Finance

Is Robinhood Safe for All Kinds of Investors?

Is Robinhood Safe

Robinhood is one of the world’s most popular online trading and investment apps. It was launched in 2013 and its commission free model helps keep investor costs low and encourages them to invest more in the stocks. Investors can trade stocks, ETFs, options and even cryptocurrency without paying commissions. The app was originally developed for Apple (AAPL) – Get Report phones and tablets but has since launched an Android version as well. 

Robinhood was born in the wake of the 2008 Recession. The product was created to fulfil a desire to “democratize America’s financial system”. The brains behind Robinhood also wanted to provide a more modern platform for young but jaded investors. 

The company was founded by Stanford University Physics graduates Vladimir Tenev and Baiju who wanted to use Robinhood to motivate a new generation of investors. When Robinhood was launched in 2014, it had a waiting list of over half a million people. The company’s mission was to make the financial markets more accessible, primarily by offering commission-free trades, no account minimums, and an easy-to-use mobile app.

Soon after that, Robinhood also launched a premium trading platform called Robinhood Gold. This platform offered extended hours trading, margin accounts, and larger instant deposits in exchange for a flat monthly fee based on Gold Buying Power tiers. 

With its fantastic array of features and incredible ease of trading, Robinhood has a large and dedicated following. It has become so popular that people outside the US are also clamoring for Robinhood to start operations in their country. Financially, Robinhood is backed by major venture capital players like Google Ventures, Index Ventures, and Andreessen Horowitz. While all of that is great, is Robinhood safe to use? Let’s find out.

Is Robinhood safe: Things to know

How Are Brokerages Regulated?

All brokerage firms, Robinhood included, are regulated by the Securities and Exchange Commission (SEC). The SEC was created by Congress as a precautionary measure after the stock market crash of 1929 which led to The Great Depression. The SEC works to oversee the securities market to ensure transparency and fair dealings.

The SEC’s primary compliance mechanism is prosecuting civil cases against companies and individuals that commit fraud, disseminate false information, or engage in insider trading. However, the SEC doesn’t provide any protection to individual investors and does not insure against loss or otherwise protect your investment from actions your brokerage firm may take.

On top of the SEC regulations, a lot of brokerage firms are voluntary members of Self Regulatory Organizations (SROs) such as the Financial Industry Regulatory Authority (FINRA). While SROs are overseen by the SEC, they are not an official part of the Government. All brokerages with FINRA memberships submit to the organization’s rules and regulations. These cover testing and licensure of agents and brokers. They also have a transparent disclosure framework that protects investors. Robinhood is a member of FINRA.

What are some other protections for investors?

Investment accounts with Robinhood are covered by the Securities Investor Protection Corporation (SIPC). It is a nonprofit membership corporation that does the job of protecting money invested in a brokerage that is financially shaky/files for bankruptcy/becomes insolvent. It was created in 1970 by Congress under the Securities Investor Protection Act (SIPA), and its focus is extremely narrow.

The SIPC doesn’t have the authority to investigate or regulate its members. It’s sole purpose is to restore investor funds (up to $500,000 for securities and cash or $250,000 for cash only per account) held by financially troubled brokerages. Luckily, RObinhood accounts fall under the SIPC’s protection.

What are some other risks to keep in mind?

For most Robinhood users, the potential risks aren’t necessarily associated with the regulatory framework covering their accounts. One of the biggest draws of Robinhood for young investors is how sleek and minimal it is. However, the minimalism also comes with the drawback that it only has rudimentary tools when compared to big brokerage firms like TD Ameritrade Holding Corporation (AMTD) and E*Trade Financial Corporation (ETFC). This can cause novice investors to make uninformed decisions using RObinhood and lose a lot of money in the process.

Another problem with Robinhood is that managing a diversified portfolio is extremely difficult on it. If you read some user reviews, you’ll discover that most people have said that Robinhood isn’t practical for tracking three or more positions. This leads to investors loading their portfolios up with just one or two equities, which is never a good practice.

Robinhood doesn’t offer a dividend reinvestment program either. However, the firm has said that it plans to introduce them in the future. There is no option to trade in bonds or mutual funds either, investors can only trade in stocks and ETFs. This adds to the risk of tilting your portfolio towards a singular asset class. 

Robinhood doesn’t integrate other financial management tools like Mint or Quicken as well. It’s impossible to track holdings as a part of your overall financial picture outside the Robinhood app. Robinhood doesn’t offer an IRA account option either, which excludes investors from the tax savings and long-term benefits of retirement savings plans.

Is Robinhood Safe: Conclusion

Robinhood might serve as the right tool at the right time for a certain class of investor. In the case of long-term investors, IRA accounts with a mainstream broker are definitely a better option. In a majority of cases, you also get the option to open a no-minimum account and get commission-free trades on most ETFs while enjoying access to all of the data, charts, tools, and educational resources that will help you make the correct investment decisions.

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