Robinhood never understood what their appeal was
/[edit 11/25/24: a trusted reader in the comments has the 3% cash back credit card, so it does really exist]
I’ve written a number of times about Robinhood, the free stock-and-ETF trading app, over the years, and back in March I wrote about what I described as “one of the best all-in-one financial products out there.” I was wrong, so today I want to explain both how I was wrong and why it matters.
Recap: the Robinhood Gold pitch
When I wrote that post, I described the new $5-per-month Robinhood Gold service as consisting of two unrelated components:
a 5% APY interest rate on uninvested cash
and a 3% cash back credit card (this product, to the best of my knowledge, still has not been launched, so set it aside for now).
Some people pointed out that this product also includes $1,000 in free margin in your investment account, but as will become clear, that is not worth nearly as much as it sounds. I would go so far as to say it is worth nothing, or less than nothing if it causes you to enroll in Robinhood Gold.
Market rates versus administered rates
My first mistake was misunderstanding how Robinhood markets the interest rates on uninvested cash, which illustrates the difference between “market” rates and what I call “administered” rates.
A “market” rate is like the one set on your credit cards or adjustable-rate mortgages: your loan agreement specifies a particular market index reported in some reputable newspaper and says you’ll pay that rate plus-or-minus an adjustment based on your down payment, credit rating, or the phases of the moon. The point being, the rate will change but it will change in a specified way known in advance: when the published market rate rises or falls.
An administered rate is set by the policy of the institution offering the investment or holding your funds. It is also subject to change, but it is set to administrative change, not mechanical or contractual change.
For example, US government Series EE savings bonds have an administered interest rate of (at least) 3.53% APY: the bond is guaranteed to pay out twice the invested amount after 20 years. If interest rates rise above 3.53% APY while you’re holding the bond, you also have the option to cash it out (with a penalty) and invest in the higher-yielding asset instead.
The rate on those bonds is administered by the US federal government, but in fact a lot of institutions work this way, normally as a way to gain customers. A bank or credit union can lose a little bit of money by paying above-market rates if their new customers also move in their lower-rate deposits or, even better, take out higher-interest loans like credit cards. This type of account is often marketed as a “Rewards” or “Kasasa” checking account, and I keep an eye on them at depositaccounts.com (although I’m sure there are other sources; I have no relationship with that website, I just use it).
Robinhood offers bad market rates, not good administered rates
In my post on Robinhood Gold I said, “The 5% APY offered on balances up to a million or so dollars of insured deposits[…]is competitive, but it’s not best-in-class; Vanguard is paying 5.28% on uninvested cash in their own brokerage’s sweep account as of today.”
But while Robinhood was advertising the Gold product as offering 5% APY, that was not true. It was just advertising its current below-market interest rate, and when interest rates went down, its below-market interest rate also went down.
This has happened twice since my post, and Robinhood has continued to misleadingly advertise the product in this way: first “earn 4.75% APY on your cash,” and now “earn 4.25% APY on your cash.”
Vanguard’s default federal money market settlement fund has a 4.58% 7-day SEC yield as of November 22, 2024. In other words, Robinhood started out earning less than Vanguard, and instead of becoming more attractive as an administered rate it has rushed ahead of them to become less attractive as a (below-)market rate.
The Robinhood Gold fee is administered
Hopefully the problem is now coming into focus: Robinhood charges a flat $5 monthly fee, but pays a fluctuating rate on uninvested cash. At a 5% APY, it takes $2,400 in uninvested cash to break even with the monthly fee. At 4.25%, it takes $2,824.
As interest rates fall and fees stay steady, it takes more and more uninvested cash to merely cover the fees on the account, before it even makes sense to start comparing interest rates.
You cannot hold both uninvested cash and use margin
The final issue, and why I didn’t bother mentioning it in my March post, is that you cannot take advantage of the free $1,000 in margin offered as a benefit of the account while also taking advantage of the interest rate offered a benefit of the account.
You can think of this in two different ways:
the first dollar of a stock or ETF you buy always comes out of your uninvested cash;
and the first dollar you receive when selling a stock or ETF is always used to repay your margin first before it begins to earn any interest.
Conclusion: don’t sign up for Robinhood Gold for any of their advertised benefits
I like to think that what makes this site different is that I always try to be as honest, straightforward, and accurate as possible, so lest any of my beloved readers get misled: I plan to continue paying for Robinhood Gold.
I’ve been experimenting with Robinhood extensively and have found some specific uses (unrelated to investing) which I’m not able to describe in detail right now, but which I’m happy to pay $120 per year to continue experimenting with.
What I certainly won’t be using it for is to hold my uninvested cash: cash is too valuable to hold with people whose business model is to make sure you get as little value for your money as possible.
As for investing with the account, I’ll be using $1,000 in cash and $1,000 in margin to partially or wholly offset the annual fee, as well as hold the free stocks they give me when people (very) occasionally use my personal referral link.
