Why Acorns is a much better product than Robinhood*

*(for most people)

Two new mobile applications are getting a lot of buzz for disrupting the fairly antiquated world of the retail investor. Both Robinhood and Acorns allow users to start investing right on their mobile phones, albeit with very different philosophies. Each does something not possible until only recently. Robinhood has devised a product that utilizes digital technology that enables it to charge zero commissions on buy and sell orders, while Acorns allows users to link their credit and debit card accounts to “round up” transactions and invests those “round ups” in a diverse portfolio of index funds. While both are radically new products that lower the bar of entry into investing, Acorns is a much better product for those looking to get started in the world of investing.

The two apps are built on fundamentally different ideas and aims. By lowering the costs to trading with zero commissions and a sexy smartphone app, Robinhood will both encourage new investors to enter the market and encourage all users to trade more frequently. A similar phenomenon happened 15 years ago when e-trade hit the scene. The platform enabled the buying and selling stocks far more conveniently and cheaply, bringing in a wave of novice retail investors (affectionately known as “day traders”). In part this newly created convenience helped fuel the tech bubble of the early 2000s.

There’s too much evidence to cite that, unless you’re an investor able to commit the time and energy into analyzing every detail of a company’s financial reports, retail investors you’re much better off owning a diversified set of low-cost index funds. And that’s where the idea behind Acorns excels.

Robinhood has improved on one of the biggest pitfalls of day-trading by eliminating the transaction costs that eat into the minimal returns from most speculative stock picking, but that doesn’t mean gambling in equities is all of a sudden a good idea. By reducing the cost of trading even further, Robinhood will bring in another wave of amateur investors, convinced that speculating in the stock market with zero transaction costs is a new way to get-rich-quick.

Now, readers of this blog will know that I’m all for the lowering of transaction costs to increase overall market efficiency. And certainly Robinhood will lower the bar for buying equities even lower than the E-Trades and Scottrades of the world have done. That in it of itself is a good thing if used properly by investors who want to purchase stock to hold. What’s not good is if this convinces a host of new retail investors into thinking that they can compete with HFT firms and hedge funds in beating the market. There’s too much evidence to cite that, unless you’re an investor able to commit the time and energy into analyzing every detail of a company’s financial reports, you’re much better off owning a diversified set of low-cost index funds that track overall markets. And that’s where the idea behind Acorns excels.

Acorns leverages a few behavioral economics principles that enable it to be a much better deal for individual investors in the long-run than Robinhood. First, (after linking your credit cards and bank accounts) it automatically “rounds up” each of your purchases to the nearest dollar. Then, once the round up amount has reached $5, it debits your bank account for that amount and adds it to your Acorns brokerage account. Yet this account isn’t your average brokerage account, a user can only pick between five different portfolios of ETFs based on hers or his risk tolerance (from “Conservative” to “Aggressive”). By restricting it to these funds, Acorns makes sure that you’re only investing in broad market-tracking ETFs that have very low expense-ratios. For this service, Acorns charges $1 per month (regardless of your investment amount) and .25%-.5% of your assets. Cheap compared to the fees of most institutional money managers.

After using Acorns for the past 4 months, I sometimes forget that I have it at all! The more money I spend, the more money is “rounded up” and the more money is invested for me by Acorns. Given the long time horizons of most the users of the app (very long), it’s a fantastic way to get exposure to the market in a way that’s proportional to your spending habits and one that won’t break the bank. All the traditional investment mantras still apply, but the app makes getting the exposure incredibly easy. I’m excited to see where they’ll be taking the product in the future (towards support for retirement accounts, I hope!)

While Robinhood’s promise of zero transaction costs may seem like the better idea, most people interested in using their smartphones to manage their investments should start by using Acorns.

Comments or questions? Send them to me @jeremysjacob