As covered in our guide to investing, the surest path to wealth is slow and steady accumulation of low-fee, diversified index funds. It’s boring and simple, but it works. This article explains how Robinhood’s approach of quick and constant trading, complex options bets, and always-on access through your smartphone, is the opposite of sound, long-term investing.
It’s time to stop using Robinhood. There are a few traits required of any financial institution: You need access to your money, access to the markets, and access to assistance if you have a question or need help.
Robinhood has proven unable to consistently meet any of these basic conditions. Between unreliable infrastructure, a lackadaisical approach to regulation, and generally perverse incentives, Robinhood doesn’t deserve your trust.
Unreliable Infrastructure – “We’re so sorry this is happening!”
March 1, 2020 saw the single biggest point gain in the Dow Jones Industrial Average in over 10 years. Unfortunately, Robinhood users were left behind. The app had a complete outage leaving accounts inaccessible for the entire day. Anyone hoping that Robinhood would stick to its word and have “all systems up and running as soon as we can” was sorely disappointed when the app crashed again the following day. If you think two major outages in two days is unacceptable, Robinhood agrees. Their concern didn’t appear to translate to actually fixing their systems however. A few days later, as markets hit their lowest point in over a year, Robinhood was down again. That’s right, three major outages in a week when the stock market made records both up and down. The service, whose mission states “everyone should have access to the financial markets,” was unavailable when investors needed it most.
Conveniently, Robinhood’s customer agreement excuses it from any responsibility when its service goes down. Buried in the terms and conditions no one bothers to read: “I agree that Robinhood will not be responsible for temporary interruptions in service due to maintenance, Website or App changes, or failures…” In other words, when you find yourself locked out of your account because its servers are broken, it’s not Robinhood’s fault.
A company with 13 million users and worth over $11 billion should be expected to quickly identify, explain, and fix issues with its core infrastructure. Almost a year later, Robinhood is only now settling the federal investigation into its March 2020 outages.
Robinhood has demonstrated profound disregard for regulation and customer support since its inception. In 2016 it was another outage that occurred at the beginning of March, exactly four years before the crashes discussed above, leading many to speculate that Robinhood had forgotten to account for Leap Day in its trading systems. In 2018, it was when they tried to roll out an illegal banking product without first talking to regulators. Robinhood falsely claimed investors’ deposits were insured and was forced to cancel the service after over 500,000 people had already signed up. In 2019 it was the critical software bug that allowed traders to access unlimited margin. The glitch was dubbed the “infinite money cheat code” after traders on Reddit purported to turn thousand dollar deposits into million dollar positions.
Most recently, the company has even failed to meet basic regulatory requirements. In a year of unprecedented strain on the tax system, making filing early more important than ever, Robinhood missed the IRS deadline for providing critical tax forms. Worse yet, the company didn’t acknowledge the issue until two days after dropping the ball, when they silently changed the language on their site from “by February 16” to “starting February 16.”
If you have an issue with your account, good luck getting a helpful response. Robinhood’s customer support is entirely automated and impersonal. You can only contact them through email and in the app itself. Robinhood has recently promised to improve their customer support and add a live phone service, though the change in heart came only after a US Representative demonstrated the current phone line during the CEO’s congressional testimony. When you call Robinhood’s official support number, you get an automated 12 second message that simply directs you to the website or app before hanging up.
This experience is a stark contrast to traditional brokerages that often have 24/7 phone lines. An easily accessible phone number inspires trust that a firm takes support seriously and isn’t trying to minimize costs by handing the process over to dysfunctional bots.
Robinhood’s core business model revolves around a controversial practice called payment for order flow. Essentially, Robinhood gets paid to route clients’ orders to 3rd parties. Instead of executing trades on a public market like the New York Stock Exchange or the NASDAQ, Robinhood sends trades to private markets called “dark pools.” The practice isn’t unique to Robinhood, with many of the large brokers engaging in payment for order flow to subsidize free trades. In 2020, brokers collectively earned $2.6 billion from the practice. Proponents of payment for order flow claim it leads to significant price improvement for trades, while critics say it creates conflict of interest between broker and client.
No matter how you view the practice, Robinhood hasn’t been honest about its use. Just a few months ago, Robinhood paid a $65 million fine for three years of misleading users about the practice. Ultimately however, payment for order flow itself is not the problem. The issue is that payment for order flow is where Robinhood makes the majority of its revenue, meaning it has a direct financial incentive to get its users to trade more. Because it gets paid for each trade, Robinhood wants its users to do so as much as possible. The company doesn’t care if you make money or lose money, as long as you keep buying and selling.
This conflict isn’t just a key part of the company’s business model, but also inherent to the design of its app. The “People Also Own” section shares an uncanny resemblance to Facebook’s controversial “People You May Know” feature, both of which are designed to drive engagement through social ties. The “Most Popular Stocks” list feels like Netflix recommending the top watched shows to keep you glued to the screen. The year-end recap mirrors Spotify’s Wrapped feature, except Robinhood’s version celebrates compulsive use of its app.
Robinhood even hides the cancel button when confirming a trade. When you swipe up and the trade is executed, animated confetti rains* down to celebrate the occasion. The whole experience can feel like a game.
Economists and psychologists have been studying Robinhood and similar apps to learn how “gamified” stock markets affect traders. To Robinhood, more trading means democratizing finance. To academic researchers, more trading means worse financial performance. Research out of Indiana University demonstrates how simply trading on smartphones “increases purchasing of riskier and lottery-type assets and chasing past returns.” Professors from Oklahoma State and Emory University highlight how Robinhood trades “are unrelated with future returns, suggesting that zero-commission investors behave as noise traders.” Further research out of the University of California concludes “Large increases in Robinhood users are often accompanied by large price spikes and are followed by reliably negative returns.” In other words, when people trade all the time, on their phones, piling into stocks presented by an algorithm focused on popularity versus financial health, everybody loses. Except Robinhood.
When pressed in congressional testimony, Robinhood CEO Vlad Tenev denied the gamification in the app, stating “we know investing is serious.” Mr. Tenev is right. Investing is so serious that when 20 year old Alex Kearns got an automated email from Robinhood last June stating his account had suffered $730,000 in losses and needed to be made whole immediately, he took his own life. Tragically, the automated email was a mistake. Kearns’ account hadn’t lost money after all. In an attempt to understand and remedy the situation, Kearns reached out to Robinhood customer service three separate times over the next day. By the time Robinhood responded to confirm the mistake, Kearns was already dead. This appalling episode highlights two common hallmarks of the platform: a dysfunctional app and nonexistent support. Kearns’ death was completely preventable.
It’s not all bad
By instituting commission-free trades, Robinhood forced the entire industry to evolve. It was barely a year ago that the other large brokers removed fees from their platforms. Before Robinhood, it cost between $5 and $20 for each trade. For younger and less wealthy investors, these fees easily ate up a significant portion of returns. Thanks to Robinhood, you can now trade for $0 on pretty much any major platform. So why use a broker you can’t trust?
As a private company, Robinhood has no publicly available financial information. When the company spontaneously halted buying of select stocks at the height of the GameStop frenzy, Mr. Tenev struggled to explain why. When initially asked if the company faced a liquidity issue, Mr. Tenev expressly denied the possibility. Days later, he revealed the company had faced a $3 billion margin call at 3:00 AM, clearly a liquidity issue on a massive scale. With so many great competing brokerages, there’s no need to settle for an app whose Wikipedia article has a longer controversy section than the rest of the other sections combined.
As explained in our guide to investing, the proven way to make your money work for you is consistent investing in diversified index funds. This strategy isn’t exciting, and there’s no confetti, but you can be confident your money is safe and growing in the long term. Investing is serious. Don’t play Robinhood’s game.
*Recently Robinhood has removed the confetti in order to “clean-up” before they IPO.