Charlie Munger and Robinhood

Munger,Warren Buffett’s long-time investing partner at Berkshire Hathaway, recently expressed his disapproval of the business model of Robinhood. As I understand it, he has two complaints: the app encourages users to trade stocks and options in reckless ways that harm to the traders’ economic health and that this recklessness itself is the main source of Robinhood’s profits. Robinhood’s reply is that the ultra-wealthy 97-year-old is an elitist.

Robinhood has a point. Traditional “full service” brokers charge high prices and deliver, in my experience, very little either in service or superior investment performance. That’s presumably because these firms get paid on some combination of assets under management and the amount of trading done in an account–not on investment performance. They’re also a dying breed.

Discount brokers, the new and improved model, make their money in similar fashion–margin accounts, stock lending, bid-asked spreads and payments for order flow. This is by and large invisible to clients. Again, profits are mostly a function of how much trading is done, not investment performance. In fact, discounters go out of their way to underline that the colorful charts and technical tools they provide are not investment advice (which of course they aren’t) for fear of being sued. Robinhood is arguably the same wine in bottles more attractive to younger investors.

Munger may have a point as well. I signed up for a Robinhood account a few months ago but haven’t used it. Preparing to write this I went back for another look. What impressed me first time around was the bright colors, the speed at which I was whisked through the regulatory formalities and the way I was pointed toward options trading, the product that history says is the most lucrative for a broker and the least so for the client. The vibe reminded me of the time I saw a long line of people in the Luxor Casino in Las Vegas waiting to pay a dollar (five dollars?) for an employee to guess their weight. A guess within two pounds meant the weighee lost all his money. A guess outside that still meant losing the money, but getting a stuffed animal worth about $.25.

When I went back the other day the bright colors had been replaced by a more sober white and there were simple charts and other market information available that was either new or I wasn’t able to find on my first visit. There’s no information about how much money Robinhood makes for directing trades to third parties for execution, or the care it takes to ensure that the executions are at reasonable prices for its clients. But that’s basically the same as for any other discount broker.

The only information I can see that might have triggered Munger’s comments–Munger may have more–about how Robinhood regards its customers’ welfare vs. its own profits comes from its declining to take customer buy orders for “meme” stocks during recent runaway Gamestop trading. Its reason? it didn’t have enough assets to post collateral for new trades during the two-day clearing process. After the fact, however, Robinhood raised several billion dollars almost instantly. To me, this says the owners of the company chose the path they took. They judged it was better for them personally to avoid paying for extra capital and run the risk of having to suspend trading, rather than incur the cost to obtain new capital that would ensure customers’ trading would be uninterrupted and not need it. Munger’s point would be that for Robinhood the idea is not that we’ll all grow rich together but instead that a dollar in my pocket is a dollar not in theirs.

None of this explains why Merrill Edge, a part of Bank of America, refused new buy orders as well.

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