Turning Market Volatility into Tax Savings Through Direct Indexing
The Situation
A business owner sold a portion of a privately held company, generating a substantial liquidity event and an unusually large capital gain in a single tax year.
The family wanted to remain fully invested in equities but was also searching for strategies to improve after-tax outcomes.
A traditional index fund would provide broad market exposure, but it would offer limited opportunities to offset capital gains generated elsewhere in the portfolio.
Our Strategy
We recommended implementing a direct indexing strategy through GAMMA, Baird's customized direct indexing platform.
Unlike a traditional index fund, direct indexing purchases the individual securities within an index. This approach allows the portfolio to continuously monitor holdings for loss-harvesting opportunities while remaining invested in a portfolio designed to closely track the benchmark.
The family invested approximately $1 million into a GAMMA portfolio designed to track the S&P 500.
Key benefits included:
- Broad market exposure
- Ongoing tax-loss harvesting
- Customized tax management
- Ability to offset realized gains elsewhere
- Potential for improved after-tax returns
- Illustrative Results
The direct indexing strategy generated*:
- Approximate portfolio return of 15%
- Ending portfolio value of approximately $1.15 million
- Tax losses harvested of approximately $80,000–$120,000 throughout the year despite positive overall market performance
- These harvested losses were used to offset gains created by the business sale and other portfolio activity.
Assuming a combined federal and state capital gains tax rate of approximately 30%, harvesting $100,000 of losses could potentially generate approximately $30,000 in current-year tax savings
Importantly, these tax benefits were achieved while remaining fully invested in the market.
The Outcome
The family maintained broad equity exposure and participated fully in market appreciation while simultaneously creating valuable tax assets.
Benefits included:
- Continued participation in equity market growth
- Significant harvested losses to offset realized gains
- Improved after-tax wealth accumulation
- Greater flexibility for future tax planning
- Enhanced portfolio customization
- Value Delivered
- For affluent families, the focus should not simply be on investment returns but on after-tax returns. Direct indexing allowed this family to pursue both objectives simultaneously—capturing market growth while using normal market volatility to create meaningful tax savings.
The result was a portfolio that worked harder for the family, generating investment returns while actively helping manage one of their largest expenses: taxes.
*Returns approximated based on 2025. Tax loss harvesting opportunities and index returns are variable and subject to market movement.
The scenario described is hypothetical and is intended solely to illustrate the types of financial planning services that may be provided. It does not represent the experience of any specific client. Actual client experiences and outcomes will vary depending on individual circumstances and it should not be interpreted as a guarantee of future results or client experience. Any interest rate assumptions, rates of return, inflation figures and other costs or figures are hypothetical and for illustrative purposes only.