How Does Robinhood Make Money? (Are they Legit?)

If you are not investing in the stock market…

…what are you doing with your life?!

Your money will work for you 24 hours a day, 7 days a week.

No breaks, complaints, or days off.

So, why are you not investing?

Myth: You need HUNDREDS OF THOUSANDS of dollars to invest in the stock market.

Fact: You can invest in the stock market with ANY amount of money.

In the past, investors were charged out the @$$ by big Wall Street firms.

These firms pay effectively *nothing* to execute stock trades.

But these firms turn around and charge YOU up to $15+ per trade.

These fees are complete nonsense for new investors!

And if this were the only option to access the stock market…

…you should not invest until you are wealthy!

Fortunately, people are calling bull**** on these trade fees.

Why?

Because they are not necessary in many cases.

You are about to find out why you should not be paying fees on your trades.

Robinhood's Mission

Two of the people calling “BS” are Baiji and Vlad, the founder of Robinhood.

Robinhood provides universal access to financial markets.

Universal access mean that anyone can invest anywhere, anytime, and with any amount.

So, how much does it cost to make trades via Robinhood?

ABSOLUTELY NOTHING.

You can trade stocks, options, exchange-traded funds, and cryptocurrency for free.

Robinhood effectively removes all costs previously associated with investing.

So, what does this mean for you?

It does not matter if you are a fast-food cashier, student, or hobo…

…you no longer have an excuse to put off investing!

And there has never been a better time to start investing than right now.

Here are the top 3 reasons to invest today:

Time allows you to take more risk;
Compound interest makes a HUGE difference; and
You will develop great spending habits.

But if you are the skeptical-type, you may be thinking, “Nothing in life is free!”

Take a deep breath, you salty old man…

…because Robinhood IS free to all.

Accordingly, we have gathered you here today for two reasons:

To tell you WHY you are not being duped by Robinhood; and
To show you HOW Robinhood makes money to avoid swindling you.

If all goes well, you start investing the second you are done reading.

Deal?

How Traditional Brokerages Make Money

Before we explain how Robinhood makes money…

…we need to look at how other brokerages make money.

To buy and sell stocks, you need a broker.

The most basic function of a stockbroker is to execute trades for investors.

As you can imagine, stockbrokers charge for this service of executing trades.

To start, most brokers require a minimum deposit to your brokerage account.

The average minimum deposit is between $500 and $2,500.

However, minimum deposits can be up to $10,000!

If you do not have $10,000…

…you need to find yourself another broker.

From there, brokers charge a commission fee for every trade.

Types of Brokers

There are two types of brokers: Discount and Full-Service.

Discount brokers merely execute trades for investors.

To put it simply, discount brokers are not paid to provide you advice.

These brokers typically charge between $5 and $15 per trade.

Full-service brokers provide other services via money managers and financial planners.

These brokers are paid (handsomely) to provide you advice.

These brokers charge anywhere from $100 to $200 per trade.

In addition to commissions, brokers also charge the following fees:

Maintenance fees;
Operating fees; and
Inactivity fees.

There are also minimum balance fees if your account drops below the threshold.

Before you work with any broker, it is crucial to understand all fees associated with your account.

But beware, the money you are paying your broker can significantly reduce your investment returns.

Perhaps you enjoy paying commissions on every single trade you make.

For those that do not, Robinhood may have something for you.

Many people feel that they are paying for something they can do themselves (e.g., execute trades).

Additionally, you may worry about your broker “churning” to generate more commission.

You can alleviate these concerns by using Robinhood.

How Robinhood Makes Money

You have likely heard of Robinhood as a market disruptor.

The company implies that traditional brokerages are ripping you off.

Furthermore, all of the “extras” offered by these brokerages are overrated.

Robinhood set out to prove these claims.

In doing so, the company offers free trading while making money in other ways.

But this begs the questions:

How does Robinhood offer free trades; and
Why aren’t other companies offering free trades?

You are about to find out the answer to those questions, and more!

Interest

Robinhood makes money on interest income.

The company lends out your uninvested cash balance.

From the Robinhood website:

“We generate money from Interest from customer cash and stocks, much like a bank collects interest on cash deposits.”

Do you have a free checking account with your bank?

Well, your free checking account is NOT due to the generosity of your bank.

In fact, your bank makes a ton of money by loaning your money.

For example, let’s say you have $5,000 in the bank.

The bank uses that money to fund another customer’s:

Mortgage at 6%
Student Loan at 6.5%
Credit Card at 18%

Instead of the lending above, Robinhood earns interest with margin trades, bonds, and savings accounts.

Robinhood may make $10 on your $500 cash balance.

That amount seems small, right?

Now think about $10 per customer over millions of customer accounts.

In 2018, Robinhood had amassed over 6 million users.

Robinhood does not pass that interest to you (you are already getting a valuable service for free).

Therefore, all that money goes straight to the company’s top-line.

As interest rates increase, investing and lending money increases revenue and profit.

The interest rate increase is responsible for strong market performances by many brokerages recently.

Premium Account Services

Robinhood makes money on premium account services.

You have the OPTION to pay for additional functionality.

Robinhood earns money from Robinhood Gold, which includes:

Larger instant deposits;
Professional research from Morningstar;
Level II Market Data from Nasdaq; and
Access to investing on margin.

Robinhood Gold starts at $5 per month.

Typical brokerages charge interest on margin you use.

Robinhood charges you to have access to the margin service.

For example, if you request $1,000 of margin, you will pay the flat $5 monthly fee.

If you borrow more than $1,000 of margin, you will pay 5% yearly interest on the amount above $1,000.

Here is an example of Robinhood makes money on margin (via Robinhood.com):

Your interest is calculated daily on your end of day margin used.

The daily interest rate is 5% divided by 360.

For example, if you use $3,000 of margin, we’ll calculate $0.28 of daily interest as follows:

$3,000 margin used

$1,000 included with your monthly fee, leaving $2,000 subject to interest

$2,000 * 5% / 360 = $0.28 per day

High Frequency Trading and Order Flow

Robinhood makes money on high frequency trading and order flow.

According to CNBC, Robinhood's order flow revenue increased by 227% in 2018.

How much is that…really?

The company brought in $69 million last year with this revenue stream alone.

Robinhood states:

“When you buy or sell stocks on Robinhood, like many other brokerages, we send your orders to market makers that allow you to receive better execution quality and better prices.

Additionally, the revenue we receive from these rebates helps us cover the costs of operating our business and allows us to offer you commission-free trading.”

Robinhood operates this way because it is cheaper for you.

Sending orders to market makers offers better execution quality and better prices.

But what is “execution quality,” anyway?

Executive quality involves the following factors:

Execution price, speed, and accuracy;
Market depth, order size, and trading characteristics of the security;
Liquidity, automatic execution guarantees, and opportunities for price improvement; and
Service levels and the cost of executing orders

The above means you are more likely to execute trades at the current market quote or better.

Robinhood uses the market makers Citadel Securities, Two Sigma, Wolverine, and Virtu.

Rebates

Robinhood makes money on rebates.

Rebates are not a huge revenue stream, but the company makes money here, too.

According to Robinhood co-CEO Vlad Tenev:

“Robinhood earns $0.00026 in rebates per dollar traded.

That means if you buy a stock for $100, Robinhood earns 2.6 cents from the market maker.”

Some skeptics say Robinhood relies too much on rebates.

But the beauty of this is that…

…it’s not your problem!

Checking and Savings

Robinhood is *trying* to make money on checking and savings accounts.

Robinhood recently announced the start of 3% checking and savings accounts on all balances.

Unfortunately, the company quickly retracted due to legal complications.

The new services were supposed to be insured by the Securities Investor Protection Corporation (SIPC).

However, Robinhood did not consult the company before its announcement of the checking and savings accounts.

The SEC is currently reviewing the matter.

These accounts could contribute to how Robinhood makes money but currently remains to be seen.

Is it Safe to Invest with Robinhood?

I am here to clear the air after the “It’s not your problem” comment.

Robinhood is regulated by the Securities and Exchange Commission (SEC).

The company is a member of the Financial Industry Regulatory Authority (FINRA).

FINRA is a self-regulated organization that relies on voluntary participation.

Last but not least, Robinhood is protected by the Securities Investor Protection Corporation (SIPC).

The SIPC protects up to $500,000 (or $250,000 for cash claims).

Long story short, it does not matter how Robinhood makes money.

What matters are these two facts:

You are trading for free; and
Your money is 100% safe.

Robinhood has you covered on both ends.

Does Robinhood make a profit?

We cannot speak to Robinhood’s profitability because the company is private.

You can only speculate how much the company is truly earning.

Many companies have tried (but failed) to offer free trades while making money other ways.

In 1999, Ameritrade offered Freetrade.com, a commission-free brokerage service.

However, Freetrade.com ultimately merged into another service that charged commissions.

In 2006, Zecco rolled out free trades and became very popular.

Zecco eventually moved into TradeKing, another broker that charges a commission on every trade.

Is Robinhood truly different from these services?

It is difficult to say.

The clear disadvantage is that Robinhood is missing out on a huge revenue stream.

On the same note, there are advantages to offering free trades.

You can assume Robinhood places more trades compared to discount brokerages that charge.

Additionally, the app-based platform offers convenience users do not have with other brokerages.

Robinhood likely has an easier time finding new users.

Consider that E-Trade acquired over 1 million brokerage accounts from Capital One.

How much did this cost E-Trade?

The transaction cost E-Trade $170 million, or around $170 per account.

E-Trade notes the purchase price of that transaction was…

“…well below our typical customer acquisition costs for a broad set of customers that meet our target profile.”

We cannot say for sure how much it costs to obtain new users.

The company acquires many users through its referral program, which pays $25 per referral.

From that perspective, Robinhood pays significantly less for new customers.

Robinhood’s Competitive Advantages

Robinhood misses out on trade fees, but the company makes up for it in several ways.

Commissions

Robinhood is committed to providing commission-free trades for the following assets:

Stocks;
Options;
Exchange-traded Funds (ETFs); and
Cryptocurrency.

If you can trade for free, why not accept that benefit?

Robinhood is accessing a market that many brokerages are missing entirely.

Account Minimum

The best thing about Robinhood’s account minimum?

The company does not require one.

This feature lowers the barrier to entry significantly.

As we said, you can invest with as much, or as little, as you have at your disposal.

Ease of Use

If you are comfortable with your smartphone, you can use Robinhood.

You can sign up fast and easy (less than 5 minutes).

Simply answer a few questions:

Personal information;
Contact information;
Social security number; and
Money to fund your account.

These requirements are standard for any brokerage.

Additionally, the simplicity of the app is a significant benefit for many new users.

The simplicity of Robinhood makes the app easy for all users and all experience levels.

Again, this feature can be good or bad depending on personal preference.

Will Robinhood’s free trades last?

The bottom line: You do not need to worry about how Robinhood makes money!

One important question is…

…can the free trades last?

According to the Robinhood FAQ page, “Investing with Robinhood is commission-free, now and forever.”

Perhaps a better question is how long free trades will last for you.

Robinhood is great for investors with limited funds.

But let’s say your investments take-off.

Suddenly, you are trading 500+ shares of stock at one time.

Robinhood does not seek price improvement opportunities.

Orders that are price improved seek opportunities to:

Buy at a slightly lower price than the customer’s limit order; or
Buy at a slightly higher price when selling.

If you are trading large quantities of stock, the commission may be worth the cost.

According to Schwab, for orders of 500 to 1,999 shares of S&P 500 companies, the average savings from price improvement is $10.80.

Robinhood’s FAQ states, “…our execution quality and speed matches or beats what’s found at other major brokerages.”

With that, it remains unclear how much price improvement you receive through Robinhood.

However, if you are trading small quantities, free trades are more significant than price improvement.

If Robinhood hopes to stay in business, the company should continue to offer free trades.

Online brokers continue to reach millennials with mobile apps, social tools, and intuitive platforms.

Unlike the failed brokers, Robinhood is capturing a unique market.

For that reason, the company is well-positioned to keep the free trades coming.

However, if you are concerned the free trades will not last…

…that is all the more reason to take advantage today.

Is Robinhood Right for You?

Robinhood is an excellent resource for investors that trade a few shares each time.

For small trades, the benefit of free trades outweighs the price improvement gainz.

However, if you are trading hundreds of shares each time, you are better off elsewhere.

You may be $5 per trade, but the price improvement can outweigh the cost.

So, is Robinhood really free?

Yes, Robinhood is 100% free.

The price improvement benefit is marginal for low volume investors.

Now, it is time to hold up your end of the deal.

You need to start investing immediately.

What is the best way to start investing today?

You will never regret starting your investment career sooner…

…but you will undoubtedly regret starting too late!