March 16, 2021

Robinhood: 7 Things to Know Before Using the Investing App

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Thinking about trading on Robinhood? Good job on getting started investing! But first, there are 7 things you need to know before investing on Robinhood.

Robinhood has become the investment app of choice for young investors. It's free and easy to use. What's not to like?

But it has also received plenty of backlash for encouraging risky behavior. Free trades are great, but there are hidden dangers. We'll get into that in this article.

We're fans of Robinhood as long as you use it responsibly. Here is some important advice to ensure a safe investing experience.

  1. Why Robinhood Is Great for Beginners
  2. Hidden Dangers of Free Trades
  3. How to Trade Safely on Robinhood
  4. Robinhood Will Not Fit All Your Investing Needs
  5. Is Robinhood Crypto Worth It?
  6. Options Trading Is Not for Beginners
  7. You Can Lose More Than You Invest with Margin Trading

1. Why Robinhood Is Great for Beginners

Robinhood is targeted toward young Millennial users. And it does that really well. Here's why it's a great choice for beginners.

  • Free trades: All stocks, ETFs, options, and cryptocurrency trades are completely commission-free.

  • No minimum: You can open an account with $0.

  • Fractional shares: This means you can buy just a tiny fraction of a share starting from $1. For example, you can buy $5 worth of Amazon stock (instead of needing $3,000 for a full share).

  • User-friendly app: New investors may be turned off by complicated platforms with lots of charts. Robinhood's simplified app is super-easy to use. Anyone and their grandma can work it.

We appreciate that Robinhood has made it easy to start investing. Maybe too easy. And this leads us into the next point.

2. Hidden Dangers of Free Trades

Having the power of unlimited free trades can be thrilling, but dangerous if you're not careful.

See a hot stock? Buy it in 3 seconds. Something not doing well? Just get rid of it.

But these kinds of rash decisions are often what get you into trouble. In fact, trading frequently leads to worse returns.

Previously, brokers charged $5-$7 per trade. So people had think about each trade more. But with free trades, it's easy to get carried away.

A November 2020 study found that Robinhood users trade 40 times as many shares per dollar as Schwab users.

The Massachusetts Securities Division even filed a complaint accusing Robinhood of using gamification tactics to encourage constant engagement.

Because the app makes trading so easy and fun, people may not think through their actions as much. And that becomes more gambling instead of investing.

Did you know? Trading on your phone can lead to riskier decisions too. A working paper by the National Bureau of Economic Research found that smartphone traders are 67% more likely to buy lottery-type stocks.

3. How to Trade Safely on Robinhood

So what can you do to invest safely and responsibly? Here are some tips to invest wisely so you keep more returns.

  • Buy and hold
    The stock market is volatile and it's normal for it to go up and down. But historically, the stock market has had an average annual return of 9.2%. You'll always come out ahead if you hold your investments long term.

    Pro tip: Holding stocks for longer is better tax-wise too. If you hold your stocks for at least one year, your capital gains are taxed at a lower rate than stocks held for less than a year.

  • Diversify to spread out risk
    The average Robinhood investor only holds 3 stocks. This is risky because if one fails, you can lose a large portion of your investments.

    Instead, diversify with fractional shares. Let's say you have $100. You can invest in 20 different companies at $5 each.

    Or buy into an ETF (exchanged traded fund). You'll be instantly diversified in hundreds of companies.

  • Research
    Robinhood tends to promote trendy stocks that others are buying. But don't just follow blindly and buy. Do your research first to see it's the right investment for you.

    The best approach is to pick several high-performing stocks and hold them for years.

  • Turn off the noise
    One of the complaints filed against Robinhood is that it uses tactics like daily emoji-filled push notifications to encourage users to get back on the app.

    To remove the temptation, disable push notifications. There's no need to constantly check your account. Remember, investing is your decision.

If you follow the above advice, you can have a safer investing experience. But you may still find that Robinhood isn't enough. We'll explain why below.

4. Robinhood Will Not Fit All Your Investing Needs

Robinhood is great for beginners looking for something simple to get their feet wet. But as you get more serious, you'll most likely need more.

Here's where Robinhood comes up short:

  • No retirement accounts
    Robinhood only has individual taxable accounts. You can't open an IRA for retirement savings. If you're serious about saving for the future, we recommend that you prioritize saving in an IRA account first because of the tax advantages.

  • No mutual funds
    Mutual funds are a popular choice for those looking for a well-diversified, passive investment. Robinhood doesn't offer any. For mutual funds, look to Fidelity or Vanguard instead.

  • Lack of research
    Robinhood's app is super-basic. It doesn't have the market data research necessary to help you make informed choices.

  • Poor customer service
    Robinhood's customer support is almost non-existent. There's no phone number to call. The only way to reach them is through email, but users have reported that responses are slow.

If you're looking for more than just regular stock trades, Robinhood does offer plenty of other investment choices. Let's take a look at those next.

5. Is Robinhood Crypto Worth It?

Robinhood also lets you invest in cryptocurrencies on the same app. You can even use funds from stock sales to buy coins.

It's not a bad option if you just want to try investing small amounts without signing up for a crypto exchange (which can be another whole world of confusion).

But just know that cryptos are even more volatile than the stock market. Don't invest more than you can afford to lose.

Another thing to note: Robinhood currently doesn't support coin withdrawals to a wallet. If you want to switch platforms, you'd have to sell your coins and use the money to buy again on another platform. But this will trigger a taxable event.

6. Options Trading Is Not for Beginners

Interested in trading options? The Robinhood app will guide you through the process with just a few clicks.

Options trading is essentially betting on a stock price within a timeframe. It's an advanced strategy that takes time to understand.

Usually, a brokerage needs to approve you for options trading to make sure you have enough experience. But Robinhood easily gives beginners access. The average Robinhood account traded 25,840 options contracts per dollar, compared to just 2,188 for TD Ameritrade users.

We're not saying don't ever try options. It can certainly be a way to earn more returns and limit losses. But make sure you really understand how it works first.

You may have heard the story of the 20-year-old college student who committed suicide after believing he owed more than $730,000 in trading options.

7. You Can Lose More Than You Invest with Margin Trading

Robinhood offers a margin account called Robinhood Gold for $5 a month. Your first $1,000 of margin is even included at no interest. This may sound like a good deal, but be careful.

Margin trading means using borrowed money to buy stocks. Here's how it works:

Let's say you have $1,000 and borrow $1,000 to buy Stock X at $50/share. In total, that's $2,000 on 40 shares. If the stock price goes up to $75/share, you'll now have $3,000. After paying back the margin, you still have $2,000 - double your original investment.

But say Stock X goes down to $25/share instead. You now have just $1,000 and all your funds are lost. If you lose even more, you'll even have to pay back debt.

That's the danger of margin trading. It can multiply your returns, but also multiply your losses. It should only be for more experienced investors.

Bottom Line

We think it's a good thing that Robinhood made investing accessible to everyone. There's nothing wrong with a simple app if it gets beginners and young people to invest.

But it's important to invest responsibly and not get carried away with free trades.

Take your time to research companies to invest in and build a well-diversified portfolio. Hold your investments so you can see some real long-term returns.

Ultimately, you're in control of your investments. Don't let an app influence your choices. The Robinhood app may be snazzy and fun, but remember that investing should not be like a game.

Stash

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TD Ameritrade

Commission-Free Trading - Online Stock, ETF and Option Trades

Applies to U.S. exchange-listed stocks, ETFs, and options. A $0.65 per contract fee applies for options trades, with no exercise or assignment fees.

Anna G is a contributing writer at CreditDonkey, a personal finance comparison and reviews website. Write to Anna G at feedback@creditdonkey.com. Follow us on Twitter and Facebook for our latest posts.

Note: This website is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content. You do not have to use our links, but you help support CreditDonkey if you do.

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