Robin The Hood took from the rich and gave to the poor, or so the story goes. What you believe may depend on what movie you watch or book you read. Although, I tend to think Robin Hood: Men In Tights was probably the least historically accurate of all of them.
When it comes to online trading, or “investing”, the brokerage house Robinhood came on the scene a few years ago. It was one of the first brokerage houses to offer “free” trading, and many of the large discount brokerage houses soon followed. While this seems good on the surface, we will run through The Good, The Bad, and The Ugly of this new trend.
The Good — Democratization & The DraftKings’ Affect
Lower Cost & Fractional Shares
Trading has become “democratized” – anyone can now place a trade. Twenty years ago, when I started in this business, it could easily cost you hundreds of dollars to place a trade, and you had to go through a broker. Not so now. You had to be well-off, or well leveraged, to play in the market.
The new lower cost is also accompanied by the ability to trade fractional shares. While this is not entirely new, the Robinhood-type apps allow you to purchase fractional shares of a company’s stock. Most small traders, or investors, could not afford to buy even one share of Amazon at over $3,000 per share, now they can buy $10 worth. This is another example of democratization of trading. You don’t have to have thousands of dollars to buy stocks.
Increased Interest In Business & Economics — The DraftKings Affect
Fantasy football, like with DraftKings, has played a large factor in the increased interest in the NFL. Having skin in the game forces people to watch more than just their hometown team. Would anyone in Minnesota really watch Philadelphia and Cincinnati unless they had players from those teams on their fantasy football team?
Like it or not, betting forces us to dig deeper. To understand factors that influence an outcome. My sons recently bought their first individual stocks on Stockpile. One bought Delta and Boeing. The other Dropbox. (Not a recommendation — Please consult your investment advisor before making any investment decision.) They both read articles on why the stocks have behaved the way they have in the recent past. It was clear they were both doing research, much like one son does with the DraftKings fantasy football.
The Bad — Nothing Is Free
As my great, great, grandpappy Jebediah Struthers used to say, “the free things come with the greatest cost”. Ok, it wasn’t Jebediah. The quote actually is from the show All American, where a mother warns her football-star son of the “free” things given to him.
Robinhood has to make money somehow, at some point. The question is, how? The answer that pops up first on a Google search is that they are selling your trading data to others. Those others will then use that data to place their own trades, most likely at your expense. The tough part is, it is difficult to quantify — to put a number to it.
An example that most people can relate to is Facebook. Facebook is “free” too. The cost for Facebook users is loss of privacy, being bothered by ads, and maybe an unhealthy device addiction. Facebook sells your data to make money. In all likelihood, Robinhood will do the same — nothing is free.
The Ugly — Gambling, Diversification, Your Personal Balance Sheet & Retirement
Are you a long-term investor? If you answered yes, then how long is long term? If you are trading on a daily, weekly, or monthly basis, that is not long term.
In most cases, day traders are closer to gamblers than investors. Is buying Amazon safer than putting $100 on the number 4 horse to place in the 6th race at Canterbury, yes. But if you are buying Amazon to hold for a day, and it makes up 50% of your liquid net worth, that’s gambling. Your retirement “investments” should be long term and diversified.
A recent study highlighted in a Bloomberg article indicated that the Robinhood folks were not quite as reckless as many people, like me, thought. Instead of buying exciting high-risk stocks, many were buying boring “safer” companies, like Disney and GE. But even though these companies can be a safer choice than a small biotech company, it doesn’t mean that they were properly diversified. As great a company as Disney is, having 5%+ of your liquid net worth in one company is not diversified, and carries a company-specific risk that is unhealthy for most investors.
The core of your college and retirement savings should be diversified and be in tax-beneficial accounts, not betting it all on Steamboat Mickey.
Personal Balance Sheet
The ugliest things I see regarding these apps are people living paycheck to paycheck, borrowing money to trade. Many have high-interest credit card and student loan debt that they can barely afford, yet they are trading several times a day. Also, they often don’t have the funds to even take advantage of their company’s 401k match, which is most often a certain 50%+ return.
If you cannot afford to gamble, don’t go to Vegas. If you are living paycheck to paycheck, don’t day trade Tesla on Robinhood.
All this ugly can lead to an ugly retirement. Making risky bets, whether it’s day trading or being too concentrated in one company’s stock, can put your retirement plan in an unhealthy place. Many should view it a little like entertainment — money you can afford to lose because your financial core is healthy.
So, when should you use these trading platforms?
- When you are taking advantage of your company’s 401k match — retirement first!
- You have an emergency fund of at least 3-6 months
- Your budget is in a good place — or on a clear path to get there
- You have no high-interest credit card debt (a guaranteed 15%-24% return)
- The trading account makes up less than 5% of your liquid net worth
- The rest of your investments are diversified
- You can control yourself — you don’t pretend like you are in Vegas
- You know and understand the costs — your data may be sold or you may have a poor execution price.
A famous Avenger once said, “With great power, there also comes great responsibility.” We all now have the power to participate in the capital markets. We all have the power to use these platforms for good, for bad, or for ugly. You decide.