An article by Rick Kahler, MS, CFP®, CFT-I™, ChFC, CCIM

“There’s no such thing as a free lunch”. The adage suggesting you can’t get something for nothing seems to have bitten millions of unwitting investors who used a popular trading platform in the USA, Robinhood.

This summer, my 19-year-old son proudly informed me he was a Tesla owner – the company, not the car. Knowing Tesla was selling around $200 a share, I asked how many shares he purchased. He said “$15 worth. I don’t know how many shares that is. I found an app called Robinhood that allowed me to buy any amount I wanted.”

In the ensuing weeks, he checked the price of his purchase daily, watching his $15 run up to $22 and then slowly fall back to $14. Prior to this experience, his investments were diversified index funds that tended to be far less volatile. The daily volatility turned out to be too much for his young stomach to handle. He sold out his position in Tesla at $14.53 to realise a $0.43 loss and concluded, “I am not doing that again.”

Robinhood revolutionised the way small and younger investors can buy and sell shares, options, and cryptocurrency by eliminating minimum purchases and trading fees. The app, with its name implying it takes from the rich and gives to the poor, makes it easy and fun for anyone to invest.

How does a free app make money? Saloons of the 1890s gave away a lunch with every drink purchased. The free food was heavily salted, which resulted in the patrons buying a lot more high-priced beer than they planned.

Similarly, Robinhood used the concept of a heavily salted “free lunch” by using gaming-type experiences that encouraged their customers to trade more frequently and invest in higher-risk investments like bitcoin and options, all of which made the company more money.

Robinhood made much of their money by auctioning off their customer’s trading orders to the firm that would pay them the most money, resulting in the worst deal on pricing for their customers. The Securities and Exchange Commission (SEC) said Robinhood’s customers paid over $34 million (USD) more than they would have paid with other brokerage firms that charged fees.

What got Robinhood into trouble with the SEC was misleading consumers by not disclosing that customers paid the highest possible prices for the shares they purchased and received the lowest price for those they sold. The company agreed to pay a $65 million fine to settle the charges in December 2020.

Before you sign on for financial products or services that are “free”, first clarify how the company or person is making their money. If the answer is not clear and understandable, move on. The chances are that you’ll end up with the lowest overall cost by paying a fully transparent and disclosed fee.

Because the old adage is right! There is no such thing as a free lunch.