sell VTI to buy a direct index. But with new funds that are continuously being invested, it could be a good option with a real tax alpha.
Does Frec integrate with any tax software? The real nightmare scenario that arises from investing like this is recording all of the trades at tax time.
All the core info is summarized in the 1099 consolidated. I’m sure the full document can end up running hundreds of pages, but I rarely have the individual trades entered these days.
If you have any wash sales you won't be able to use the summarized form. Frec should be able to avoid this scenario but in the past I used wealthfront and it would occasionally generate these which required me to list every trade in my taxes. Overall Frec looks really interesting, I might give it a shot myself.
Avoiding wash sales seems pretty foundational!
I’m hoping tax software is getting more used to these types of larger file imports.
A great feature would be the ability to split the direct index stocks between taxable and retirement accounts, with high-dividend stocks in retirement accounts.
I'm not sure why robo-advisors and direct indexers are so interested in TLH. It's easy to have zero gains and max out your $3000/year loss indefinitely with minimal manual effort. If Frec could reduce my taxable dividends, I'd be very interested!
Thanks for the research and write-up, Andre. Are you beholden to Frec's TLH algorithm, or do you have any control over the timing and magnitude of TLH?
As far as I know you are beholden to Frec's algorithm. That could be a good question for Mo (Frec's CEO) during the FIRE side chat. At least to see what their thoughts are on the future development and potential personalization.