- Finance expert Farnoosh Torabi tried the popular investing app Robinhood for six months
- Her conclusion: It puts too much emphasis on easy trades. Studies show frequent trading actually makes you less likely to achieve long-term wealth
- If you’re thinking of investing, check out any fee-free brokerage and see if a Roth IRA is right for you
One Friday afternoon in June, I arrived at Party City to purchase a few last-minute items for my son’s sixth birthday. After waiting in line for 20 minutes , I walked out with a dozen blue balloons, a helium tank — and 235 shares of the company.
I can explain.
While many businesses have suffered in the pandemic, Party City appeared to be an exception. The store was packed, and customers were buying hundreds of dollars worth of merch. When I was ready to check out, I was 15th in line.
In that moment, I began to see Party City as more than just an occasional hot spot for inflatables. Now in a pandemic where large gatherings have come to a screeching halt, Americans are going big with smaller, at-home festivities. And Party City, armed with its massive inventory of confetti, glow sticks and streamers, will reap some profits.
Now 10th in line, I grew curious to see where Party City stock was trading. A quick check on my phone revealed it was sitting at a very low $1.70 per share, down from over $7 per share a year prior. A news search pointed to a recent headline of a deal that would cut the company’s debt by 25% and strengthen its balance sheet.
Now, full disclosure: I’m not a stock picker, nor do I recommend individual stock picking as a way to get rich. I primarily invest in an array of index funds and exchange traded funds, and I plan to hold them for a long time. They’re all inside a SEP IRA designed for my retirement, decades away. The last time I ever bought an individual stock outright was … never.
When it comes to long-term investing, I find this to be the most sensible and cost-efficient route.
So I don’t know if it was the helium in the air that afternoon or what, but I jumped to purchase Party City stock totally on speculation.
To grab the shares, I used the Robinhood app, the quickest and cheapest way I knew how to invest in individual stocks. And I’m delighted to report that my single stock investment has zig-zagged its way to now over $6 per share, a more than 200% increase. I bought some more shares along the way and finally cashed out when it hit $6.47 per share in December, pocketing roughly $2,500 (before taxes).
But this isn’t a piece about Party City’s rebound or my dumb luck as a stock picker.
It’s about navigating Robinhood and my advice for using the popular brokerage app, which has experienced massive adoption in 2020, thanks largely to heightened interest in investing during the pandemic.
My conclusion is this: After using the Robinhood app for close to six months, I like the convenience and access it provides toward making a quick stock purchase, if you’re into that sort of thing. But the best part of the investment platform is also a real potential financial pitfall: It makes trading too easy and attractive. It can feel too much like a game.
I fully support democratizing the financial world and providing more affordable entry points for investors. For that reason, I appreciate Robinhood’s fee-free platform and zero account minimums, trends it pioneered in the market but that are now common features at many other brokerage firms.
The company was founded in 2013 and has now attracted 13 million customers, mainly young investors (the average user is 31 years old) who, my guess is, felt excluded from the stock world. Around half of Robinhood’s users say they’re first-time investors. “Customers have grown up mobile-first and they tell us our product makes investing less scary, more accessible, easier to understand and more personal,” a company spokesperson told me.
Yet, a part of me worries that Robinhood is profiting off these younger and potentially less-experienced investors who lack the literacy and, frankly, the restraint, to invest wisely. The CFA Institute found that four in 10 millennials cite a “lack of knowledge” as a big barrier to investing.
Those educational shortcomings are not Robinhood’s fault, of course. And the company, to its credit, offers articles, a newsletter and podcast to educate its community.
But instead of recommending the investing app to anyone, I want to offer a few important caveats.
1. It’s Not a Money-Making Tool
That’s right. This is not a place to build wealth. The platform encourages short-term trading, which we know can often lead to more losses than gains. This study, which examined Robinhood traders, found the app’s users tend to “herd” around a small set of volatile stocks, and that those stocks tend to experience negative average returns over the next month.
Along with many other studies, it reinforces why I don’t recommend individual stock picking as a way to build long-term wealth. Passive investing in low-fee index funds is easy, cheap, and for the win, in my book.
Assuming you’ve covered all your financial bases — contributing to a workplace retirement account or a Roth IRA, with an emergency fund and no consumer debt — and you have some extra in savings with which to “play” or “gamble” with, then okay. Robinhood, for its zero commissions and fees and no account minimums, is a quick and easy way to trade in this fashion.
Just consider it a pricey pastime that won’t necessarily pay off. That’s what I did, fully accepting that my Party City stock pick could fall on its face. In the end, it gave me something silly to brag (and laugh) about with friends — not a blueprint for making money.
2. It Shouldn’t Be This Thrilling
The user experience on Robinhood can be fun … until it’s not.
When I opened the app, the first thing I’d notice was the “Total Value” of my portfolio, which adjusted every few seconds with digits rolling up or down. Buttons colored bright neon green or red, depending on if my portfolio was up or down, would tell me to “deposit funds” or “invite friends.” Another button wanted me to click to learn how to earn “free stock.”
Critics of the app have cautioned against this playful and frictionless nature of Robinhood, which they fear can trigger users into making too many trades and losing money.
“Robinhood is the gamification of investing. The whole point of it is to keep hitting the buttons, pulling the levers and turning the knobs as much as you can,” says Morgan Housel, author of the bestselling book The Psychology of Money.
Sure enough, Robinhood users have been found to trade nine times as many shares per dollar in their account compared with investors at E*Trade, and 40 times more shares than investors at Charles Schwab.
Some regulators are none too pleased with Robinhood. Late last year, Massachusetts securities regulators issued a complaint accusing the platform of aggressively marketing to novice investors and doing little to stop them from making wreckless choices. Robinhood disagrees with the allegations. Around the same time, Robinhood paid $65 million to settle charges with the SEC that it failed to properly disclose to its users how it was making money off their trades and that the company failed to “satisfy its duty to seek the best reasonably available terms to execute customer orders.” While Robinhood has touted its commission-free trades to users, the SEC charged it was making up for it by executing trades at inferior prices that deprived its users of $34.1 million in total.
My advice: If the experience overwhelms or incites you, it probably won’t help make you smart money moves. At least mute it as best you can. You can head to the settings feature and turn off push notifications for everything from price movements in your holdings to shareholder updates. This helps to avoid making moves hyped up on emotion. You can also adjust the theme from “dark” to “light”, which, personally, helps to reduce my heart rate. I also opted for “accessible” colors, which turns the bright red tones to a softer magenta.
3. Buy and Hold
Robinhood says most of its customers use a buy and hold strategy, but it’s clearly becoming the go-to platform for making trades for many users. In June, the month when I pulled the trigger on buying Party City, the app experienced 4.31 million average trades per day, surpassing peers like Charles Schwab and E-Trade. The company’s number of Daily Average Revenue Trades, or DARTs, for the second quarter of 2020, more than doubled when compared to the first quarter.
Studies continuously show that passive investing is a better way to build wealth over time. “The investors who do the best on average are the ones who make the fewest decisions and the least amount of activity in their portfolios,” says Housel.
So, don’t trade. Stick with diversified investing for the long term.
Clearly I didn’t take my own advice on this one, proving again how tempting it is to cash in. For my lack of patience, I’ll be subject to short-term capital gains tax, which is equivalent to my current income tax rate. Waiting a year before making a move would have meant a smaller tax bite.
4. Prepare For Mistakes — and Consequences
Before buying Party City stock, I transfered $500 from my bank account to Robinhood. For some reason, though, when I went to purchase the stock minutes later, only $400 worth of shares got purchased. The other $100 remained behind as part of my cash balance in the app. I chalked it up to Robinhood probably wanting to keep some cash liquidity in my portfolio (a good thing) but, when I asked, the company said that wasn’t the case. Instead, it’s possible that Robinhood was letting me have what it calls ‘instant access’ to buying a stock up to a limit, while your cash transfers over. In this case, maybe my limit was $400? It remains a head scratcher.
I remember being so confused at the time, wondering why my portfolio balance was lower than it should have been. I’ve been a personal finance journalist for practically 20 years; a less experienced investor or someone who risked more might have panicked.
This lesson speaks to the importance of only wagering what you can afford to lose and preparing for mishaps.
“There is a part of me that is glad that the Robinhood phenomenon will teach their investors — who by and large are very young — lessons early on in their life. Maybe that’s a good thing,” says Housel. “But I also think there’s a side of the gamification of investing that is dangerous because people’s money is not a game. It has real life consequences.”
The best way to think about building wealth is as an investor, not a trader. Have clear goals and objectives before getting in the market. If you follow the advice of most experts and seek tax-friendly IRAs and low-fee mutual funds (rather than just individual stocks or crypto), look into investment accounts with Fidelity, E*Trade, Charles Schwab and TD Ameritrade. There, your options are broader, you can still benefit from commission-free trades, and the platforms aren’t set up in a way to encourage more frequent trading.
And unlike me, avoid buying stocks while running errands.