Fidelity Opens Direct Indexing Option to Retail Investors

Building wealth has grown more accessible than ever, thanks to declining trading costs and fractional share investing. Many brokerage firms already offer zero-commission online and exchange-traded fund (ETF) trading, and now, behemoth financial firm Fidelity Investments has brought one more such tool to the masses.

Fidelity Investments, which administers $11.1 trillion in assets, filed documents with the Securities & Exchange Commission on January 19, 2022, to launch the first professionally-managed direct-indexing product for retail investors. Called Fidelity Managed FidFolios, Fidelity’s newest offering aims to combine direct indexing with fractional shares – opening a once capital-heavy investment strategy to any investor who can meet the $5,000 account minimum.

Investors often leverage direct indexing to reduce their tax burden or implement a specialized investment strategy, enabling them to save more for retirement and build wealth faster. A qualified financial advisor can help you determine if such strategies are an appropriate option for you.

FidFolios: Inside Fidelity’s New Product

Fidelity already manages $33 billion in direct-investing assets under its separately managed accounts (SMAs), which Fidelity says “seek index-like returns with enhanced after-tax” benefits. However, Fidelity’s new product is designed with the average person in mind: though the company’s existing direct-investing accounts require a $100,000 minimum to open, the new FidFolio requires 20 times less.

Direct indexing is not a new strategy. Since you cannot directly buy shares of an index, such as the S&P 500, many investors commonly attempt to replicate an index’s performance by buying mutual funds and ETFs to track it. An alternative to buying managed funds is to invest directly, buying the individual stocks of an index so your investments have similar characteristics. This is called direct indexing.

Why not just buy a fund that tracks it instead? Generally, investors build direct-indexed portfolios (both professionally managed and individually built) to maximize after-tax returns or customize for environmental or social causes.

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Direct Investing for the Masses

In 2020, Fidelity joined other major investment firms to offer free stock trades and fractional investing, making it possible to build substantial portfolios for much less than it cost in the past. By lowering the requirements to open a direct-indexing account to $5,000, Fidelity is further revolutionizing the industry, opening managed accounts to the mass market.

Especially useful for investors who are just beginning to diversify their wealth-building strategies, these new accounts break down what might be very high-cost indexed stocks into smaller, fractional shares, thus spreading each stock’s cost among its fractions. Although fractional investments correlate to fractional gains, the ability to partake in a previously-limited investment strategy can help lower-net-worth individuals build wealth and save for retirement in a way that was not possible before.

What are the Benefits of Direct Indexing?

In fact, a key advantage of direct-indexing accounts is the ability to leverage certain tax strategies, such as tax-loss harvesting. If you own shares of a mutual fund or an ETF, you can only buy or sell one at a time. On the other hand, holding hundreds of individual stocks rather than shares of an index-tracking fund allows investors to harvest multiple losses from selling individual positions, thereby balancing those losses against other taxable gains. This can effectively lower a retail investor’s tax bracket if employed properly.

But one of the possible questions surrounding this new product is whether mom-and-pop investors would truly be interested in a direct-indexing account – especially given the 0.4% account fee. Expense ratios can vary widely, with passively-managed ETFs charging as low as 0.2% and actively-managed mutual funds going as high as 1.5%, and the FidFolio fee falls at the higher end of the passively-managed range.

Then again, these direct-indexing accounts may offer more than tax benefits. Fidelity’s new product has a fully digital interface, allowing customers to personalize an index to reflect investing preferences. Sustainable and thematic investment strategies could potentially appeal to broad demographics, with customization options that remove individual stocks or entire industries.

Fidelity Managed FidFolios are still only in the pilot phase, but the company will soon offer the product to all investors within the coming months.

Bottom Line

Decreased costs and innovative financial products are opening more wealth-building opportunities to retail investors. Fidelity Managed FidFolios represent this trend by opening direct indexing options to those with just $5,000 to invest. Although the sheer multitude of available products can prove confusing, younger and lower-net-worth individuals would likely benefit from researching and opening investment accounts where fees and financial education are more accessible.

Wealth-Building Tips

• Not sure which investment strategy will help you retire early? For a solid, long-term financial plan, consider speaking with a qualified financial advisor. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

• Use SmartAsset’s free investment calculator to get a good estimate of how to grow your money over time.

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