There's little in the staid old financial industry that doesn't seem ripe for disruption these days--just ask the folks over at Robinhood. The Palo Alto, California startup joins a crop of Silicon Valley ventures that are throwing themselves at the challenge of building better bank accounts, payment systems and basic loans. Add to that list brokerage services, where Robinhood is offering stock trades--for free.
By eliminating fees on stock trades and allowing consumers to transact easily on mobile devices, Robinhood is trying to make a Millennial-friendly trading platform, one that younger, tech-savvy customers will use in lieu of live brokers or financial advisors.
“We are capturing the first-time investors, the Millennial investor who has been underserved by financial products and investment products,” Vlad Tenev, one of Robinhood’s two founders, said during a recent interview.
Robinhood emerged from its beta in December with an iOS app. Its founders claim 800,000 people signed up for early access, although only "several hundred thousand" are active customers now. As far as making money, Robinhood plans to earn interest from funds its users hold in accounts, as well as from margin accounts for day traders, which will let users borrow money to purchase stocks in exchange for paying interest.
Analysts say Robinhood is likely to make money in yet another way: Selling trades to market makers who wholesale various stocks. Basically, wholesalers would supplement the cost of Robinhood's trades by buying the orders in bulk.
Co-founders Tenev and Baiju Bhatt, 28 and 30 respectively, have known each other since their Stanford University days, where they roomed together and studied physics. The duo in 2010 founded Chronos Research, which made high-frequency trading software for Wall Street bankers and hedge fund managers. (Such systems enable traders to buy and sell large volumes of stocks for fractions of pennies.)
“We were the two kids in the physics department with 1972 Mick Jagger haircuts,” Bhatt says. “I thought we were the two cool kids.”
Tenev and Bhatt’s latest venture, which uses aspects of their high-frequency trading technology on the backend, has attracted $13 million in Series A funding from high-profile venture capital firms Andreessen Horowitz, Google Ventures, and even movie star Jared Leto.
The founders' background and their younger spin on older financial products excite investors like Jan Hammer, a partner of Index Ventures, which led Robinhood’s first round in September.
“They have put themselves in the position of the users and written a product for their generation, where they perceived a gap in the market,” says Hammer.
Robinhood has taken on a big market. Non-professional traders in the retail brokerage industry have accounts worth roughly $2 trillion of assets in the U.S., according to research firm Aite Group. The companies from which Robinhood hopes to steal business include the now old-guard online trading companies such as Charles Schwab, TDAmeritrade, Etrade, and Scottrade, which generally charge between $7 and $10 per trade.
So it's certainly easy to stand out by giving trades away. But offering something for nothing usually comes with a catch. In this case, it could be an absence of seasoned financial advice for Robinhood's new-to-trading target audience.
Investing in the market, and in particular individual stocks, can have risks--something that Robinhood mostly glosses over so far. And studies have found that individual investors who tend to make frequent stock trades seriously underperform the market. The median 12-month return for frequent traders was just 0.1 percent, compared to 4.7 percent for those with a low stock turnover rate, according to the portfolio tracking service SigFig in a report from December 2014.
“The reality is that most financial advisors will tell you that you should have a diversified portfolio, and not individual securities,” says Darrin Courtney, a research director specializing in wealth management at financial research firm CEB TowerGroup.
More than 25 percent of Robinhood customers, who are on average 26 years old, have never used an investment product before. Two thirds of Robinhood’s customers are also openly mistrustful of Wall Street and traditional banks, Tenev says.
But not everyone is convinced that Robinhood is a better way. By way of a very small, informal sample, I asked Inc. intern Thompson Wall, 22, who recently signed up for a trading account with the app, what he thought about the service. While he said he appreciated the free trade idea and the ease of getting started, he said he also felt the level of information provided was a bit too shallow, which made him somewhat mistrustful.
“Since it’s a financial account, I’d like as much detail as possible,” Wall said.
Over time, Bhatt and Tenev say, the service could change to include more personalized information. They also foresee a premium service customers might pay for, as well as a secondary business in licensing their free trading API to other businesses, such as brokerages or even individuals.
For now, though, both are happy to have a created a product that gives consumers more choices, and greater access to financial markets.
“Our generation likes to use tools and do the thinking ourselves, so the self-directed approach is interesting,” Tenev says. “There’s a need for this.”