Tax-Loss Harvesting for Investment Portfolios: Direct Indexing and Beyond

If you have built meaningful wealth, you likely already understand the fundamentals of tax-loss harvesting:

1. Sell an investment that has declined in value.
2. Realize the loss for tax purposes.
3. Use that loss to offset capital gains — or up to $3,000 of ordinary income each year.
4. Reinvest in a similar security at the same time.

Unused losses carry forward indefinitely, creating a growing reservoir of tax benefits you can deploy in future years.

The stakes may be higher and the opportunities may be larger if you have concentrated positions, capital gains from business sales, real estate transactions, or equity awards. Each of these creates gains that harvested losses can offset.

The result is what is known as “tax alpha” — the after-tax return enhancement that comes from systematically realizing tax losses. More direct holdings increase the ability to capture losses symmetrically, which has given rise to direct indexing. Direct indexing has grown into a mainstream capability for wealth management, with assets closing out 2024 at $864.3 billion — nearly double the level reported in 2021.^1,2 A 2026 FTSE Russell survey found that 83% of advisors are using or plan to use direct indexing in the next 12 months, and 42% cite tax efficiency and tax-loss harvesting as the primary reason for increasing their use.³

How direct indexing functions

Instead of buying an exchange-traded fund (ETF) or mutual fund that tracks an index, investors own the individual stocks that make up that index directly in a separately managed account (SMA). This structure lets you sell specific positions that have declined while buying similar — but not substantially identical — replacements to keep your market exposure steady. Because even in a rising market, individual stocks within an index may decline, and harvesting opportunities are available every year, not just during downturns.

The tax-alpha math

Research published in 2026 found that systematic tax-management techniques — including tax-loss harvesting, gain deferral, and tax-aware rebalancing — produce implied annualized tax alpha typically in the range of 0.7% to 3.5% for equity direct indexing.⁴ Industry data points to a range of 1% to 2% annually (per the chart below), although results vary based on market conditions, tax rates, and the investor’s specific circumstances.

The value of those harvested losses depends on what they offset. A loss that offsets short-term capital gains taxed at your ordinary income rate is worth more than one that offsets a long-term gain taxed at a lower rate. For investors in the top federal tax bracket who also pay the 3.8% net investment income tax (NIIT) and state tax, every dollar of harvested loss can save 30 cents or more on the dollar in taxes. Those savings compound over time, especially when fresh deposits create new tax lots with higher cost basis — generating still more harvesting opportunities.

Direct indexing vs. ETFs and mutual funds

One study found that direct indexing often outperforms ETFs for tax-sensitive investors, particularly over shorter investment horizons and when deposits are recurring rather than a lump sum.⁵ ETFs largely eliminate capital gains through in-kind redemptions, but they cannot harvest losses at the individual security level. That is the structural advantage direct indexing offers: You control which lots to sell, when to sell them, and what to replace them with. Over the past two decades, U.S. equity mutual funds have distributed capital gains averaging roughly 7%-9% annually, creating tax drag that direct indexing can help reduce.⁶

The 61-day window and “substantially identical” rule

The IRS wash-sale rule, codified in Internal Revenue Code Section 1091 and described in IRS Publication 550, disallows a capital loss if you buy the same or a “substantially identical” security within 30 days before or after the sale — a 61-day window in total. The rule follows you, the taxpayer, not your brokerage account. That means selling a stock at a loss in one account and rebuying it in another within the window still triggers the rule, even if neither broker reports it on Form 1099-B.

The IRA issue: Permanent loss of the deduction

If you sell a security at a loss in a taxable account and buy the same or a substantially identical security in your IRA or Roth IRA within the 61-day wash-sale window, the loss is disallowed. Unlike a typical wash sale involving taxable accounts, however, the disallowed loss does not increase the basis of the investment in the IRA or Roth IRA, so you generally lose the tax benefit of that loss. It is permanently forfeited. The same result applies to a buy in your spouse’s IRA.

Automatic features like dividend reinvestment plans can inadvertently trigger a wash sale if the same security is sold at a loss within 30 days.

Coordinating across household accounts

Because brokers are only required to report wash sales within individual accounts, you’re responsible for tracking cross-account wash sales yourself. This is where the coordinated approach Mercer Advisors offers can be beneficial. When your investment management and tax planning are handled by one team that knows your full financial picture, that team can help you harvest losses across accounts without accidentally running afoul of the rule.

Tax-loss harvesting can be most useful when it’s not a stand-alone exercise but part of a comprehensive plan. Here are three ways to coordinate harvesting with other planning strategies across tax, investment, estate, and charitable giving.

1. Pair harvested losses with charitable giving of appreciated stock

When you harvest losses, you are selling positions that declined. At the same time, you may hold positions that have appreciated significantly. Instead of selling those winners and paying capital gains tax, you can gift the appreciated shares directly to a qualified charity or a donor-advised fund (DAF). You can avoid the capital gains tax on the embedded gain and receive a charitable deduction for the full fair market value. Meanwhile, the losses you harvested offset gains from other transactions. The two strategies complement each other: Losses offset gains, and charitable gifts remove gains from your portfolio entirely.

This pairing can be especially helpful for investors with concentrated positions who want to diversify their portfolios while supporting causes they care about. By gifting appreciated stock, you can reduce your concentrated position without recognizing the gain — and by harvesting losses elsewhere, you may further reduce your overall tax liability.

2. Use direct indexing to unwind concentrated positions tax-efficiently

If you hold a large position in a single stock with a low cost basis, selling it all at once can trigger a significant capital gains tax. Direct indexing lets you unwind that position over five to 10 years, selling portions gradually and using the losses harvested from the diversified portfolio to offset the gains from each sale. This coordinated approach can help reduce the tax impact of diversification and support a more balanced portfolio over time.

As the concentrated position is sold down, the portfolio becomes increasingly diversified, and the losses generated by the direct indexing strategy continue to offset gains from each tranche of the sale. This is an example of how investment management and tax planning can reinforce each other.

3. Coordinate harvesting with Roth conversions and rebalancing

Roth conversions create taxable ordinary income in the year you convert. If you have harvested losses available, they can offset capital gains realized during any rebalancing, freeing room to convert more assets to a Roth IRA at a lower tax cost. Similarly, when you rebalance your portfolio to restore your target allocation, the sales that generate gains can be paired with harvested losses to reduce the tax impact. Additionally, you can use up to $3,000 of capital losses to offset the ordinary income from the Roth conversion.

The key insight is that each of these strategies — harvesting, charitable giving, concentration management, Roth conversions, and rebalancing — creates tax consequences on its own. When they’re coordinated, those consequences can be managed together, and the result can be greater than the sum of the parts.

Direct indexing is generally most effective for investors with meaningful taxable account balances, high marginal tax rates, and regular capital gains from other sources. If you have concentrated stock positions, anticipate a business sale or liquidity event, or make regular deposits to your taxable accounts, the strategy can generate more harvesting opportunities over time. It’s also well suited for investors who want to make their portfolios more personal — excluding specific sectors, incorporating values-based screens, or managing around existing holdings to avoid duplication.

The benefits may be quantifiable but depend on individual circumstances, so an analysis tailored to your situation is essential before implementation. Not every investor needs direct indexing and, for some, tax-managed funds or exchange-traded funds (ETFs) may be a more appropriate starting point. The right answer depends on your portfolio size, tax situation, and goals.

Tax-loss harvesting through direct indexing is a powerful tool, but it can deliver more value when it’s coordinated with your tax planning, estate strategy, charitable goals, and investment management. When one team knows your full financial picture, every loss harvested, every position sold, and every gift made can fit into a larger strategy designed to protect and grow what you have built.

Our team can assess your portfolio, identify harvesting opportunities, and build a coordinated plan that aligns your investments with your goals and your family’s future.