How does direct indexing compare to buying ASX ETFs

Do you like index investing, but want more say in which stocks you pick?

Man smiling at a laptop because of a rising share price.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Investing using ASX exchange-traded funds (ETFs) has exploded in popularity on the Australian stock market over the past two decades or so. Using ETFs or index funds to invest has attracted thousands of investors, and billions of dollars, thanks to these instruments' low cost and simple nature.

Some of the ASX's most popular index funds and ETFs now command a huge presence on the ASX. Today, the most popular ASX ETF on the market – the Vanguard Australian Shares Index ETF (ASX: VAS) – has close to $15 billion in assets under management alone.

But ASX investors increasingly have another option to consider if they want to invest in an index – direct index investing.

When you invest in an ASX ETF or traditional index fund, you are effectively indirectly investing using a trust structure. It is the trust that owns the shares on your, and all other investors', behalf, with you being the beneficiary.

That's why ETF and index fund investors would be accustomed to seeing some fairly complex forms in their mailbox around tax time.

But direct index investing is a little different. Instead of a trust owning all of the shares in an index on your behalf, you instead own the shares directly.

According to financial advice firm Nucleus Wealth, direct index investing used to only be available for the ultra-rich. However, advances in technology have brought down the costs closer to that of an ASX ETF.

So why would one invest in direct index funds rather than ETFs? Well, there are some reasons one might prefer the direct model.

How does direct indexing compare to ASX ETFs?

For one, direct indexing enables investors to filter out any companies, perhaps tobacco stocks or mining shares, that they might not want to invest in for ethical reasons. With an ASX ETF, you pretty much have to take the entire index, warts and all.

Some ETFs do offer an ethical screen. But these can vary in what they include or exclude, and often charge users far more for the privilege.

But with direct investing, you can simply pick out the companies (or entire industries) that you don't want your money going to. Let's say you don't have a problem with uranium or tobacco shares, but you might not want to invest in coal, weapons manufacturing or oil. Well, you are free to modify your portfolio to reflect this preference. Or any other ethical bias you may possess.

You can also customise your exposure to different corners of the market. Perhaps you might like the idea of an ASX-based index fund, but you don't want a quarter of your money invested in bank stocks. Well, direct indexing lets you tweak your exposures to whatever your heart may desire.

Direct investing reportedly does still cost more than the lowest-cost ASX ETFs. According to Nucleus, fees start at around 0.5% per annum for a $10,000 investment and decrease the more cash is invested. That compares to around 0.05% for the lowest-cost ASX index funds.

But it's nice to know that there are alternatives out there for ASX investors who might not be getting all that they want out of their ASX ETF investments.

Motley Fool contributor Sebastian Bowen has positions in Vanguard Australian Shares Index ETF. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on ETFs

Man looking at an ETF diagram.
ETFs

Where to invest $10,000 into ASX ETFs this month

Let's see why these funds could be worthy of investor attention right now.

Read more »

A man wearing a red jacket and mountain hiking clothes stands at the top of a mountain peak and looks out over countless mountain ranges.
ETFs

3 reasons why the Vanguard Australian Shares Index ETF (VAS) is a good buy for the long-term

The VAS ETF has a number of pleasing characteristics.

Read more »

A stopwatch ticking close to the 12 where the words on the face say 'Time to Buy' indicating its the bottom of the falling market and time to buy ASX shares
ETFs

3 of the best ASX ETFs to buy and hold for 10 years

These funds could be quality picks for buy and hold investors. Let's find out why.

Read more »

ETFs

The best ASX ETFs to buy to build a super strong portfolio

These funds offer investors access to some of the best stocks in the world (and Australia).

Read more »

A male investor sits at his desk looking at his laptop screen holding his hand to his chin pondering whether to buy Macquarie shares
ETFs

I think this ASX ETF is an unmissable buy

This fund offers everything that I’m looking for.

Read more »

Woman charging an electric vehicle.
ETFs

Global EV sales were up 17% in 2024. Time to consider an EV focused ETF?

Does higher EV sales equate to a good investment opportunity?

Read more »

A man and woman sit at a desk staring intently at a laptop screen with papers next to them.
Share Market News

ASX 200 ETF vs S&P 500: which has outperformed over 5 years

Let’s compare the Aussie and US markets over the last 5 years based on the performance of these two ETFs

Read more »

A young woman uses a laptop and calculator while working from home.
ETFs

$10,000 invested in VHY ETF a year ago is now worth…

With savings interest rates expected to fall, should you buy ASX dividend shares?

Read more »