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Robinhood - Commission Free Investing. Is it free? Thumbnail

Robinhood - Commission Free Investing. Is it free?

Today I wanted to discuss the online trading platform known as Robinhood. I'll try to break this down in its simpler form. If you have questions feel free to reach out.

What is Robinhood?

In short, Robinhood is an online trading platform that allows its customers to buy and sell stocks for free. They target rookie and novice investors by using gamification and of course everyone's favorite word...free. But is it really free? Let's break it down.

Is Robinhood Really Free?

I would bet most of us have a older relative or know an older person that has used the phrase, "There is no such thing as a free lunch." Which simply stated means you don't get something for nothing.

Robinhood's customers are what is referred to in the industry as Market Makers, such as Citadel Securities. A Market Maker is a member firm of an exchange that also buys and sells securities for its own account at prices it displays in its exchange's trading system with the primary goal of profiting on the bid-ask spread.

Ex. A Market Maker buys your trade on Robinhood for $1. The Market Maker then advertises and sells your trade for $1.10. Market Maker makes 10 cents off the buying and selling of your trade. Then they pay Robinhood 5 cents for giving them the trade.

Essentially the Market Maker buys the right to execute your trade at $1 while knowing they will have a buyer at $1.10. They make their money off that difference in price. It doesn't sound like much but extrapolate that over millions of customers and it becomes big dollars for Robinhood and Citadel.

Notice I didn't say that Robinhood's customers are retail customers such as yourself? You are not the customer. You are actually the product. You are the feeder fish that feeds the big fish. Make sense? I'll explain further.

When you open an account at Robinhood or any "free" trading platform that company gets paid by order flow. Order flow means Robinhood gets paid on how many feeder fish, which is you, they can deliver to the the big fish, which are professional investors. Can you see now how this game is rigged?

Essentially, you are sitting down at a poker table in Vegas with professional poker players. Another analogy. You are playing checkers, they are playing chess. You won't win and you can't win.

How Much are You Worth to a Company like Robinhood?

Companies like Citadel on average pay around 17 cents for Robinhood customer trades. They pay around 11 cents for Charles Schwab customers. Why do you think that is? It's because Robinhood customers are typically rookie investors that have no idea what they are doing. That makes you more valuable to the feeder fish. They pay more for you because you make them more money.

If something is "free" rest assured you are the product. This is how a company like Robinhood that offers 'free" trading is worth 11 billion dollars! They are in the business of trading YOU. You are the product!

What can you do?

I totally get it. Online shopping can be great. You don't have to deal with a person. You can always find what you want immediately. But buyer beware. Talk to a person in the industry. Go see a reputable Broker Dealer or Registered Investment Adviser. We work for you and not some Market Maker. We work to achieve your goals not the goals of some hedge fund on Wall Street. You wouldn't jump in a boxing ring without having ever visited a gym. Don't do the same the same with your investments. Go find a real person that can help you.

For more articles about retirement planning and investing click here.

Thanks for reading!

Brian Coleman/Retirement Planner/Investment Manager

80/20 Financial Services is an independent  Registered Investment Advisory Firm. Our focus is working with retirees, and we specialize in working with retirees who are approaching or going through the retirement transition. We are located in Ozark, MO but we have the ability to work with clients throughout the United States. Contact us today for help with your retirement needs.