Robinhood is a modern innovative broker that offers commission-free stock trading. Their mobile app and free trade feature attract a lot of young investors and millennials, so today, I wanted to take a look at how to best use Robinhood and how NOT to use it. I have used Robinhood in the past and asked myself: what’s the best way to make money on Robinhood?
How To Make Money On Robinhood. The best way to make money on Robinhood – and through any other broker for that matter – is to buy and hold exchange-traded funds (ETFs). I would recommend a simple three-fund portfolio consisting of Vanguard’s Total Stock Market Fund (VTI), Total International Stock Market Fund (VXUS) and Total Bond Market Fund (BND).
Before we dive further into today’s topic, let’s first have a look at why it is so easy to lose money on Robinhood.
How NOT to make money on Robinhood
It’s a bummer I know, but Robinhood was not really build to help you – as a retail investor – make the most money.
Their main business is selling trading data to institutional high-frequency traders which is why they are able to offer commission-free trades.
If you keep this in mind, it becomes quite obvious why Robinhood’s platform and app are set up to encourage investors to trade multiple times a day. When you place a trade, it rains confetti. This is called operant conditioning. You may have heard of it.
Should you still insist on using Robinhood as you broker, here are some things the prudent investor should keep in mind:
When you confuse trading with investing, you lose. Trading stocks, as opposed to investing in companies, is the practice of buying and selling stocks based on “technical indicators” or price action.
Although it can be profitable in the short term and you may have a lucky streak for even a few months, there are very, very, very few traders who have managed to remain profitable over the long-term.
In addition to this, trading is horribly time-intensive and will drive you slightly insane.
Speculating and trading are similar concepts. Usually, trading refers to speculation as applied to shorter time frames. “Investing” in gold, for instance, is a form of speculation – though be it a sophisticated one.
Thus, the main difference between speculating and investing is the fact that you base your decision not solely on the price you think someone else is going to pay you in the future.
Sure, when you buy stocks you’d like them to go up in value. But in the meantime, you will also collect dividend payments.
Back in the day, Benjamin Graham came up with a definition of investing which goes something like this:
Thinking you can beat the market
Both of the above fallacies have their root cause in the fact that you think you can beat the market. If not, why would you be day-trading like a degenerate gambler?
The truth is 99.9999999999% of investors don’t beat the market. So there is no reason to think that you will.
With all this out of the way, let’s focus on how to really make money on Robinhood.
How to make money on Robinhood
Yes, you can make money through investing in the stock market. People have done for over 100 years. In the following section I’ll outline a simple 3-step-process that can be repeated again and again to make money on Robinhood:
Step #1: Buy an ETF
The very first step is to buy an ETF, ideally, one that tracks a total market index such as Vanguard’s Total Stock Market Fund (VTI).
ETFs are an easy way to get exposure to the entire stock market without buying individual shares. This mitigates risks by diversifying your funds among hundreds or even thousands of different companies.
Additionally, they are highly liquid and tax-efficient as shares are traded among investors allowing the fund to maintain a relative consistent portfolio of securities.
Step #2: Don’t sell the ETF
Now for the hard part: don’t sell.
I know, it’s crazy right? Even if the market takes a nose-dive? Yes, even then.
There are several reasons why you should simply hold on to your funds for the long-term. On average, the stock market has yielded around 7.5% per year. It is simply more efficient to leave your capital in the market than to try and time the market.
You can’t time the market.
Even when prices rise and it is tempting to withdraw some of your profits, it is wise to leave your money where it is unless you absolutely need it. Every time you sell a stock and make a profit you will be subject to capital gains tax.
You can avoid this and mitigate your tax burden simply by holding funds for a long time and thus declaring your dividend earnings as qualified dividends.
Step #3: Collect dividends
And now for the fund part: earning dividends. One of the easiest ways to make money on Robinhood is to hold ETFs and have their dividends distributed to your Robinhood account once every quarter.
When you scroll down a bit on the page for each fund you’ll find the current dividend yield:
For VTI this yield is around 2% as of June 2020. This means you’ll receive $200 of dividends paid out straight to your Robinhood account every year for every $10,000 you own of VTI. Or $50 per quarter!
How long does it take to make money on Robinhood?
As we have seen, with the above method it will take you about 3 months to make some money on Robinhood in the form of dividends. You may also receive your first dividend payment even sooner depending on when in the current quarter you buy the fund.
Dividends are paid out to investors who hold the given security on the ex-dividend date. For most companies and ETFs these dates are set roughly one month before the dividend payout date.
Can Robinhood make you rich?
Yes, eventually Robinhood can make you rich.
However, this is not because of Robinhood or their sleek mobile app. Whether or not you will become rich through Robinhood solely depends on your own investment decisions.
Trading and speculating will very likely not make you rich. Investing in broad market funds, holding them for a long time and collecting their dividends will eventually make you rich.
Robinhood is some magical app that deposits money in your bank account. But it has potential. As outlined above, the biggest problem I see with Robinhood is that it incentivizes bad investing habits.
If you are drawn to the modern platform and commission-free trades but at the same time prefer a long-term approach to investing and wealth building, take a look at M1 Finance.
I personally use them as my trusted broker on my path to financial independence.
Lastly, I just want to highlight the general importance of conducting your own research. In most cases, the quick and easy route is not the one that will offer the greatest rewards.
Put in effort, be patient. The rewards will come.