One of the big investing stories of 2020 involved Robinhood and similar companies, which offer free or low-cost trades. Although such companies may claim to democratize investing, critics say these apps can “gamify” investing and encourage short-term excitement over long-term plans. For example, when users make their first trades, digital confetti falls in the app. It also includes a watch list of stocks for users to track. Robinhood’s investment app stands out for offering a streamlined trading platform and free cryptocurrency trading. Its account minimum is $0.
Users should be careful. Investing experts say what’s good news for the trading app — record trades this past June — is likely not good news for a user’s long-term financial health.
These behavioral nudges can encourage investors to act with only their short-term interests in mind. Financial planners liken trading apps to gambling apps rather than investing apps. A better way to build wealth, investing experts say, is to recognize that the most reliable investing results come from long term strategies.
Robinhood and its competitors are not inherently bad tools that should be avoided. However, they remove some of the guardrails of investing that have historically pushed investors to take longer term strategies. Today’s individual investor needs to be even more informed of the risks in order to make sound investing decisions.
Among Robinhood’s competitors are InteractiveBrokers and SoFi, as well as many big-name online brokers that in late 2019 eliminated trading commissions and fees. But Robinhood is one of the few brokers to give investors the opportunity to trade cryptocurrency, which can be very risky. Cryptocurrency is a relatively new type of investment. As with any new technology, its future use and therefore value is still largely unknown. In many ways it is comparable to the internet in its infancy. While it turned out the internet has created vast amounts of wealth, many of the early investments in it did not pan out. Robinhood makes it easier than ever for untrained investors to invest in cryptocurrency.
On the apps, even novice investors can make complex trades with one click, and they don’t need a ton of money to get started, which has historically been an obstacle for some. Half of Robinhood’s 13 million users had never invested before.
With the ease of investing paired with the feedback triggers that Robinhood provides, the fear is that the money invested may not feel real. When money does not feel real, emotions and intuitions that are typically associated with less risky actions can take over.
But the money invested with Robinhood is very real, and Robinhood makes money off its users even if it doesn’t charge for each trade. Market makers like Virtu or Citadel Securities pay e-brokers for the right to execute customer trades. The broker is then paid a small fee for the shares that are routed, which can add up to millions when customers trade as actively as they have this year.
Investment experts are terming it the perfect storm for increased retail trading — people working from home, boredom from social distancing and the ease of using a trading app. With the U.S. facing record-high unemployment, some have seen trading as a way to make money, driving people to the market and to online usage.
The issue is not that more Americans have access to investing. The issue is that unrestricted access without the training that professionals receive can lead to bad outcomes, especially when more complex tools are readily available.
Take options. An options contract gives the holder the right to buy or sell an underlying security at a specific price until a certain date, and Robinhood users traded them at the highest pace of any retail brokerage, according to an analysis from The New York Times. Options trading is not standard to Robinhood, but the app encourages users to look at their account settings and step up free options trading. If you’re accustomed to using a smartphone, you’ll find the sign-up and account-funding process easy, users say. Approved customers are notified within the hour and can initiate bank transfers. But investing in options is much more speculative, providing more upside but also more downside losses.
Traders use options contracts to speculate or to hedge other risks. Investors are required to disclose their investment experience and knowledge when applying to trade options. They’re also required to acknowledge the risk they’re taking on. App users have reported not understanding what they’re getting into.
The bottom line? Take it slow. If it feels like you need to make an investment or you are going to lose out, that is a good sign that unhelpful emotions are driving the investment decision. Don’t be afraid to consult an expert, or read what the experts have to say. Knowledge and experience will help counteract the added risk that Robinhood and its competitors now make bring to the table.
