Lead-Lag Live

The $1,000 Revolution: Sam Nofzinger on Direct Indexing, Taxes, and the Future of Investing

Michael A. Gayed, CFA

In this episode of Lead-Lag Live, I sit down with Sam Nofsinger, General Manager of Brokerage at Public, to discuss how the company’s new direct indexing feature is bringing institutional investing tools to everyday investors.

For the first time, investors can build their own index, own every underlying stock, and optimize for taxes with just $1,000 minimum. Sam explains how fractional shares, automation, and tax-loss harvesting are transforming what used to be a high-net-worth strategy into something anyone can use.

In this episode:
– What direct indexing is and how it differs from ETFs and mutual funds
– Why customization and tax-loss harvesting matter for long-term returns
– How Public’s technology makes personalized portfolios accessible to everyone
– How fractional shares broke down the biggest barriers to entry
– Why the future of investing is personal, automated, and tax-efficient

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SPEAKER_00:

There are a couple of important differences we think relative to indexes compared to an ETF or a mutual fund. So one is it's a pooled fund that you're investing in if it's an ETF or a mutual fund. You have no ability to change what's in that fund. You get what it is, and you are beholden to whatever Vanguard's doing, whatever the manager of that fund is doing. And so it's a great strategy, but it does have limits in terms of you can't customize it if you wanted to not um you know uh invest in a certain security, you know, that the index is a good thing.

SPEAKER_01:

I'm your host, Melanie Schaefer. Welcome to Lead Leg Live. Now these days, everyone's looking for smarter ways to invest, not just to chase performance, but to actually manage it. With this in mind, Public, a multi-asset investing platform, just rolled out fully customizable direct indexing, a feature that lets investors build their own index, own the individual stocks inside it, and even optimize for taxes automatically. And here's what's different you don't need to be a millionaire to do it. For the first time, public's bringing direct indexing to everyday investors with just a$1,000 minimum and an annual fee that's under 20 basis points. That's a massive shift from what's traditionally been a high net worth strategy. My guest today is Sam Nossinger, the general manager of brokerage at Public. Sam's been leading this rollout, and it's great to have him here. Thank you so much for being here, Sam.

SPEAKER_00:

Thanks so much, Melly. Uh, pleasure to be here, and we're really excited for this launch.

SPEAKER_01:

So um, just to get started, can you tell us a little bit about what the big picture is? Why direct or why did you launch direct indexing now? And what problem are you trying to solve?

SPEAKER_00:

Sure. Uh index investing, I think, has been around for a long time. And I think most investors know that tracking an index, following an index, investing in index funds is generally a relatively good way to build long-term wealth. Historically, uh, the only way to access uh you know investments in an index, which are uh you know, basically baskets of stocks that you know are tracking some type of methodology, whether it's the SP 500 or the NASDAQ, uh, the only way to access investments in these indexes was to buy a mutual fund or an ETF that tracked these indexes. So you would buy the Vanguard S P 500 ETF. Uh, that would be one ETF that would track the SP 500. And that was how most investors, um, in individual investors would get access to a lot of these index products. So ETFs and mutual funds are a great way to access these indexes, but that we think there's an even better way, which is direct indexing. Uh, direct indexing is an investment strategy, has been generally, as you mentioned, available to ultra-high net worth investors. And so what is it? Instead of buying an ETF or a mutual fund that tracks the index, you actually go out and buy all of the underlying constituents of these index. So if you're tracking the SP 500, you'd go out and buy all 500 securities within that index, and then you would track it that way instead of owning uh, you know, a fund or uh you know an ETF. And the ability to own the underlying holdings directly as opposed to a fund comes with a lot of benefits. Uh, you know, for one, uh, you know, our investors are allowed to customize the direct index. So if you don't want energy in the SP 500 or you don't want you know NVIDIA or Tesla, for instance, you know, you could exclude those from your personal index. And now your index is not tracking the index, but tracking a more personalized, customized version uh that is suitable to you in your investment strategy. And so, you know, you're able to customize it, you're able to personalize it. Um, there are also extra tax benefits. Uh so we have a tax loss harvesting methodology that we employ. So every day, you know, we're searching for losses, trying to generate uh you know losses to offset gains in your other portfolio so that your compounded returns are even greater than they otherwise would have been. And so for us, we think direct indexing, we're able to invest in the underlying securities, is a really, really good way for investors to build long-term wealth and achieve their financial goals uh, you know, over the coming years.

SPEAKER_01:

Yeah. So I just want to take a step backward to the side actually, just for a minute. And and and let's speak to people who um are hearing about direct indexing for the very first time. How can you describe it very plainly in plain English and in the most simplest way possible?

SPEAKER_00:

Uh, direct indexing is an investment strategy where an investor chooses an index and instead of buying a fund or an ETF that tracks that index, you actually purchase the underlying holdings of the index instead.

SPEAKER_01:

So, what's really the difference then between owning an ETF and owning the actual stocks inside the index itself? I know you've touched on that a little bit, but I want to get more into it.

SPEAKER_00:

There are a couple of important differences we think relative to indexes compared to uh you know an ETF or a mutual fund. So one is it's a pooled fund that you're investing in if it's an ETF or a mutual fund. So you have no ability to change what's in that fund. You get what it is, and you are beholden to whatever Vanguard's doing, whatever the manager of that fund is doing. And so it's a great strategy, uh, but it does have limits in terms of you can't customize it if you wanted to not um you know invest in a certain security, you know, that the index is. I think another one is you know, you don't have the ability to um, you know, uh tax loss harvest an ETF, and tax loss harvesting is a very important strategy um, you know, compared in in direct indexing relative to an ETF. So if you think about um owning an ETF, if the stock market is up in a year, that stock market has gains and there's no ability to tax those harvest. If you own the 500 individual stocks, have a however that replicate that index, in any given year, there's a good chance that a lot of those stocks will be down, even if right in aggregate they are up. And so by owning the individual holdings, you are able to sell uh you know the the stocks at a loss and reinvest them in similar securities, and you're still able to get the exact same performance as the ETF or the mutual fund, but you have an extra tax benefit that you would not have had in the ETF. So I think it's you know personalization, customization, the ability to tax loss harvest the underlying holdings are very, very big benefits for an ETF, you know, for sorry, for a direct index over an ETF.

SPEAKER_01:

Yes, and for advisors watching, how should they think about using direct indexing for their clients? And when does it make sense for them to use it alongside maybe ETFs?

SPEAKER_00:

I think for financial advisors, it's a really, really good toolkit, you know, tool that they can have in their toolkit. Uh for one, I think they can go out to their customers and say, you know, instead of investing in this broad index that everyone can invest in, you know, let's devise a strategy that is bespoke to your situation. So what are your values? You know, where do you think uh you know growth lies in the economy? Let's build an index that actually replicates where you want to invest as opposed to kind of where the industry wants you to invest. And so for advisors, it really allows that one-on-one relationship to blossom as they're able to basically dig into this, you know, this investor's actual personal values and create um you know a vehicle that will perform similarly to the broader market, but is bespoke to them and really captures their values and where they're you know they think they should be invested. Um there are also, I think, cost benefits. Um a lot of direct index um you know uh products are very, very cheap. Ours is you know 19 basis points. The average ETF, I think, is 75 basis points. So it can also be a good cost savings for advisors as opposed to investing in ETFs. And so I think for advisors, you know, looking uh whether they want an ETF or whether they want direct indexing, you know, direct indexing gives them a lot more customization. Uh, and it also allows them to have much, much deeper conversations and understand their clients and build those personal relationships that are very, very important in the advisor-customer relationship. And that's not said that ETFs uh you know don't deserve a place in the portfolio. ETFs you know can have a very, very important role. Um, you know, for instance, it's harder to direct index in an international stocks. So you may want an ETF for your international exposure because it's more difficult for domestic investors to you know access the underlying stocks of a Chinese index or a European index. So international may be a very, very good place to still have um you know kind of uh you know ETF exposure, while you know, if you're investing in the US, direct indexing may be more appropriate there.

SPEAKER_01:

Yeah, and you've mentioned it a couple of times, but one of the biggest draws is tax loss harvesting, the idea of turning Mercado Dips into potential tax advantage was that can you explain how it actually works behind the scenes at public? And what do investors need to understand about when and how uh it kicks in?

SPEAKER_00:

Sure. So tax loss harvesting um uh at a high level is the process of looking through all of the holdings in a portfolio, looking for uh you know, holdings that are at a loss, an unrealized loss, selling those securities to actually turn that unrealized loss into a realized loss, and then using the cash proceeds to buy a stock that is similar in nature and is expected to perform similarly so that your overall portfolio still is on, you know, tracking the index. And so if you're still tracking the index, but you've harvested this realized loss. And that's a really, really good tax benefit that in the future you can use to reduce your tax payments. And so instead of paying$10 to the government next year, you can put$10 back in your investment portfolio and that compounds year after year after year after year. And so it's not just the first year of savings that you get from tax loss harvesting, it's that these savings in this first year and the second year and the third year compound for the rest of your life. And so the tax compounding benefits of tax loss harvesting is really a huge benefit of direct indexing versus an ETF.

SPEAKER_01:

Yeah, and as I mentioned uh in my intro, you dropped the minimum to just$1,000, big change from traditional direct indexing, um, which used to start even in the six figures.

SPEAKER_00:

Why was it important to lower that barrier? So I've been in this industry for 20 years, and direct indexing has been the next thing for literally the past 25 years. And I think finally this year, uh, you know, it's gonna ring true. And a lot of that has become advancements in technology. 25 years ago, there was not fractionalizing of securities. So if you wanted to buy, you know, the SP 500, you had to buy one share of each of those things. At the time, you know, Amazon was$1,800. So, you know, if you wanted to buy all every the whole index for$1,000 and one stock costs$1,800, you can see how that doesn't add up very, very quickly. So one of the things that the industry had to do was fractionalize securities so that you could buy any stock for as little as$1 or$5. And so that opened up that so that reduced the minimums a lot because it became a lot easier to access every single investment in these indexes because instead of having to have the dollars for the price of the stock, you just had to have the ability to invest a dollar or five dollars in the underlying. And so that was a huge benefit, was just bringing the dollar size of each stock down. Another thing was lowering costs through automation and technology. So historically, um, you know, there would be a portfolio manager who would be looking at these portfolios, placing the trades, making sure they were in line with targets. All of that is now done behind the scenes, you know, through our software, through our automatic, you know, rebalancing tools that look for all the nuances, look across all the portfolios, run a whole bunch of math behind the scenes to recommend their actual trades that we place every day in order to keep you in line with your index, but also generate losses so that you have tax benefits that you can use in the future. And then I think the third point why it's actually the time for direct indexing is because you know the average individual investor is very, very smart and sophisticated these days. You know, every day we are seeing your investors get more smart, more sophisticated, and more intelligent about what products they want and where their investments, you know, where they want their investments to be. And so we've had a lot more people asking about direct indexing over the past couple of years because I think the individual investor now understands the benefits not just of investing in index, index funds, but actually owning the underlying securities and the added benefits of uh you know investing in index directly as opposed to the ETFs. So I think a lot of it is technology, bringing down the size of a share from hundreds of dollars or thousands of dollars to$1,$5. It's you know, behind the scenes technology so that all this automatic portfolio management can be scaled across thousands and millions of accounts. And then I think a lot of it is us and our peers have done a great job educating investors over the past five, 10 years about the benefits of long-term investing, the benefits of index products, and the benefits of owning stocks directly and being able to customize to your personal needs. And so finally, I think, you know, for for anybody out there, you know,$1,000 is pretty um, you know, low hurdle for folks to get uh you know an institutional quality asset that they can have around for the rest of their lives.

SPEAKER_01:

Yeah, and to add on to that, since the launch and even more in general, how are you seeing investors using the this flexibility? And are you seeing people build around values, sectors, or performance themes, et cetera?

SPEAKER_00:

Yes, uh there are a lot of people who, you know, certainly I think the the the core of our base continues to just want very, very standard index products. So a lot of people do the two-click S P 500. That's good enough for me. But we are seeing about a quarter of our investors either choosing more niche investors, whether they're sectors or even subsectors such as semiconductors. Um, but we're also seeing folks exclude a lot of companies. Um, and a lot of folks, you know, are you it's you know the energy companies that people that may not ascribe to their values. Um, we're seeing a lot of you know, folks you know exclude certain companies that may not align with their values. We're also seeing um, you know, folks exclude holdings that they have a lot of exposure to already. Um, you know, a lot of our investors are uh you know have a very large holdings in Tesla and NVIDIA and Microsoft and Apple. And so a lot of our investors are actually designing indexes that diversify their current holdings away from some of these concentrated positions. Uh and so, you know, for instance, um, you know, we have a couple folks, you know, we have a lot of folks, you know, who work at large tech companies and a lot of their compensation, for instance, is in their company's stock. And so if they wanted to, you know, they can build a direct index basically exclude their company's stock. And then as the losses generate in their direct indexing, they can take gains in their concentrated position. And so we've we've seen a lot of different use cases for it. Uh, people are either targeting specific sectors or areas that they think are poised to grow, or you know, they're building diversification around their main holdings in their main brokerage accounts. And so we're seeing a lot of different use cases for direct indexing. Um, and they're all you know great in you know, as far as we can tell.

SPEAKER_01:

Yeah, and finally, for anyone who wants to learn more about public's new direct indexing uh platform or try it out, where's the best place to start?

SPEAKER_00:

Public.com uh is the place for everything about uh where you can find information on you know on our firm, on all the different products, on direct indexing. Uh, you can see all of the different indexes that we have to choose from. There's over hundreds of them. Um and then you can sign up for an account and you can you'll see how it works for yourself.

SPEAKER_01:

Sam, thanks so much for joining me, and thanks to everyone for watching. Be sure to like, share, and subscribe for more episodes of Lead Leg Live.

SPEAKER_00:

Thanks so much for having me, Melanie.