Recently, there has been an increasing number of reports about giant companies like SpaceX and OpenAI going public one after another. When companies with a market capitalization exceeding $1 trillion go public, the entire market is poised to change significantly. However, this presents quite a trap for investors, especially those investing in index funds.

Think about it. If SpaceX were to go public with less than 5% floating shares, what would happen to index funds? The moment it is included in the index, the fund has no choice but to buy those shares regardless of the price. Since index funds worth trillions of dollars are forced to purchase simultaneously, the stock price would surge rapidly. This is great for existing shareholders of the company, but it’s the worst timing for index investors who buy later.

Here’s the key point. Companies tend to go public when their stock prices are high. In other words, by the time ordinary investors can buy on the secondary market, internal insiders have already judged the stock to be “overvalued.” Index funds have no such discretion. They must buy according to the rules, regardless of valuation.

Historically, IPO stocks tend to perform poorly. Looking at data from 1970 to 1990, the average annual return of IPOs was only 5%. Meanwhile, established companies of the same size earned about 12%. In other words, to get the same return from IPO investments, you need to invest 44% more money.

A 2025 paper points out that if the S&P index adopts a “fast track” method to quickly incorporate new listings, hedge funds and others will front-run the purchases, causing index funds to buy at high prices. The stock prices peak on the inclusion date and then plummet sharply within two weeks. Ultimately, this results in individual investors suffering losses.

Low float IPOs like SpaceX are even more dangerous. Since 1980, only 11 IPOs with less than 5% of issued shares have succeeded. Of those, 10 have underperformed the market average within three years, dropping more than 50% below the offering price. While limited supply initially drives up the price, most tend to perform miserably afterward.

If SpaceX were to go public with a market cap of $1.75 trillion, its price-to-sales ratio would exceed 100. The average for the S&P 500 is 3.1, illustrating how overvalued it would be. The higher the stock valuation, the lower the expected future returns tend to be. This is an unavoidable reality for index investors.

Another critical issue is index rebalancing. Market-cap-weighted indices reflect changes in market composition and require frequent rebalancing. Companies go public at high prices and buy back their shares at lower prices. As a result, index funds are unknowingly forced to buy high and sell low. According to the 2025 paper, this passive timing adjustment alone can reduce portfolio performance by 0.47% to 0.70% annually.

Some might consider investing in private equity. But wait. Survivor bias is severe. While successful examples like SpaceX and OpenAI stand out, thousands of private companies have failed. Moreover, fees are exorbitant. There are reports that special purpose vehicles (SPVs) buying SpaceX shares charged upfront fees of 4% plus 25% of profits. Liquidity risks are also significant.

For index fund investors, large IPOs are an unavoidable reality. Once included in the market index, they are automatically caught in the high-price trap. Recognizing these hidden costs, it may be worthwhile to consider alternative index products that do not blindly buy IPO stocks. After all, it’s always the retail investors who get caught up in inflated expectations and suffer losses.