New cash contributions can extend a direct indexing portfolio’s ability to harvest tax losses. Tax loss harvesting turns unrealized losses in taxable accounts into realized losses that may offset capital gains. As a portfolio appreciates, fewer holdings may remain at a loss. Adding cash creates a new cost basis and potential opportunities to harvest losses in the future.
Why tax loss harvesting opportunities decline
When a direct indexing portfolio is established with cash, every stock starts with a cost basis equal to its current market value. As markets fluctuate, some holdings fall below their purchase price. Selling those holdings realizes losses that may offset the investor’s realized capital gains. The manager reinvests the proceeds in other stocks in the target index to keep the portfolio aligned with its objective.
As equity markets rise, fewer positions remain below their cost basis, reducing future tax loss harvesting opportunities. Long-term market appreciation benefits investors, but it can also reduce the flow of realized losses available to offset gains.
How ongoing cash contributions help
Each contribution buys shares with a new cost basis at current prices. The portfolio manager generally adds to existing positions rather than buying new names from the index. These purchases create new tax lots, or groups of shares bought at a particular price. Those shares may become candidates for tax loss harvesting during future market declines.
Dollar-cost averaging (DCA) means investing a fixed amount at regular intervals. It spreads purchases across different prices and tax lots, reducing reliance on a single market entry point.
Research has shown that monthly cash contributions equal to 1% of an account’s value can maintain a steady tax benefit after the initial decline. As the account appreciates, maintaining that 1% contribution requires larger cash amounts.1
Clients may already have sources of cash for periodic investments, such as annual bonuses, quarterly vesting of company stock, or excess required minimum distributions (RMDs) from IRAs.
Dollar-cost averaging vs. lump-sum investing
Most new cash-funded direct indexing accounts we open begin with a lump sum. If the market falls immediately afterward, automated tax loss harvesting can help reduce the after-tax effect of those losses.
In March 2020, Covid-19 caused a sharp decline in the S&P 500®, and new direct indexing accounts fell with the market. During that calendar year, a representative new account harvested 19.7% in losses. By year-end, the S&P 500® finished up 18.4%.
DCA may not provide an additional benefit unless markets fall sharply. Even then, investors may hesitate to keep adding money to a declining market, interrupting their planned contributions.
What advisors should know about funding direct indexing accounts
We often counsel financial advisors against trying to time the market when opening a direct indexing account. Tax loss harvesting can begin once the account is invested, allowing the portfolio to respond when volatility creates opportunities. Examples include March 2020 and the tariff-related volatility in March and April 2025.2 In later years, as market values rise relative to the cost basis, new contributions can add opportunities to harvest losses.
For clients who can add cash over time, periodic contributions can help sustain tax loss harvesting opportunities as a direct indexing portfolio matures. Market declines create losses to harvest; new purchases add tax lots that may provide future opportunities.
