The Death of the Index Fund
The S&P 500 is fast-tracking mega-cap, deeply unprofitable companies into the index. What does it mean for you?
Occasionally, a financial story lands that sounds technical enough to ignore — and turns out to matter to almost everyone. This is one of those stories. So please read on. I promise to make it as painless as possible.
In 1976, a man who had recently been fired ran a financial experiment that Wall Street called “Bogle’s Folly.” John Bogle had just founded Vanguard and launched the first index mutual fund available to ordinary investors — a fund designed not to beat the S&P 500, but simply to match it. The premise was almost insultingly simple: stop paying managers to guess, buy everything in the index proportionally, and let the market do its work. Lower costs, less trading, performance that mirrored the broader market — and over time, returns that beat most actively managed funds.
The folly, it turned out, was everywhere else. The index fund won because it made one non-negotiable promise: no one is making discretionary bets with your money. The rules decide who gets in. The committee applies fixed criteria. Emotion stays out. That promise — mechanical, consistent, boring and incorruptible — is what tens of millions of Americans bought when they enrolled in a 401(k), opened a Vanguard account, or let a Target Date fund manage their retirement. As of 2024, according to S&P Dow Jones Indexes’ annual survey, roughly $20 trillion in assets is indexed or benchmarked to the S&P 500 alone. The appeal is well-supported by evidence: after fees, the vast majority of actively managed funds fail to beat the passive benchmark over time. Tens of millions of Americans have accepted this investment strategy, on the logic that it is better to stop trying to beat the market and just own it, an easy option with the advent of index investing.
That logic may have been sound. But it rested on the assumption that the index itself was a neutral, rules-based instrument. The scale of passive investing makes this assumption massively significant for everyone — including those of you who never heard the term “index fund” before today.
What is an “index fund”? An index fund is a portfolio designed to mirror a specific market benchmark. There are index funds for various different benchmarks (aka “indexes”)- tracking everything from the S&P 500, which itself tracks 500 of the largest publicly traded U.S. companies; to the Russel 2000 list of small companies; to SPDR SSGA Gender Diversity Index, tracking companies with relatively better gender equity in leadership. When you own an index fund you’re not making bets on individual companies — you’re buying a proportional slice of every company in the corresponding index.
The indexes’ credibility comes from one thing: inclusion is not supposed to be a discretionary decision. As Morningstar’s Brendan McCann explains, market-cap-weighted indexes like the S&P 500 were specifically designed to construct portfolios that accurately represent the stock market, with the largest stocks carrying the highest allocations. A committee is supposed to apply fixed criteria, under which companies either qualify for inclusion or don’t. Under current rules, a company must have traded publicly for at least 12 months, demonstrated GAAP profitability over four consecutive quarters and in its most recent quarter, and maintained sufficient public float — meaning enough shares actually trade on the open market that funds can buy and sell efficiently.
These aren't arbitrary bureaucratic hurdles. The dot-com collapse showed what happens when they're ignored — S&P added richly valued, money-losing companies near the peak, the index fell 40% as those names imploded, and ordinary savers paid the bill.
Then SpaceX filed its S-1, a regulatory form for becoming publicly listed. (There will be a follow up article on my predictions for the future of this company based on this wildly unusual and absurd filing, but for now let’s just note that the filing starts with 18 pages of pictures of rockets; Musk has structured SpaceX’s voting stock so that the only person who can oust Musk is the CEO himself; and Musk has incentives based, actually, on getting a colony of 1 million people on Mars).
SpaceX, OpenAI, and Anthropic are all preparing to go public. Once public, all three would instantly rank among the largest publicly traded companies in the United States — with SpaceX targeting a possible $1.75 trillion market cap, OpenAI recently valued at $852 billion, and Anthropic in discussions at around $900 billion. Sky high valuations for companies that are NOT PROFITABLE by Generally Accepted Accounting Principles (GAAP). To the contrary, SpaceX reported a $4.28 billion GAAP loss in the first quarter of 2026 alone. Under existing rules, none of these companies would qualify for S&P 500 inclusion for at least a year after their IPO debuts.
So why are they getting fast tracked into the index? The bankers and index providers argue that an index should accurately represent the market, and excluding companies this large would leave a significant gap. As Morningstar’s Zachary Evens puts it, any of these stocks would instantly be among the largest in the United States, and an index aiming to accurately represent the contours of the U.S. stock market should hold all important stocks. Fair enough — in theory. In reality, aren’t we just sacrificing the entire point of passive index funds, which was to be unemotional, consistent, and rules-bound?
The profitability requirement, seasoning period, float minimum were the fixed, algorithmic, non-negotiable criteria that gave the index its credibility. The whole reason we were supposed to use passive investments instead of active. It was supposed to be boring. Then three unprofitable companies with trillion-dollar valuations prepared to go public, and S&P opened a “Consultation on the Treatment of MegaCap Companies.” The consultation period for changes affecting trillions of dollars in retirement savings lasted less than a month.
S&P is not alone. Nasdaq was first: it approved a “fast entry” rule on March 30, now effective May 1, that allows qualifying mega-IPOs into the Nasdaq-100 just 15 trading days after listing — provided the company would rank within the top 40 holdings of the index, a threshold currently around $113 billion in market cap. Practically speaking, that rule was written for exactly five companies: SpaceX, OpenAI, Anthropic, Stripe, and Databricks. FTSE Russell is considering a similar fast-entry rule and is relaxing its already-low 5% minimum float requirement for large IPOs.
Index providers are private companies so they get to write their own rules, which they can change when it serves competitive and commercial interests. The pressure here came from multiple directions simultaneously: investment banks structuring these IPOs, the issuers themselves, and the largest passive asset managers who would prefer to own these names sooner.
But the passive index is (was?) valuable precisely because it removes emotional decisions and replaces them with rules. The implicit promise to every investor holding an index fund is: we are not going to make speculative bets with your money. The rules will decide who belongs here.
Passive investors won’t have a vote on whether to own SpaceX. Their funds’ governing documents require them to mirror the index. If SpaceX joins, they buy SpaceX — at IPO valuations, without a profitability requirement, with minimal float, under rules that were different before SpaceX filed its paperwork. The index, which was designed to reflect the economy, will instead be used to validate it.
The financial mechanics of what happens next are worth understanding clearly: Index inclusion triggers immediate price appreciation because passive funds and ETFs are obligated to purchase the stock, creating a surge in demand that often outpaces supply. The combination of forced buying and increased demand provides a short-term boost to the stock’s valuation — share prices frequently rise upon news of inclusion, which benefits existing shareholders — meaning the founders, early investors, and private equity backers who have held SpaceX for years get to sell into a market that passive funds are legally required to buy. The index inclusion doesn’t just give these companies a higher price. It also manufactures a captive buyer for whatever price the market sets on IPO day, with $20 trillion in index money providing the floor. Once the forced buying clears, returns typically re-anchor to earnings power, guidance credibility, and valuation — and the marginal bid disappears. The founders have already been paid.
Now the index makers are changing the rules to let unprofitable companies with insufficient track records into the index — and trillions in savings have no choice but to follow. At some point, momentum becomes the only thing holding the price up. The question is who's last at the party when the momentum stops. I promise it won’t be Musk.
SO WHAT NOW?
For most of the last decade, buying a broad index fund and ignoring the noise was a defensible strategy — not perfect, but reasonable. That era of “just buy the index and relax” is harder to defend now. When the rules governing $20 trillion in savings get rewritten in under a month to accommodate three unprofitable companies, the index is no longer a passive instrument — it’s an active bet dressed in passive marketing material.
True passive investing, in my opinion, is gone. The question is not whether to be active or passive any more, but whether you’re actively paying attention.