Facebook was added to the S&P 500 yesterday (announced on 12/11/13). Here’s what the stock did in after-hours trading immediately after the announcement:
Facebook’s stock price jumped about 4% after the announcement. Does inclusion in the S&P 500 suddenly make Facebook more profitable? Did inclusion in the benchmark add magic to Facebook’s business model? No. What you see here is traders playing ahead of the guarantee that every major index fund tracking the S&P 500 will now be forced to buy Facebook stock. And those index funds will now have the privilege of paying about 4% more for the stock than before the announcement. The S&P 500 index funds will also have to sell the stocks kicked out of the benchmark (and these stocks will have taken a nice tumble after the announcement as well).
These index changes create two problems for index fund investors: unnecessary portfolio turnover and trading inefficiencies. Turnover creates trading costs and potential tax liabilities, and these trading inefficiencies force the index fund to buy high(er) and sell low(er). Better, broader index fund options are available to investors looking for US stock market exposure.