Robinhood Investors Are Playing With Fire With Their 3 Favorite ETFs

The Robinhood investing app has taken the world by storm, attracting millions of people to start putting some money directly into the stock market. It's great news that so many Americans who had never invested before are dipping their toes in now. However, some of the choices that these new investors are making seem questionable at best, and some of the most popular Robinhood stocks are extremely risky.

Many investors who want to get greater diversification and reduce their risks do so by buying exchange-traded funds rather than solely picking individual stocks. Many of these funds are built to match major market indexes or reflect the moves of whole industries.

However, even among these diversified ETFs, there are those that can be just as speculative and risky as some individual companies stocks. If you look at the three most popular ETFs on Robinhood right now, you'll quickly see the extent to which many users of the app are making bets on a single momentum-based trend -- and leaving themselves exposed to significant losses if that trend doesn't continue.

Data source: Robinhood. As of July 21, 2020.

Big bets on Big Oil

All three of these ETFs are tightly tied to the energy markets, which have experienced extremely volatile swings in 2020. Over the past several years, prices of crude oil, natural gas, and other energy products have moved sharply lower, reflecting the expanded supply created by greater production from shale oil and gas plays. Even the efforts of OPEC nations during the late 2010s to stabilize prices had limited impact, and the lower crude prices that resulted left some of the more marginal players in the industry on the brink of collapse.

The COVID-19 pandemic introduced a huge disruption into an already unstable energy market. The result was an unprecedented level of price movement, with futures prices for West Texas Intermediate crude even going negative for a brief period due to a lack of storage space for the glut of oil. Those price moves crushed most energy stocks, and left many ETF investors with substantial losses connected to the poor performance of companies across the sector.

Image source: Getty Images.

Since then, though, oil prices have recovered somewhat, climbing back above the $40 per barrel mark. That hasn't been enough to get most energy stocks anywhere near back to where they were at the end of 2019, but the rally has nevertheless been strong. Robinhood investors who only recently got into the oil market have in some cases seen significant gains.

High risk for Robinhood investors

However, it's important to understand that all three of these ETFs carry a lot of risk. They're all related to the energy market, but are exposed to it in different ways:

• The Direxion fund targets an index of oil and gas exploration and production companies. It then provides leveraged exposure, with the goal of providing double the daily return of the underlying index. With index components that include not only the biggest energy giants in the world but also small niche players in key areas, the volatility from this 2x-leveraged ETF is considerable.
• United States Oil Fund has a simpler mission: to match the price changes of crude oil. Yet because of the disruptions in the futures markets, U.S. Oil Fund had to change its methodology. That introduced new potential for tracking error, and the ETF's returns year to date haven't matched up well with the behavior of spot crude prices.
• The ProShares ETF is somewhat similar to U.S. Oil Fund in that it uses futures contracts to give investors exposure to the price of oil. However, the ProShares ETF is 2x-leveraged, providing even bigger gains when prices move in the right direction -- and bigger losses when they don't.

Moreover, these ETFs generally have expense ratios that are considerably higher than what you'd get from a typical index fund. Expenses of as much as 1.04% for the Direxion fund mean that the longer that Robinhood investors hold these funds, the more they lose to cover the fees paid to those who run them.

Robinhood investors: Be careful with these ETFs

As long as oil prices continue to rise, then there's a good chance that these three top Robinhood ETFs will keep gaining ground. However, investors in these funds should proceed with extreme caution. For those looking for less speculative ways to invest, there are plenty of strong ETF picks to consider instead.