Making Better Use of Losses: Direct Indexing vs. Long/Short Harvesting

Who Actually Needs Direct Indexing (or a Long Short Harvesting program)

Direct indexing makes the most sense when there’s a specific tax problem to solve.

Concentrated stock unwind
You’re sitting on a large single-stock position and want to diversify without triggering an enormous gain. A direct index can offset that realization through systematic harvesting elsewhere.

Those with large capital gains from other assets
If you’ve got capital gains from things like a real estate or business sale, the losses generated from the direct indexing program can help reduce the total amount.

Low-basis stock positions and customization preferences
You can “swap” out specific names within a direct index, gradually rotating into diversified exposure while minimizing realized gains. You can also restrict particular securities or industries to match your values or circumstances.

Who Doesn’t Need Direct Indexing or Long/Short Harvesting

Not everyone benefits from these strategies — and for many investors, they add more complexity than value.

Retirement Accounts
There’s no tax benefit to loss harvesting inside tax-deferred or tax-free accounts. Direct indexing only makes sense in taxable portfolios. 

Investors in Low Tax Brackets without Large Capital Gains from Other Assets
If your marginal rate is under ~24%, the after-tax benefit of harvesting losses shrinks. Coupling that with no offsetting gains, you end up with a large carryover loss that’s not all that valuable.

Small Accounts
Accounts under $250K (for example) simply won’t have enough positions or volume to generate a material amount of losses.

Short Time Horizons
If you expect to liquidate the account within a few years (e.g., for a home purchase or business funding), there’s not enough runway to realize and utilize losses effectively and you’ll likely end up realizing a bunch of gains when you unwind the strategy.

Those Who Hate Complexity
Direct indexing and especially long/short overlays involve hundreds of securities, daily trading, custom lots, and potentially extra tax forms. If simplicity and predictability are higher priorities, you’re probably better off with ETFs.

What to Expect from Direct Indexing

Some of this is theoretical, some of this is debated. Ultimately, the manager matters significantly and the type of market you start in matters more. If you start the strategy and everything goes straight up, logically you won’t have as many available losses as starting the strategy right in front of a market drawdown. 

Typical tax alpha
Expect 1–2% of portfolio value per year in harvested losses under normal market conditions. High volatility years can amplify the amount. Low volatility years can reduce the amount. 

Timeline
The first 12–24 months tend to generate the most losses as new tax lots diverge from the benchmark. After that, opportunities taper off — unless you keep adding cash. Most of the incremental tax benefit is realized in the first 7-10 years.

Regular contributions
Investors who contribute periodically keep “refreshing” their cost basis, allowing ongoing harvesting even in bull markets to benefit the most.

The ending portfolio
After several years, you end up with something that looks like an S&P 500 ETF (or whichever index you’re benchmarking to) — but with hundreds of unique tax lots and embedded deferred gains.

Enter the Long/Short Version

Now take the same tax logic — but give it tools to keep harvesting indefinitely. That’s the long/short tax-loss harvesting strategy.

How it works
You stay fully invested long (say, in the S&P 500).

You selectively short correlated securities or factor baskets to generate loss opportunities without changing overall market exposure.
You can realize losses every year, not just when markets dip.

What to Expect from Long/Short Harvesting

I like to think of plain Direct Indexing as the trash can and Long/Short as the recycling bin.

Typical tax alpha
Expect 2-4%% of portfolio value per year in harvested losses with less sensitivity to market conditions. 

Timeline
The first 12–24 months still tend to generate the most losses, however the incremental tax benefit extends far beyond 7-10 years.

Regular contributions
Investors who contribute periodically will still benefit the most, but the strategy reduces the importance of ongoing funding.

The ending portfolio
The portfolio remains neutral-to-market much longer and because losses are continually harvested from the short program, the likelihood of being stuck with a long list of securities with embedded gains is reduced/extended.

Conclusion

Volatility isn’t just noise — it can be a valuable resource.

Direct indexing helps capture that resource. A long/short strategy can extend that benefit.

Either way, both are about building a better after-tax portfolio that makes better use of losses — converting market movement into a renewable tax advantage.