Investing is an important part of building a strong financial future for yourself. By investing your money in the market, you can grow your savings over time, making it easier to achieve goals like buying a home and retiring.
There are many companies that help people buy and sell investments like stocks, bonds, mutual funds, and Exchange Traded Funds. Robinhood is one such option, which has become well-known for a variety of reasons.
What is Robinhood?
Robinhood is a mobile-focused brokerage company. Brokerages help customers buy and sell investments like stocks. The company was founded in 2013 and has grown to have more than 13 million users.
Robinhood was one of the first brokerage companies to offer commission-free trades, meaning customers could buy and sell stocks without having to pay any fees for each transaction. The company charges no fees to its customers, though it does offer a subscription service to those who want premium features, such as instant transfers and margin trading.
This fee-free approach to trading and sleek, phone-focused design helped catapult Robinhood to popularity, especially among millennials and other tech-savvy consumers.
Detractors argue that Robinhood has been too successful at gamifying trading, encouraging people to make more frequent transactions that may increase risk and reduce returns. The company has also added features such as pre-market and after-market trading, and the option to trade on margin (borrowed money), which can also increase risk.
Who uses Robinhood?
Robinhood is particularly popular with younger and first-time investors. The app’s average user is 26 years old. For about half of people who buy stocks with the app, Robinhood is where they made their first investment.
Because of its popularity with younger, tech-savvy consumers, Robinhood has spawned large online communities on websites like Reddit and Twitter.
How to Invest with Robinhood
Investing with Robinhood is relatively straightforward, which is another reason for its popularity. It’s easy for people to get started.
To start, you have to download the app, which is available for both iOS and Android. Then, you’ll create an account. You’ll need to enter some personal information and your Social Security Number, then set a password. You also have to answer some regulatory questions, such as whether you work in finance or are a significant stockholder or senior officer in a public company.
After you create your account, it’s time to link a bank account. You’ll need your bank’s routing number and your account number to create the link. Choose the amount you want to transfer from your bank to Robinhood. It can take up to five days for the transaction to clear.
After you’ve funded your account, Robinhood lets you buy and sell stocks, Exchange Traded Funds, cryptocurrencies, and options. To buy an investment, search for the investment and enter the dollar amount you’d like to invest. Robinhood lets you purchase fractional shares of stocks and ETFs, meaning you don’t have to save up enough money to buy a full share.
Things You Should Know (or Avoid)
For many Robinhood users, the app is their first experience with investing. These are some things that you should know (or avoid) if you decide to invest with Robinhood.
Diversification is important
Diversification is an important part of building a stable portfolio to best weather the ups and downs of the market. If you put all of your money into a single company and that business goes bankrupt, you could lose your entire investment.
For people just starting out, it can be hard to build a diverse portfolio because you don’t have much money to spend on different investments. With Robinhood’s ability to buy fractional shares, you have more freedom to diversify your portfolio.
You can also consider investing in an Exchange Traded Fund (ETF). ETFs, like mutual funds, hold a huge variety of securities, letting you get exposure to hundreds or thousands of stocks and bonds while only investing in a single fund.
Options can be incredibly risky
Robinhood makes it incredibly easy for its customers to buy and sell options. Detractors point to this as one of the many ways in which it can encourage customers to take unnecessary risks.
If you’re considering trading options, keep in mind that they can be incredibly risky and that you should be prepared for their volatility.
When you buy an option, you purchase the right, but not the obligation to either buy or sell shares at a set price until the option expires. One option contract covers 100 shares of a stock, so investors can use options to get control over 100 shares of a stock at a price that’s typically much lower than the cost of buying 100 shares.
Selling options is riskier because if someone exercises the option, you must purchase or sell the shares at the price specified in the contract. Depending on the type of option you sell, your potential losses could be unlimited.
Valuing options can also be complex, as it involves more than just looking at the stock’s price. You should only consider trading options if you know what you’re doing and can afford to lose the money you’re trading with.
Robinhood’s interface and gamification make it easy to want to buy and sell shares regularly. If you trade frequently enough, you may be considered a day trader. If this happens, it may limit your ability to trade stocks on Robinhood.
A day trade is when you buy and sell the same stock or options contract within a single day. If you do this three times in any five day period, you’re considered a “pattern day trader.”
The government places restrictions on who is allowed to day trade. If you are a pattern day trader, you will need to maintain an account balance of at least $25,000 (not including cryptocurrencies) to continue trading the next day.
Related: How to Become a Day Trader
Only invest money that you can afford to lose
It is important to emphasize that all investing is subject to risk. The type of investing that Robinhood tends to encourage, trading options and regularly moving in and out of stock positions, can be even riskier.
If you’re going to consider investing through Robinhood, make sure to only invest money that you can afford to lose.
Don’t forget about things like your 401(k)
Investing with Robinhood can be fun, but it’s important to keep other investing goals in mind.
For example, if your employer offers a 401(k), you shouldn’t ignore it in favor of investing through Robinhood. Putting money in a 401(k) comes with tax incentives and many employers offer matching contributions that give you even more reason to contribute. Those without a 401(k) can get similar benefits from Individual Retirement Accounts.
Robinhood can be a fun app for people who want to build a portfolio with their extra money but make sure that you’re also saving for your other goals.
How Do Taxes Work With Trading On Robinhood?
For many people using Robinhood, it’s the first time they’ve tried their hand at investing. Investment taxes can seem daunting, but they’re not as complicated as they first seem.
When you buy and sell investments, you may incur a capital gains tax. You only have to pay taxes on investment gains and you can use investment losses to offset gains.
When you buy an investment, your broker will note the price at which you bought the investment. This is called the cost basis of that investment. When you sell the investment, you can compare the sale price against the cost basis to determine your gains and losses.
For example, if you bought 10 shares of XYZ at $50, your cost basis for the investment is $500 or $50 per share. If you later sell those shares for $55 each, your total capital gain will be $50 ($550 – $500).
If you later bought 20 shares in EFG at $100 each, giving you a cost basis of $2,000, then sold them at $90 each, you’ll book a capital loss of $200. That loss can offset the $50 gain you earned earlier in the year, giving you an overall capital loss of $150 for the year.
If you buy shares at different price points, things may get more complicated, but your brokerage should keep track of your cost basis for you.
If your capital gains for a year exceed your capital losses, you have to pay capital gains taxes. If you owned an investment for less than a year before selling it, the capital gains tax rate is equal to your normal income tax rate. Investments held for longer than a year have a lower tax rate.
If you have more capital losses at the end of the year, you can use those losses as a deduction against a portion of your normal income, reducing your income taxes. Whatever amount you can’t use as a deduction gets carried forward to the next year.
Be sure to consult a tax professional if you need help with filing taxes as they can provide advice that is customized to your unique situation.
What’s Going on With Robinhood and Wall Street?
Because of its popularity, Robinhood frequently shows up in the news.
In January 2021, the app made waves because of a large group of its users who invested in Gamestop stock.
Gamestop is a brick-and-mortar video game retailer that many believe is on the brink of failure. This belief led many professional investors, including hedge fund managers, to bet against the company (also called shorting).
When you short a stock, you earn a profit from decreases in the stock price. However, if the company’s price rises, those shorting the stock could lose significant sums. To maintain a short position, investors may need to buy additional shares in the company they’ve shorted as its price rises.
Largely driven by users of a Reddit community called Wall Street Bets, Robinhood users discovered that Gamestop was incredibly heavily shorted by major investors and hedge funds. This created an opportunity for them to cause a short squeeze. Robinhood users heavily purchased Gamestop shares, causing the price to rise. This forced the short-sellers of Gamestop to buy more shares to maintain their short positions.
As the stock’s price rose, even more investors bought shares, forcing short-sellers to buy more shares to maintain their positions. This cycle continued until Gamestop’s stock price spiked from about $20 on January 12th to a high of almost $470 on the morning of January 28th.
The ability of an online community to heavily influence a stock’s price has led many to accuse them of market manipulation while others have cheered everyday investors making money at the expense of hedge fund managers.
These are some questions that people frequently ask about Robinhood.
Robinhood doesn’t charge commissions when its customers buy or sell investments, so it uses other methods to make money. Its primary revenue sources are earning interest on customers’ cash balances, charging interest to investors who borrow money to trade, and selling order information to other investment companies.
Robinhood makes it easy for anyone to open an account and start investing, but that doesn’t mean it’s good for beginners. The app does a good job of gamifying investing and encouraging people to do more trading, but doesn’t offer all of the research and education tools that other brokerages have. Beginners may have fun and succeed when using Robinhood, but they should make sure to read up on investing and how it works from a variety of resources.
Robinhood makes it much easier than other companies to trade options on its platform. The company does not publicly post precise eligibility requirements but says you do need some stock trading experience. When you apply for options trading, the app will look at your financial information and trading experience before deciding whether to let you trade options.
Related: The Best Online Discount Brokers
Robinhood is a mobile-focused brokerage that makes it easy for investors to buy and sell stocks, ETFs, cryptocurrencies, and options without paying fees. It has gained many supporters and detractors for the way it has gamified investing. If you’re a beginner considering using Robinhood to invest, keep these tips in mind and make sure that you think about your long-term investing goals and risk tolerance before getting started.