Robinhood, the mobile-only online brokerage, was launched in December 2014 with a waitlist of more than 500,000. 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. Company founders Vladimir Tenev and Baiji Bhatt, Stanford physics graduates, believed that Robinhood would motivate a new generation of would-be investors. (See also: How Robinhood Makes Money.)
Since its launch, the company boasts that it has saved its roughly one million investors over $200 million in commissions and fees. It also launched a premium trading platform, Robinhood Gold, offering extended-hours trading, margin accounts and larger instant deposits in exchange for a flat monthly fee based on Gold Buying Power tiers. For example, margin accounts in the $3,000 to $6,000 range with $3,000 of margin buying power are charged $15 per month. (See also: Robinhood Takes Aim at Wall Street.)
There's no doubt that Robinhood has won a loyal following, and the company is backed by major players such as Google Ventures, Index Ventures and Andreessen Horowitz. But is it safe? Here's what you should know.
How are brokerages regulated?
Robinhood, like all brokerage firms that handle securities, is regulated by the Securities and Exchange Commission (SEC). The SEC was established by Congress after the stock market crash of 1929, and it 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 does not offer protections for the individual investor – it does not insure against loss or otherwise protect your investment from actions your brokerage firm may take. (See also: Understanding the SEC.)
In addition to SEC regulation, most brokerage firms voluntarily participate in self-regulatory organizations (SROs) like the Financial Industry Regulatory Authority (FINRA). SROs are overseen by the SEC, but they are not part of the government. Brokerages that are FINRA members submit to the organization's rules and regulations, which cover testing and licensure of agents and brokers and a transparent disclosure framework that protects investors. Robinhood maintains membership in FINRA. (See also: FINRA: How It Protects Investors.)
What other protections are available?
Investment accounts with Robinhood are covered by the Securities Investor Protection Corporation (SIPC), which is a nonprofit membership corporation that protects money invested in a brokerage that files for bankruptcy or encounters other financial difficulties. SIPC was created by Congress in 1970 under the Securities Investor Protection Act (SIPA), and its focus is extremely narrow. It has no authority to investigate or regulate its members – it exists only 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. All Robinhood accounts are protected under the SIPC. (See also: Are My Investments Insured Against Loss?)
Are there other risks associated with trading on Robinhood?
For most investors, the potential risks involved with using Robinhood aren't associated with the regulatory framework covering their accounts. For instance, Robinhood is a very sleek and minimal application, and investor tools are rudimentary compared with those of other major brokerages like TD Ameritrade Holding Corporation (AMTD), E*Trade Financial Corporation (ETFC) and Scottrade. This can lead to hasty and uninformed decision making, especially for novice investors. (See also: Robinhood and Scottrade: What's the Big Difference?)
In addition, the Robinhood app makes it difficult to manage a diversified portfolio. Most reviewers suggest that tracking more than three or four positions isn't practical with Robinhood, which leads to overweighting your portfolio with one or two equities – never a good practice. It is also worth noting that there is no dividend reinvestment program in place, although the company indicates that this may be offered in the future. The Robinhood platform currently permits only stock and ETF trades – bonds and mutual funds are excluded. Again, this risks tilting your portfolio toward a single asset class. (See also: Achieving Optimal Asset Allocation.)
As a matter of convenience, Robinhood doesn't integrate with other financial management tools like Mint or Quicken, so there's no convenient way to track your holdings as a part of your overall financial picture outside the Robinhood app. In addition, there is no IRA account option, excluding investors from the tax savings and long-term benefits of retirement savings plans. (See also: Best IRA Accounts for Beginners.)
For a certain class of investor, Robinhood may be the right tool at the right time. However, for long-term investors, IRA accounts with a mainstream broker may be a better alternative. In many cases, you can open a no-minimum account and get commission-free trades on many if not most ETFs while still having access to all the data, charts, tools and educational resources you need to make informed decisions. (See also: Roth or Traditional IRA: Which Is Right for You?)