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Robinhood is looking to educate novice investors on the first steps they should take. But financial experts argue that people just starting off on their financial journeys should proceed with caution when using investment apps.
On Tuesday, Robinhood
HOOD,
rolled out a new service called “First Trade Recommendations” aimed at first-timers just breaking into the investing landscape. The service “allows customers to learn by doing,” the company said in a blog post.
New customers will be given an option to receive help investing. When they click on that option, they will be directed to fill out a questionnaire about their appetite for risk, their investing goals and how long they plan to be investing.
It will produce personalized portfolios, featuring four exchange-traded funds. “The recommended ETFs will give customers exposure to a diverse set of domestic and international equities, as well as exposure to the U.S. bond market,” the firm said.
(Robinhood didn’t immediately return a request for comment.)
Not everyone believes this is necessarily a good idea. “A broker is not normally considered a fiduciary — that is, someone who must work in your best interest,” James Royal, principal reporter at Bankrate, told MarketWatch.
“‘My biggest concern with a program such as this is whether Robinhood must act in the interests of its clients and to what extent.’”
“Robinhood gets paid when its customers trade. Investors themselves don’t pay for the cost of placing trades there, but big investors may pay Robinhood for access to its clients’ trades, allowing the big guys to get a better price,” he added.
“My biggest concern with a program such as this is whether Robinhood must act in the interests of its clients and to what extent. A broker is not normally considered a fiduciary — that is, someone who must work in your best interest,” he said.
“Will Robinhood recommend the lowest-cost funds from a leader such as Vanguard?” Royal said. “Or will it offer only higher-cost funds? And perhaps more to the point, is it getting paid for its recommendations by a fund company?”
“That’s the business model. So that setup incentivizes Robinhood to get its clients trading more frequently than they otherwise might,” he added. With that in mind, here are some words of caution — and advice — for first-time investors:
Platforms like Robinhood can be good learning tools
These new features are being ushered in after a year in which Robinhood found a captive audience of freshly-minted day traders seeking to get rich on meme stocks like AMC
AMC,
and GameStop
GME,
and cryptos like Dogecoin
DOGEUSD,
Part of what made services like Robinhood appealing to new investors was the low barrier to entry. Unlike more traditional brokerages, many services came with low or no fees (though customers may have paid the price in other, less explicit ways.)
With volatility comes the excitement of new blood. Many investing apps and services, like Robinhood, have also historically focused on educating their younger, relatively greener users, particularly in times of market volatility.
Some experts applauded Robinhood’s push to educate their new users and steer them toward diversified assets. Dennis Nolte, a financial adviser with Seacoast Investment Services in Winter Park, Fla., called the initiative “outstanding.”
“Knowing who seems to be gravitating to Robinhood — lots of younger investors with ‘smaller’ investment dollars,” he said, “it’s outstanding, especially since many of these investors are focusing on the “gambling” aspect of investment dollars at risk.”
Portfolio diversification can obviously provide safety
Most financial experts compare chasing a big return by buying and selling stocks to gambling in a casino. As a result, it’s a very risky approach, but can lead to large rewards in some cases. Still, diversification provides more safety.
“The risk of owning one stock is known as ‘idiosyncratic risk,’ where you are exposed to the risks of a single stock or company,” George Gagliardi, founder of Coromandel Wealth Management in Massachusetts, previously told MarketWatch.
So how do you offset that risk? “Studies have shown that you need to own at least 10 different stocks in similar amounts in order to reduce most of the idiosyncratic risk, and even better 20 or more,” he said.
“‘Studies have shown that you need to own at least 10 different stocks in similar amounts in order to reduce most of the idiosyncratic risk, and even better 20 or more.’”
One way to offset the volatility in stocks is to hold the shares for a long time. From day to day, the price will go up and down. But if the company is generally on an upward trajectory, holding those shares for a long time will avoid that volatility.
Of course, companies do go bankrupt, and stockholders can lose out when that happens. Because trading securities is so risky, it’s not an ideal way to invest money toward longer-term goals.
For those goals, it’s better to put your money into something like a 401(k) or an IRA — in most cases, that money will be invested in funds. Funds, including ETFs, still carry their own risk, but it’s different from buying and selling stocks.
Here the concern is more about systemic risk. A single company’s shares falling won’t hurt fund investors too much. But if there are large movements in the stock market
DJIA,
SPX,
that can have an effect.
Investment apps can push investors toward risky behavior
Nevertheless, the service doesn’t fully eliminate some of the issues that come with the ease of investing with trading apps. Some have previously compared the ease and access offered by platforms like Robinhood as having “Vegas in your palm.”
Some tech-based platforms have gone a step beyond what Robinhood has done to help investors avoid reckless behavior. Betterment has historically disallowed its customers from trading individual stocks, instead limiting them only to ETFs.
“One of the biggest concerns is newer investors seeing a ‘hot’ stock, but not fully understanding the ramifications of investing in it and producing serious risk,” Dan Egan, vice president of behavior finance and investing at Betterment, said.
Trading isn’t the same as investing
Chances are many, if not most, people signing up for Robinhood are interested in trading stocks. But that isn’t the same as long-term investing or planning, and Robinhood may be limited in its ability to encourage longer-term thinking.
Sure, many people manage to score a few bucks by buying and selling stocks at the right time. For the average retail investor, though, actively trading stocks isn’t the best way to build a nest egg.
And there’s the rub: Novice investors may be better served by using a platform that provides them with ongoing financial advice and education — or turning to a more traditional adviser.
In the meantime, Royal says, “ETFs are a great starting point for novice investors, since they offer diversified exposure to a specific area of the market. But that doesn’t make all ETFs a good investment nor does it make them all the same.”
He advises a long-term strategy: “ETFs invest in a range of assets, from single-sector funds to broadly-diversified funds based on the S&P 500
SPX,
Index, and your returns depend on what exactly the fund is invested in.”
“This diversification can reduce the risk for new investors of buying a few individual stocks,” he adds.
