How Much Will SpaceX Actually Cost Your Index Fund?

This week SpaceX is having its initial public offering (IPO) where it plans to raise $75 billion at a $1.77 trillion valuation. Anthropic and OpenAI have their own IPO plans for later this year.

With these highly valued companies coming to market, there’s been a lot of discussion around how index providers will include them in their funds. Index funds are governed by a set of inclusion criteria which determine which stocks can be added to a particular index and when.

For example, historically the Russell 1000 only added a stock to its index if at least 5% of its overall shares were available to trade (i.e., 5% float). However, since SpaceX’s IPO is only offering around 4% of its overall shares into the float, FTSE Russell decided to modify their inclusion criteria. Nasdaq also made changes to its inclusion criteria to fast-track larger IPOs after just seven days of being listed rather than on an annual basis in December.

The good news is that not all index providers are changing their rules to fast-track SpaceX, Anthropic, and OpenAI into their funds. S&P Global recently stated that “there will be no changes to existing methodology” for their large and megacap index funds. In other words, SpaceX, Anthropic, and OpenAI will need to be public for 12 months and hit certain profitability metrics before they can be considered for the S&P 500 (and similar megacap funds).

Nevertheless, some investors are up in arms with Nasdaq and FTSE Russell. They believe that the purpose of the recent rule changes is to force index investors to buy companies like SpaceX at elevated prices.

In other words, some believe that index investors are being used as exit liquidity. I see the argument, but how much does this really impact the typical index investor? Let’s find out.

How Much Will SpaceX Impact the Typical Index Investor?

When an index provider adds a new stock to their fund, the weighting is determined based on the float of the stock, or the total value of all shares publicly available to trade. In this case, SpaceX should have a float of around $75 billion. This is the amount of money the company plans to raise at its IPO. So, for a fund like VTI (Vanguard’s Total U.S. Stock Market Index), which tracks a U.S. market worth around $70 trillion, SpaceX would represent about 0.11% of the index.

But not every index does a simple weighting based on float. For example, Campbell Harvey noted how the Nasdaq 100 changed a rule to weight SpaceX at 3x their float, or around $270 billion in Harvey’s estimation. Given that the Nasdaq 100 has a total market capitalization of around $40 trillion, SpaceX would make up roughly 0.68% of the index.

In dollar terms, for every $100,000 invested in VTI, $110 would be in SpaceX. And for every $100,000 invested in QQQ (i.e., the Nasdaq 100), $680 would be in SpaceX.

This isn’t a lot in the grand scheme of things, but many investors believe that SpaceX is overvalued. And it might be. Aswath Damodaran recently did a deep dive on SpaceX and valued the company at $1.21 trillion before reviewing their prospectus and $1.22 trillion after digging in. This is 31% below the $1.77 trillion valuation that SpaceX plans to go public at.

If we assume that Damodaran’s valuation is accurate in the long run, then the typical VTI investor would lose 0.03% [31% of 0.11%] and the typical QQQ investor would lose 0.21% [31% of 0.68%] from the SpaceX investment. This equates to an expected loss of $30 for every $100,000 invested in VTI and $210 for every $100,000 invested in QQQ.

This isn’t nothing, but it isn’t that large either. And this assumes that Damodaran is better at pricing SpaceX than the market, which may not be correct. Either way, while I agree with outraged index investors in principle, the dollar impact for the typical index fund investor is quite small.

I don’t want anyone to lose money from their investments, but, in the end, we have to trust the market to set prices. That doesn’t mean the market is always right, just that it usually is. What will happen with SpaceX’s valuation (and eventually Anthropic and OpenAI’s) remains to be seen.

Nevertheless, if you are still worried about investing in any of these companies through your index funds, there are some ways to overcome this.

How to Avoid Being Exit Liquidity

If you don’t want to be “exit liquidity” for Elon Musk or Sam Altman, here are your best options as a passive index investor:

• Avoid the impacted funds. The best way to avoid overvalued IPO companies joining an index is to avoid the funds that will hold them. Of course, this is easier said than done. Avoiding tech (QQQ) is straightforward, but avoiding a total U.S. stock market fund is much harder. What you can do instead is own the S&P 500. An S&P 500 ETF won’t immediately be impacted by these IPOs and yet still has a very high correlation with the overall stock market. It’s easy to make this switch in a non-taxable account (e.g., IRA, 401k, etc.), but in taxable accounts you’ll need to decide whether paying capital gains taxes is worth it. For most, it probably isn’t.
• Use direct indexing. Another approach to avoid IPO companies is to use direct indexing. Direct indexing is the recreation of an index through a separately managed account (SMA) from a third party. So instead of owning an S&P 500 ETF, you would hold 500 (technically 505) stocks to replicate it. The best part about direct indexing is that you can create whatever index you want. You can have the S&P 500 minus SpaceX or the S&P 500 without OpenAI. One downside of direct indexing is that the account minimums tend to be a bit higher than if you were to buy a single share of a fund. While some fractional share direct indexing options exist, they are more limited in their effectiveness.
• Accept that you aren’t smarter than the market. If avoiding these highly valued stocks isn’t an option, then you may need to accept that they aren’t as overvalued as you believe. I know how crazy that sounds when AI companies are participating in complex, circular financing deals. But the market is a lot smarter than you or I. For example, I’ve felt a bit bearish on AI since last year, yet many of these companies have managed to hit and even exceed their earnings targets. I’m glad I only “sinned a little” and left most of my equity allocation unchanged. This is further evidence that Just Keep Buying is the right long-term approach. Since we can’t know which stocks will outperform (or underperform), owning all of them (via an index) is the most rational option.

Ultimately, the impact that SpaceX, Anthropic, or OpenAI will have on your index funds pales in comparison to almost every other financial decision you make. Your career, your spending, and your asset allocation matter far more than whether your index fund has a weighting of 0.5% to a given stock.

Don’t get me wrong. I don’t like how some index providers are changing their rules to fast-track stocks into their funds, yet I also don’t think the impact is as large as the naysayers claim. If you want to learn more about the nuances of this issue, I recommend this deep dive on the topic.

Happy investing and thank you for reading!