Robinhood Can Turn Every iPhone User Into A Trader

The mobile stock trading startup turns stock buying and selling into yet another thing to be done inside a mobile app. The target is young people that have turned away from traditional stockbrokers — or never had one at all.

Vlad Tenev and Baiju Bhatt are on their third startup, their third finance startup. And it was inspired by Occupy Wall Street.

The founders of Robinhood — the sons of immigrant dads who moved to the U.S. to go to graduate school — met at Stanford, studied physics, then math, and founded a proprietary trading firm called Celeris. After that, they founded a software company with their own money, living "on a steady diet of bulk foods and government cheese," co-foudner Vlad Tenev said, that helped build trading systems for large banks and hedge funds. Then Occupy Wall Street happened.

"That was a pretty big eye opener, a lot of our friends and close personal contacts were, not to mince words, like 'what the hell are you doing, why are you doing this?'" co-founder Baiju Bhatt said. "We asked ourselves that question, 'why are we doing this?'"

"Weren't we the ones who were expected to have a better outlook and not become part of this system that is broken, that really troubled us and got us to really ask some deep questions about what we were doing and why we were doing it?"

Their idea for helping fix the system: trading stocks, for no commission, on your cell phone.

Robinhood, whose app goes live on the App Store Thursday morning, already has attracted interest from young, tech-savvy investors who are many decades removed from the standard clients of a discount brokerage like Charles Schwab or E*Trade.

The way they explain it, the commissions these companies charge of around $7 or $10 do not in any way relfect the cost of doing a trade. "The physical cost is zero [of making a trade], it's like sending an email. We saw institutional clients aren't placing trades and paying dollars, they're basically placing trades entirely for free," Tenev said. There are also no account minimums.

Instead, the founders maintain, the high costs reflects the marketing spend of these companies, along with client service costs like paper records and storefronts. Robinhood has no plans to air Super Bowl ads, at least for now.

Robinhood plans to make money instead by letting customers use what's known as margin — borrowing money to buy more stock — and then collecting interest. They will also use what's known as payment for order flow — selling orders to large trading shops who then execute the trades themselves, although Bhatt says this is a not a significant revenue generator. Other retails brokers sell their orders — Charles Schwab routes many of its orders to UBS, e*Trade uses a former subsidiary for the bulk of its trades.

They also plan to eventually make the Robinhood API available to other app users, charging developers for access to the system.

One reason Robinhood's established rivals need to charge commissions on buying and selling shares is they need to cover the cost of trying to lure middle aged and older savers near retirement age, or win them from other brokers. Thus the Charles Schwab Cup Championship golf tournament in Scottsdale, Arizona, or the infamous e*Trade talking baby. Or TD Ameritrade's NFL sponsorship. Or Interactive Brokers' CNBC ads.

What Robinhood has found so far with its beta test is that its users are by and large not experienced investors or traders trying out a new toy, but instead first investors. The average age is 27, Bhatt said, about 30 years younger than typical discount brokers.

This has meant a lot of attention to security and authentication of users – not only do they want to make it easy — they are dealing with clients without much banking or credit history, some even have social security numbers that aren't recognized by credit bureaus, Tenev said.

First time investors, despite encountering an attractive, easy to use interface, will be asked upfront to give far more information than they do for most apps: banking information, date of birth, address, social security number, whether a relative owns more than 10% of a publicly traded security. Approval can take up to three days.

A few thousand people are using the app in beta, giving Tenev and Bhatt more insight into how people actually used the product. One thing they found — users averaged only four trades per month, but still checked the app about 20 times a week, even when they weren't trading. "It's really a daily habit, almost like opening your email or checking your Instagram," Tenev said. It even looks like the native iPhone stock app, Tenev said, which was a deliberate design choice to make young, first time traders more comfortable with it. The company says it has an almost 500,000 person waitlist.

The app's design and layout was partially inspired by payment apps like Venmo and Square Cash, with layers of verification for actually executing a trade, including a swipe before the trade finally goes through.

The rhetoric coming from the founders is reminiscent of what other financial and investing startups like Wealthfront or Betterment say about themselves: low cost, institutional-quality service, enabled by technology, without massive marketing and advertising spending. And of course it's all all aimed at younger people who are scared of saving and investing. But while the music is the same, the lyrics are different.

Wealthfront and Betterment, which construct automated investment portfolios using formulas borrowed from academic finance, are an explicit criticism of daily, weekly, or even monthly trading in individual stocks. The two services preach diversification and not really paying attention to the short term fluctuations of a client's portfolio.

Bhatt says that Robinhood can help alleviate distrust people have about investing in individual stocks. "I think the deeper problem is that for a lot of young people just think the idea of investing is quite dull, that it seems like it's for people who are about to retire." While Bhatt and Tenev say they don't want people to become twitchy, 90s style day traders, they do think everyone should get cheap access to individual stocks.

"We think it's healthy for normal investors to be directly invested in these companies, as opposed to buying exchange traded funds where the funds are picking companies and managing these products," Tenev said.

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