Robinhood has taken the investing world by storm. This investing app gained fame for offering commission-free stock trades through a smartphone app. Soon, the app had risen in popularity, particularly among the millennial demographic that has otherwise been less interested in investing than other generations at a similar age.
However, that has also raised an interesting question about how responsible Robinhood should be for its less experienced users. Investing can be complex and difficult, and novices are more likely to make simple, avoidable mistakes. But at the same time, you don’t want to allow the consequences of not making the best investing choices to outweigh the overall benefits of choosing to build wealth through the stock market.
So is Robinhood good for attracting more people to investing? Or is it bad for potentially setting up less informed users to make avoidable mistakes?
Last updated: Sept. 21, 2020
What Is Robinhood?
Robinhood is an online stock brokerage that comes in the form of an Apple or Google Play app. By taking profits from selling order flow rather than charging per-trade commissions, it saves the typical user a lot of money compared to other online brokerages that are still charging on a per-trade basis. In fact, it’s been so successful in attracting new users this way that most of the other discount brokerages followed suit by eliminating their per-trade fees.
In addition to basic buying and selling of stocks, Robinhood also offers the chance to conduct more complex trades, like those using options or currency trading.
Why Are So Many People Trying This?
One area where Robinhood appears to have succeeded is in building a connection between its users and investing. Stock ownership is not common in the United States — just 55% of the population owns stock — and helping a larger portion of the population take advantage of the growth offered by the stock market could go a long way toward relieving some wealth and income inequality.
What Does It Mean To 'App-ify' Investing?
One way that Robinhood has made headway with users who might previously not have considered trading stocks is by including the sort of bells and whistles that other apps use to keep people interested. Things like confetti bursting across your screen to mark a transaction is a departure from the more traditional approach to investing.
Higher Stakes Than Farmville
Unfortunately, there are questions about just how ethical it is to take advantage of the same methods that an app like Farmville or Candy Crush use to keep users interested with an app for trading stocks. The financial consequences of falling into bad habits is far greater than it is with those games, and pushing inexperienced investors to keep making more and more trades could also mean more and more losses for the wrong people.
Serious Questions Driven by Trader Suicide
The issue of novice users getting in over their heads came into sharp relief after Alexander Kearns, a 20-year-old student, committed suicide after he misinterpreted the display on his app. Believing that he was in debt of almost three quarters of a million dollars, Kearns was distraught, but the negative balance that displayed on the app wasn’t actually an amount Kearns was responsible for. The incident raised serious questions about whether Robinhood was doing enough to screen users signing up for the more complicated service of options trading.
Don’t Be 'Dumb Money'
Even if you’re sure you wouldn’t get involved with more complex financial products like Alexander Kearns did, it’s worth remembering that retail investors are often referred to as “dumb money” by professionals. People who try to buy and sell individual stocks based on hunches typically overreact to every piece of news, usually waiting too long to sell bad stocks and selling good stock way too early. The big investment banks that have the ability to make more educated guesses and stick with them routinely get better returns because they don’t fall victim to the sort of impulsive trades that individual investors often make.
Basic Tips To Get the Most Out of Robinhood
Here are some basic tips for ways you can use Robinhood to start investing without falling into the traps that will make you “dumb money.”
1. Limit Transaction Size
One thing to understand about “selling order flow” is that it basically means that the price you pay per share is often about $0.01 higher than it would be if you used one of the pricier services that emphasize executing trades at the best possible price. If your trading usually never exceeds more than a hundred shares at a time, you’re still probably saving money over paying a per-transaction fee. However, if you are lucky enough to be transacting in amounts of thousands of shares at a time, you might want to explore your options.
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2. Don’t Try To Be Too Clever
One of the most important elements of what makes retail investors “dumb money” is that people are naturally overconfident in their own ability to make quality trades. It can be easy to allow your confirmation bias to let you focus on the trades that worked and ignore the ones that don’t. However, overestimating your own ability is a classic trap that many beginning investors fall into.
3. Stick To Passive Investment Strategies
One way to avoid having to make any major decisions on your own is by sticking to passive investment strategies. These focus on simply accepting market returns without trying to beat them. That might sound like you’re giving up, but even the best mutual fund managers struggle to beat the returns of the S&P 500 for more than a few years in a row. In the long run, simply investing in index funds and/or ETFs that track a well-known index (like the S&P 500) and charge very low fees is usually most likely to produce the best results for your portfolio.
4. Track Your Trades
If you do persist in making your own trades, make sure you’re being careful to track the details of each trade carefully. Keep records showing how much you paid per share and the date on which you made the trade. Then, periodically check up on each trade so that you can compare how that trade has done in comparison to the broader market. Unless you can learn from mistakes, you’ll likely never be able to really find success.
5. Keep a Long-Term Perspective
Strategies that rely on moving in and out of different stocks frequently rarely produce the desired results. As tempting as it might be to try and chase a big return from week to week or month to month, you should be thinking in terms of how a stock will perform over the next five to 10 years. Quick trades might feel like easy money when they work, but almost no one can actually be successful at a high enough rate to produce consistent results.
6. Don’t Forget Taxes
Another reason for sticking to long-term investing is that it will help reduce your tax burden. As long as you hold a stock for at least a full year, any profits you make from ultimately selling it will be “long-term” capital gains that are taxed at a different, lower rate from other income. If you own the stock for under a year, you qualify for the “short-term” capital gains rate — which treats any profits like regular income.
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7. Don’t Forget Fees
Take the time to do your research on any mutual funds or ETFs that you look into on Robinhood. And when you do so, nothing is more important than the “expense ratio.” That is the fee you’re paying for using their financial product. And while the difference between an expense ratio of 0.5% and 0.05% might seem like it should be inconsequential, it can add up to hundreds of thousands of dollars over the course of a few decades.
8. Don’t Be Overly Confident
Don’t allow success to cloud your judgement. It can be easy to let a few wins convince you that you’re now an expert. However, if that means you start getting more aggressive in your trades, significantly increasing how much money you’re putting at risk or even experimenting with more complex instruments, you could be putting yourself at risk.
9. Don’t Forget You’re Only Half of Every Trade
As confident as you might feel about the research and analysis you’ve done to come up with a potential trade, you shouldn’t forget that Wall Street is full of professional analysts and researchers who spend their entire career trying to understand this subject. For any trade you make, someone else is on the opposite side of it and has arrived at a different conclusion than you. Before you start assuming that a few good trades mean you’re the next Warren Buffett, maybe consider how likely it is that you’ve outsmarted everyone else as opposed to just getting lucky this time around.
10. Skip the Penny Stocks
The world of penny stocks can be enticing to the novice trader. Small share prices mean you can buy more stock, and the big swings up and down mean you get faster results than you would with other stocks. However, very few people manage to find success trading these volatile stocks, so you would probably be better served by staying away entirely.
11. Plan On Slow Results
A lack of patience is one of the key issues most novice traders face. Results in the stock market tend to come far slower, but the slow and steady approach is one of the only ones that shows consistent success. Just because you open the newspaper and see news that a stock shot up doesn’t mean you should start chasing fast returns. Stick to the strategies that have a clear track record of success over the long term.
A Final Thought on Robinhood and Your Investments
Getting involved in the investing world is usually going to be a good decision. Even the worst stock investments are going to offer a much higher expected return than betting on blackjack at the casino. You can invest pretty poorly and still be much better off than someone who didn’t invest at all.
However, it’s also important to remember that apps like Robinhood have a financial incentive to get you to make more trades, whether that’s a good choice for you or not. If you aren’t careful about how Robinhood might be manipulating you, you could easily end up losing money on decisions you could have avoided.
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This article originally appeared on GOBankingRates.com: Robinhood Has ‘App-ified’ Investing — How To Dive In Without Big Losses