The greatest possibility allowed by the fee structure of Robinhood vs. other brokers, is the possibility of cheap indexing. Robinhood generates revenue probably primarily in two ways: the bid/ask spread(acting as a market maker between Robinhood users), and selling your trading data to institutional investors who want to inverse you. Both amount to a tiny fee relative to both a flat-fee and percentage basis, and the second one doesn't actually cost you anything at all(it actually benefits you by providing liquidity). We all know this of course. This is what we love about Robinhood. But what most people may not realize, is that this platform enables a small investor to have a greatly diversified portfolio, without having to buy an index fund. Ben Graham, Buffett's mentor, exemplified the incredibly-diversified but non-indexed portfolio. You can have it too.
OK, so why not just buy an index fund? Well, index funds carry some fundamental flaws. Not all of these apply to all index funds, but most apply to the popular ones. 1. They are less passively-managed than you think. S&P 500 funds, for instance, have to buy and sell stocks as the stocks in the S&P 500 index are reclassified(for instance AMD was recently added). There are data to show that whenever a stock joins the S&P 500, it goes up a lot. This is probably mostly due to purchasing by these mutual funds. Mutual funds don't directly pay these fees and taxes, but they pass them through to the consumer. This problem is largest with the S&P 500 fund, but all funds generally engage in buying and selling. (they have to, by their very design; no index can own the entire market without owning garbage penny stocks, which would present its own problems) This generates fees and taxes, all of which have to be paid by the consumer. 2. Most indices are market-cap weighted. This has the systemic effect of over-weighting overvalued companies. An equal-weighting approach or value-weighted approach will outperform. 3. Garbage companies. Stocks are frequently overvalued, much more often than they are undervalued(this is due to the asymmetry between going long and short-- going short entails much more risk). Indices will contain garbage companies. If you're willing to do a little research, you can probably avoid many of these garbage companies, with say, a simple stock screener.
OK, to sum up, I do not believe that all of these problems can be avoided simultaneously with a market index. If you buy the S&P 500, you will avoid garbage companies, but you will pay too much. If you buy the full-market index, you will end up with garbage companies. All indices to my knowledge buy and sell and generate fees. You can do better. Here is what I recommend:
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If you have less than $1000, you will probably not be able to diversify enough with this method in order for it to matter. Therefore, go for either super-low risk investments like T-bonds, ultra-blue chip stocks like Berkshire Hathaway, or if you can afford to lose everything, go for something incredibly risky and with a potentially extremely high expected return( i.e. crypto, but could be anything).
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Now we can begin. You will just have to look at lots of stocks. Start with a stock screener or another automated method whose purpose is to generate ideas. If you don't have the time to actually analyze any stocks(in other words, you are a rational person who actually understands that focusing on one's career is far more important than trying to make a buck playing the stock market), then just use the results of that screener. There is good evidence that simple stock screening strategies actually can outperform the market. Low P/E, small cap, and Book/market screeners all tend to outperform(some academics think that this is because these stocks are inherently undiversifiably riskier; that may be part of it, but most would agree there are genuine outperformance factors as well, due to lower liquidity, institutional investors with short-term focus, etc. ). Sorry to digress.
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Buy very small quantities of the stocks that pass your screens, or pass a quick analysis, say less than $50 per stock(sorry, this strategy means you can't own $AMZN). If you have a portfolio of $5000, then you can own 100 different stocks. That is a lot of diversification. I don't know about you, but I would sleep easier at night knowing that I don't have 100% of my savings in $AMD. If you like a stock, you don't have to fret too much about it, and scare yourself silly with the prospects of losing it all. Sometimes the riskiest-seeming stocks are actually a lot less risky than you might think, and the ability to invest with less fear may well boost your picking ability. When you do buy these stocks, consider using only limit orders to minimize risk from liquidity scalpers( I am a little bit torn as to whether this is a good idea or not, I have generally been doing it).
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Forget about these stocks. Some will go up, some will go down. A small fraction will appreciate considerably, a modest fraction will go to 0. You will have created your own fund that is actually, over the long term, lower in fees than any index fund is, or could possibly be. Of course, this fund will get less diversified as time goes on, but you will probably be a net buyer of stocks over your lifetime, so who cares? You can always increase your diversification by buying more stocks.
To sum up, I hated being forced to choose between high fee as a percentage of trades, and diversification. You really cannot outperform the market long-term through a $5/trade flat-fee broker, with less than $10,000, unless you are very very skilled, or get lucky. But with Robinhood, I believe you can. You can simultaneously reap the benefits of diversification and systematic market inefficiencies such as underpricing of small-cap stocks. I hope this made sense. Unless it's bad advice, in which case, I hope it didn't make very much sense so you don't follow it. Good luck.
Submitted June 10, 2017 at 02:38AM by Jowemaha http://ift.tt/2s7EXRH
