Robinhood outage underscores risks of investing in the digital age

It's been a rough week for do-it-yourself investors who use Robinhood, the mobile brokerage app that exploded in popularity by offering free trading long before the rest of the brokerage industry.

As global markets rebounded Monday from last week’s sell-off, and as the Dow experienced its biggest point gain since 2009, Robinhood was inaccessible to its millions of customers for the entire trading day, shutting its users out of any potential gains. Service was restored on Tuesday.

The investors who were hurt most were those who purchased options, one of Robinhood’s most touted features, betting markets would continue falling Monday. When markets instead surged, Robinhood investors were unable to sell the options and had to eat the losses.

Robinhood has faced other setbacks recently, including a $1.25 million fine levied by the Financial Industry Regulatory Authority Inc. for failing to ensure investors received the best prices on securities orders, but Monday's outage looks particularly bad. Co-CEO Vlad Tenev has criticized technology at traditional brokerages like Charles Schwab and Fidelity, yet it was his digital-first platform that struggled most during one of the biggest trading days in recent memory.  

Finance Twitter of course pounced on the opportunity for some schadenfreude at the fintech start-up’s expense. Robinhood’s technology just isn’t ready for prime time, some said, while others said millennials were due for a lesson in bear markets as none of this would have happened if they had used a long-term, buy-and-hold strategy instead of chasing short-term gains by day trading.

All fair points, but there is a bigger issue here that isn’t being addressed by mocking the company that pushed the rest of the brokerage industry to finally eliminate trading fees.

These sorts of disruptions are now an unfortunate reality of doing business in the digital age, said SMArtX Advisory Solutions founder and CEO Evan Rapoport. With all the convenience and cost savings the new digital investing infrastructure provides, there are also new ways the system can fail.

“Technology breaks, technology fails. It’s inevitable that a system is going to go down at some point,” Mr. Rapoport said. “There’s no way that any custodian or any brokerage firm could guarantee 100% uptime.”

Jason Wenk, founder and CEO of RIA custodian start-up Altruist, said the problem isn’t a digital-first architecture, it's having a digital-only architecture. For example, though Mr. Wenk pitches Altruist’s modern technology as an advantage over traditional custodians, the company still has a human customer support team in the event of a digital service outage.

Robinhood was hardly the only trading platform challenged by the volatility. TD Ameritrade, Fidelity, Charles Schwab and Vanguard all experienced varying degrees of service disruptions as frightened investors flooded servers to check their accounts or make trades.

“That has to do with aging infrastructure. If they don’t rebuild it, they’re going to struggle,” Mr. Wenk said. “It’s about finding the right balance of a modern infrastructure and the value of offline help.”

No system can be totally foolproof, and Mr. Wenk argued that digital systems are still more reliable than the past setup in which investors would have to call a broker to place orders during volatility.

Digitizing more of the investing ecosystem also removes the opportunity for human error, said Facet Wealth CEO and co-founder Anders Jones.

“I would venture to guess that if you look at [digital] systems going down versus trade errors done by humans back in the analog days, I’d imagine there’s a lot more value destroyed by humans,” Mr. Jones said.

If no system – whether analog or digital – can be perfect, it's important that firms build in the necessary backups and fail-safes. For example, traditional brokerages maintain a massive human workforce to provide support in case of an outage, and customers could still call in to a trading desk if they were willing to put up with phone wait times.

This may be Robinhood’s biggest weakness. The app’s purely digital structure gave customers no other recourse. Even support emails reportedly bounced back as undelivered.

The event could trigger regulatory scrutiny as to whether Robinhood met business continuity requirements, Mr. Rapoport said.

For some financial advisers, the entire episode simply reinforces the value of working with a professional. Investors with a long-term plan aren’t worried about getting in or out of the market on any given day and wouldn’t be affected if the service goes down, Mr. Jones said.

“The retail investor who isn’t thinking about long-term planning is the one who is going to get hurt,” Mr. Jones said, adding that his firm didn’t see an uptick in investors logging on, though his advisers did get more questions and emails.

However, Facet Wealth did see an uptick in new prospects as people came looking for financial advice and planning, Mr. Jones said.

“The better way to approach a health financial life is to focus on long-term planning,” he said.