When will you own Facebook in your 401(k)?

(MoneyWatch)  With an expected value of more than $100 billion dollars, Facebook will be one of the most valuable companies in the U.S. In fact, even if the stock doesn't move above the offering price of $38, the social networking juggernaut would be worth $104 billion, making it number 22 on the list of most valuable companies and knocking PepsiCo (PEP) down a notch. That would give it a significant weight in an index mutual fund that owns the U.S. stock market. But most index funds won't own Facebook for some time. 

If, for instance, you own an S&P 500 index fund, you will not own Facebook until the Standard and Poor's Committee decides to admit it into the index (and which company to throw out to make room for it). Though the S&P committee could always avoid having to bump one of the 500 members out by waiting until one is acquired or goes private, that could take a long time, which is one of my arguments for avoiding S&P 500 index funds.

The case against S&P 500 index funds
Bogle on S&P 500 vs total U.S. index funds
Complete coverage of Facebook IPO

Narrower index funds, such as small and mid-cap funds, will probably never own Facebook. Unless the stock does even worse than most naysayers expect, only index funds that include large capitalization companies can ever own Facebook, given its huge size.

A total US stock index fund will, however, have to buy Facebook. I asked Vanguard how its Total U.S. Market Index Fund (with more than $150 billion in assets) will be buying Facebook. Since this fund follows the MSCI US Broad Market Index, Vanguard will first have to wait until MSCI admits it to the index. Considering it is rules-based and doesn't have to wait for a committee to decide, the admission should happen pretty fast. 

Since I was unable to get MSCI to comment when that would be, I checked with Wilshire Associates, suspecting that the methodology of its Wilshire 5000 index might be similar. Wilshire admits new IPOs once a month on the close of the third Friday of each month. While that happens to be today, Facebook will have to wait another month, as Wilshire said it would not have enough time to inform clients. Even though the date was announced some time ago, delays of IPOs do happen.

I suspect most total US index funds will own Facebook within the next month. Yet, most may not own much of it.  That's because the Vanguard Total U.S. Index Fund and most index funds are weighted by the amount of stock that is available for public trading. With an IPO estimated at $16 billion, that means that only about 15 percent of its stock will be publicly traded on the first day.

Later this year, insider stock will start trading early when private equity investors and employees start cashing out. Still, founder Mark Zuckerberg will own much of the company, and that may not trade for some time. Thus, the Vanguard and most other total US index funds will own less than the total value of the stock relative to other publicly held companies of similar value.

The last question I had for Vanguard was how the Total U.S. Index fund would buy Facebook, once it's admitted to the MSCI US Broad Market Index. Presumably, if this mammoth fund bought all the shares at once, it could temporarily drive up the price of Facebook and end up buying at higher prices. Vanguard declined to get into the specifics of the portfolio transactions. This would, of course, be tipping off traders looking to make short-term gains from the massive purchases the fund will be making.

My take

I'm just fine with how my total US index fund will be getting me into Facebook. It won't be on the first day when emotions are running the most rampant. And it will not even be at the weighting of the full market capitalization.  But as insiders sell their shares and they become publicly traded, the index fund will slowly be increasing its holdings in Facebook, similar to dollar cost averaging.    

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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