Fidelity brings DIY direct indexing to the investing masses

Ordinary investors can soon build their own versions of indexes like the S&P 500, and for the price of a large Starbucks latte.

Fidelity Investments said Tuesday that it would allow Main Street investors to create custom indexes and put money in their chosen underlying stocks. With no account minimums and a flat $4.99 monthly fee for the service, the Boston-based mutual fund giant is aiming for the wallets of mass market investors lured by commission-free trading and no minimums at brokerages like Charles Schwab, Merrill Edge and Robinhood Markets. 

The Fidelity Solo FidFolio platform, to be rolled out in coming weeks, aims to capitalize on the boom in personalized investing that reflects a saver’s values and preferences, often along environmental, social and governance (ESG) lines. It’s also a response to the growth of stock trading during the pandemic. Retail investors increased their weekly trading nearly 14% in the early days of the health crisis as COVID surged and dented the economy, according to a May 2022 academic study from researchers at the Southwestern University of Finance and Economics in China. Investors historically trade more during economic downturns, the study said. 

Kyle Moynihan, a Fidelity spokesman, said that comments from investors with Fidelity brokerage accounts on the firm’s official Reddit channel “inspired” the new platform. Fidelity launched its subreddit in March 2021 to "answer customer questions and gather direct feedback to influence products and services," Moynihan said.

“Redditors are ‘the engaged investor’ and are really enthusiastic and checking their Fidelity accounts every day,” Moynihan said, adding that Fidelity saw from "next-generation investors the desire for something customizable that aligns with their values/interests/etc.” The firm's new platform, he said, “would give them more ability to control and manage their investments.” 

That could create retirement nest eggs to be passed on to the next generation — with Fidelity hoping to later earn the lucrative business of managing wealth for those people and their heirs.

Tushar Kumar, a partner at Twin Peaks Wealth Advisors in San Francisco who oversees financial planning and business development, said that while Fidelity's platform is a way to create a basket of investments “that’s truly unique to an individual,” it may have pitfalls. One is that the service "does require initial and ongoing effort by the end user to look at what is in there and do they want to continue to hold it.” Another: Individuals tend to have a myopic view of things they’re interested in. “If you’re only investing in companies and sectors that you’re truly familiar with,” Kumar said, “you might be missing the boat on diversification.”

Index this
Fidelity’s move morphs a once obscure and expensive strategy used by the wealthy into a mom-and-pop investment. Called direct indexing, the strategy involves selecting dozens or more stocks with one or more common themes, then weighting them in a DIY “index” according to their price, market capitalization or other factors. The investor then buys shares in an amount that corresponds to their index weight. The direct ownership contrasts with exchange-traded and mutual funds, in which an investor owns shares of a fund, not of its underlying stocks.

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Josh Krugman, Fidelity’s product area leader for Solo FidFolios, said the new service “is for the more engaged investor, the investor who already manages money on their own.”

Wall Street institutions from Goldman Sachs and Morgan Stanley to UBS and BlackRock have raced to tap into the direct indexing boom in recent years, via a land grab for fintech and traditional players that specialize in the technique. Because an investor can also trade her positions, direct indexing creates openings for boosting tax efficiency that other fund types lack — a way of boosting ultimate returns.

Like a Build-a-Bear workshop, Fidelity will let investors design an index from scratch or choose from one of more than a dozen thematic portfolios, including those devoted to fintech, clean energy and cyber security. What might be dubbed the “it’s all about me” approach to investing requires work and knowledge that not all investors have. After all, there’s a reason fund managers are highly paid. 

Fidelity, which also manages retirement plans for companies, was once synonymous with actively managed funds and star stock pickers like Peter Lynch. Now it’s offering Main Street investors a DIY chance to be just like him. Last April, the firm launched Fidelity Managed FidFolios, a first-of-its-kind custom indexing service for well-heeled clients with separately managed accounts at the firm, setting minimums at $5,000 and initial expenses at 0.40% — far above those for low-cost exchange-traded funds. 

Before that custom service appeared, most Wall Street banks and brokerages required investable minimums of $50,000 to $300,000 for separately managed accounts, which are typically sold through financial advisors. Fidelity requires $250,000, which includes the cost of a financial advisor.

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Both of Fidelity's direct indexing options use fractional trading, which is when an investor buys only a portion of a stock. Krugman said that for clients with a managed account, “the index is managed for you” after you create it, while for solo accounts, “you’re managing on your own.” Still, he said, the solo accounts “don’t require that you actively manage and trade on a day-to-day basis.”

Direct indexing through a separately managed account often pays for itself, thanks to tax-loss harvesting opportunities. That’s when an investor sells a stock, fund or other asset that has declined and puts the proceeds into another asset. The investor uses the capital loss from the sale to offset taxable gains on other investments. Losses can reduce taxable capital gains and offset up to $3,000 of ordinary income, with any excess amounts available to reduce taxes in future years.

Cerulli Associates said last August that direct indexing would grow 12% a year over the next five years, outpacing mutual funds, ETFs and separately managed accounts that don't use the technique. Last March, the research firm found that more than half of advisors to affluent clients were unfamiliar with direct indexing, with broker-dealers three times more likely to be on board. Fidelity clients with separately managed accounts have over $33 billion in direct indexing assets.

Said Krugman of the new service: “We think there’s a large portion of engaged investors and self directed investors that this is appropriate for.”