A warning about Robinhood's 3% Checking Account…

What's up you guys, it's Graham here. So I'll just get right into it. CNBC just recently published an article saying that Robinhood, the stock trading platform, is now going to be offering checking and savings accounts. My initial reaction to this was great. I mean, it kind of makes sense that they want to move into the banking industry.

But then I saw something absolutely shocking, and that is that they're gonna be offering 3 percent interest on their checking and savings accounts. Now, I gotta say that offering three percent is really nothing new, and many local smaller banks offer way higher than this. But it's usually with a caveat that you have to make direct deposits into that account, it's only up to the first $5,000 or up to the first $10,000, and you'd have to make like five minimum debit card transactions a month. Usually, at that point, it's just not worth the hassle.

But I was very pleased to read that Robinhood checking and savings accounts come with no fees, minimum balances, or deposit requirements. Also, I couldn't find anywhere on any of their fine print that there's any sort of account maximums, which basically means that if this were the case, I can go and put two hundred and fifty thousand dollars with Robinhood and just sit back and collect three percent interest, which works out to be six hundred and twenty-five dollars a month. And as soon as I read that, I was honestly that meme where it's just like shut up and take my money. That was me until I started reading a little bit deeper because everything this good usually just comes with a bit of a catch.

Now, in the past, Robinhood has made some pretty significant moves for the sake of gaining market share and gaining future customers. I initially found them because they began offering commission-free stock trading, and literally everyone was talking about them, so of course I had to try it out. I actually really liked their service, and I even mentioned it a few times here in the channel.

So with that said, my experience so far with Robinhood is that they've been a very good service. But when it comes to them offering a three percent return on their bank accounts, I kept reading and kept reading and kept researching all in the fine print because this sounds a little bit too good to be true. I was really intrigued because offering 3 percent right now is a lot, and what makes it even better is that their payments are paid out on a daily basis. Kinda reminds me a little bit of BitConnect, but again on the surface, that beats out a lot of banks and pretty much every single other bank out there that pays out their interest on a monthly basis.

So already this is sounding a little bit too good to be true, and as they say, you know if it sounds good to be true, and that's why I kept reading and looking into this a little bit further. This is where things start to get a little bit dicey. Now, the big catch here is that technically Robinhood is not a bank, and you're actually opening up a brokerage account where your money in that account is not considered FDIC insured.

What that means is that every other bank out there is required to have FDIC insurance for up to the first two hundred and fifty thousand dollars. This means that if something happens to the bank where everyone goes and tries to withdraw all their money out of the bank at the same time and the bank doesn't have enough to pay everyone back, the government is insuring your money to make sure that you will get your money back if anything ever happens to the bank. However, Robinhood doesn't do this because they're not a bank, they're a brokerage. So instead, they offer you what's called SIPC insurance.

Now, the SIPC protects you as the consumer from up to two hundred and fifty thousand dollars in cash, or up to five hundred thousand dollars in assets upon broker failures. This means that if Robinhood ever closed down due to financial difficulties and clients' money went missing, SIPC would step in and ensure that everyone had their money covered up to those two limits, and that's still generally safe for the most part.

Now, when Lehman Brothers went under in 2008, their customers received ninety-two point three billion dollars back. But the main issue I see here is that SIPC will not cover your assets in the event that Robinhood breaks any laws, any regulations, or commingles your money, or if they ever use someone else's deposits from paying off your returns. As we all know, that is what's called a Ponzi scheme.

Now obviously, that's a huge stretch of the imagination to ever suggest that Robinhood would ever run a Ponzi scheme, and that is never something that I am suggesting here. I'm just saying if they did, and the one in a billion chance that for some reason they did do it, SIPC would not be covering your money in the event that you eventually lose it. Another small risk that I see here is that the president and CEO of SIPC claims that SIPC protects cash that is deposited with a brokerage firm for one limited purpose. The purpose is of purchasing securities; cash deposited for other reasons would not be protected.

Now, of course, Robinhood claims that because their checking and savings accounts are technically a part of their brokerage that can be used to purchase other investments, they should be covered under SIPC like any other brokerage. This is because they claim that people can go and buy assets and trade stocks with money that they have in their checking or savings accounts, and of course that is true. Now whether or not they can actually make that argument to get SIPC insurance is yet to be determined. I think they're assuming that it is covered, but I'm a little bit worried about their definition of checking and savings accounts and whether or not SIPC actually agrees with this and agrees to insure it.

Now, personally, this seems a little bit sneaky of Robinhood to call this a checking or savings account but then characterize it as a brokerage account just to get the insurance. To me, this is really one or the other; it's either a brokerage account that offers a three percent interest rate or it's a checking or savings account. I don't really think it could be both, but you know, however they characterize it and whatever SIPC agrees with, by all means.

Now, in order to understand this, it's first important to understand how banks make money. Now, typically when you give money to a bank, they pay you back a little bit of interest for the privilege of you lending them some money. Now from there, banks will either use that money as collateral or invest some of that money in higher-yielding investments to go and make them some money and also pay back a little bit of interest.

Now when it comes to banks making money, they don't just stop there because now you're a customer of that bank, and they're more likely to make money off you by giving you a mortgage, maybe a loan, maybe other services that you pay for, and they make more money off you in the long term on the back end. That's pretty much the banking industry in a nutshell.

But with Robinhood offering a three percent return, it's pretty suspicious because this is way more than any other bank will offer without any other limits, especially when you consider that U.S. Treasuries are paying below that on shorter-term notes. So that begs the question: where is all of this money coming from? The rate on a three-year U.S. Treasury is sitting right now at two point seven eight percent. Now in terms of investment return, this is pretty much as safe as it gets, and Robinhood will end up investing a portion of your money in U.S. Treasuries.

This means that if they invest all of their money in U.S. Treasuries, they're going to be running a loss by offering you a three percent interest rate, and this is a net loss to them of 0.22%. The way I see it—and I'm sure the way they're seeing this too—is that this is really just the cost of customer acquisition. This is how much they believe one customer is worth to them long-term, and again their net loss is really only 0.22%, which they're likely to make up from profit on other services that they offer, like margin trading or Robinhood Gold.

And their genius reasoning to doing this is really just to take as much market share as quickly as they possibly can. That's it. They want people to talk about it; they want people to become Robinhood customers. In order to do that, they have to do something very dramatic; otherwise, no one would bother even talking about it. Like if they announce that they're doing this and offering like two and a half percent interest, no one would care. But if they offer three percent interest, everyone loses their minds.

Now once they gain all of this market share, and rates eventually increase over the next year, well at that point they're no longer going to be at a loss, and they will have taken a large portion of the market with them. This is a great business move if it plays out like they think it will, and by offering something like this now, before anyone else is able to do this, they really get the first mover advantage.

Now here's what I personally think is gonna happen, and that is that the checking and savings accounts are just going to end up being a loss leader for the company. I also think that Robinhood is going to significantly underestimate just how many people are gonna be signing up for these accounts. Right now, Robinhood says they have about four million accounts, but not all of them are funded. No, we don't know exactly how many accounts are funded, but let's just say it's 70% of them. So that means that we have two point eight million accounts with Robinhood that right now have money in them.

Now let's assume that of those remaining 2.8 million accounts, that 20% of them go and then open up a checking or savings account. This means that five hundred and sixty thousand checking and savings accounts are going to be added. By the way, I signed up for early access of the service just six hours after it was announced, and already it said I was number 253 thousand. So this could very well exceed those numbers I just mentioned.

Let's also go a little bit further to say that they get an additional three hundred thousand users just from people reading about them that never wanted to use them to trade stocks, but they'll use them for the checking and savings accounts. That means that in total, they can see about eight hundred and sixty thousand new accounts for checking and savings almost immediately.

Now let's even take it a step further and say that of these eight hundred and sixty thousand accounts, the average balance in them is two thousand dollars. Well guess what? That is 1.7 billion dollars for Robinhood. And like our example earlier, let's just say they invest all of that in U.S. Treasuries making two point seven eight percent interest. They're gonna be taking a point two two percent loss on one point seven billion dollars.

This just means that for eight hundred and sixty thousand accounts with an average balance of two thousand dollars, their net loss the first year is only going to be three point seven million dollars, and that honestly doesn't really sound that bad considering that they've probably just grown their customer base substantially. Then as the Fed slowly increases interest rates and Treasuries eventually yield beyond three percent, Robinhood then starts making a profit, and meanwhile, they've gained a large foothold in the market.

Now, of course, you run the risk of them being a relatively newer company that's not FDIC insured, and you're taking all of that risk just to get an extra 1%. When you compare that, Ally Bank, Vanguard, or American Express currently offer a two percent interest rate. So the difference there is really only one percent. Is it worth taking a risk to put it all in Robinhood? Maybe? I don't know. Am I gonna do it? Maybe. I don't know.

The real risk here is that if something happens to Robinhood and they break the law or they do something that isn't to regulations, and SIPC says, "You know what? We're not gonna be covering that because we don't cover checking and savings accounts, we only cover brokerage accounts," and if that's the case, you might be screwed.

We're also taking a little bit of a gamble with a company that was only started five years ago and hasn't really fully proven themselves. I mean that's a very small risk considering what they've done so far, but it's definitely just a small consideration of mine.

Now the good news when it comes to Robinhood doing all of this is that it really forces other companies to be as aggressive as they possibly can and maybe be a little bit more competitive with what they have to offer. I think Robinhood doing this is really going to force other companies to follow suit. Starting in January or February, we're gonna see a lot of other online checking and savings accounts offering slightly higher interest just to try to be competitive with Robinhood, and for that, I say thank you very much Robinhood for doing that.

So anyway, that's my thoughts on this and what I think is gonna happen. If you guys agree or disagree, if you guys are gonna be signing up for this, let me know down below in the comments. I would be curious to see what your thoughts are on this as well. So with that said, thank you so much for watching. If you haven't already, smash that like button and smash that subscribe button, smash that notification bell, smash your screen.

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Thank you again for watching, and until next time!