White paper: Impact of deposit frequency on tax efficiency in direct indexing
In our previous white paper, we explored how direct indexing can offer additional tax efficiency during the withdrawal phase of a portfolio. Here, we take a closer look at a more nuanced question: Does changing the frequency at which you deposit into a direct index meaningfully affect tax loss harvesting performance over time?
A common challenge for direct index investors is deposit timing—balancing the desire to put cash to work immediately against the need to space trades to avoid wash sale restrictions. To address this pain point, Frec has introduced strategic wash sales, a new feature that liberates investors to deposit at any frequency without timing concerns. This capability eliminates the traditional trade-off between investment efficiency and tax optimization, allowing you to manage your portfolio on your schedule, not the tax calendar’s.
Strategic Wash Sales
In our study, we have enabled strategic wash sales, a feature in the Frec direct indexing engine that allows for “buy-buy-sell” wash sales. This approach allows investors to deposit any frequency they desire without worrying about how it will impact their performance. Under alternative methods—such as fully excluding a security after it has been sold for 30 days—deposit limitations could arise and reduce the opportunities for tax loss harvesting when using monthly or more frequent contributions. To learn more about this feature, as well as how the IRS treats “buy-buy-sell” wash sales, check out our feature announcement here.
In our simulations, allowing buy-buy-sell wash sales improved the average tax loss harvesting performance by an estimated 15.5% for weekly deposit frequencies and 13.7% for monthly deposit frequencies.
Allowing for buy-buy-sell wash sales increased tax loss harvesting performance across all deposit frequencies, and tracking error does not suffer as a result.
Summary of Results
- Deposit Frequency Impact: We found no statistically significant difference in tax loss harvesting outcomes based on how often cash is deposited (weekly, monthly, quarterly, or yearly).
- Money-Weighted Returns: The money-weighted returns for each deposit frequency remained comparable, largely because deposit frequency did not lead to meaningful changes in tracking error. Consequently, deposit frequency does not materially affect overall portfolio performance.
These findings suggest that investors should place minimal emphasis on deposit frequency within direct indexing, freeing them to prioritize factors such as personal cash-flow requirements, convenience, or other individual considerations when deciding how often to invest.
Methodology
To evaluate the impact of deposit frequency on tax loss harvesting performance over time, we conducted multiple 10-year simulations using portfolios set to track the S&P 500®. A 0.1% AUM fee was applied following Frec’s pricing as of February 14, 2025. Each simulation began with an initial deposit of $50,000 and followed it with recurring contributions at varying frequencies.
Simulation Setup
We performed 36 overlapping 10-year simulations, each starting 90 days apart. The first simulation ran from December 17, 2003 to December 14, 2013. The second ran from March 16, 2004, to March 13, 2014, and so on. This overlapping approach ensured a comprehensive evaluation across a wide range of market conditions.
Deposit Frequencies Tested:
- Weekly: $500 per deposit
- Monthly: $2,150 per deposit
- Quarterly: $6,500 per deposit
- Yearly: $26,000 per deposit
These amounts were selected to approximate $26,000 in total contributions per year, ensuring a fair comparison. By structuring the simulations in this manner, we isolated the effects of deposit frequency while controlling for variations in market performance over different periods.
Performance Comparison
We analyzed each portfolio’s performance by focusing on two key metrics:
- Total Tax Loss Harvested: A measure of the cumulative amount of harvested losses, offering potential tax benefits.
- Tracking Error: The total “excess return” or deviation from the underlying index over the 10-year period.
Within each 10-year window, we computed a ratio of the metrics (tax loss harvesting and tracking error) for each deposit frequency to the same metrics for the yearly deposit schedule, our benchmark. All metrics were computed on a per-dollar-invested basis, allowing for consistent comparisons across different deposit frequencies.
To ensure a fair comparison, all metrics are computed on a per-dollar-invested basis. This means that returns are calculated as money-weighted returns, accounting for the total amount of contributions. Similarly, total tax loss harvested is evaluated relative to the invested capital, allowing us to assess the efficiency of tax loss harvesting across different deposit schedules.
By structuring the analysis in this way, we isolate the effects of deposit frequency while controlling for variations in market performance across different time periods.
Results
Our findings suggest deposit frequency does not affect tax loss harvesting performance or tracking error.
Tax Loss Harvesting Performance (TLH Performance)
Our findings indicate that deposit frequency does not significantly influence TLH performance over time. However, we observe a slight increase in variance compared to the yearly schedule. The figure below highlights tax loss harvesting outcomes for each deposit frequency over the analyzed period.
Throughout the simulation, each observation shows low variance in loss harvesting performance, and any deviations from the yearly base case appear idiosyncratic. When we examine the performance deviations in more detail, there is no consistent pattern of overperformance or underperformance for any deposit frequency. This indicates that there is no significant difference among these frequencies.
All deposit frequencies display a similar distribution of deviations from the yearly TLH performance. However, the Quarterly frequency exhibits slightly lower overall variance and a modest positive skew.
Tracking Error
Our findings show that tracking error remains largely unaffected by deposit frequency, although its variance does increase. The figures below illustrate the tracking error for each deposit frequency across every year of the simulation.
All deposit frequencies experience fluctuations relative to the yearly base case that appear random and lack any meaningful correlation. This implies that an investor’s choice of deposit frequency does not adversely affect tracking error over time.
The distribution of tracking error outcomes, relative to the yearly baseline, closely mirrors the pattern seen in TLH performance. The key takeaway here is that all outcomes look very similar, and investors should not worry too much about how deposit frequencies will impact tracking error.
Conclusion
Our research supports the idea that investors should not place excessive emphasis on deposit frequency in their direct indexing strategies, as it does not significantly impact tax loss harvesting performance or tracking error. Instead, investors can decide how often to deposit based on convenience, personal financial circumstances, or individual preferences without sacrificing the core benefits of direct indexing, such as customized portfolio construction and targeted tax loss harvesting.
By focusing on direct indexing’s inherent strengths—tax benefits and a high level of customization—rather than deposit timing, investors may find it easier to remain consistent and strategically aligned with their broader financial goals. At Frec, we continuously push the boundaries of what’s possible with direct indexing, delivering a powerful solution that makes direct indexing as easy as ETF investing.
Disclosures:
The simulations for this white paper made an assumption that customer deposits are frequent small to medium-sized deposits and do not take into consideration deposits that are 50% or larger than the portfolio value. Such large deposits require a case by case study.
This white paper describes the implementation and performance details of a Direct Indexing approach similar to that used on the Frec platform at the time of writing (02/26/2025) details may differ from the implementation used in the product now and in the future. This paper may be amended at any time to reflect new findings, improve readability, or correct inaccuracies. The results in this white paper are hypothetical, do not reflect actual investment results, and are not a guarantee of future results.
This white paper is for information purposes only and is not intended as tax advice. Frec refers to Frec Markets, Inc. and its wholly owned subsidiaries, Frec Advisers LLC and Frec Securities LLC. Frec does not provide legal or tax advice and does not assume any liability for the tax consequences of any client transaction. Clients should consult with their personal tax advisors regarding the tax consequences of investing with Frec and engaging in these tax strategies, based on their particular circumstances. Clients and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the investor’s personal tax returns. Frec assumes no responsibility for tax consequences to any investor of any transaction.
The effectiveness of Frec’s tax loss harvesting strategy to reduce the tax liability of the client will depend on the client’s entire tax and investment profile, including purchases and dispositions in a client’s (or client’s spouse’s) accounts outside of Frec, the type of investments (e.g., taxable or nontaxable) or holding period (e.g., short-term or long-term. The performance of the new securities purchases through the tax loss harvesting service may be better or worse than the performance of the securities that are sold for tax loss harvesting purposes.
The S&P 500® index is a product of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”), and has been licensed for use by Frec Markets, Inc. S&P®, S&P 500®, US 500 and The 500 are trademarks of Standard & Poor’s Financial Services LLC (“S&P”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Frec Markets, Inc. Frec’s direct indexing strategy is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500® index.
