If you zoom out, the story of investing over the past 100 years is not really about products. It is about technology.
Each new structure, from individual shares through to ETFs, has solved a problem from the previous era. But each has also baked in new limitations. Direct indexing is best understood in that context. It is not a revolution. It is the next logical step.
The 1920s to 1930s: The Era of Individual Stocks
If you wanted exposure to the share market, there was only one option. You bought individual stocks. That worked, but only if you had capital, time and access. Diversification was hard. Execution costs were high. Most investors ended up concentrated, whether they intended to be or not.
The 1970s to 1980s: The Rise of Mutual Funds and Pooled Investing
The next leap came with pooled investing. Mutual funds allowed investors to buy a diversified portfolio in a single trade. This solved a real problem. It democratised investing. You no longer needed to build your own portfolio from scratch. Professional managers did it for you.
But it came with trade-offs. You lost control. The tax consequences were out of your hands. If a fund sold assets, you paid the tax, whether you wanted to or not.
A lot of that was technology – with limited computing, bundling everyone into one tax fund was far more cost effective.
The 2000s: The Index Fund Boom
The idea that an efficient market meant that you could buy the index, provided the fee was low enough, and beat many active investors took hold. It is not that active fund managers always underperformed, it is that they often charged a higher fee than the value they added.
But the unit trust problems remained. And you would often be buying at the yet unknown end of day price.
The 2010s: The Widespread Adoption of Exchange Traded Funds (ETFs)
ETFs refined that model further. They stripped out the cost and removed the guesswork. They gave better tax outcomes. They had more efficient intraday pricing. The appeal was obvious. Low cost. Broad diversification. Transparency.
Much of the advent is a technological one. Market makers can price and arbitrage an ETF in milliseconds, features not available in the 1980s.
For most investors, ETFs became the default building block of portfolios. And for good reason. They are efficient, scalable and easy to access. You can buy hundreds or thousands of stocks with a single click. But again, there are limits.
The key one is that ETFs are blunt instruments. Every investor in the same ETF owns exactly the same underlying portfolio. There is no distinction between different investors’ circumstances.
That might sound like a feature, but in practice it creates inefficiencies, particularly around tax. When you hold an ETF, you do not own the underlying shares directly. You own a unit in a pooled structure. That means you cannot choose which individual holdings to sell, or when. You get whatever the fund gives you.
Direct Indexing vs ETFs: A Tax Management Example
Direct indexing changes that. At its core, direct indexing is simple. Instead of buying an ETF, you buy the individual shares that make up the index in your own account.
From a market exposure perspective, the outcome is similar. You still track the index. You still get broad diversification. The difference is control. Because you hold each stock directly, you can decide which parcels to sell, and when. That opens up a level of tax management that simply is not available in pooled vehicles.
Again, this is a technology leap. The technology to manage thousands of portfolios, use fractional shares and trade cheaply simply wasn’t there 15 years ago. It is now.
Take a simple example:
- You started investing five years ago, adding monthly to your investment. You own multiple parcels of NVIDIA, ranging from the one you bought years ago which is up 1,000% to the parcel you bought last week which is down 1%.
- A big stock enters the index – say Micron. You need to sell some NVIDIA to buy Micron.
- In an ETF, it doesn’t matter when you “bought” the additional NVIDIA shares – it is a pooled structure. It matters when other investors did.
- In direct indexing it does matter. you can choose to sell the higher cost parcel first, minimising the taxable gain. Multiply that across hundreds of stocks, and the difference becomes material.
This is why tax management sits at the centre of the direct indexing proposition. Even in a rising market, many individual stocks will be down in any given year. Those losses can be realised and used to offset gains elsewhere.
The important point is not that direct indexing magically increases returns. Before tax, the expectation is broadly the same as the index. The difference shows up after tax.
Is Direct Indexing Just for US Investors, or Effective in Australia?
Historically, this approach was limited to institutions and ultra-high-net-worth investors. The operational complexity was too high. You needed scale to make it work. That has changed.
Fractional shares, zero-commission trading and improved portfolio management systems have brought the cost down to the point where it is now accessible to a much broader range of investors. In other words, the technology has finally caught up with the idea.
For US investors, the benefits are well understood. Tax optimisation is a primary driver of outcomes. In a high turnover, high capital gains environment, the ability to manage individual tax parcels is significant.
In Australia, the story is a little different. Tax still matters, but personalisation arguably matters more.
Direct indexing allows investors to tailor portfolios in a way that ETFs cannot. That might mean excluding certain sectors. Managing concentration risk. Integrating ESG preferences. Or simply aligning a portfolio more closely with an investor’s broader financial position.
This is where the conversation shifts. The question is no longer whether ETFs are good. They are. They solved a huge problem. The question is whether they are the end point.
History suggests they are not. Every iteration in investing has pushed towards greater efficiency, lower cost and more investor control. Direct indexing fits that pattern. It keeps the benefits of index investing, but removes one of its core constraints.
The trade-off, as always, is complexity. More control means more decisions. More moving parts. And a greater reliance on systems to manage them.
That will not suit everyone.
But for investors who care about after-tax outcomes, and who want more control over how their portfolio is constructed and managed, it is a meaningful step forward. Seen through that lens, direct indexing is not a niche strategy.
It is the next version of the same idea that started a century ago. Better access. Better efficiency. And increasingly, portfolios that reflect the investor, not the product.
Take Control of Your Portfolio with Direct Indexing
As technology continues to drive the next era of investing, you don't have to be locked into the rigid boundaries of traditional pooled funds. If you want to maximize your after-tax returns, minimize capital gains, and build a portfolio that truly reflects your personal values, it’s time to explore the next frontier. Visit directindexing.au today to discover how our tailored direct indexing solutions can give you the transparency, control, and efficiency you need to grow your wealth.
