Whenever some financial services provider starts talking about “democratizing financial services for all,” that’s a huge red flag. In the vast majority of cases, they’re pissing on your leg and telling you it’s raining. Robinhood might be the epitome of a fintech that says one thing and does another. The company may be named after a fictional character who took from the wealthy and gave to the poor, but is Robinhood really taking from the poor and giving to the rich?
Investing vs. Speculating
You cannot democratize the creation of wealth by having a business model that only grows when people do risky stuff. Speculators trade speculative vehicles like options and cryptocurrencies, while investors invest in quality assets with time horizons measured in decades. Only the latter comes out ahead in the long run. It’s about time in the market, not timing the market. The majority of Robinhood’s revenues come from people speculating, not investing. (More on this in a bit.)
The first thing to understand is how a free-trading app makes money in the first place. In Robinhood’s case, 81% of last quarter’s revenues came from what’s called payment for order flow (PFOF).
A majority of our revenue is transaction-based, in that we receive consideration in exchange for routing our users’ equity, option and cryptocurrency trade orders to market makers for execution. With respect to equities and options trading, such fees are known as PFOF.
Credit: Robinhood S-1 Filing
In the first quarter of 2020, Robinhood users “traded nine times as many shares as E-Trade customers, and 40 times as many shares as Charles Schwab customers.” That’s from a recently published paper, Attention-Induced Trading and Returns: Evidence from Robinhood Users, which talks about why Robinhood users are so prone to speculate.
Robinhood investors engage in more attention-induced trading than other retail investors. That’s not just because the platform attracts relatively inexperienced investors, it’s also partially driven by the trading app’s unique features which make it very easy to trade, or even encourage trading (they used to employ elements of gamification). Focusing the attention of investors on a small set of stocks promotes herding behavior which is typically followed by periods of negative returns. It’s what happens when you throw a bunch of newbie investors together, give them access to a market which they know nothing about, and focus their attention on a small set of stocks. This causes Robinhood users to chase performance, perhaps thinking they can trade their way to a better life.
Robbin the Hood
If you ain’t never been poor, you won’t know that being poor is expensive. Just look at the racket payday loan companies have going. Most people don’t realize that you need money to make money. If you don’t have much money to invest, you’re prone to take massive risks. People without much capital are attracted to giant returns in much the same way a gambler’s purse strings loosen when they see someone else win the jackpot. Robinhood capitalized on this by offering margins to first-time investors and encouraged them to speculate on risky financial products such as options.
A 123-page report by FINRA detailing all the ways Robinhood let down their customers also provides some interesting insights into the average customer profile. As of February 2021, the median age of Robinhood’s customers was 31, with half identifying as first-time investors. The median customer account size was approximately $240, and the average account size was approximately $5,000. Most people on Robinhood aren’t playing with very many chips, so they tend to look for cheap tables.
The Cheapest Stocks on Robinhood
When you don’t have lots of money to invest, you may be tempted to look for “the cheapest stocks to invest in.” And indeed, people do. Of the five most popular searches involving the term “Robinhood stock,” three involve looking for cheap stocks.
A common mistake newbie investors make is to associate the actual price of a stock with how much the stock is worth. The truth is, a stock priced at $10 a share is not worth less than a stock priced at $100,000 a share. The desire to purchase a bigger number of shares with a smaller amount of money explains why so many investors think trading penny stocks is the way forward. It’s a fatal mistake to make which the media caters to with “ten stocks under ten dollars” articles. You’ll find a whole slew of articles from “respectable institutions” feeding this information gap. The end result is an investing environment which pushes real value aside in favor of garbage like NFTs, ICOs, and meme stocks.
In the same year we learned Y2K was a nonevent, Vin Diesel was putting on one of the best performances of his career in the movie Boiler Room. The scene where Ben Affleck motivates new trainees wouldn’t be out of place in any late 90s investment bank. Boiler Room is a movie that every Robinhood weekday warrior needs to watch. It pulls back the covers on pump and dump scams which used to be conducted by phone. From there, they moved to Yahoo Message boards, then to InvestorsHub, and today they’re taking place on Reddit.
What are now called “meme stocks” are nothing more than pump and dump operations – stocks being manipulated by cheerleaders who can now command a million morons. Any retail investor who thinks they’re going to get rich on the short side of a meme stock is bound to get their margins tested. As one Redditor put it, “we can stay retarded longer than you can stay solvent.” The real winners in this mess are the small number of cheerleaders orchestrating the pump, along with the deep-pocketed hedge funds that are laughing all the way to the bank. There’s a special place in hell for financial pundits who encourage this behavior by labeling it “the poor sticking it to the man,” when precisely the opposite is happening.
Pitching the Bitch
One of two rules that new trainees were taught in Boiler Room was “don’t pitch the bitch.” That’s because men are far more likely to do stupid stuff with the least amount of effort required. Now that Robinhood has already picked all the low-hanging fruit, they’re moving to the next rung of the ladder. On Women’s Day, the company’s Chief Marketing Officer wanted to discuss women and investing. She talked about how the number of women Robinhood customers nearly quadrupled between February 2020 and February 2021, as if that’s a good thing.
Just days ago, Robinhood published a PR piece on how their “customers are more diverse than customers at incumbent brokerages.” It’s incredible how Robinhood pitches their platform as a way to distribute wealth to supposedly “disadvantaged populations” when exactly the opposite happens on a platform built to encourage speculating. The same piece talks about how “strong financial education is critical to empowering the new generation of investors.” So when will Robinhood start warning their clients – 50% of whom are newbie investors – that buying options, or speculating on crypto crap, is a surefire way to lose wealth? The accompanying YouTube video, featuring the Co-Founder of Robinhood, talks about “building generational wealth” and how “the new generation is being so intentional about their future instead of just the now.” The emperor has no clothes indeed.
How Robinhood Makes Money
Perhaps most telling is how Robinhood makes their money, something that says a lot about how the company is being incented to behave, regardless of what they say. If we look at assets under custody as of last quarter, we see that over 80% of customer assets are in equities, while an increasing percentage of assets are being held in cryptocurrencies – from 2.5% to 14% in just one year.
Speculating on volatile cryptocurrencies which rely on a greater fool for value isn’t how you build generational wealth, but the real story comes out when we look at fee structures. As clickbait articles often say, you won’t believe what happens next.
While options make up just 2.5% of Robinhood’s assets under custody, these risky financial tools make up just over 47% of their transaction-based revenues.
Options are extremely risky for experienced investors, not to mention novices. When you add cryptocurrency transaction revenues to the mix, you’ll see that 68% of transaction revenues – or nearly 55% of Robinhood’s total revenues – come from selling consumers extremely risky financial products. So, when the company tells CNBC that most of their accounts are buy and hold investors, that needs to be taken with a grain of salt.
Doing Good With Robinhood
One thing Robinhood managed to do was eliminate trading fees for retail investors across the entire industry, something that turned out to be a double-edged sword. On one hand, it opened up the market for anyone to speculate. On the other hand, the smart brokerage accounts over at brokerages like Schwab used it to their advantage. It’s something we wrote about in our piece on The Impact of No Brokerage Fees on Retail Investors.
We always talk about the importance of dollar-cost-averaging, buying a stock in small chunks over time to reduce market timing risk. When we were building our dividend growth portfolio, we were doing 30 trades a month over more than half a decade. Not having transaction costs, along with fractional share ownership, means even someone with very small amounts of discretionary income can accumulate assets slowly over time.
You could use a platform like Robinhood to start saving for your future, but there’s no need to now that most firms have eliminated transaction fees. We use Interactive Brokers for our tech stock portfolio (mainly to transact in foreign stocks) and Charles Schwab as our primary broker. If your broker encourages you to get involved in cryptocurrency trading, they’re catering more to speculators than to investors.
The Robinhood initial public offering (IPO) has been a volatile ride so far. You see, Robinhood is now being eaten by its own. It’s a victim of its own success, and retail traders are stirring up the share price into a volatile frenzy. In short, it’s becoming a meme stock, and it’s just another reason to avoid a company that’s probably going to be hurting for new user growth once those stimmy checks get spent.
Being a newly traded company, we’re curious to see if ESG analysts have the cojones to call out Robinhood for being a company that takes advantage of newbie investors and people who are Foolish enough to think they can day trade their way to a better neighborhood. Some subscribers have asked if we’ll cover the stock as a fintech play, and the answer is no. It should be obvious by now that this company – in its current manifestation – is being incentivized to concentrate wealth, not democratize it.
We’ve talked before about how Some Fintech Companies Aren’t Good For Investors. You can add Robinhood to that list. If you’re a shareholder in the company, don’t expect to sleep well at night. No, that’s not because of the shame you’re feeling, that’s because you’re investing in a volatile meme stock now – at least for now. And in the face of volatility, human emotions will always get the best of you.
Is there money to be made off the stupidity of others? Loads and loads. That’s not something we want anything to do with. If you’re a user of Robinhood, do yourself a favor and find a brokerage firm who has your best interests at heart, at least a bit more than the one you’re currently using. It shouldn’t be very hard.
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