SpaceX in your index fund, explained

Index funds are touted as one of the safest ways to invest. Rather than picking and choosing individual stocks, index funds let you bet on the market as a whole. So what happens when a company like SpaceX — a giant gamble, and, in my opinion, terribly overpriced — is fast-tracked into the Nasdaq-100? Does it suddenly threaten the stability of index funds based on the Nasdaq-100? Can a $1.77 trillion IPO crater the retirement funds of regular people who would ordinarily have no interest in investing in Elon Musk’s meme stock?

SpaceX in your index fund, explained

Index funds are supposed to be the safest way to invest — does SpaceX change that?

Index funds are supposed to be the safest way to invest — does SpaceX change that?

The answer has less to do with SpaceX and more to do with index funds — how they work, their history, and why they’ve been treated as one of the least risky ways to interact with the stock market. So I talked to Burton Malkiel, one of the people most responsible for the rise of the index fund.

“If I were buying individual stocks, I would think twice about buying SpaceX, which is tremendously overhyped,” he tells me. But SpaceX isn’t a reason to avoid index funds, he says. To explain why, here’s a dive into index funds, how SpaceX interacts with them, and how it all might play out.

What is an index fund?

An index fund is an investment vehicle that seeks to match a specific market benchmark, such as the S&P 500 or the Nasdaq-100. It was popularized in part by Malkiel’s 1973 book A Random Walk Down Wall Street. The “random walk” of the book’s title means that the past prices of a stock don’t predict the future, and because it is hard to predict the future, it is very difficult to beat the overall market returns over a long period of time. For that reason, most of us might as well just invest in the overall market and trust it will increase in value as a whole. “A very small minority of stocks are responsible for the whole return, and experts can’t pick them any better than the index as a whole,” Malkiel told me.

The strategy of index fund investment has been endorsed by Warren Buffett, who has suggested that the average investor is best served by putting 90 percent of their money in “a very low-cost S&P 500 index fund.”

And they are very popular! In 2024, the assets under management in passive investing, such as index funds, outpaced that of active funds, according to Elise Ryan of State Street Investment Management.

Why are people worried about SpaceX specifically?

Shortly before SpaceX went public, the Nasdaq changed its rules for the Nasdaq-100, so that a newly public company that’s large enough can join the benchmark on its 15th day of trading. That rule change was requested by SpaceX, Reuters reported.

When SpaceX joined the Nasdaq-100, on July 7th, index funds had to buy in. Interestingly, at close on July 6th, the stock was down. There’s some structural reason for that — namely, that everyone knew the index funds would have to buy in, and so banks and hedge funds most likely did some fun trades. Index rebalancing funds made out like bandits. Finance is fascinating and full of monsters.

There’s reason to believe that the index fund buying is part of the reason SpaceX had its initial IPO pop, according to research from Harvard Business School. What’s more, SpaceX is the initial entry into indexes for a number of expected mega-IPOs. Anthropic and OpenAI are expected to make their debuts later this year.

What does the index fund inclusion mean for SpaceX?

Some degree of price stability. New IPOs often fluctuate wildly. For instance, Facebook’s shares dropped 25 percent the Monday after its 2012 IPO, tripping breakers to halt trades.

Beyond the fluctuations from the market itself, a lot of people will soon be able to sell SpaceX shares that aren’t yet on the market. SpaceX employees are subjected to “lockup periods,” where they can’t immediately cash out and sell their stock following the IPO. Those periods are going to expire, and doubtless some people will want to sell shares. The index funds are likely to “help absorb some of the selling,” thus keeping the price from dipping too low, according to The Wall Street Journal.

How important is SpaceX in these index funds?

The company has a market cap of more than $1.5 trillion as of this writing, which is obviously enormous. But the IPO sold less than 5 percent of the company’s shares. Because of the way the Nasdaq adjusts its index, SpaceX will be treated like a much smaller company.

But remember, next month more SpaceX shares will be released from lockup. People with 180-day lockups can sell more shares than were initially sold in the IPO after SpaceX publishes its second quarter financial results, notes Bloomberg’s Matt Levine. Those results are expected in mid-August. That will make it more important in those index funds — though whether the price will fluctuate much is anyone’s guess, as short sellers are also anticipating the lockup releases. These market mechanics may explain some of the stock’s short-term price fluctuation, even though the company hasn’t had much major news occur.

SpaceX may take up more room in index funds as more shares are sold. But it might not, as selling usually drives down the price.

Why are people mad about SpaceX in index funds?

One big reason is the amount of power it puts in the hands of Musk. The CEO of CalPERS, an important retirement fund, and the New York state and city comptrollers sent SpaceX a nastygram about its “novel and extreme governance structure” — specifically, that only Musk decides what to do with the company and everyone else is along for the ride. Musk is temperamental, imperious, and prone to erratic behavior. That has consequences for shareholders of his companies, sometimes leading to enormous swings in value.

Musk has the majority of the voting rights for SpaceX. In other companies, shareholders can theoretically influence outcomes through shareholder proposals. With SpaceX that isn’t true. Other companies can be sued by shareholders for bad behavior, but SpaceX has limited shareholders’ litigation rights. One way to avoid a company that has made these choices is to sell the stock — but the inclusion in index funds means that’s harder.

But wait. I don’t vote on the corporate governance for companies in my index funds. Why does corporate governance matter to me?

You don’t, but the big indexers do. That means a lot of power is concentrated in just a few hands. It’s one of the worries people have about index funds. There are some other criticisms of index funds, too — that they buy high and sell low when they rebalance, for instance — and some investors believe they distort the market, making big companies even bigger. That’s why some analysts have called index funds “worse than Marxism.” Coming from capitalists, that’s a pretty big insult.

But still — if you believe those big indexers are sophisticated investors who are working on your behalf, you want them to make choices in corporate governance. To, for instance, vote against acquisitions that might be bad for shareholders, or install problematic members of the board of directors.

It seems like if you add up all these mega-IPOs along with the existing tech companies, there’s a lot of AI concentration in the index funds. Should I worry about that, in case AI is a bubble that pops?

Even before SpaceX entered the Nasdaq-100, most of its biggest companies were already AI-heavy — like Nvidia, Apple, Microsoft, Amazon, Google parent Alphabet, Broadcom, and Meta.

One of the biggest criticisms Malkiel hears about index funds is that the market is extremely concentrated, so that 10 companies are worth more than 30 percent of it. But he doesn’t view that as an argument against index funds. “The market’s always been concentrated,” he says.

“We’ve overhyped every technological change in history,” Malkiel adds.