A start-up called Robinhood Markets is taking on the big brokerage firms with its commission-free trading app, and appears to be making headway. Since its introduction in December 2014, the app has attracted a million users and executed more than $30 billion in trades, up from $2 billion in 2015.
Despite the app’s hype and surging popularity, some industry experts question if the free-trades business model can survive, or if it will wind up joining other start-ups that have crashed and burnt. The company currently makes money primarily from interest on customer cash balances.
At Robinhood, there is no minimum deposit to register an account, and there are no trading fees for customers who buy and sell US-listed stocks and exchange-traded funds. To keep costs down, the company, in Palo Alto, California, takes a no-frills approach.
It has no storefront offices. It does not provide research reports, analytical tools, stock screening gizmos or options trading on its platform.
“Uber opened our eyes that if you could hail a car off your phone and watch movies, why can’t I trade 10 shares of Facebook or a thousand shares?” said Howard Lindzon, a general partner of the Social Leverage Fund and a founder of StockTwits, a financial communications platform. His fund holds an equity stake in Robinhood.
Chase Kaye, a 21-year-old Manhattan resident, signed up for Robinhood over a year ago after he grew tired of paying the $7 commission on trades at the Vanguard Group.
“The interface on the phone app is way better,” said Kaye, a marketing management student at Baruch College. “It’s simple, not as intimidating and very intuitive.” Today about 70 per cent of his assets are with Robinhood, Kaye said.
Still, nothing is truly free in the world of finance.
“The illusion of being free encourages frequent trading, which is well known to be a cause of lousy investment returns,” said Tad Borek, an investment adviser at Borek Financial Management. “Is this just handing some free chips to gamblers?”
Even the name conjures up images of a firm helping the poor, when it may actually be doing the opposite, he contends.
Robinhood’s founders dispute these concerns. Their goal is to make investing accessible to everyone, not just the super-wealthy, which is why the name Robinhood was chosen, said Vladimir Tenev, 30, a founder.
“We have active investors who are moving their trading over from other brokerages where they have paid thousands to tens of thousands of dollars in trading commissions,” Tenev said. “We also have younger customers who are accumulating stocks and building mini diversified portfolios over time.”
A customer could buy one share in a stock or ETF today and five more shares next month to slowly build a portfolio. The fees at larger firms would make such a strategy cost prohibitive. Big brokerage firms like TD Ameritrade, Schwab, Fidelity and E-Trade typically charge $7 to $10 a trade.
Robinhood’s bare-bones business model has led to complaints about its customer service, with long waiting times by phone and emails that are not answered. Internet blogs are also filled with complaints about lengthy waits — up to eight days — to transfer money from a Robinhood account to a bank or vice versa. Tenev said the company was looking to solve these problems.
And some customers are frustrated that the company doesn’t offer options trading, a website trading platform or automated transfers from other brokerage accounts. Tenev said that would change. “If you look down several years, we’ll offer all of these things,” he said.
Robinhood is the brainchild of Tenev and Baiju Prafulkumar Bhatt, Stanford graduates who shared a passion for math and physics. In 2009 they moved to New York, where they began Celeris and Chronos Research, which made high-frequency trading software for hedge funds and banks.
Inspired by the Occupy Wall Street movement in 2011, they rethought their priorities. “The financial services industry should serve all people, regardless of net worth,” Tenev said. In 2012, they moved back to California, hired engineers and spent the next 18 months building Robinhood.
In late 2013, Robinhood set up a beta version and invited people to test the app. When the sign-up page was posted on Hacker News and Reddit, the site was flooded with requests.
“We had almost 50,000 people that signed up that first weekend,” Bhatt, 32, recalled. By the time the app began in the App Store in late 2014, it had a wait-list of a million people, most under the age of 30.
The company has raised $66 million in start-up cash from such high-flying investors as Andreessen Horowitz, GV, Index Ventures and New Enterprise Associates, as well as entertainers like Jared Leto, Snoop Dogg and Nas.
In addition to cash balances, the company makes money from “payment for order flow”, which refers to the money it receives for selling its orders to market makers to be executed.
“These revenue streams alone are not enough to sustain an online broker providing $0 trades — not even close,” said Blain Reinkensmeyer, the head of broker research at StockBrokers.com.
Recently, Robinhood introduced a Gold programme, which offers margin accounts and after-hours trading, for a fee.
“Robinhood Gold is where we anticipate the bulk of the revenues to come from in the future,” Tenev said.
Robinhood charges Gold accounts a fixed monthly fee that works out to 5 to 6 per cent interest on margin accounts, whether the customer uses the credit line or not. At larger firms, like Schwab, customers are charged interest only on the margin amount that’s used.
“I got the email to sign up for a free month trial of their new Gold account, but it’s not something I’m interested in,” Kaye said. “I’ll probably stay with Vanguard for margin accounts.”
Another firm, Zecco, attempted a similar “free trades” model in 2006. Despite raising more than $35 million in financing, the company struggled to get off the ground, and eventually merged with TradeKing in 2012. It now charges $4.95 a trade.
“Zecco couldn’t find a path to profitability without charging for commissions and evolving into a traditional online broker,” Reinkensmeyer said. “It’s amazing how quickly history is forgotten.”
Lindzon, the Robinhood equity investor, noted that Zecco operated when smartphone use was in its infancy. “With a couple billion people now on smartphones, it’s a very different market today,” said Aaron Levie, a founder of the cloud company Box, and another of Robinhood’s equity investors.
Other start-ups have entered the territory to challenge Robinhood. They include Ustocktrade, which charges a $1-a-month membership fee and offers $1 trades, and Loyal3, which offers no-fee trades on a limited number of stocks, partial shares and initial public offerings. There’s also Bank of America’s Merrill Edge, which offers 30 free stock and ETF trades each month for customers with a balance of at least $50,000 and 100 free trades a month on balances of at least $100,000.
So far, the big brokerage firms do not appear concerned about Robinhood. Kim Hillyer, a spokesman for TDAmeritrade, said investors value a full-service firm that offers free education, webinars, research tools and investment consultants in addition to a full trading platform that includes futures and options.
She noted that TDAmeritrade accounts have continued to grow since Robinhood’s introduction, rising to 7 million in fiscal 2016 from 6.3 million in 2014. “The growth in new accounts is a validation for the value proposition that we have,” she said.
Erin Montgomery, a spokeswoman for Schwab, agreed. “We know that investors and traders alike are looking for value from their brokerage firms, and our clients find that here,” she said. The firm’s investment services and products include financial planning and research as well as a full-trading platform and commission-free ETFs.
Still, the two firms said they are always looking for ways to stay competitive, and sometimes offer low-fee and no-fee trading promotions.
— New York Times News Service
