SpaceX Joins the Nasdaq-100 on July 7. What It Means for Index Fund Investors

On June 12, SpaceX (NASDAQ: SPCX) completed the largest initial public offering (IPO) in history, raising about $85.7 billion after underwriters exercised their overallotment option. Less than a month later, the company is about to become something more than just a hot new stock, but also one that millions of people will own indirectly without ever choosing to buy it.

Before the market opens on July 7, the company will join the Nasdaq-100, the index that sits behind the Invesco QQQ Trust (NASDAQ: QQQ) and a long list of 401(k) and retirement-plan funds. More than $800 billion is benchmarked to that index, and all of it now has to make room for Elon Musk's rocket company.

Here's what that actually means if you hold a Nasdaq-100 fund.

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Why some funds will have to buy SpaceX stock

An index fund doesn't pick stocks. It holds whatever its index holds, in the same proportions, and leaves the judgment calls to the rulebook. So when the Nasdaq-100 adds SpaceX, every fund tracking it has to buy the stock -- not because a manager decided it was a bargain, but because the index says so.

That forced buying is the whole story here. J.P. Morgan estimates it at about $4.3 billion, and much of it will likely happen after the close on July 6 -- the day before the change takes effect. This means that a fund built to track an index can't wait for a better price.

What makes this unusual is the speed. SpaceX qualifies just 15 trading days after going public -- a fast-track entry under the Nasdaq-100's new rules, which allow certain IPOs to be added after 15 trading days without meeting the usual seasoning requirement. SpaceX would not have qualified under the old rules.

S&P Global, by contrast, has said it won't relax its own rules and will wait at least a year before weighing SpaceX for the S&P 500. And because this is a fast-track addition, no current member is being dropped to make space. The index will simply hold more than 100 names for a while.

Your slice is smaller than it looks

At a valuation of more than $2 trillion, SpaceX is one of the most valuable companies in the country, so you might expect it to enter the index as one of its largest members. It won't.

The Nasdaq-100 uses a modified weighting method that doesn't simply weight stocks based solely on market capitalization. The stock is estimated to enter the Nasdaq-100 Index at a weighting of less than 1%.

So what should a passive holder of any fund tracking the NASDAQ-100 expect? In the near term, a one-time bump in buying around July 6 and 7, and then a small position in SpaceX (indirectly, of course), whether you wanted it or not.

Personally, I wouldn't change a thing in my portfolio because of this. But it's worth knowing that your Nasdaq-100 fund will now hold a piece of a barely public, money-losing company at a wild valuation. This is just part of index investing.

Of course, just because SpaceX stock looks overvalued today doesn't mean it won't pan out to be a good investment over the long haul. But it also doesn't guarantee that it won't be a poor investment. One thing is certain, though: shares have traded extremely volatily since they went public. The stock has traded as high as $225.64 and as low as $147.11. Today, it's trading at $169.44. Investors should expect this volatility to continue. But since it will initially be weighted at less than 1% of the index, its impact on Nasdaq-100 tracking funds should be small.

Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.