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Out of curiosity, I started googling what would happen to the S&P 500 Index when a new stock is listed on it. And I wasn't able to find the answer.

From my understanding, when a new stock enters the list, the hedge fund firms are required to purchase and add that new stock into their portfolios. However, my question is, alternative to what happens to the stock that enters the list, what can potentially happen to the Index itself? Does it mean it might slightly drop as it goes through the purchasing process or does it imply that it's value in fact increases due to addition of a new stock, thus value is added?

Take TSLA for example, there is a potential chance of it being listed on the index, given the Q2 results prove to be profitable.

Can that factor boost S&P 500 value or dampen it?

Thanks.

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    Note that discussion type questions are discouraged here. (ref) Your first two paragraphs look fine to me. I'd recommend removing at least the third or rephrasing it as a question with an actual answer, rather than a discussion. – glibdud Jul 12 '20 at 19:10
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    Good answer below, but wanted to add that the index itself is just a list, so it does not go through a purchasing process. Only funds that align themselves with the index do this adjustment. – Hart CO Jul 12 '20 at 21:39
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Index-tracking funds are not the index. The index undergoes an instantaneous change. One stock is substituted for another, and the divisor is altered at the same time so that the value of the index at the moment after the substitution is identical to the value a moment before.

But a fund attempting to track the index has to actually buy and sell stock to make the substitution, and can't do that instantly. The trading has to be done before the fact, or after the fact, and the trades themselves are liable to affect the prices of the stocks, so it's extremely unlikely that the fund receives exactly as much cash from selling the replaced stock as it spends on buying the required amount of the new stock. So the fund itself can gain or lose in value as a result of the replacement, even though the index doesn't. Since index funds have less freedom compared to other traders who have access to pretty much the same information about the index, they're more likely to lose than gain from changes in the index's composition or balance.

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  • Last I bothered to look, some 500 funds hold more than 500 stocks as they move in/out of the holdings over time. – Jon Custer Jul 13 '20 at 22:15
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The S&P 500 is always made up of exactly 500 companies. If one company is added to the list, another company must be removed. When there is a company change in the S&P 500, the index divisor is adjusted, so technically the index doesn't change.

I'm practice, though, as you mentioned, when a new company is added to the index, all the funds tracking that index (mostly mutual funds and ETFs, not hedge funds) will adjust their holdings by adding the new company to their portfolios and selling the old company. This can cause the value of the new company to increase, consequently increasing the cap of the index if it happens after the stock is already included. This is part of why such changes are typically announced ahead of time, so that the buying happens before the stock is included in the index.

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