Investing apps that make stock trading look like a video game have attracted younger and more diverse investors in recent years. But free platforms can also be risky, especially for inexperienced investors. That’s why it’s important to know how to use them safely.
Millions of novice investors have flocked to mobile investment apps like Robinhood, WeBull, and Coinbase. These digital investment services allow you to open an account and trade stocks and cryptocurrencies for free. But the experience is not focused on making smart long-term investments, according to some financial experts. Instead, the screen is filled with flashy graphics and suggestions for frequent trading, making it more like a video game or online gambling.
“The biggest drawback of investment apps is that they encourage trading too often,” says Nick Bormann, a certified financial advisor based in Spokane, Washington. “They emphasize short-term price movements, provide audio and visual feedback to make trading seem fun, and use other strategies that get their users to buy and sell more often.”
If investors lose money or have a negative experience at first, they may be discouraged from saving and investing for the long term. That’s why the first step for a new investor should be to establish a long-term savings plan and use more sophisticated investment platforms such as robotic advisors, which offer investment advice tailored to your long-term goals.
“Before you start choosing shares, you should create your account 401(k) and start contributing to the maximum as soon as possible. possible,” says Arthur Flores, a New York-based certified financial advisor who works with a broad spectrum of clients, from high-net-worth individuals to people just starting out. You should also have created a solid emergency savings fund and paid off your high-interest debt.
“I will always recommend robotic advice as your first type of investment, rather than going into a Robinhood or a more self-directed type of account,” says Flores. “ they are basically ‘install it and forget it’ products that take care of almost everything. But turning to Robinhood before you’ve created a retirement account is too speculative. It’s more like gambling.”
A spokesperson for Robinhood responded to criticism of the platform by him by saying that the company makes investing more accessible and affordable for everyone.
“It is a serious mistake to equate that with the promotion of risk behaviors”, said the spokesman. “Over the last year and a half we have enhanced our educational resources, both on Robinhood Learn and directly within the app through the launch of First Trade Recommendations for new clients and phone support 000/7 [24 horas del día, 7 días de la semana]. We remain committed to making Robinhood a place to learn and invest responsibly.”
In fact, Robinhood notes that it is currently working to create investment products more in line with retirement planning.
“Tax-advantaged retirement accounts are on the roadmap, and teams are already hard at work developing this functionality,” said Robinhood CEO Vladimir Tenev , during a webcast last year. However, a company spokesperson did not provide Consumer Reports with any additional details on when these products would be available.
If you’ve already established a solid retirement plan and have some extra money you want to invest, you can take advantage of these free investment platforms. But you have to be quite cautious when it comes to investing and be aware of the risks of using these apps. Here are some guidelines to help you.
Don’t trade too often
Your trades are how you self-directed investment apps make money and want you to do it often, but experts say there’s plenty of research to suggest frequent activity is detrimental to returns.
“There is an inverse correlation between how often you trade and the return on your investments,” says Spencer Jakab, author of “The Revolution That Wasn’t: GameStop, Reddit, and the Fleecing of Small Investors.” “It’s been shown in many studies that just looking at your account is dangerous for your net worth,” he says.
The important thing is to understand your investment goals, says Steve Windell, head of Morningstar Behavioral Sciences. “The incentive of the platforms is that you trade more and, as a consumer, you have to ask yourself: “Is my incentive to save or trade?”, he says.
Avoid emotional transactions and instinctive
“Self-managed brokerage sites may not charge commissions, but they can cost you more just because of overtrading and overreacting to news when the best Investors will tell you to buy and wait”, says Bormann.
“A lot of people time the market and want to get in and out, in and out, in and out. And that system doesn’t work,” says Flores. “What works best for people is to think about continuing to invest, especially if they have a long-term goal.”
To avoid emotional trading, you should limit your news alerts of the market and avoid following the advice of social networks. News and social media apps coexist with investment apps on smartphones, broadcasting messages in real time and constantly encouraging users to act based on the latest information. This instant and constant connection reduces the time it takes from receiving new information to making a decision based on it (known as friction).
Frequent market alerts can easily overwhelm users, short-circuiting their critical thinking. They can cause investors to inadvertently make hasty decisions and manipulate their investments more often than would be beneficial.
“Most market news is best viewed just for entertainment,” says Bormann. “Removing news app alerts can be a good idea so they don’t get your attention.”
You should also be careful with social networks, says Jakab.
“If you go to social media for advice,” he says, “the advice that gets the most attention is not necessarily the best, but the one that gets the most votes, rather the case of Reddit. It is the one with the most clicks, in the case of YouTube or TikTok. He is the most televised person, the most well-known person, perhaps a kind of ‘influencer’, in quotes”.
Manage the default settings of your application
Depending on the app, users may by default access services that encourage them to start trading as quickly as possible or even when they don’t have enough money in their account.
For example, Robinhood users are by default enrolled in a lending program called Instant Cash, unless they opt out during the onboarding process. With this program, Robinhood gives users up to $1,000 in credit to start trading right away, instead of having to wait a few days while it clears. your bank transfer to your Robinhood account.
If you prefer not to participate in the program, opting out of this option is not very intuitive. Users must scroll to the bottom of one of the app’s onboarding pages. There is another document there. The user then has to scroll to the bottom of this document to find the opt-out option. If you choose to click on it, a pop-up appears describing the non-Instant Cash version of Robinhood as being downgraded from the service.
In addition, many brokerage accounts have margin trading turned on automatically. “With debt margin, you can easily buy more securities than you have cash in the account and the broker lends you the difference,” says Bormann. The problem is that it may incur interest charges, or if the value of the securities falls, the broker may send you a margin call or settle your charges to cover the debt. “There are many, many investment horror stories that come from overuse of margin,” he says.
Don’t forget about taxes
Short-term gains are taxed as regular income, which reduces total returns. “It’s one of the reasons frequent trading is harmful,” says Bormann. “If you sell at a loss and then repurchase substantially the same security within a period of 30 days, it is a fictitious sale and you cannot claim the loss to offset the gain “, he says. Many brokers will keep track of fictitious sales for you, but the consequence is that you may end up paying more tax than expected. “Transacting less frequently makes it less likely that you will make short-term profits or have fictitious sale problems,” says Bormann.
In the case of cryptocurrencies, the Exchanges are less regulated and tax reporting weaker, but the IRS is becoming more active in auditing crypto earnings. “The investor must keep accurate personal records of his cost basis and profit or loss on each transaction,” says Bormann. “If you don’t report it, the IRS will show up sooner or later!”
Stay away from options trading
In some self-directed investment apps, you can sign up to trade options quite easily. That’s problematic because these are among the riskiest investments out there. They are only supposed to be available to investors who can demonstrate their experience, exposure and track record. Windell says that the screening process used by many self-directed apps is too narrow, allowing people who might not be suitable for this type of transaction to participate.
“For most Of investments, the worst result is that it reaches zero, but with some options strategies it is possible to lose even more than what you invest”, says Bormann. “Financial models for trading options are dense and complicated, so inexperienced investors can end up acting like gamblers because options magnify both profits and losses,” he says.
And the psychological swings are huge, because options are time-limited and provide huge leverage even at small price movements. “In extreme cases, it becomes like a gambling addiction and people lose much more than they can afford,” he says.
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Consumer Reports has no financial relationship with advertisers on this site. Consumer Reports is an independent, nonprofit organization that works with consumers to create a fair, safe, and healthy world. CR does not endorse products or services and does not accept advertising. Copyright © 2022, Consumer Reports, Inc.