Robinhood has been getting more traction and press coverage recently. It’s catching on with some of my friends from school and I’ve gotten into interesting conversations over Robinhood’s value as a business. The purpose of this post is to explain why I think Robinhood will hurt its own users despite its well-intentioned mission to “democratize access to the financial markets.”

[Note: this blog is cross-posted from willrobbins.org. Visit my site for more writings and access to my direct mailing list! View this post on the original site by clicking here.]

A Random Walk Down Your News Feed

Retail investors (non-professionals) can’t beat the market in the long run. This phenomenon has been well documented and I am not aware of any compelling evidence contradicting it. Active retail investors also tend to perform worse than passive investors in the long run. This doesn’t mean that everyone will lose money—it means that if an investor’s portfolio grows 5% in a year, it’s highly likely that they could have made more (say 8%) just by buying a simple index fund and holding it.

Most traders use some mix of a few common trading strategies:

Fundamental Analysis

This refers to the idea that traders should focus on the intrinsic value of a security when making decisions. If a company is selling stock at $5 per share, you should only buy if you can expect to earn $5 in dividends over the entire course of the company’s lifetime.

Famous investors like Warren Buffet don’t buy anything that isn’t priced cheaper than the underlying asset’s value. This is the only rule you as a consumer need to follow unless you really know what you’re doing. The hard part is determining what the true value of an asset is.

Technical Analysis

This refers to the idea that quantitative indicators, historical market data, and social/psychological/political analysis can help you predict where the price of a stock is going. If you can tell when the right time to buy and sell is, the actual price and valuations of an asset don’t matter.

In practice, this is extremely difficult to do well. The vast majority of day traders lose money trying to predict how other people will make trades. But for certain (highly advanced) firms, this strategy is amazingly profitable. This philosophy also plays a part in how bubbles form—if speculators think that they can make money with an investment, they’re often willing to overlook prices that are way above the true value of whatever it is that they’re buying.

Throwing Darts

Alternatively entitled “buying Apple, Berkshire Hathaway, and whatever company I like seeing on my Facebook News Feed.” Needless to say, this is a losing strategy. But a non-negligible number of people still run their portfolio this way.

Throwing darts has been especially tempting the past several years because markets have been doing so well overall. It’s easy to be encouraged by modest returns but equally easy to forget that putting money into an index fund would be at least as profitable and less work.

Which of These Strategies Works Best With Robinhood?

Two of these strategies (not the third) are valid investment theories. There is a lot of debate over which is more viable, and real-world professional investors sit somewhere on the spectrum between fundamental and technical analysis.

But all three strategies are doomed to underperform using Robinhood Remember the fact that retail investors already can’t beat market indexes. Robinhood doesn’t provide any information or systematic advantage to reverse users’ predisposition to poor performance. I’d guess that it’s even harder to make informed decisions because there will always be lower quality information available to users on a mobile-only platform.

The lack of quality financial information will let users rely more on irrelevant news seen on social media, their friends, and their guts to make decisions. That’s not good.

Robinhood’s Product and Strategy

“Democratize access to the financial markets.” What does that mean? Are markets not already accessible to the masses? There are plenty of brokers who let you set up an account for free with low minimum balances and small trade fees. Does Robinhood’s beautifully designed mobile app and free trades policy really democratize things? There are two groups who seem to think that it does:

Retail Investors: Millennials and Generation Z

Robinhood is one of most elegant and aesthetic apps on the market right now. It has smartwatch companion apps, a fun intro video, and creating an account takes less than 4 minutes.

Robinhood as a company is clearly in touch with modern product expectations. People my age want to go through the full user experience on mobile, start to finish, with as few exceptions as possible.

The actual features are similarly streamlined. The premium account option, Robinhood Gold, gives users access to more advanced trading options and margin lending (loans from the broker that amplify the profits or losses you’ll make).

So do these features help people access financial markets? Sure they do. But that’s not necessarily a good thing knowing that retail investors underperform averages.

Robinhood markets their margin lending as a way to “get up to 2x your buying power.” There’s no mention of risk or the financial mechanics of margin lending. It just sounds like a great way to make more money—“buying power” is such a positive and harmless descriptor. People without the proper experience will get burned by this unless the loans are better explained.

I’ll ignore the lack of tools available to users (Quicken integration, export to Excel, ability to easily manage many diversified holdings) because they can be easily implemented in the future. But even that wouldn’t solve the underlying issue with mobile-first stock trading: it’s too hard to fit all the relevant information into a 5" screen. The charts are overly simplistic and making an informed investment decision requires more detailed research. Of course users could do research on a computer and just execute the trade on their phones, but that defeats part of Robinhood’s value proposition. So it’s in Robinhood’s interest to convince users that they can get by with mobile alone (again, this will make it easy for users to under-educate themselves and speculate).

Low Table Stakes Investors

A quick Google search found data showing that the average Millennial saves less than 8% of their income and has a net worth between $-20k (debt) and $20k.

Zero commission on trades and no minimum account balance is clearly an advantage for these users. It removes the biggest barrier to entry. Robinhood markets itself as a way for low stakes consumers to get started in investing.

As a quick aside, there’s even doubt that the free trades are a net benefit for users. Slippage is the difference between the price of a trade as it’s ordered and the true cost of trade as it’s executed. Paid trades with larger firms are generally thought to be executed more efficiently and more likely to trade at the the best price. So over time, depending on trading volume and portfolio size, users could theoretically be better off just paying for each trade at with a different broker. But Robinhood could definitely improve this over time if it is a real problem now so I don’t hold it to them.

It’s hard to get more into this topic without making hand-wavy judgements about what people should or should not be able to do. I know for sure that users attracted by the low fees and lack of minimum balances are likely to have a weaker financial safety net. This is why the SEC requires that investors be accredited before investing in risky unregulated securities like startups. Since part of Robinhood’s success depends on people taking out loans (more on this later), I feel that appealing to low-stakes consumers approaches a grey area, especially when the product is designed to be as easy as possible (you only need to tap your phone 3 times to make a trade!)

Anyone who can’t afford fees or minimum account balances simply should not take the risk of trading stocks. There are cheaper and safer investment opportunities out there. Again, people should be able to do whatever they want. But I think it’s worth speaking out to prevent Robinhood from convincing these potential users to actively trade.

Even the name “Robinhood” makes users feel like they’re empowered to take control of their own financial future and able to beat the pros at their own game. At risk of sounding like a broken record, this is impossible (well, highly unlikely on average, to be more accurate.) Of course Robinhood makes all of the appropriate disclaimers crystal clear but the brand seems to signal that active trading is a good idea.

The Fundamental Flaw

As I mentioned above, Robinhood doesn’t earn revenue by executing trades. It makes money through interest on users’ uninvested funds, “Robinhood Gold” which includes access to margin lending and advanced trading features, and interest on margin loans.

Putting the advanced features aside (I imagine that a subscription to after-hours trading access and instant deposit of funds is relatively cheap and only scales with respect to the numbers of users), Robinhood’s success is dependent on maximizing (a) the amount of money left in accounts as cash, and (b) margin loans.

Knowing that Robinhood users are highly likely to underperform the market or even lose money, Robinhood’s success metrics are inversely related to users’ success metrics. The more cash users store in their accounts, the more interest they are losing out on. Worse, users will lose more and more money in aggregate as they increase leverage on their investments using margin lending.

I consider this to be a fundamental flaw in Robinhood. I just don’t see a way for both Robinhood and its users to be financially successful under this business model.

Robinhood’s Long Term Vision

A world where Robinhood succeeds in fully “democratizing access to the financial markets” is a world that’s less stable than the one we live in now.

Frankly, I’m surprised that most Robinhood users aren’t more cautious of participating in the stock market. Millennials (Robinhood’s core audience) were hit hard by the recession. I suppose that several years of recovery has erased memory of previous bubbles — markets have maintained strong, steady recovery growth between Robinhood’s 2013 launch and now.

If playing the stock market from the comfort and convenience of your iPhone became common, markets would become more volatile and susceptible to bubbles. I haven’t met any Robinhood users who express this concern which is even more worrisome, in a way.

Most people think that bubbles are caused by banks and the government. In some cases this may be true—consumers weren’t the ones giving out subprime mortgages and building complex financial instruments in the 2000s. But bubbles are definitely possible in the broader economy. Look at the Japanese bubble in the ’80s for example. The Japanese real estate market was valued at just over $20 trillion. That’s just over one fifth of all the world’s wealth at the time. Clearly an island that’s 5% the area of the U.S. could not possibly have that much intrinsic value. Yet the bubble continued to inflate.

A more recent and fitting example is Bitcoin. Cryptocurrencies are interesting to me because they seem to be used and understood most by consumers. Banks and governments weren’t particularly interested or involved in blockchain tech until recently. It was mostly speculative consumers who drove the price of BTC over $1000 in 2014. About a year later, after a peak and crash cycle, BTC was priced around $350. Luckily Bitcoin was (and still is) too small to affect the overall economy.

The point is that people en masse aren’t always rational. Only a small fraction of the population can spend the time to read up on finance, economics, and current events. So an economy where every college kid, lawyer, salesperson, Uber driver, and stay-at-home parent is encouraged to actively invest is bound to experience the unreal highs of a bubble and, of course, the disastrous crash of the pop.