Direct indexing: a smarter way to invest in the market

What is direct indexing?

Direct indexing means you own the actual stocks that make up an index, rather than shares in a fund that owns those stocks.

When you buy an S&P 500 ETF, you own shares of the ETF itself. The fund owns the 500+ companies that make up the index, but you don't. With direct indexing, those same companies sit directly in your account. You own the individual stocks that make up the fund yourself — not a fund that owns them.

This might sound like a small distinction, but it unlocks some big advantages.

What are the advantages?

More Control: You can customize your portfolio to focus on or avoid certain sectors, rather than buying into whatever the fund manager chose. If there are companies you want to avoid for personal reasons, for example, you can do that with direct indexing.

Tax Benefits: Direct indexing enables a strategy called tax-loss harvesting. When one of your stocks is down, we automatically sell it and replace it with a similar one. This locks in a capital loss that can be used to offset other taxable gains, all while keeping you invested in the market. 

What else should I know about tax-loss harvesting?

The biggest benefit for many Canadian investors is tax-loss harvesting. Here's how it works.

Let's say you own 100 shares of a stock that you bought at $50, but it's now trading at $40. That's an unrealized loss of $1,000. With a tax-loss harvesting ​ strategy, we can sell that stock to realize the loss, then immediately buy a similar (but not identical) replacement to maintain your position in the market.

That $1,000 loss can now be used to offset other taxable capital gains, which could help to lower your tax bill. And because we're replacing the stock with something similar, you keep your market exposure and can still benefit when the market recovers.

How important are regular contributions with a direct indexing strategy? 

Recurring deposits can amplify these tax benefits. Without them, most stocks in your portfolio will likely appreciate over time, meaning there will be fewer opportunities to harvest losses.

But when you make ongoing deposits, you're buying stocks at different prices. This can increase your average cost per share. The higher your average cost, the more opportunity there is to harvest tax losses when markets dip.

For example, let's say you buy one share of a stock for $50. Later, as part of your recurring deposit, you buy another share for $70. Under Canadian tax rules, these shares are pooled together, so your average cost is now $60 per share. If the stock's price later drops to $55, you can harvest a $5 loss per share — even though the stock is still above the $50 purchase price for some of your initial position.

This is why a direct indexing strategy like ours, which harnesses the advantages of tax-loss harvesting, can become more valuable with consistent contributions.

Can’t I just buy all these stocks on my own?

Technically, yes. But here's why that's harder than it sounds.

A properly diversified index portfolio includes hundreds of stocks. To weight them correctly, you’d often need to buy fractional shares (like 2.47 shares of a stock) — something many self-directed investing platforms don’t support. Managing hundreds of positions and rebalancing them as prices change is time-consuming and prone to error.

Tax-loss harvesting requires constant monitoring. You need to watch for opportunities daily across your entire portfolio while navigating Canada's superficial loss rules, which prevent you from claiming a loss if you buy back the same security within 30 days. Finding appropriate replacement securities also requires sophisticated analysis.

Even if you’re a math wiz, you have to balance two competing goals: harvesting as many losses as possible while keeping your portfolio's performance close to the benchmark. Doing this manually across hundreds of stocks is essentially a full-time job.

That’s why we built our Direct Indexing portfolio — to do the heavy lifting for you.

This all sounds great. But is it the right fit for me ?

Direct indexing is ideal for clients who are investing in non-registered accounts, because you can’t tax-loss harvest in registered accounts like a TFSA or RRSP. It’s also great for clients who want to invest in a broad index but would like to exclude particular companies. The minimum investment is $10,000, and we find that clients making less than $110,000/year tend to see less tax benefits.

Conclusion

Direct indexing builds on the same passive, index-based philosophy that makes ETFs so effective. But by owning stocks directly, you unlock tax advantages and customization that simply aren't possible with a fund. For Canadian investors, that difference can add up to meaningful value over time.

^{Self-directed Investing is offered by Wealthsimple Investments Inc. (“WSII”). All investments involve risk. To get more info on our products, investment decisions, fee schedules, user testimonials, promos & more visit wsim.co/disclaimers}

^{The Morningstar Indexes are the exclusive property of Morningstar, Inc. Morningstar, Inc., its affiliates and subsidiaries, its direct and indirect information providers and any other third party involved in, or related to, compiling, disseminating, computing or creating any Morningstar Index (collectively, “Morningstar Parties”) do not guarantee the accuracy, completeness and/or timeliness of the Morningstar Indexes or any data included therein and shall have no liability for any errors, omissions, or interruptions therein. None of the Morningstar Parties make any representation or warranty, express or implied, as to the results to be obtained from the use of the Morningstar Indexes or any data included therein.*Based on hypothetical tax-loss harvesting model projections. Actual after-tax returns may vary. All investments involve risk. To get more information on our products, investment decisions, fee schedules, user testimonials, promotions & more visit wsim.co/legal}