Elon Musk’s SpaceX (SPAX.PVT) is set to go public on June 12, splashing into the market at a targeted valuation of nearly $1.8 trillion.
If you’re investing in a 401(k) for retirement via broad index funds, a sliver of the rocket and satellite company is likely to wind up in your account, even without you buying a single share.
Here’s why: Rules to protect passive investors by keeping unprofitable firms with no track record out of the index funds where millions of Americans invest their retirement savings have been eased for the SpaceX IPO.
This opens the door for index fund providers to waive the profitability requirement and allow SpaceX to begin trading on one index in as little as five days.
Already, SpaceX’s much-hyped IPO has its skeptics. Morningstar initiated coverage of SpaceX with a fair-value estimate of $780 billion, less than half the roughly $1.8 trillion valuation the company is targeting in its initial public offering. And it’s worth noting SpaceX has yet to turn an annual profit.
So should the average retirement saver be worried? Excited?
“Mega IPOs reinforce the value of diversification,” said Rodney Comegys, Vanguard Capital Management’s chief information officer and head of global equity. “Even the largest IPOs represent a small piece of a diversified portfolio. Diversification ensures investors participate in innovation and growth while reducing reliance on the success or timing of any single company.”
The public debut of Elon Musk’s rocket and AI company is expected to make history.
Under new rules
The Nasdaq 100 (^NDX) index and the Russell 1000 (^RUI) have changed their rules to accommodate mega IPOs like SpaceX into their flagship indexes within the first few days of trading.
The Russell 1000 could include SpaceX shares around a week following the IPO. The waiting window for the Nasdaq 100 will be roughly 15 trading days for companies large enough to rank among the index’s largest members. That could put SpaceX in the Nasdaq 100 sometime in early summer.
The S&P 500 is currently considering a rule change that would allow SpaceX into its portfolio earlier. To join the S&P 500, a company must have traded publicly for at least 12 months and have posted four consecutive quarters of profitability. The rule change being debated now would relax that requirement for megacap stocks, allowing those stocks in after six months of trading.
Once that happens, index funds will buy SpaceX and other IPOs on the horizon, including those of artificial intelligence giants Anthropic (ANTH.PVT) and OpenAI (OPAI.PVT), in order to precisely track the relevant index.
As a refresher, index funds are built to track the performance of a specific financial market benchmark. They passively buy and hold securities in the same proportions as the index they follow. This isn’t a human’s hand-picked selection based on company health and performance.
So, any investor who owns shares in these total-market-aligned funds will own SpaceX. Millions of us are invested in these funds through our employer-provided plans.
Vanguard’s Total Stock Market fund, for instance, adopted a fast-track rule that allows a qualifying IPO to be added after just five trading days.
Critics of the rule changes say allowing SpaceX into retirement accounts amounts to a lucrative exit strategy for Musk and other insiders to sell their shares to the public at a huge premium.
Still, while SpaceX is poised to become the largest IPO in market history, not everything about its debut is without precedent.
“Institutional investors already invest in many unprofitable growth companies, and most 401(k) exposure would likely come through diversified funds rather than direct ownership,” said Mark Johnson, an investments and portfolio management fellow at Wake Forest University. “There is probably a broader conversation around whether retail investors like me and you become exit liquidity in IPOs, but that is not unique to SpaceX.”
Index fund investors can take a breath
For index fund retirement savers, the story is more strategic over the long haul.
“For index investors, timing and investable size matter more than headline valuations,” Comegys said.
What makes an index fund appealing is that it holds only a percentage of the stock of companies on the open market. That’s a far slimmer portion than the massive total amount the IPO valuation might turn out to be.
Index funds are “transparent,” Comegys said. In other words, you can easily find precisely how large a share of your index fund is allotted to any holding, including SpaceX.
“While several index providers have adapted their rules to allow for faster inclusion of very large IPOs, inclusion still occurs over defined windows and based on eligibility criteria,” he added.
What about target date funds, which dominate retirement savers’ accounts?
“The impact is going to be even less than it will be for owning total market funds in a retirement account, since target date portfolios are presumably not 100% equity,” said Zachary Evens, a passive strategies research analyst at Morningstar.
Consider this: If SpaceX stock made up 0.15% of a target-date index fund that is 60% equities and 40% bonds, only 0.9% of an individual investor’s holdings would be in SpaceX at first. That would slowly increase as the initial IPO investors sell in the open market, but “it shouldn’t increase substantially.”
A cautionary note
A high share price that often follows an IPO doesn’t necessarily mean the company is worth it.
“It has been argued that SpaceX in particular has created a situation where there is almost no chance that the price of the stock will fairly reflect the expected profitability of the company, resulting in enormous wealth for the owners,” said Michael Finke, professor of wealth management at The American College of Financial Services.
One disadvantage for retirement account investors is the risk. “By convincing the index to let you in right from the start, SpaceX gets an instant flow of investment dollars without having to grow organically because it has a good business model,” Finke added.
Still, there’s no reason to panic.
“I don’t think it’s something to be alarmed about in the short term,” Evens said.
For a 401(k) investor, the impact will depend on the funds they hold. If they hold a broad-market index fund, like Vanguard Total Stock Market Index Fund, for instance, they’ll probably hold SpaceX stock shortly after it IPOs.
“The impact to their portfolio is likely to be pretty small,” Evens said. “SpaceX is a huge company in terms of the possible total market cap. The publicly available shares, however, (are) likely to be very small, so its impact on a total well-diversified broad market index is likely to be relatively small, especially in the short term.”
As SpaceX insiders are allowed to sell their stock after required holding periods expire, the total number of shares on the market will increase, which will make the company more prominent in broad-based index funds, according to Evens.
“But at that time, more will be known about the company,” he said. “Hopefully, some of the kind of wonky trading that is common to early stage IPOs is over at that point, and maybe the stock has settled down at that point to where investors understand a bit more about the stock.”
