Robinhood Just Got Cancelled

What's up, you guys? It's Graham here!

So, you might have recently noticed that something has been missing from the channel lately, and no, it's not the free stock you can get worth all the way up to $50 down below in the description. Instead, it's some good old-fashioned stock market-related drama between two of the biggest heavyweights when it comes to investing. On the one side, we have the billionaire investor Warren Buffett, and on the other side, we have Robinhood.

That's right! Every year, Warren Buffett hosts an annual meeting to discuss his thoughts on the markets, where he thinks the economy is going, and how Berkshire Hathaway is investing its $140 billion worth of cash. But this time, he decided to take it a step further and issue a warning to new investors about why they’re potentially about to lose a lot of money, along with something else that none of us expected: how Robinhood could be to blame.

And listen, if one of the most successful investors of all time is voicing his unhappiness about a stock trading platform and then warning users against it, I think it's important that we take a look into this further. We need to understand why he's worried that investors could wind up losing a significant amount of money and then what you could do about it to make sure you don't fall victim to the same mistake.

But before we go into that, I have to say a huge thank you to our video sponsor today: Robinhood! Just kidding, there is no video sponsor. So, if you appreciate just the information and that's it, it would help me out a ton if you could hit that like button for the YouTube algorithm by making it turn blue. Doing that helps my channel tremendously. So as a thank you for all of your support, here's a really cute picture of a baby koala. So, thank you guys so much!

Now, with that said, let's begin.

All right, so as I'm sure we're all aware, Robinhood is certainly not a stranger to controversy. By the way, if you want to skip past some of their previous controversies and get to why Warren Buffett is not a fan, just skip to this timestamp right here. But otherwise, here's a bit of the backstory.

Robinhood emerged on the scene about 7 years ago with the goal of providing you a completely free brokerage for you to buy and sell stocks without paying any commissions in the process, which by the way was completely unheard of at the time. So, how did they go from being the hero underdogs that paved the way for free stock trading to now being the lifeless punching bag for Warren Buffett?

Well, I think some of it has to do with their growing pains along the way. The first hiccup came in 2018 when they attempted to launch a checking and savings account within the app, but there was a problem: technically, they were not a bank, and they couldn't offer FDIC insurance on customer deposits. They also couldn't get SIPC insurance, which applies to investment accounts and not checking and savings accounts as Robinhood has.

After a whole bunch of confusion and public back and forth, the entire idea was scrapped. Then in 2019, users of Reddit's WallStreetBets discovered an unusual glitch within the system that allowed for unlimited margin trading, essentially becoming an infinite money loop, while some users racked up over a million dollars.

But all of that so far to me just seems like light-hearted growing pains of starting a new company that could be fixed relatively easily. Although now, this is where things started getting a lot more serious. In early March of 2020, just as the stock market was plummeting due to the pandemic, Robinhood experienced a system-wide outage, meaning that users of the platform were not able to buy or exit their positions until the problem was fixed—almost 2 days later.

Now, some people theorize that this was due to a coding error within their system that didn't properly account for the leap year, but a more plausible reason was that it was just a really busy time for the market. $1.1 trillion had just poured in, and Robinhood was not prepared for all of that traffic, so they temporarily shut down.

Then, again early this year in 2021, users of Reddit's WallStreetBets discovered the perfect storm for GameStop to skyrocket in price because of how overvalued it was. This caused hedge funds to lose billions of dollars in the process. And just as things were getting started, the buying of meme stocks was completely halted on Robinhood, where for 24 hours the only option was to sell.

As you would expect, this caused a huge uproar with everybody, including the SEC, who began investigating the relationship between Robinhood and the company that routes their order flow, Citadel. See, Robinhood doesn't actually execute their own trades but instead they route their order flow to a company that pays them for that privilege.

In this case, the company receives Robinhood's orders. Citadel lent money to Melvin Capital who shorted GameStop, and the higher the price went, the more money they lost. So, given that Robinhood is affiliated with a company that has a financial interest in the price of GameStop going down, some believe that this was done purposely to give hedge funds enough time to cash out.

But Robinhood says that this was more of a logistical issue and that there simply weren't enough shares of GameStop to be guaranteed delivered to your account if you bought them. Whatever the reason, though, this brought into question the ethics of Robinhood routing order flow to a company that has a financial interest against Robinhood's own users.

So now that you understand some of the backstory of this, here’s what Warren Buffett just said and how this applies not only to you but the entire market in terms of how to make money.

Now, during Warren's annual stockholder meeting, he came out against the app by saying that Robinhood was catering towards the gambling instinct of investors and contributing towards the speculative, casino-like trading activity in the stock market. He goes further to say that American corporations have turned out to be a wonderful place for people to put their money in and save, but they also make terrific gambling chips.

He continues, "If you cater those gambling chips for when people have money in their pockets for the first time and you tell them to make 30 or 40 or 50 trades a day, you're not charging them any commission, but you're selling their order flow or whatever. I hope we don't have more of it." In other words, his concern is that if Robinhood has a financial interest in getting you to trade as often as possible because that's how they make their money, it unknowingly promotes the type of behavior that could be detrimental to you as an investor at your expense.

And the words get even harsher from the billionaire Vice Chairman, Charlie Munger, who said that it's just "God awful" that something like that brought investments from civilized men and decent citizens. "It's deeply wrong. We don’t want to make our money selling things that are bad for people."

And that is where things start taking a slightly darker turn: from what originally turned out to be a commission-free brokerage aiming to democratize investing to now what the most successful investors believe is just a gambling app making money at your expense. For example, a few months ago, the New York Times ran an article describing a 32-year-old investor who said he was lured into the app through features that included falling confetti and emoji-filled phone notifications.

But after repeatedly losing money, he took out $60,000 worth of home equity so he could buy up riskier stocks and options hoping to make his money back. After then having some initial success turning that account into more than a million dollars, he proceeded to lose almost all of it, and now has about $7,000 left.

Now, according to analysis of industry data and legal filings, as well as interviews with current and former Robinhood employees, they say that the app was built on what appears to be a Silicon Valley playbook of behavioral nudges and push notifications to draw investors towards risky trading, which happens to make Robinhood a lot of money in the process.

And well, it's working! In the first 3 months of 2020, Robinhood customers traded nine times as many shares as E*TRADE customers and 40 times as many shares as Charles Schwab customers. They also bought and sold 88 times as many risky options contracts as Schwab's customers relative to the average account size. They say that’s led customers to making decisions which are not in their own best interest but instead in the best interest of Robinhood, which benefits from excess trading.

Others are also concerned that Robinhood is not doing enough to protect their own customers against the risks of investing, as evidenced by a tragic situation where 20-year-old Alex Kurns took his own life, thinking that he had lost $730,000 trading an investment that he should not have been qualified to make.

And for Warren Buffett, knowing that 80% of active traders lose money and only 0.03% are able to consistently earn large amounts, he feels like a company which encourages excess trading is doing so at the benefit to themselves and at the detriment to you.

Now, Robinhood very much denies this, and they say the new generation of investors aren't a casino group; they're tearing down old barriers to investing and taking control of their financial future. The CEO of Robinhood also said that even with some of their customers losing money, young Americans risk greater losses by not investing in stocks at all and that they made investing less intimidating to new investors.

But Warren Buffett disagrees, and instead, his advice was this: he started off by noting something really interesting. None of the biggest stocks in the world in 1989 would still be on that list today, and that is something that investors should pay very close attention to.

Like the top companies of 1989 included the Industrial Bank of Japan worth $104 billion, Sumitomo Bank, Exxon, General Electric, and IBM. He goes on to say that we were just as sure of ourselves, and Wall Street was in 1989 as we are today. But the world can change in very, very dramatic ways.

His biggest lesson here is that even though you might be incredibly sure of yourself now, the future is very unpredictable, and it's unlikely the biggest winners today are going to be the biggest winners 20 years from now. That's why he stressed the importance of having a broad, well-diversified portfolio of passive index funds.

He also cautioned investors about trying to find winners in growing industries, pointing out that a large number of companies that made automobiles in the early 1900s ended up closing down well before the industry had matured.

All of this to say, at the core, buying and selling speculative stocks through a company that benefits from you trading as much as possible is likely to wind up losing you more money than holding on to a passive index fund long term.

And that’s it!

But as far as my own thoughts on this and Robinhood's response to what's going on here, you go. Overall, I feel like Robinhood has done a lot of good for the entire investing community. They've engaged a brand new audience who ordinarily would have had no idea that investing was accessible. And most importantly, they've made investing fun! Plus, you could almost get near-instant access to leveraged money through options trading, which magnifies your return in a very short period of time.

But the question then becomes: has Robinhood taken this slightly too far and made this slightly too fun?

Well, the behavioral finance professors Brad Barber and Terrence Odean, who have studied investor performance over these last few decades, believe that yes, they have taken it too far, and it might be time to pull back. In a recent study, they saw Robinhood as a platform that included features to make investing feel more like a game, such as getting a free stock through an image that looks like a scratch-off lottery ticket with confetti coming down once you're finished.

They say that's more likely to attract new, unsophisticated investors who have no prior experience investing. The top 20 movers also encourage investors to buy a limited selection of stocks based on past performance, while the simplification of information leads investors to rely more on their intuition than on critical thinking. Not to mention, even more surprising, it was found that the average Robinhood investor had just three stocks, which suggests a lack of diversification and overconfidence that would lead to an overall lower return.

They even went so far as to say that sophisticated investors would be able to exploit patterns within Robinhood's platform to short stocks that experience a runup based on Robinhood's recommendations.

However, in Robinhood's defense, the finance Professor Chester Spatt argues that active stock trading may not be as beneficial over the long term as simply holding on to a low-cost index fund, even if it is commission-free. But it could still be better than leaving your money in a savings account.

In terms of my own opinion, though, I see both sides. Their target demographic, much like mine, is probably between the ages of 18 and 35. They want to learn as much as they can about personal finance, and it's up to you to make it as accessible as possible to a demographic that otherwise might not ordinarily be interested in investing.

I've done this through relating titles and thumbnails back to real-world scenarios, where on their own they're super boring, but then I add some spice to them, and all of a sudden they're exciting. For example, I could have made a video about how to set up a Roth IRA for new investors step by step in 2021, but guaranteed the people who needed to see that video the most would skip past it because that's boring.

However, if I title that video "How to Be a Tax-Free Millionaire with $12 a Day," all of a sudden, I could reach almost a million people and help them see the benefits of starting up a Roth IRA as soon as possible.

I really think investing is a topic that needs to be positioned in such a way that attracts people who ordinarily wouldn't think about starting a 401k, building up their credit score, or investing in a broad index fund, which otherwise is dull. And from that perspective, I feel like Robinhood followed that same path because that's what they needed to do.

They had to make investing fun if they wanted to grow their platform, and they had to push the limits and rush out some features when they're competing with multi-billion dollar corporations. But I do admit, and I've said it openly, that lately it started to feel more like a casino and gambling than a stock trading platform, and Robinhood seems to be at the center of it.

Now, I get that some people just want to be left alone, and they think that if they lose money, that's their own fault. But the SEC has determined that it's their responsibility to step in to protect people against themselves once the company has a financial interest in you doing something that increases your likelihood of losing money over time.

I have a feeling they’re going to be more strict about their disclosures, limit activity until you reach a certain threshold, or they're going to remove features which might be too gamey for an investment platform. It's really tough because on the one hand, I feel like people should have the freedom to do what they want to do without any limitations.

But if a company profits from you doing something that could be detrimental to you long-term, that needs to be disclosed so that you know the risks associated with what you're doing. Let me know what you think of this down below in the comments, because I certainly see both sides of the equation. But overall, I tend to agree a little bit more with Warren Buffett that what we’re seeing right now is more akin to a casino than it is investing.

And eventually, I could certainly see more regulation put in place, not because they don’t want people to invest, but instead because more transparency never hurt anybody.

So with that said, you guys, thank you so much for watching! I really appreciate it. As always, make sure to destroy the like button, subscribe button, and notification bell. Also, feel free to add me on Instagram; I post there pretty much daily. So if you want to be a part of it there, feel free to add me there.

As for my second channel, The Graham Stephan Show, I post there every single day I’m not posting here. So if you want to see a brand new video from me every single day, make sure to add yourself to that. Thank you so much for watching, and until next time!