The emergence of free investing apps over the last decade has changed the brokerage industry forever.
Commission-free platforms like Robinhood and Webull have propelled the industry along with cutting-edge apps and fully accessible platforms. Now, major brokerages like Charles Schwab are following suit by eliminating commissions on trading and making legacy open to everyone!
But, like so many other free platforms out there, it can be difficult to see how a company running a free service is actually making any money. A lot of people even question whether or not these free apps are a scam!
We can assure you that Robinhood and the other free apps we review are not a scam.
And in fact, they do make money. Just not in the way that you would suppose.
Robinhood, and other free apps, have millions of dollars in venture funding that back them and allow them to offer great sign up incentives like free stocks for new users!
If you prefer watching instead, check out our video on this topic below!
Robinhood first launched in 2013 as one of the first-ever commission-free trading platforms. It has since grown to nearly 20 million active monthly users and has amassed holdings of greater than $95 billion of assets under custody.
This incredible accomplishment has been fueled by Robinhood's unrelenting pursuit to provide a great customer experience and make investing available to all.
Robinhood offers free trades on stocks, ETFs, and cryptocurrencies and has no minimum account balance.
It offers all of this while still being one of the absolute best beginner-friendly investment platforms available. Robinhood's mobile app offers a great on-the-go investing system and boasts a large amount of usability.
With all this in mind, it is easy to see why Robinhood has grown to be the investing giant that it is today.
As mentioned earlier, Robinhood is not operating a charity. The company does make money outside of the old brokerage model of charging trading commissions and fees.
It is also important to note that the company follows a number of cost-cutting measures to reduce losses. Some of these tactics include sending all documents and statements electronically and keeping all operations remote by not operating any physical locations. Unlike many legacy investing systems.
That being said, here is how the company is making money.
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The first way Robinhood makes money is the Robinhood Gold tier of service, the paid features of the Robinhood system.
While Robinhood is entirely free to use, you are able to purchase a subscription in order to gain access to its premium features.
Robinhood Gold starts at $5 per month.
With it, you gain access to professional research from Morningstar, margin investing, and larger instant deposits.
In 2018, Robinhood said that 75% of its transactions went through the Gold tier service. It doesn't give exact numbers here but we can see that a lot of its users are taking advantage of this product.
Buying on margin is popular with a lot of investors but the practice does work slightly different on Robinhood than with other platforms.
First, you’ll have to get a Robinhood Gold subscription.
You will pay a $5 fee monthly in order to have access to $1,000 of margin.
If you would like to borrow more than $1,000, you will pay 2.5% interest yearly on any amount above $1,000.
The amount of interest you owe is based on the amount of margin you are using at the end of each day.
There is an example of this on the Robinhood website which we will show below:
The daily interest rate is 2.5% divided by 360.
For example, if you use $3,000 of margin, we’ll calculate $0.14 of daily interest as follows:
$3,000 margin used
$1,000 included with your monthly fee, leaving $2,000 subject to interest
$2,000 * 2.5% / 360 = $0.14 per day
Robinhood also makes money by investing your excess cash reserves.
By doing this Robinhood can earn a small amount of interest on your idle cash.
This is the same practice that banks use with your money if you have an account with them. There isn’t a whole lot of money made off of each individual account. But when you add up all of Robinhood’s nearly 20 million users this can really start to pile on.
Because of its broad usage, you shouldn’t be too concerned about this tactic. In addition to being used by nearly all banks, your money is also SIPC insured if something were to happen as a result of it being mismanaged or mishandled.
Order flow is another extremely lucrative process that Robinhood uses to make money.
Robinhood states that it will sell your order to market makers that allow you to receive reportedly “better execution quality and better prices."
This means that market makers will pay Robinhood to send orders their way instead of going to a different market maker.
This is common practice for a lot of brokerages today but has drawn a lot of scrutiny. When you sell as many shares as Robinhood does in a day, this can turn into some serious profits.
Robinhood uses this strategy so efficiently that in 2018 it made up over 40% of its total revenue.
Rebates do not make as much money for Robinhood as the other practices, but the company still uses it to bring in revenue.
A rebate is what happens when a brokerage sells securities that they do not own to market makers. As we’re sure you can tell, Robinhood does this on every trade.
Robinhood makes a tiny amount, around $0.00026, for every dollar that is traded on the system.
Robinhood recently revealed its Cash Management program. This allows you to put unused investment cash into an account that will earn interest. You also will be able to spend this like it was cash with a debit card.
Just like your investments, your cash is also protected from fraud and other misuse by the company.
There are no transfer fees or foreign transaction fees with Robinhood, but the platform makes money through the Robinhood debit card.
Sutton Bank, which issues the debit card, earns an interchange fee that they pass onto Robinhood.
This one might sound obvious, but we’re not talking about investors as in people using their service, though they might be.
We mean big investors that have been supporting the company financially, a.k.a. venture capital.
With all the waves that Robinhood made when it launched, it’s not surprising it got a lot of interest from big-time investors. Since it’s still pretty new in the investing world, a lot of these investors are still funneling a lot of money into the company.
Robinhood has raised $5.6 billion in total funding so far.
Though this isn't considered revenue, these funds allow the business to keep thriving!
Again, this is why they can offer new users a free stock for signing up with them.
Brokerages like Robinhood make money in several different ways. The items we have covered above are just the big ones.
Even though it is a free service, Robinhood is just as safe to use as many of the other investment platforms that charge fees for their services.
There are two big ways Robinhood makes money:
Robinhood also makes money via margin lending which can earn up to a 2.5% daily interest rate.
And of course, the Robinhood Gold tier membership. This costs $5 per month and provides access to more features on its platform such as research tools and margin lending.