The recent astronomical rise in meme stock first brought many people to the stock market, mostly through Robinhood, the commission-free stock trading app that has pledged to democratize access to the stock market. According to a number of financial advisers, the app appears to be democratizing certain types of risky investing, such as day trading. There are potentially less risky – and equally easy to use – app options out there.
The thing is, it is impossible to predict the market. Many professionals spend their entire careers doing this, with varying degrees of success. And common people who invest in individual stocks in the short term are likely to lose money no matter what you hear on TikTok. Study after study said it
Of particular concern are & # 39; herding events & # 39; including events sparked in Reddit's WallStreetBets community that encouraged large numbers of people to invest in certain stocks, such as GameStop and AMC. On Robinhood, people were already more likely than other private investors – people who aren't professionals – to invest in the same stocks as other users, said Christopher Schwarz, faculty director of the University of California Irvine & # 39; s Center for Investment and Wealth Management and one of the authors of one paper looking at the results of investor behavior on RobinhoodWhen too many people crowd out a stock, "the stock price goes higher than it should be and is corrected over the following days."
The study, which was conducted using Robinhood trading data from 2018 to 2020, found that those who invested in the top 10 newly bought stocks achieved returns 5 percent lower than the S&P 500 in the following month index – a "pretty gruesome" result, Schwarz said. Robinhood is the only trading app that has disclosed user ownership, so the researchers didn't compare investor performance against competitors.
Put another way, "If you were a Robinhood user and bought those top 10 stocks every day, you would have lost 97 percent of your money in two years," Schwarz said. He added, "It is probably one of the greatest negative returns documented by academics."
Robinhood has been criticized to make people trade on credit and to make investing feel like a game, using elements like confetti and color coding in the app to drive trading.
"We are proud to expand access to the financial system and empower millions of people to learn and invest responsibly," a Robinhood spokesperson told Recode. "We see evidence that most Robinhood clients have a buy-and-hold strategy, and research from the National Bureau of Economic Research found Robinhood clients acted as a market stabilizing force through market volatility in 2020."
Still, even professionals don't have a great track record of stock selection.
Cory Clark, chief marketing officer at financial services market research firm, mutual fund investors consistently perform below the S&P 500 index Dalbar and lead author of a long-standing report on the topic.
These institutional investors fall prey to confirmation bias, with a positive trade making them overly confident in their capabilities, he said. There is reason to believe that ordinary people may be even more susceptible.
"In the context of day trading, that's on steroids," said Clark. "It's very dangerous for average investors."
All of this is to say that day trading – buying and selling stock in short periods of time – is not a reliable way to build wealth, according to these financial advisors.
Such as Gretchen Behnke, director at Pearl financial planning, it said, "Individual stock selection is almost always too risky for ordinary people."
What she and every other financial professional we spoke with suggested the opposite of individual stocks in day trading: investing in highly diversified and low-cost exchange-traded funds (ETFs) or index funds and leaving that money in there for a long time. .
Of course, talk to your own financial advisor or investment professional to decide what's best for you.
"Prudent investments can be boring," Zach Teutsch, managing partner at the consulting firm Values Added Financial, told Recode. "If it's fun, it's probably because someone turned it into a game to make it more fun as entertainment – all to help benefit the investor."
How to Best Use Robinhood and Other Day Trading Apps
The safest bet on Robinhood is to buy a wide variety of ETFs, rather than individual stocks like GameStop or even riskier products like options. Like mutual funds – which you can't buy on Robinhood, but you can buy in apps from competitors such as Schwab, Fidelity, and Vanguard – ETFs are low-cost baskets of professionally managed stocks that follow a particular investment strategy. For example, some ETFs and mutual funds offer exposure to all stocks in the S&P 500, while others focus on different company sizes or industries.
One of those funds, Adasina Social Justice All Cap Global ETF, includes 900 companies that, according to Adasina, are in line with social justice movements such as Black Lives Matter.
"This whole situation with GameStop stemmed from popular dissatisfaction with wealth inequality," said Rachel Robasciotti, the founder and CEO of Adasina Social Capital. "When you are ready to put your money where your values are, do it the smart way. Use a fund that is diversified."
Financial advisers encourage investing in such funds to give people exposure to a wider range of stocks than they would get by choosing individual stocks so that their risk is more balanced. The idea is that hopefully declines in some stocks will be offset by gains in others.
Many financial advisors also recommend leaving your money in these funds for an extended period of time. Teutsch is trying to get huge yields quickly by replacing a recipe that requires 400 degrees for an hour with double the temperature half the time.
"That's what people try to do when investing. That's not how investing works," he said.
When people invest in individual stocks for the short term, it can be tempting to buy and sell with market fluctuations, he said. Huge gains – like the more than 1,700 percent increase on GameStop this year before the ensuing fall – are possible, but so are massive losses. Stocks are volatile in the short term, but in the long term, the market as a whole tends to rise. That's why advisors recommend investing money and then leaving it alone for years, if not decades.
Long-term investments are also fiscally better. People new to trading on Robinhood might be surprised how much investment income is taxedFor example, if you sell your investments within a year of purchase, you could be taxed at significantly higher capital gains rates than if you held them for more than a year.
Financial advisors we spoke to said, if you're going to day trade apps like Robinhood, make sure you're doing it with only a small percentage of your money.
"You can take a small amount and play with it, but consider it an entertainment expense," Behnke said. "This is separate from savings and retirement."
Likewise, the experts also say you shouldn't invest money that you don't have. Robinhood lets people trade on margin, which means they give you a small loan. This allows people to potentially invest – or lose – more money than they have.
Other investment apps take a different approach
The latest meme stock news has raised awareness of investing in general as a way to accumulate wealth and save for retirement. And the rise of Robinhood has been accompanied by increased popularity in investment apps that don't include day trading, such as Acorns, Betterment, Wealthfront, and, to an extent, Stash. For example, Acorns saw 100,000 new customers on the day of the GameStop news.
For a fee, these apps handle the slow, tedious work of investing your money in diversified funds (usually ETFs) and provide some other services like portfolio rebalancing and tax loss harvesting. so that your money can slowly but surely make more money. . We have outlined how they work:
Acorns ($ 1- $ 5 per month)
With Acorns, you can automatically add money to a wide variety of ETFs in a range of pre-selected portfolios, through regularly scheduled deposits and by rounding money on your purchases and putting that money in your account. It also does unsexy things like reinvest dividends and rebalance your portfolio.
Acorn's CEO Noah Kerner wants customers to invest their money for as long as possible.
"People get into trouble because people suddenly panic and incur a loss," he said. "Now is the time to stick with it and invest even more."
Acorns has a monthly subscription model, unlike Robinhood, which doesn't charge users but makes money depending on the volume of the transactions. Kerner believes that Acorns' business model allows it to better serve its customers.
"The business model determines how a company makes decisions," said Kerner. "I am not trying to make decisions that are not in line with your interests."
Improvement (0.25 percent of the assets under management per year)
Improvement provides investors with a range of diversified ETFs based on a number of factors, such as their age and risk aversion, all of which are determined by a questionnaire.
"These are not short-term speculative things," Dan Egan, VP of Behavioral Finance and Investing at Betterment, told Recode.
Investors can choose Betterment for them or decide to put their money in socially responsible portfolios, such as those related to climate change prevention or promoting social justice.
Accounts are like harvesting tax losses, which helps people lower their tax bills by using losses to offset gains. The app also lets people trying to sell assets know how much more they may have to pay in tax compared to holding the investment longer.
Like Robinhood, Betterment uses visual cues within the app. Unlike Robinhood, which is color-coded based on how much a stock rises or falls and can get people to respond to prices afterwards, Egan says Betterment uses color-coding to motivate people to follow their stated investment goals.
"You can't change yesterday's returns, but you can make changes to get your financial plan on track," he said.
Wealth (0.25 percent of the assets under management per year)
Wealthfront also uses a questionnaire to determine the best investment strategy for people, depending on criteria such as age and risk aversion. The site is designed to work very differently from Robinhood.
“We are certainly at the other end of the spectrum of a day trading platform. Our whole thesis on investing is that you cannot control or beat the market on a consistent basis, ”said Kate Wauck, VP of Communications. Instead, the company puts people's money in low-cost diversified index funds.
It also does portfolio balancing and tax loss harvesting, things that most mainstream investors are not believed to want to get involved in.
“We are for people who have some money saved in their bank account and who know it won't make money, but who don't want to spend time thinking about investing and getting actively involved,” she said.
Stash ($ 1- $ 9 per month)
Stash is sort of an amalgam of Robinhood and Acorns. Like Robinhood, it allows you to invest in individual stocks and ETFs, but tries to hold onto them for a longer period of time.
“We purposely built a bad day trading system,” founder and CEO Brandon Krieg told CNBC earlier this month. "Our brand and message, as well as our onboarding, are not attractive to anyone who comes to daily trading."
Like Acorns, it encourages people to increase their investments with automated deposits and rounding up the money spent on purchases. The user is responsible for choosing individual stocks and ETFs to build a portfolio, but the app asks the user to diversify those assets.
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