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Robindhood: Democratizing the Stock Market

Robinhood is not the first zero-commission brokerage offering, but it is arguably the first to combine free stock trades with a clean, user-friendly application targeting the young investor. Will the company be able to capitalize on its initial success and fanfare and disrupt the existing brokerage model?

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Robinhood is one of several new financial technology (fintech) start-ups with a mission to “democratize” the investment management industry by reducing the cost and complexity of investing. Currently in beta stage, Robinhood offers an iOS app allowing investors in self-directed individual cash or margin brokerage accounts to trade U.S. listed securities without any commission. The company earns money both on margin interest and by investing any uninvested cash sitting in customers’ accounts at the federal funds rate.

What makes Robinhood a Digital Winner?

What separates Robinhood from other brokerage companies is the opportunity for investors to trade U.S. stocks without paying any commissions. Robinhood is able to offer this service by keeping overhead costs low (no physical branches), focusing solely on phone apps (an Android version is scheduled to be released this year) rather than the web, and the significant investments made by the likes of Andreesen Horowitz and Google Ventures.
But other business and marketing decisions have also played a role in Robinhood’s early success. The firm is currently employing an invitation-only approach, where individuals sign up for the service through the firm’s website and then wait for several months to advance in the queue. This, along with the decision to initially release the app on iPhones only, has created an aura of “coolness” and exclusivity (and probably helped the company respond more quickly and efficiently to issues).

Two other aspects of the business are worth noting. First, there are no account minimums to open an account and the zero-commission offering is available to all regardless of amount invested. This is a sharp distinction from some of the incumbents who offer a sliding-scale commission schedule, where the greater the amount invested, the lower the commission paid.

Second, the iOS phone app was designed to attract young investors looking for a clean, user-friendly and streamlined interaction. A trade can be made on the app with three taps. In contrast, many of the apps available through incumbents for trading and monitoring investments tend to be clunky and overwhelming in terms of the information available and the time need to accomplish simple tasks.

What challenges does Robinhood face?

Despite only being at the beta stage, Robinhood has clearly made progress in its mission of “democratizing the financial markets.” By combining zero-commission trades with a user-friendly app, Robinhood has compellingly demonstrated the potential of engaging with and capturing the assets of young investors who grew up during the Financial Crisis and are wary of the stock market and Wall Street.

And yet the company faces several challenges. First, the company has yet to release an Android version of app, despite the constant peppering of demands by users who have received an invite to join the service but cannot do so because they do not own an Apple device. Second, users are restricted to trading U.S. stocks and ETFs only. To the extent that users prefer to have all of their accounts with one firm and the opportunity to invest in a broad set of U.S. and foreign stocks (not to mention bonds mutual funds and options), this limited capacity may discourage widespread adoption. Third, as a new start-up operating in a fairly intensely regulated space, the company will need to keep a constant eye on security and privacy issues, especially because of the senesitive personal information investors must provide to open such accounts (such as social securitiy numbers and banking credentials).

Fourth, because Robinhood only offers the ability to invest in stocks, the company's early success is at least partially due to the current euphoria surrounding the markets. It will be interesting to see what happens when the markets inevitably turn, especially in light of the fact that Robinhood does not currently provide any advice offerings (unlike Wealthfront and Betterment). Lastly, Robinhood must be on the look out for any competitive responses by the existing incumbents. Many of the large investment management firms already offer zero-commission trading for their ETF offerings. Cutting commissions slightly might be enough to encourage an investor to keep her brokerage account with an incumbent and take advantage of the non-digital services (such as customer service support and investment guidance) rather than transfer her account to Robinhood.
 

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Photo of Andrew

Interesting post and discussion to jump into -
My expectation is that Robinhood will catalyze a transformation of the pricing structure within retail investing, but not expand an investing bubble to the broader population. First, If you ask an average person why they don't invest in the stock market, you'll likely hear "I don't know how to" rather than "the fees are too high." I've found execution very easy in my own personal use of the app, but alone it doesn't teach you how to invest.

Second, since trading fees pose the greatest barrier to individuals making small trades, it might be reasonable to expect that a no-commission structure would increase small trade behavior, but not impact the volume of large and highly leveraged trades made by individuals, which arguably would otherwise have taken place anyway.

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