Robinhood, the investing app that pioneered free trading, saw record trades in June. But what’s good news for the trading app is likely not good news for a user’s long-term financial health, investing experts say.
Time and again, research has shown that the best way for the average person to accrue wealth is to invest for the long-term: Routinely contributing money to passive funds that track an index, like the S&P 500, shows historically better results than stock picking. Investing in a mutual fund or ETF spreads out risk; betting it all on a handful of stocks does not.
Of course, apps like Robinhood don’t force users to trade, and they can be used responsibly. But critics say Robinhood gamifies investing, sending regular push notifications to users about their individual stock positions. When a user makes their first trade, digital confetti “falls” in the app; it also makes suggestions to users on what to trade next. Those behavioral nudges can encourage investors to act with only their short-term interests in mind, Erika Safran, certified financial planner, tells CNBC Make It.
Robinhood’s main pitch is that users can make unlimited free trades: It bills its product as “investing for everyone.” This encourages some to buy and trade stocks daily, says Safran, who owns New York-based Safran Wealth Advisors, a tactic that financial planners almost always warn against. She likens these trading apps to gambling apps, rather than investing apps.
“I don’t see it as a serious vehicle for building wealth,” Safran says. “A better way to build wealth is to recognize that investing is not a short-term gain. You need to have time for your investments to grow.”
Day trading has always appealed to a certain type of investor, but Safran says apps like Robinhood are different because the barrier to entry is so low: Even novice investors can trade with one click, and they don’t need a ton of money to get started, which has historically been an obstacle for some. In fact, half of Robinhood’s 13 million users had never invested before signing up.
“We believe that broader participation in the markets is more democratic and can bring opportunities to many,” a Robinhood spokesperson tells CNBC Make It. “Those who dismiss retail investors as ‘gamblers’ or ‘gamers’ perpetuate the myth that investing is only for the wealthy and highly educated.”
But it is real, and Robinhood still makes money off of its users, even if the company doesn’t charge for each trade.
While the U.S. is facing record-high unemployment, the stock market is currently riding high, and some see trading as a way to make money. Robinhood’s top three days based on trading volume all occurred in June 2020, and the app added 3 million accounts in the first four months of 2020, according to a spokesperson; TD Ameritrade, a similar investing service, is also reporting record trades.
But day trading as an investment strategy often has disastrous results, says Safran. Even the most seasoned brokers on Wall Street can’t beat the market consistently. It’s highly unlikely the average investor, home and bored from social distancing, will be able to. The ease of Robinhood’s app may encourage users to make bad decisions.
The Robinhood spokesperson added that the vast majority of users are not traders. “Most of our customers use a buy and hold strategy with their investments,” they said.
Robinhood gives users access to risky investment options
The company is so successful in part because of how easy the interface is to use, Michael C. Whitman, a North Carolina-based certified financial planner, tells CNBC Make It. But ease-of-use doesn’t necessarily translate to easily understanding what you’re trading, particularly when you are a novice.
“These are super dangerous, because trading securities can be complex,” says Whitman. “You should really weigh pros and cons before blindly purchasing stocks.”
And it’s not just stocks. The app provides its largely novice base access to trading more complicated instruments like 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 a recent analysis from the New York Times. The app encourages users looking at their account settings to “step up with free options trading.”
Traders use options contracts to speculate. Robinhood, like other brokerage firms, requires customers who want to trade options to disclose their investment experience and knowledge, among other information. They are also required to acknowledge the risk they are taking on, says a spokesperson.
An extreme example of the danger of trading options occurred earlier this year, when Alex Kearns, a 20-year-old college student in Nebraska, died by suicide after his Robinhood account — through which he was trading options — appeared to show a balance of negative $730,165. Suicide is the result of many contributing factors, not a single event, but his family said Kearns, who was a novice investor, may have misunderstood his financial statement.
In the wake of his death, Robinhood announced it would make changes to its platform, including making it more difficult to access options trading. Other users have reported not understanding what they were getting into.
“During one of my conversations with a probono client, she asked me what the difference is between a swing trade and a day trade,” says Safran, noting the client, who used Robinhood, had just $700 invested, total. “It wasn’t important that she knew what the terms meant, most people don’t. What was dangerous was that it was on her radar.”
Trading isn’t necessarily bad if you already have a strong financial foundation: You’ve paid off debt, built up your emergency savings, and you are investing consistently in a diversified portfolio of stocks and bonds with a long-term outlook. Most important, you need to understand the risks involved and do the research before you invest extra cash in individual stocks. (Robinhood does offer beginner investor guides on its website.)
If Atlantic City were open, I would recommend they go there. At least you get a free drink while you gamble.
Safran Wealth Advisors