13 Dec Robinhood’s 3% Checking and Saving Account: The fine print
12/15 Update: Robinhood said on their blog that they “plan to work closely with regulators as we prepare to launch our cash management program, and we’re revamping our marketing materials, including the name.”
12/14 Update: SIPC CEO and president Stephen Harbeck told Bloomberg “I disagree with the statement that these funds are protected by SIPC.”
There are three things in life that make me unreasonably excited: good waves, skinny margaritas, and a savings account with a bomb-ass rate. So when my phone went off this morning, I thought that I might have to grab my surfboard and run to the beach. But nope, people were excitingly sharing the brokerage firm Robinhood was offering a 3% Checking and Savings account.
3% is REALLY high
I immediately went to sign up and snooped around the site to see if it was FDIC-insured. This is a personal non-starter for savings accounts, as the US Government protects you against $250k of losses.
However, Marketwatch points out that while these “function much like a typical bank account, they are technically investment accounts.” And this technicality is important when it comes to FDIC protection. Robinhood’s account is not FDIC-insured, and per its FAQ it’s covered by SIPC insurance (emphasis mine):
SIPC insurance covers your checking, savings and investments. Your cash and securities in Robinhood are protected up to a total of $500,000 by the SIPC, $250,000 of which can be in cash, the rest in securities. SIPC insurance provides protection for your cash balance and securities holdings if Robinhood fails financially, but does not cover investment losses due to declines in the value of securities themselves.
This can be cross-checked with the SIPC website (emphasis mine):
SIPC protection is limited. SIPC only protects the custody function of the broker dealer, which means that SIPC works to restore to customers their securities and cash that are in their accounts when the brokerage firm liquidation begins.
SIPC does not protect against the decline in value of your securities. SIPC does not protect individuals who are sold worthless stocks and other securities.
Where could investment losses come from?
The Robinhood FAQ also explains how it will invest the cash in your account (emphasis mine):
Similar to a bank, Robinhood keeps your cash in interest-earning assets. Because we’re a brokerage, we only use the safest assets, such as U.S. treasuries that are backed by the full faith and credit of the U.S. government. These assets yield interest, and we pass those earnings back to you.
It’s important to remember that safe assets can go up and down in value. A “proxy” for safe assets is a AAA-rating from the major ratings agency; these are never supposed to take a loss of principal. However in 2008, AAA assets with exposure to mortgage-related securities did. Some lost astronomical amounts causing cash-management funds (like the Reserve fund) to lose investor principal – in finance parlance, they “broke the buck.” Now remember SIPC insurance “does not protect against the decline in value of your securities.”
What questions remain?
Like any investment product, to get more return you need to take more risk. Once this product launches, it would make sense to see exactly what they will invest in and if there are hard constraints on AAA-rated investments outside of US Treasuries.
But as Vanguard and ETFs have demonstrated, another way to boost returns is to reduce costs – and it’s very possible that Robinhood’s cost-structure enables them to pass these savings to its users. The devil is in the details.