Everyone’s talking about RobinHood, the new trading app that offers commission free trading to retail investors. In their approach, co-founders Vladimir Tenev and Baiju Bhatt are betting on a best case scenario where the service will reach a critical mass of customers and daily trade volume that allow it to operate and profit through payments for order flow and account balance interest accumulation. If the best case scenario isn’t attainable? Then there is competitive margin (in beta) and options trading (still in planning). Some believe it is the brokerage firm that will finally bring millennials into the stock market with its free and mobile-only attributes, but the truth is that their business model isn’t an entirely new idea; their ultimate path to profitability may not put young investors’ best interests first.
The $0 commission business model is yet to rock the self-service brokerage industry or show any glimpse of sustainable practice. Also, no brokerage house or institution has been able to effectively “capture” the millennial market (although many are trying). After raising $25 million and taking a shot at commission-free trading, Zecco merged with TradeKing after slowly imposing fees and higher minimum balances on its “free trade” lured client base. For RobinHood, dodging the industry average 15% of revenue made from commission fees means compensating with an optimal amount of trade volume and/or interest collection. Since this approach has been unsuccessful in the past, it is certainly concerning to see a millennial-targeted trading platform with a revenue plan B based largely on leverage.
With college tuition debt soaring and post-graduation unemployment a very real danger, is it ethical to be targeting 21-34 year-olds for margin trading? One cannot help but imagine how many will rationalize diversion of “would be” commission fees into margin position interest. In fact, the prospect of free trading in RobinHood’s case might dilute the intricacy of risk in margin trading by way of the coupon mentality. With $0 trades, margin appears to be more like an upsell. After all, only 24% of young adults born between 1978 and 1994 could answer four or five questions correctly on a basic financial literacy quiz. In spite of that, the recent CI syndicated study “The Millennial Shift” found that although millennials themselves are concerned about financial literacy, 84% contradictively chose not to utilize financial education tools offered on institutional brokerage sites regarding retirement investing.
Thus far, the marketing seems to be working. According to the company’s correspondence with CNN Money, a notably lengthy wait list of 800,000 people grew before RobinHood’s successful public launch. The millennial reception is apparent. The average age of RobinHood users is 26, and 25% of customers are first-time investors. The co-founders frequently use the term “younger people” when discussing the user base, while repeatedly reminding the audience that they are not in it for the money.
Another company that has been particularly effective in targeting millennials and maintaining a $0 commission structure without public mention of margin trading is ACORNS. ACORNS allows users to round card payments to the nearest whole dollar and allocate that change towards a smart portfolio of their choosing. Account holders pay $1 per month for account balances under $5,000 or 0.25% per year against amounts over $5,000. Their user base was 35% 18 to 32 years old in October 2014 and as of May 2015 has attracted 750,000 people.
In Merrill Edge’s study “How Millennials Budget, Spend and Save Their Money,” 73% defined financial success as having no debt, while 73% said it meant living comfortably today; 70% said it was having enough for the retirement they want. This age group has real concerns and needs that could charm them into margin trading at the presence of reduced commission fees or service payments. Irrationality is at the center of behavioral finance. Cognitive dissonance between the need to save or pay bills and the prospect of margin trading amplifying market gains could very well combine into a new form of crisis, one in millennial margin debt loading. How could this millennial debt loading affect trading and saving behavior in the future? More importantly, how will it affect trust in the financial services industry over the next century?