The setup
The S&P 500 had a great year in 2025, up 18%. Say you had $100,000 sitting in something like SPY or VOO. You are now looking at roughly $18,000 in unrealized capital gains, all locked inside one security. When you own the ETF, you own the index as a single package. You get the 18%, but you have no control over what is happening underneath it.
What direct indexing changes
Direct indexing flips that. Instead of owning the S&P 500 as one ticker, you own all 500 stocks individually. The index was up 18%, but not every stock was up. Some names had a rough year. Direct indexing lets you go in and harvest the losses on those names. Say one holding is down 50%. The strategy sells it, banks that loss for tax purposes, and then buys the same stock back 30 days later so you keep your exposure. So you can finish the year up 18%, the same as the ETF, but along the way you also booked something like $18,000 in realized losses to offset gains elsewhere. Same return, far less tax.
You also get control
On top of the tax advantage, you get flexibility an ETF can never give you. Because you own the individual stocks, you can customize the portfolio. Do not want much exposure to oil companies? Want less technology? You can dial those down. It can be a much more tax-efficient way to own stocks in taxable investment accounts.