#236 - Direct Indexing Strategies with Greg Kanarian, JD, CFA

0:00 Our guest today is my friend and former colleague, Greg Canarian. Greg is an investment strategist at Natixis Investment Managers, representing the firm's direct indexing strategies. Greg joins us to talk about all things direct indexing, what it is, common benefits and tax advantages of direct indexing, which clients it may or may not be appropriate for, what personalization, customization options are available, and more. If you've been curious about direct indexing, but haven't taken time to learn much about it, this episode is for you. What's it time for? It's time for a Wicked Pisa podcast. Wicked Pisa podcast. Wicked Pisa podcast. It's time for a Wicked Pisa podcast. Welcome to the Wicked Pisa podcast, a production of the Financial Planning Association of New England, intended for financial planning advisors.

0:46 Hello, and welcome to another episode of the Wicked Pisa podcast. I'm your host, Kathleen Keneally, founder of Catapult Financial Planning and current board member and director of programming for the FPA of New England. Co-hosting with me today is FPA New England past president and current head of the AMR team at Wealth Enhancement Group, Chris Boyd. Our guest today is my friend and former colleague, Greg Canarian. Greg is an investment strategist at Natixis Investment Managers, representing the firm's direct indexing strategies. In his role at Natixis, Greg collaborates closely with the direct indexing portfolio management team and client relationship managers, acting as an expert on all investment solutions that incorporate direct indexing. In addition to promoting the benefits of direct indexing with clients and prospects, Greg also researches and writes about relevant investment, tax, and financial planning topics.

1:35 Before joining the Natixis Investment Strategies Group in 2024, Greg served as a portfolio consultant at Natixis for 12 years. He was also a portfolio consultant with Deutsche Bank and before that was a financial planning associate with Pillar Financial Advisors. Greg has a BS in finance from Babson College and a JD from Suffolk University Law School. He currently serves on the investment committees for Boston's Armenian Heritage Park, St. Stephen's Armenian Apostolic Church, and Camp Hiaston. He is a CFA charterholder and is FINRA Series 7 and 66 licensed. Greg, welcome to the Wicked PISA podcast. We're really excited to have you here. Thank you guys for inviting me. I usually start off by asking our guests to tell us about themselves and their professional journeys, not only for our listeners' sake, but for my own, but this is a special circumstance because in the interest of full disclosure to our listeners, I've known you since almost the beginning of both of our professional careers.

2:34 Greg and I are both graduates of Babson College and we met as financial planning associates at Pillar Financial Advisors, but you started there about two years before I did, so you've got a couple of years on me, but I'm totally going to date ourselves and that was more than 20 years ago at this point. Did you ever think that either one of our 20-something-year-old selves would believe it if we were like, we're going to talk on this podcast called the Wicked PISA podcast in 20-something years? I don't even think podcasts existed back then. I don't think they did. I mean, I remember one of my first projects at Pillar was evaluating 529 plans that had just come out and we just were looking for data and to be able to evaluate different states' plans to offer those to clients.

3:23 And yeah, there's so many things that have evolved in our industry since then, but yeah, it's been an interesting last 20 years. Yeah, it's been quite the ride. I know you became the expert on 529 plans and I sort of became the office expert on Roth conversions, and I think we both benefited from having bosses that were really good at getting us really involved and in the weeds about topics and giving us room to run. For our listeners that haven't known you for quite as long as I've known you, why don't you tell us a little bit about yourself and how you found yourself as the direct indexing expert for Natixis? Sure, yeah. So I started my career with Pillar.

4:04 They gave me a lot of opportunity to write the two principles of the firm. One was a CPA, one was an attorney by training. And so we had exposure to some really high net worth, sophisticated clients. So I was learning from all my mentors at Pillar at the time. And one of the things that I decided to do was pursue my JD. And so I started doing that at night. I moved over to Deutsche Bank where they had a very generous tuition reimbursement program. So I pretty much had that all paid by Deutsche Bank doing it at night. So in a similar role, I was helping financial advisors build asset allocations for their clients at Deutsche Bank doing financial planning.

4:44 I finished my JD there. I also was pursuing the CFA at the same time. So I had this kind of dual study sessions going on for a number of years. Clearly an academic slouch here. Yeah. Well, you know what? I like to say I'm good at taking exams during golf season. So my handicap certainly has suffered over the years because of that. But yeah, I had a good experience at Deutsche Bank and then have been at Natixis ever since. Joined here in 2011 as really a consultant doing asset allocation, investment work for financial advisors who oftentimes are more focused on their clients and maybe put together a bunch of mutual funds, but don't really know how everything interacts together.

5:30 So we provide a consulting service to them. And then in the last year, I transitioned into this role for direct indexing, which very much kind of aligns with my personal beliefs and index based investing. And so also the components of direct indexing, which is tax lost harvesting and kind of using the tax code to your benefit really kind of plays to my interest in the legal aspects and structuring of portfolios, making sure clients are getting the most tax efficient portfolio that they can. Tell us a little bit more about, from a high level, what direct indexing is.

6:12 How do you describe it? How would you define it? We hear about index funds a lot, and that has become very second nature, at least in the consumer world. And I'm sure some of our listeners have heard about direct indexing. But for those who haven't, tell us more about what that actually involves and how would you describe it? Sure. So I say that direct indexing is an equity strategy designed to match the performance of an index on a pre-tax basis, but outperform it on an after-tax basis. And that outperformance on an after-tax basis comes through several different tax management techniques. Number one is tax lost harvesting.

6:55 Gain deferral is number two. Avoiding wash sales, number three. And earning qualified dividends, number four. Those are the types of things that I talk about with advisors and clients. And if we just kind of break the words out, direct means clients own individual stocks in their own account. And that's important because when there's an opportunity to harvest a loss, the client gets that loss. That loss is theirs to use on their own tax return, as opposed to if they owned an actively managed mutual fund and a portfolio manager harvested a stock for a loss, it gets stuck in that fund.

7:38 Mutual funds can only distribute capital gains to investors. And we can get into the scenarios what that looks like. So direct means clients own individual stocks. They have their own cost basis. The indexing part means we're just trying to replicate the performance of an index, but we do it by owning a subset of securities. Maybe it's 150, maybe it's 300, but we don't want to own all 500 stocks in the S&P 500, because when that tax loss harvesting happens, when we sell a loser, we need to replace it with a stock that we don't already own to avoid this wash sale rule. And if you just look at the market over the past several years, we know the Magnificent Seven has driven a lot of the performance of these indices.

8:24 So you don't need to own all 500 stocks to get performance that looks like the index. And so using a representative set, typically we have computers and optimization systems that help us track the index pretty closely, but also gives us a flexibility to do that tax loss harvesting. It sounds like there's at least some level of active management in the sense that you're not buying all 500 stocks, but you've got to pick which subset of those stocks that you are going to buy. Is that also done by algorithms, computers? Is that a portfolio manager making that decision? Yeah, exactly. So every firm that does this is going to have some kind of algorithm.

9:05 We call ours a multi-factor algorithm. So it looks at different characteristics of the index. But yeah, the idea is to own a representative number of securities. Generally, you're going to match market cap weights similar to the index that you've selected. S&P 500 is the most common, but you can certainly do this for other indices. And also you want to make sure your sector weightings are very similar to the index within bands. In terms of having conviction around individual stocks, no, it doesn't matter. So you're not saying, hey, I want to own Apple instead of Microsoft. You're just going to own a subset of stocks.

9:45 And if one of those goes down, a common example is if you own Home Depot, we harvest that at a loss. You're going to replace it with something similar. So it might be Lowe's or Coke or Pepsi. But you really don't care which stock you own because you're just trying to maintain your beta exposure. Could you elaborate the question of what indexes are commonly utilized? So I have no doubt the S&P 500 is most common and most popular. What are other commonly utilized indices? Our firm typically uses the S&P indices. So the S&P 500 is the most popular.

10:25 S&P 1500, which includes the 400 mid cap stocks and the 600 small cap stocks. So getting more of an all cap exposure. You can do this on a global basis. So a combination of U.S. and international, you could do it on just international stocks, or you could just segregate them out, large cap in one account, mid cap in another account, small cap in another account. But if you look at data for where outperformance is more likely to happen, it tends to be in those less efficient areas, so small caps in international. So you might want to hire an active manager to manage your funds there, whereas the large cap space, as you know, is pretty efficient.

11:12 So it's very common to have this core large cap holding in a tax efficient direct index. All right. So focusing on the S&P 500 for the sake of discussion as the commonly utilized, and you expressed the notion that you really don't have to have all 500 stocks to represent the index. 300, I think you said, was a common estimate for how many stocks one might hold to represent that. How do clients react to the idea that there's 300 names showing up in their brokerage statement? Do they have trouble with that or is it appealing? It is for some clients, a turnoff.

11:54 But when Kathleen and I started, our clients were getting statements sent to them in the mail. So it might be a 50 page statement, right? You can suppress statements. So at the end of the year, you're going to get your 1099 and you're going to see all the activity that has happened and your CPA is going to deal with that. Some clients might say, this is too much for me to handle. But when we're focusing on clients that this works the best for, it tends to be those in higher tax brackets. So the 32% tax bracket generally or higher. So these are people that have higher income and they're used to sophisticated strategies.

12:36 And so seeing 150, 300 stocks is not a turnoff knowing that it's going to help them. So they're complaining until they get their tax statement when they realize, oh, we realized some capital losses that I wouldn't have been able to do otherwise. Exactly. Yeah. And that's a good point. People with that kind of capital or income may, in some instance, have an attraction to the idea of individual security selection being a component of their portfolio. Yeah. And like it provides a lot of optionality when you have all these individual stocks, that's what you're looking for. You're looking for the volatility of stocks going up and down.

13:18 So you can harvest these losses, but also provides opportunity for charitable giving, right? So now you've got individual tax slots that you can look at at the end of the year when you're doing charitable giving, you can pick out those tax slots that have appreciated the most and donate those, get those out of the portfolio and avoid paying capital gains taxes on those. How much does one... Oh, sorry, Kathleen. No, I was just going to say, and to be fair, like how many clients actually look at their statements on a regular basis instead of just once a year, but go ahead. That's probably fair. That's probably a fair point. My question was going to be, you indicated that this may not be for everyone.

14:02 Where does it make sense in terms of account size or client's wealth or whatever the benchmark criteria might suggest? When should advisors be turning on a light bulb of this might be a good fit for a direct indexing occasion? Fees for these accounts are all very reasonable. So you're going to pay a little bit more than an index-based fund or an ETF, a lot less than an active manager. A lot of the platforms and managers will offer these at $100,000 and $250,000 minimum. So for clients that most advisors are working with, it's usually a pretty easy hurdle, but there are several use cases.

14:47 So the first is, I just want an efficient large-cap equity holding. So instead of an index-based mutual fund or index-based ETF, I can have this strategy that's going to, again, match the performance of the index, but it's going to generate losses. And so even in years where the market is up, we're able to produce net losses for the client. So I don't have the final numbers for 2023, but if you look at like, sorry, in 2024, but if you look at 2023, the market's up 23%.

15:28 You put $100,000 in at the beginning of the year, it's worth 123,000 at the end of the year. Depending on the manager, you have likely produced net losses in the tune of two to 3% for that client. So their portfolio is appreciated 23%, but they're showing, call it $2,000 in losses for their tax returns. So that's kind of a core efficient holding in the large-cap space. But also think about a client that maybe has a known future capital gain event. Maybe they're going to sell a business in five years. Maybe they have a piece of investment real estate, and they're going to get out of investment real estate.

16:12 They're not going to do the 1031 exchange. So they're going to sell that for a gain, or maybe they're going to sell some stock or exercise some options. So now we're using direct indexing as a lost harvesting engine planning for a known future capital gain event in building up this war chest of losses. And we're in the industry, so we talk about losses, but when I'm talking to clients, and I'm talking about tax savings, tax benefits, tax write-offs, those are the types of words that we're going to use. So we're going to generate this war chest of tax write-offs to mitigate that cost in the future. Also, if an advisor is bringing over a client from another firm, so maybe they want a business, one business, a client has this collection of individual stocks, or maybe there was a large cap value manager, separately managed account, that the new advisor wants to fire.

17:09 They have this collection of individual stocks they don't know to do with, 100 large cap value stocks. They can use direct indexing as a sponge. Those 100 stocks are probably members of the S&P 500. So it's a way to transition those in a tax-efficient manner. You'd sell the losers, you'd keep the winners, and then you'd start diversifying around them. Or if you have a concentrated stock or a low basis stock that the client or the advisor thinks it's time to de-risk. So let's use an example of Microsoft. So let's say you have Microsoft stock, $20 ,000 worth with a cost basis of $5 ,000.

17:55 So big capital gain. For a $100,000 account, we'd have $20 ,000 in Microsoft, and if you give us $80,000 in cash, we would buy other stocks in the S&P 500 that we don't own. So now we've built this kind of completion portfolio. We'd look at those stocks on a quarterly basis, and we would loss-harvest them. Anytime a stock's down 4% or 5 % on a short-term basis, harvest those losses, and that allows us to simultaneously take a gain in the Microsoft. So for the client, it's a tax-neutral impact. So quarterly, they're seeing their Microsoft position being de-risk, but they're not having to recognize any net gains because we've used losses that we've harvested to offset.

18:45 So those are some common examples and use cases of how advisors are doing this. It seems like it makes a lot of sense if people come to you with a portfolio of individual securities. But in my experience over the years, I've seen a lot of clients that have large -cap mutual funds that have crazy embedded gains and would be a lot more difficult to kind of unwind those to move into a direct indexing strategy, for example. Do you see that in the work that you do and the clients that you're doing this with? Is it sort of just a lost cause? Should people even bother trying to do it if they have a portfolio of mutual funds with crazy embedded gains?

19:28 Yeah, so that's a good question. The question's always, are you over-concentrated in an area? So if it's an individual stock, it's probably an easier case to make that, yeah, we could de-risk or diversify. If it's a diversified holding that's done okay, there might not be a reason to get rid of that security. Oftentimes, it's a question with the client, are you willing to recognize some gains upfront to create some cash and liquidity to fund a direct indexing account? And we're always going to need some kind of cash to be able to start the process by individual tax slots, again, to be able to loss harvest.

20:11 But if it's an ETF position that has large embedded gains or like a diversified mutual fund, then it's a conversation with the client, are you willing to recognize some gains? But the mutual fund structure, as you know, holding these things in taxable accounts can be very tax inefficient as well. And the example I always use is you go back to 2022, you have the S &P down 18%. If you looked at the large cap blend universe of actively managed funds, 100% of those lost money in 2022.

20:52 They were all down. 83% of those paid a capital gain. You've got a client that owns a mutual fund, their NAV went down, but they're at the end of the year given a capital gain distribution. Because when you are sharing cost basis with other investors, if they hit the eject button, the portfolio manager is forced to sell securities to raise cash. And they're often recognizing gains to do that. And at the end of the year, if you own that in a taxable account, you're going to be hit with a capital gains tax. So I think the industry is getting away from the inefficiencies of those actively managed funds, which is why you've seen obviously a lot of money going into ETFs and now direct indexing for those that are more tax sensitive.

21:39 I could benefit from a little bit of the remedial math here. I have trouble getting my head around the idea that on the one hand, I'm going to make money but on the other hand, I'm going to lose money. How do I do both? It just seems like and still keep up. You know what I mean? Something about it seems like bad math. You know what I mean? How's it work? Maybe you can elaborate and get me past some of this. And is it that we're just putting off gains that are happening elsewhere and I'm going to have the same problem of embedded capital gains later on? Or I've thrown a lot. You can pick which one. Yeah, yeah, yeah. It's a great question.

22:19 So if we use an example, if you buy Coke and it's down 10%, you sell it. And if you replace it with Pepsi and the market bounces back, right? Maybe it's more just market movement that's giving me the opportunity to have this loss you're saying. Exactly. So you capture that loss while you exist. You replace it with something else. And if that security bounces back, then you're back to the same position, right? If that appreciates another 10%, let's call it you're back to neutral. But you just harvest 10% in a loss. When you purchase your new security, your cost basis, again, to your point is lower.

23:01 So now you have this embedded gain in that new security that you bought. But here's the kind of magic, which is this tax rate arbitrage. So as that position, you hold that position, you go from having a short-term capital gain, unrealized short-term capital gains to an unrealized long-term capital gain. Depending on your tax bracket, the difference between those two can be as much as 20%. So if you're in this year, it's basically $500,000 to $600,000 in income, the difference between what you're going to pay on a short-term capital gain and a long -term capital gain is 20% difference in tax savings.

23:45 So gain deferral is a really important part of this process. And the loss that you harvested is a short-term loss, which will offset other short -term gains that you recognize. Those short-term gains are taxed at the client's ordinary income tax rate. The highest rate this year is 37%. But to your point, if you needed to liquidate the portfolio, you are likely going to have to pay capital gains. But this is a deferral process. By not having to pay Uncle Sam today and taxes today, you are deferring that and letting money compound in the market without having this tax track.

24:31 You can use up to $3,000 of those excess realized capital losses to offset other income. So if you are in that highest tax bracket, there's a little bit of additional tax savings on your other ordinary income that's not even tax savings on your investment portfolio. That number has been static since 1978. So yeah, $3,000 might have been a big deal then. Today, it's not much. But right, you can bank these losses and carry them over indefinitely until you die. And then you got one last chance if you have a surviving spouse to be able to use them, otherwise they disappear.

25:11 But yeah, again, like I said, one of the core use cases is building up these losses to help offset a known taxable event that's going to happen in the future. I have the impression that the tax benefits of tax-loss harvesting somewhat diminish over time. Is that an accurate impression? Yeah. So at some point, you've got a portfolio that hopefully is all winners, and they're all long-term winners. And I think we hear this a lot is like, what do you do? What do you do then? And my response is, you thank the manager for doing a good job. Great. Yeah, big picture perspective here, yeah.

25:53 Their worst problems to have. Keeping up with the market for generating all these losses for me over the years, and then giving me a portfolio of all these long-term winners. But people get addicted to seeing these losses, and they want to do more. So what do you do? Well, first of all, if you can continue to add cash to the account, that's helpful. Helps you create new cost basis. You're going to buy new tax lots. If you've got dividends, if you're reinvesting those dividends, that helps improve the longevity. If you have clients that are charitably inclined, you take out those securities that have appreciated the most, donate those to charity, and replace - Use cash to buy them again, or something.

26:35 Yeah. Some will say, hey, I've got a portfolio that generally is the S&P 500. Maybe I'll sell index call options against that portfolio to generate some cash. And I can use that cash as income, or I could take those call premiums and add it and create new basis. And you've got some other strategies that tend to be more sophisticated that say, hey, once you've got this portfolio that, in the vernacular of direct indexing, is what they call ossified. Basically, it becomes bone, right? There's no more losses to squeeze out. Well, what if we start shorting stocks? Because if you short stocks, it's a good way to lose money because the market generally goes up.

27:19 And then we take the short proceeds and we buy another basket of long securities. So we still, we have this kind of extension strategy added on to the direct indexing. So we've been doing this for 22 years. We have over $20 billion in AUM today, but the first 15 years, we had less than a billion dollars. So only recently have we seen a really strong increase in AUM. So we're not at that point where we're seeing a lot of these ossified accounts, but it's something that the industry is keenly focused on. Are there opportunities or ways to extend the longevity of these direct indexing accounts?

28:02 And I imagine if you, you know, you might run into that problem if you only have one direct indexing account that contains like US large cap stocks, for example. But if you have sort of a portfolio of a few different direct indexing accounts that all track a different index, like you've got US large cap in one, small cap in another, international in another, you have these different sleeves that in theory should be all zigging and zagging at different times. So even if you don't have losses in your US large cap account, you might have some in your small cap or international that you can use to offset each other. If you have somebody, if you have clients that are doing that, does the direct indexing manager look at those three accounts across the board or do they really just look at each one in a silo and not necessarily consider it's one client with three different accounts?

29:00 Yeah, that's a really good question. So well, the first point that I want to highlight is this is not a area where you split the ticket. In other words, you can be searching for a large cap value manager, you narrow it down to five that you like, and you say, oh, just spread money among two or three. You don't do that with direct indexing. You go with one manager because you can't have two large cap direct indexing accounts because you're going to have a wash sale nightmare. So that's number one. So we're not going to do that.

29:40 But to your point, yeah, I'm going to have a large cap, I'm going to have a mid cap, I'm going to have a small cap, maybe an international. International is a great opportunity for loss harvesting over the past five years. So you're going to keep those things all separate. And the manager is just going to focus on each of those indices to track, and you're not going to have much movement among securities. But if you have a mid cap stock that performs really well, that might get kicked out of the index, at which point the manager would recognize the capital gain because it's no longer in their universe.

30:21 So if you have more of an all cap strategy, you can kind of let the winners run without having to recognize capital gain. But next level is a unified managed account, right? In a UMA, you have an overlay manager that's able to see everything that's going on. And you might even have an actively managed strategy involved in there. Maybe you've got an active small cap manager that you think can add alpha sitting alongside an index based small cap manager, in which case they can do tax lot exchanges and making sure that there isn't going to be a wash sale happening between multiple different strategies.

31:03 So we at New Texas do that. We do it on a couple of different asset management platforms and some other direct indexing providers can do that oversight as well. But yeah, it can get tricky and complicated. You mentioned that your firm has been offering a program for direct indexing for a long time, Texas. There are other brands names that people may know that are also offering a direct indexing solution. How do we identify points of differentiation? What should I be paying attention to? And what should I look for when I'm trying to decide who do I go with? The first thing I'd say is the client experience and customer service, right?

31:47 So this isn't as easy as dropping a ticket, typing in a ticker. You are establishing a relationship with a firm because you have individual clients that are going to be receiving service from that firm. And so this is not the easiest sale, but once the advisor gets used to it and understands the process, they tend to really start using it in their practice. So before we open any account, what we're going to do is we're going to talk to the end client and do what we call a tax transition analysis. What's your portfolio look like today?

32:28 What's your target index? And how are we going to get you there? Are we going to need to take any gains along the way? How much do you have in losses? And we're going to show them what that transition would look like today's portfolio to the future portfolio. And also along the way, the client might want to add some customization. Maybe they want to, next year they decide they want to exclude a particular stock or add a business involvement screen. Maybe they don't want anything to do with animal testing in their portfolio. So these are all things that will come up that you want to be able to have a good customer service and also be able to show the client what their portfolio results look like, not just pre-tax returns, but after tax returns and what we call tax alpha and being able to outperform.

33:19 So that's number one. And then I'd say is flexibility and customization to be able to handle things like concentrated stocks or to transition portfolios over time. Some managers will just focus on tracking error, meaning, hey, I'm going to run this portfolio for you, but I want the tracking error to be very low. I want the portfolio to look very much like the index. So if you have a position, a concentrated stock that you want to diversify or de -risk, you need to hold it outside of the direct indexing account. They're not going to accommodate it.

34:00 But in terms of managers, what they do, they're all going to do the tax-loss harvesting. They're all going to do rebalancing. Everybody's going to have a different flavor. I think our strategy tends to be the most aggressive when it comes to tax-loss harvesting. And what I mean by that is if you have a big position, and I've always been using this example, just this week, it came true. If you have Nvidia that's down 20%, some managers will say, okay, if we've got a loss in Nvidia, I'm going to trim it, but I'm not going to sell out of it completely because it's too big of an index name.

34:42 If I don't own it even for 31 days during the wash sale period, I'm going to create very high tracking error. So there's this tug between tracking the index very closely and tax-loss harvesting. So everybody has a different philosophy around things like that. So that's another thing to take a look at. I'm curious from a practical perspective, if this is something that I was interested in using for some of my clients. I custody with Schwab. I know there are people out there that custody with Fidelity or other custodians. Can you talk us through the logistics and the practical aspects of employing this strategy?

35:26 What does it actually look like from a paperwork perspective, from an onboarding perspective? Do you work with all custodians? I'm sure separate accounts get set up. Do you do reporting? I'm curious about what that looks like in everyday life, working with a direct index account. Yeah. So I'm fortunate that we have a team of 10 here that do all that onboarding. But yeah, it's very much a hand-holding process to get these accounts set up. Often direct indexing managers will be available on a variety of different platforms, the Schwabs, the Fidelities, the independent platforms, the wirehouses. And it usually starts with the advisor indicating their interest in a particular index, and then determining how they're going to fund the account.

36:12 If it's funded with cash, great. If it's funded with securities, then we're going to want to take a look at those securities in advance. We're going to want to see the cost basis on the individual tax lots when they were purchased to be able to do this tax transition analysis. The intake paperwork is also going to say, hey, do you want to exclude any individual stocks? So hey, I want to own the S &P 500, but I work for Moderna. So let's not own Moderna in this portfolio. Or I work for Moderna, so let's not own Moderna, but let's also not own any other biotechs in the particular GIX industry or sector.

36:56 Or I want to add a business involvement screen. I don't want anything to do with alcohol or tobacco, abortion, contraceptives, all that stuff. And then once that's all figured out, this tax transition analysis is going to give you a sense for what the portfolio is going to look like. The account's funded, it's traded, and then from there it's going to be tax loss harvested on a periodic basis. Some firms do daily, monthly, quarterly, but you're going to be able to take advantage of that market volatility.

37:36 And then the client statement can be requested. So we don't send these out to every client, but depending on what platform you're using it on, you can have access to a portal that will show you all the tax loss harvesting activity. So it's going to show you why we traded a security. Was it because of a tax loss harvest? Was it because the security went out of the index? Was it a rebalance? Or the advisor can request a custom quarterly report that we can run and send to them. We also talk to advisors and clients and explain, we can do quarterly reviews explaining what we did and why we did it.

38:23 But you mentioned a couple of things that I'd love to just circle back on, on a couple of these. And I think you kind of already in your last response kind of hit on the whole, I was going to bring up the whole ESG question. It seems like direct indexing is a great opportunity for people who want to have control of where they want their money not invested or planned, that kind of values kind of thing. But you mentioned previously this using qualified dividends, and we didn't really talk much about that and just love to have you elaborate on that a little bit more. And then the frequency of loss harvesting, you said, I think you said something about quarterly, and I was thinking that didn't sound like as frequent as I would have expected.

39:13 So could you hit on either or both of those kind of topics a little more? Yeah, sure. So 80% of the stocks in the S&P pay a dividend, and whether that dividend is treated as qualified or non-qualified depends on your holding period. So if you've held a stock for 61 days and it pays you a dividend, it's going to be treated as a qualified dividend, and that is going to be taxed at the preferential long-term capital gain rate. And again, if you're in that 35% bracket, you're going to be receiving that dividend and you're going to pay 15% on it, so you're going to save 20% in taxes as opposed to if you held it for less than 61 days.

39:57 So that's something that shouldn't be overlooked. Earning qualified dividends can, again, help your after -tax performance. So that's number one. The second question around... Well, it sounds like maybe you just answered part of that as to why quarterly, right? There you go. Those are related considerations. It is. So the more frequently frequent that you're trading, you're less likely to earn qualified dividends. The more likely if you have other active managers trading individual stocks. Again, if you have a large-cap growth separately managed account and you have a large -cap direct indexing strategy, you could run into wash sales if you're trading more frequently.

40:43 But I think it's less about the frequency of the trading and more about the magnitude of losses or the taxes saved. So what I mean by that is every firm is going to have a threshold. Short-term losses are worth more than long -term losses. So if a security is down 5% on a short-term basis, that is attracted to us to harvest a loss. For another firm, it might say, hey, if it's down 2%, I'm willing to take that loss. And then long-term losses are worth less because they're going to be taxed, they're going to offset gains at a lower rate. So you're going to want those securities to be down more before you harvest them.

41:25 And markets tend to exhibit momentum characteristics. So if you harvest monthly and the stock continues to go down, then you just kind of left some money on the table, but you never really know. So it goes back to the manager's strategy in balancing this idea of wash sales and how long you're willing to be out of a stock, how much is a loss worth to you. If you look at how much somebody might be able to expect in losses, if you think about just a cash-funded account, so no restrictions, we're just taking all the market volatility as it comes.

42:08 Over the long term, we say, think about 20 to 25, sorry, over like a three to five year period, consider 20 to 25 % of the portfolio's value. We can generate the losses. So if you've got a million dollar portfolio at the end of three to five years, depending on market volatility, you could have anywhere from 200 to $250,000 of losses that have been generated. Meanwhile, that strategy is going to perform in line with the index. So just because we have a year like the last two years where the market's up 23%, there's still volatility that happens intra-year.

42:51 This isn't just an end of the year activity. So you harvest those losses. And a lot of firms will also accommodate lost harvesting requests. So we tend to do it more on a quarterly basis, but the client can say, hey, do you mind harvesting some losses? I see it in the account and we will accommodate that. Again, it's a relationship. It's not just setting it and forgetting it with an index fund or ETF or a mutual fund. You have some say in the process. The client can take that investable universe or that opportunity set and narrow it into an investable universe based on their own personal values or specific needs.

43:34 Thank you so much, Greg. We've covered so much today in our conversation. We really appreciate you being here. As we wrap up, is there anything else that you want to share with our listeners that we didn't ask you about that we should definitely make sure to get in before we end our conversation? I think every advisor has a client where direct indexing is going to be a good fit. It helps advisors take the underperformance conversation off the table. You don't have to worry about apologizing for a manager that underperformed, and you're elevating the level of conversation from how did I do relative to the index to now how much after-tax outperformance did you provide?

44:19 Going back to this idea of owning individual stocks in a portfolio, you guys know that the most important, at least in my opinion, most important job that an advisor has is keeping their clients invested in the market. Direct indexing, I think, really addresses the behavioral aspect. When there's market volatility, clients get nervous, and they want their advisors to be doing something for them. They want to see activity. What are we doing? Are we going to fire this manager and move somewhere else? You know that the best thing to do is usually just sit tight. Well, with direct indexing, you can see trades happen.

45:01 When there's market volatility, we're turning those lemons into lemonade. It is taking advantage of this market volatility and generating these tax losses or these tax write-offs for the client to use in the future. I think it's really important to help keep clients invested. I think it solves a pretty cool use case in that respect. Greg, do you ever have to do education to the client to explain, this is actually a good thing, we're selling this thing while it's down? I think sometimes clients get hung up on the idea of, now you realize that loss, as if that's not helpful when it actually is.

45:43 Yeah. With indexing, we don't care about the individual stock that we're harvesting. We're agnostic there. But if you had a conviction, certainly, about a particular stock that you owned, and you saw that down and you didn't want to part with it, that's another story. But advisors have been tax-loss harvesting for clients forever, usually at the end of the year. Clients know this is something that my advisor usually does for me. It's just, we're doing it on a systematic basis throughout the year. Yeah, so not as much education on that.

46:23 But it does take some education to talk to clients, explain what's going to happen. Once they see it working, they usually love it and stick with it. Greg, I bet there's some people who'd like to know how to learn more. You should certainly give them some insight as to how to reach you and learn more about your firm's offerings. Sure, yeah. So they can check out Natixis, and we have a direct indexing kind of microsite. I'm also active on LinkedIn, posting articles and blog posts and covering my travels and who I'm speaking with. And so you can find me on LinkedIn at Greg Canarian.

47:03 Perfect. Thank you, Greg. And just one piece of housekeeping before we wrap up, I just want to remind all of our listeners, well, invite you really to join us for Taxes and Tombstones, Estate Planning for a Wicked Smooth Exit, which will be our first Wicked Good half-day talk of 2025. You'll find us at the Conference Center at Waltham Woods on Thursday, March 20th. I'm really excited about the lineup. We have Fiduciary Trust Counsel Tricia Smock, who will dive into the recent changes to Massachusetts estate tax laws. Kate Huffnagle, the digital wrangler, will discuss helping individuals and families with the practical aspects of getting their affairs in order.

47:46 And I'm really excited about our keynote speaker. Natalie Choate will join us to share her expertise on Post-Secure Act Retirement Distribution Planning. So please visit fpanewengland.org for more information and to register. And we hope to see you there. Greg, thanks again so much for taking the time to join us today to talk about direct indexing and to share your experience and wisdom. It was lovely to see you, as it always is. And I hope we can catch up for drinks soon. Sounds good. Thank you so much for having me. If you'd like to learn more about the Financial Planning Association or FPA New England, visit our websites, financialplanningassociation.org for the National Association or fpanewengland.org.

48:30 You can learn more about our organization and all the upcoming chapter events. We hope you'll join. That's fpanewengland.org. Until next time, have a wicked good day.