Robinhood’s recent initial public offering (IPO) has brought the online trading platform back into the limelight. The company, launched in 2013, is an app that allows users to trade individual stocks, exchange-traded funds (ETFs), crypto assets, or options without paying transaction fees.
For years, investors paid when they bought or sold stocks. The first company to break down business barriers for ordinary investors was Charles Schwab, a San Francisco-based firm that believed that even individuals with small amounts of money should participate in the world of investing. In the last 40 years since Schwab introduced low-cost trading, fees have been coming down.
Enter Robinhood, the first company to offer commission-free trading to clients (more on that later). Other large online brokers, including Schwab, E-Trade, and TD Ameritrade, quickly followed suit, but it was Robinhood that became the trading app of choice among young investors. The awkward circumstances of the COVID pandemic, where millions of Americans were at home and many flush with extra savings, helped Robinhood flourish. With more than 22 million customers, up from just 500,000 in 2015, the company posted a profit of $7.3 million in 2020 and its IPO valued the company at about $29 billion.
That’s a rich value for a company that doesn’t charge transaction fees, so how does Robinhood do it? Like online behemoths Facebook, Amazon, and Google, which sell your personal data to advertisers to make a profit, Robinhood makes money in a less obvious but lucrative way. Robinhood sends customer orders to high-frequency merchants in exchange for cash. This legal practice is called “payment for order flow” (PFOF).
If you use Robinhood, you won’t see a line item for PFOF, but you’ll get a slightly worse price for your transaction (we’re talking a few pennies) than another potential broker for your business. are) is likely to be obtained. Although some pennies may not sound too bad, they add up to the company when volumes go up. The SEC fined Robinhood $65 million after it was unclear with investors how it makes its money. Separately, the Financial Industry Regulatory Authority (FINRA) announced a $70 million slap to resolve various alleged customer care and suitability violations.
Robinhood also makes a lot of money from its “Robinhood Gold” account, which costs $5 per month. Gold accounts allow clients to participate in margin trading, which is a way of borrowing money from the firm to trade. Margin has been around for a long time – it’s essentially a way to supersize your investment returns, but it can also amplify losses. Finally, like large investment companies and banks, Robinhood makes money from the cash you hold in your account and charges a $75 fee to transfer the account to another brokerage firm.
If that all sounds fine, you might wonder why people like me, who want to encourage people to invest, are concerned about Robinhood. Trading with a few taps is great but enticing inexperienced users with video game and online betting gimmicks can be problematic. Robinhood’s early practice of rewarding investors with winning trades with confetti animation (now removed from the platform) and digital nudges was seen in Robinhood’s early practice, such as when you’re up the screen to beat and When you are down it turns red. , which encourages a lot of business.
Adding to the concern is Robinhood’s practice of marketing trading strategies, such as margin and options, without providing adequate investor education. If you would like to learn more about trading with borrowed money and options, I encourage you to visit the FINRA and SEC websites. And of course, like any risky investment, limit your investments to 5% of your total investment portfolio.
Jill Schlesinger, CFP, is a business analyst for CBS News. A former options trader and CIO of an investment advisory firm, she welcomes comments and questions at [email protected] Check out his website at www.jillonmoney.com.