Don't Get Over Your Head in Investing
One of the big investing stories of 2020 involved Robinhood and similar companies, which offer free or low-cost trades. Although such companies may claim to democratize investing, critics say these apps can "gamify" investing and encourage short-term excitement over long-term plans. For example, when users make their first trades, digital confetti falls in the app. It also includes a watch list of stocks for users to track. Robinhood's investment app stands out for offering a streamlined trading platform and free cryptocurrency trading. Its account minimum is $0.
But users should be careful. Investing experts say what's good news for the trading app — record trades this past June — is likely not good news for a user's long-term financial health.
These behavioral nudges can encourage investors to act with only their short-term interests in mind. Financial planners liken trading apps to gambling apps rather than investing apps. A better way to build wealth, investing experts say, is to recognize that investing is not a short-term gain. You need to have time for your investment to grow.
Among competitors are InteractiveBrokers and SoFi, as well as many big-name online brokers that in late 2019 eliminated trading commissions and fees. But Robinhood is one of the few brokers to give investors the opportunity to trade cryptocurrency, which can be very risky.
On the apps, even novice investors can trade with one click, and they don't need a ton of money to get started, which has historically been an obstacle for some. Half of Robinhood's 13 million users had never invested before.
The worry is that it doesn't feel like real money. But it is real, and Robinhood makes money off its users even if it doesn't charge for each trade. Market makers like Virtu or Citadel Securities pay e-brokers for the right to execute customer trades. The broker is then paid a small fee for the shares that are routed, which can add up to millions when customers trade as actively as they have this year.
Investment experts are terming it the perfect storm for retail trading — people working from home, boredom from social distancing and the ease of using a trading app. With the U.S. facing record-high unemployment, some have seen trading as a way to make money, driving people to the market and to online usage. It's highly unlikely the online user will be able to beat the market consistently. The ease of Robinhood's app may encourage users to make bad decisions.
Take options. An options contract gives the holder the right to buy or sell an underlying security at a specific price until a certain date, and Robinhood users traded them at the highest pace of any retail brokerage, according to an analysis from The New York Times. The app encourages users to look at their account settings and step up with free options trading, critics claim. If you're accustomed to using a smartphone, you'll find the sign-up and account-funding process easy, users say. Approved customers are notified within the hour and can initiate bank transfers. But investing in options is more speculative, providing more upside but also more downside losses.
Traders use options contracts to speculate. Investors are required to disclose their investment experience and knowledge. They're also required to acknowledge the risk they're taking on. App users have reported not understanding what they're getting into.
The bottom line? It may be more prudent to work with professionals on your investing plan and not treat it like a game. A strong financial foundation and understanding the risks involved, plus doing research before you invest, is strongly advised by investment experts. Be careful not to get in over your head.