Voices: Robinhood is democratizing markets, not disrupting them

Robinhood Financial and other online brokerage firms are overrun with rubes and gamblers naively bidding up U.S. stock prices and destabilizing the entire market.

That has been the dominant narrative around U.S. stocks since the market began its surge in late March. It’s not true, or at least there’s scant evidence for it. It’s also not new. The narrative borrows from a Wall Street saw that ordinary investors are fools not fit to handle their own money, a caricature that has long been used to exclude them from markets.

If ordinary investors are less sophisticated than the well-to-do, it’s not entirely their fault. They have too little money to gain access to elite financial firms, so they often lack the full range of investments and financial services available to well-heeled investors. Even worse, financial regulation bars ordinary investors from “complex” investments such as venture capital, private equity and hedge funds on the theory that they’re too simple to understand them. The paradox is plain: How can ordinary investors become savvier without access to markets?

Thankfully, the walls are beginning to crumble. A growing number of automated investment platforms, or robo-advisers, now offer money management to anyone who wants it. Hedge fund strategies are increasingly showing up in mutual funds and exchange-traded funds. And federal regulators, led by the Securities and Exchange Commission and the Department of Labor, are taking steps to open private markets to more investors.

Invest Insights

Lawmakers grill Robinhood following 20-year-old trader’s suicide

July 16, 2020 6:14 PM

Perhaps the most visible symbol of the movement to democratize investing is Robinhood. Since its founding in 2013, the trading app has allowed anyone to open a brokerage account with no minimums or commissions, eventually forcing other discount brokers to follow. As Robinhood co-CEO Baiju Bhatt put it recently, “People that previously didn’t feel like the markets were for them are for the first time feeling a sense of inclusivity.”

There are seemingly lots of those people. Robinhood opened more than 2 million accounts in the first quarter, topping the number of new users at Schwab, TD Ameritrade and E*Trade combined. More than half of Robinhood’s 10 million customers opened their first brokerage account using the app, and the median age of its users is just 31, according to the company.

If those new investors expected a red-carpet welcome, they were in for a disappointment. Robinhood’s users have been mocked endlessly for their inexperience and even blamed for a stock market many view as out of touch with reality. While the number of U.S. coronavirus cases continues to soar and the economy struggles to restart, stock market gauges such as the S&P 500 Index are approaching record highs and the technology-led Nasdaq Composite Index has eclipsed its pre-Covid peak. The culprit, according to a popular theory, is the horde of Robinhood users wasting their extra time and money gambling on stocks they know little about.

Volatility

Robinhood’s new traders ignore danger signs to bet on stocks

June 19, 2020 5:39 PM

It’s a silly explanation. For one, Robinhood’s users are playing with small sums, so they aren’t likely to move markets. Research firm Alphacution estimates that Robinhood’s average account size is $4,800, which puts the total value of its accounts at roughly $48 billion. That’s a tiny fraction of the roughly $11 trillion in market value added to U.S. stocks since the market bottomed on March 23, according to Bloomberg data.

There’s also little indication Robinhood users favor companies that are moving the market higher. The most popular stocks on the trading app represent a broad cross section of the market, from highflying technology companies to struggling banks and airlines. In fact, Robinhood’s customers may be betting on losers more often than winners. Barclays recently examined the account activity of Robinhood users and concluded that, “More Robinhood customers moving into a stock has corresponded to lower returns, rather than higher.”

A better explanation of the disconnect between the stock market and the wider world, as I recently pointed out, is that there has never been a reliable relationship between the market and the economy or the broader political or social environment. The market’s only job is to tabulate investors’ consensus view about the health and prospects of publicly traded companies, and right or wrong, the unmistakable consensus is that a robust earnings recovery is on the way. Robinhood users are indeed part of that consensus, but only a small part.

That doesn’t mean Robinhooders are faultless, obviously. Like all first-time investors and most seasoned ones, they will inevitably make costly mistakes — particularly the ones who are day trading, a notoriously ruinous game. The answer, however, isn’t to impose restrictions on them and other retail investors, as some have suggested, or to roll back efforts to open markets to everyone, but to give Robinhood users the information they need to make smart decisions.

There’s not much to it:

1. Day trading is entertainment, not investing. And like all entertainment, it costs money. If you don’t want to lose money, don’t day trade.
2. Owning one stock, or even a handful of stocks, is risky because companies can and often do go out of business. The way to protect yourself is to own many stocks. The easiest and most sensible way to do that is to buy a low-cost fund that tracks the broad market and hang on to it for as long as possible.
3. Don’t trade derivatives or use margin unless you’re an expert investor — and even then, it’s a dangerous game. If you don’t know what that means, you’re not an expert investor.

There are good reasons to believe ordinary investors make responsible investment decisions when given the opportunity.

“The bigger, badder retail investor army is the $8 trillion sitting in low-cost index funds,” my Bloomberg colleague Eric Balchunas told me. “More and more people are seeing that the way to build wealth is by keeping costs low and being patient, not chasing hot stocks and investment fads. And it’s very likely Robinhood’s day traders will arrive at the same conclusion at some point. Whether it ends in laughter or tears, it will be an education they can use for the rest of their lives.”

Robinhood can do its part by educating customers about the dangers around trading, especially with borrowed money. It should also tone down features on the app that make it feel more like a game than an investment platform. Those steps will go a long way to determining whether the app enriches ordinary investors, as its namesake implies, or leaves them poorer.

But it’s ultimately up to Robinhood’s users. Markets are finally opening to them. What they do with that access must be their choice.