Charles Schwab Has a $3.6 Trillion Edge on the Fintechs

Charles Schwab’s cheeks redden in a mixture of amusement and outrage as he recites the ways people on Wall Street make money. They take little nicks, he says, gesticulating with his left hand as if gripping a kitchen knife. High fees, fat spreads, excessive trades. “They all want to do it the old-fashioned way: Take advantage of the customer,” the white-haired chairman and founder of Charles Schwab Corp. says at his San Francisco office, a comfortable 3,000 miles or so west of the New York Stock Exchange. “Get the high commission, baby!”

His blue eyes widen behind his glasses as he describes the Schwab way: Take Wall Street’s principle of free enterprise “but minimize the friction, the cost of investing. It’s gotta be reduced down to near zero.”

That basic concept made Schwab a pioneer in low-cost investing and his company the powerhouse it is today. With a combination of slim fees, a dedication to homey, approachable customer service—remember those “Talk to Chuck” ads?—and a focus on technology, Charles Schwab Corp. has morphed from a discount retail brokerage into a financial supermarket helping to handle $3.6 trillion of clients’ money. A fintech firm long before the word “fintech” was coined, Charles Schwab offers everything from bank accounts to mutual funds to wealth advisory platforms, reeling in more than 100,000 clients a month. Over the course of nearly five decades it survived such carnages as the dot-com crash and the financial crisis—outlasting storied trading firms—to vault into the ranks of money-management behemoths such as Fidelity Investments, BlackRock, and Vanguard Group.

To stay at the top, Schwab and his company must contend with the sort of advances being engineered not on Wall Street but around the corner from his office in San Francisco’s South of Market district. In tech corridors like that one, hives of coders are developing big-data capabilities that may upend investing. The rise of artificial intelligence, along with potential competition from the likes of China-based fintech giant Ant Financial or even Amazon.com Inc., makes it crucial for money-management firms to develop an edge. For Schwab, that means plowing money into innovation—and leveraging the company’s combination of scale, tech savvy, and customer focus to outperform the upstarts. “We will survive if we do the right thing for people,” Schwab says. “We will collapse if we ever deviate from that mission.”

At 81, Schwab is also tasked with ensuring that his ideals are enshrined in company culture. Although he gave up his role as chief executive officer a decade ago, he’s the firm’s spiritual leader. He still chairs the board and oversees shareholder meetings. He’s still its biggest shareholder. And while he shows few signs of slowing with age, he’s guiding Charles Schwab and its 18,700 employees toward life after Chuck. “I’m the guy who holds the compass in his hand,” he says.

These days, he shares the compass with CEO Walt Bettinger, a sort of Chuck 2.0 who, like Schwab, played on his college golf team and was a finance entrepreneur. Bettinger, 57, carries on the founder’s ideals, reciting corporate principles like Bible verses. The company, he says, operates essentially by the “do unto others” Golden Rule. He tells you about a “virtuous cycle.” Lure new clients with low fees and easy-to-use services. Strong financial results and shareholder value follow. Repeat.

Whatever the strategy, it seems to be working. Since Bettinger took over management in October 2008, Charles Schwab’s client base has soared more than 50 percent, to 11.3 million accounts, and client assets tripled. The company now handles more than 7 percent of the $45 trillion that people in the U.S. have available to invest. In the next five or so years, Schwab says, “I would be disappointed if that weren’t doubled.”

That growth will likely come from new areas. Half of Charles Schwab’s customer assets came to it through registered investment advisers, a category that’s expanding as more financial planners parted ways with big banks in the aftermath of the financial crisis to open their own shops. In 2015 the company started a robo-adviser, Schwab Intelligent Portfolios, to take on upstarts such as Betterment LLC and Wealthfront Corp.Charles Schwab’s digital-offering units now oversee $33 billion.

More than half of Charles Schwab’s new retail accounts were opened by people under age 40, according to the company. Many of them are do-it-yourselfers who graduate to higher-fee personal advisory service as their finances become more complex. It shows the company’s reach, from small investors who rely on tech to wealthy clients who work closely with advisers, says Devin Ryan, an analyst who tracks brokerages and asset managers for JMP Securities LLC in New York. “Schwab is trying to attack all channels of potential growth,” he says.

Investors have taken notice. The company’s stock averaged annual returns of more than 20 percent during the five years through August, besting BlackRock, Morgan Stanley, and most other banks with large wealth-management units. Its market value is close to $70 billion, giving its founder a net worth of almost $10 billion.Bettinger was awarded total cash and stock compensation worth $16.5 million for 2017, according to the Bloomberg Pay Index. That’s less than BlackRock’s Larry Fink or Morgan Stanley’s James Gorman.

The company’s biggest direct rivals—Vanguard and Fidelity, which aren’t publicly traded—are in a race to the bottom on fees, putting the heat on Charles Schwab, which traditionally has been a low-cost leader with no-fee robo-advice, free trades on exchange-traded funds, and single fees for all funds. In July, Vanguard offered commission-free access to almost 1,800 ETFs run by competitors. Fidelity announced a month later that it was dropping fees to zero on two mutual funds, underbidding Charles Schwab’s lowest funds, which charge 3¢ per $100. Then JPMorgan Chase & Co. came up with an offer of no fees on as many as 100 trades a year.

Bettinger says the company wants to stay competitive on cost. “Our objective is to remove price as a barrier for anyone considering Schwab,” he says. He’s lured customers by slashing fees and commissions by $500 million over the most recent six quarters. The company has also spent $500 million on “client experience”—mostly technology and hires to accelerate everything from transaction execution to answering phone calls. The result: 827,000 new accounts in the first half of 2018, the most in 18 years. Net income reached a record $866 million in the second quarter, up 51 percent from a year earlier.

Profitability also comes from keeping down the company’s own costs. Charles Schwab’s proprietary funds are commodity-like indexed mutual funds and ETFs. The company’s doing more hiring in areas including Austin and Dallas, where salaries are lower and real estate less expensive than in the Bay Area. That’s all helped drive the drop in average costs to clients per $100 under management, from 67¢ in 1996 to 26¢ in 2005 to 16¢ today.

Bettinger jokes about the importance of controlling expenses when he offers a visitor a plastic bottle of water and no cup. “You can’t get to 16 basis points spending money on glasses,” he says.

Frugality comes with the territory at a company that one man built into the biggest U.S. discount brokerage within nine years of its founding. Born in Sacramento in 1937, Schwab grew up with a comfortable middle-class life as the son of, as he puts it, a “small-town lawyer.” He showed an early entrepreneurial bent selling bags of walnuts, then at age 13 moved to raising chickens. He took up golf a year later and found his first financial success as a well-tipped caddy who invested some of his earnings in the stock market. He played on his high school golf team (and was captain), opening the door to Stanford University “when tuition was $225 a quarter,” Schwab says, chuckling at the price.

Stanford now costs $16,900 a quarter, and Schwab would probably be lucky to get admitted. He struggled in school because of dyslexia, which wasn’t diagnosed until he was about 40. “There are some benefits to it,” he said of the reading disorder in a video he recorded for the Child Mind Institute, which helps children with mental-health issues and learning disabilities. “I could conceive of things more quickly than other people could. And it helped obviously in trying to determine and develop a company and come up with novel ideas.”

Schwab compensated for his reading struggles with strength in numbers. He majored in economics at Stanford and went on to earn an MBA there. After graduate school, he worked at a financial advisory firm, started an investment newsletter, and in 1971 co-founded an investment company called First Commander Corp., which he renamed Charles Schwab & Co. after buying out his partners. His breakthrough came in 1975, after the U.S. Securities and Exchange Commission approved negotiated commissions. While many Wall Street firms saw deregulation as an opportunity to raise fees and pad profits, Schwab went the other way—discounting.

By 1980, Charles Schwab Corp. was the largest U.S. discount brokerage—well positioned for what became a decades-long boom in individual participation in the stock market. It kept evolving, adding branches, then selling itself to Bank of America in 1983 for $55 million. Four years later, Schwab led a management buyout, paying $280 million for the firm, which he took public in September 1987 to finance the transaction. The company began online trading in 1996 as the dot-com boom sparked an explosion of day trading. The Charles Schwab board named David Pottruck, a hard-driving Brooklyn native and Citibank veteran, co-chief executive in 1997 and sole CEO in 2003, with Schwab stepping aside.

In the aftermath of the dot-com bust, the change in leadership proved disastrous. The company was bleeding accounts, and trading fees plummeted. The directors ousted Pottruck after about a year and put Schwab back in command in 2004. He then tapped Bettinger—who’d sold his Ohio-based retirement-plan record-keeping company to Schwab in ’95—to be his chief operating officer.

Schwab’s priority at the time was attracting new accounts, which depended on returning to its low-fee origins, Bettinger says. He recalls a board meeting at which he joined Schwab to pitch the turnaround strategy. “The board said, ‘We’ve just lost 40 percent of revenue, and now you’re suggesting we give up 15 or 20 percent. How are we going to make it up?’ ” Bettinger recalls. “We said, ‘The goodness of human nature.’ We sit here 14 years later with evidence that that’s exactly what works.”

The comeback took awhile. The number of accounts didn’t bottom at 6.7 million until two years later, before starting to climb. In 2007, Schwab promoted Bettinger to president, setting him up to take the CEO role, which he did in October 2008, just as the country was spiraling deep into the financial crisis. Still, the company managed to add accounts throughout the downturn, even as client assets plunged 21 percent from 2007 to 2008.

Bettinger attributes Charles Schwab’s relative success during the crisis to its foundational principles. Competitors worried more about their share prices and eliminating jobs rather than about cutting fees or improving service to help customers. “We kept our focus on the client,” he says. “And of course that led to enormous market share gains both in the height of the crisis as well as the period coming out of it.” Assets marched steadily higher starting in 2009, fueled by the bull market and an influx of customers at a time of rising distrust of traditional Wall Street firms.

“It’s incredible how [Schwab has] been able to put himself in the middle of all these revenue streams,” says Robert Burgelman, a professor at the Stanford Graduate School of Business who wrote several case studies on the company. “The question is: How can the original model keep going? How can they continue to add parties to this ecosystem? Does the new leadership understand the logic of the model that’s worked? My experience is, often company leaders over time lose that insight. There’s no reason to believe this couldn’t happen in the future at Schwab.”

Bettinger isn’t worried. He says the company’s employees have internalized the client-first philosophy. Several top executives—Senior Executive Vice President Jonathan Craig, Senior Vice President Tobin McDaniel, and Chief Financial Officer Peter Crawford—served as the founder’s chief of staff before moving on to other positions. All of them say Schwab is still driving the company forward, years after he stepped away from day-to-day management.

As fees and commissions shrink, his company is making money elsewhere: as a banker. Most of its revenue over the past 12 months came from net interest margin, which is primarily the gap between what it pays clients for their cash and what it earns from investing a lake of money. It reported $200 billion in low-interest-bearing bank deposits as of June 30. Some analysts question whether the strategy squares with the company’s client-first mantra. These days, money-market accounts can pay as much as 2 percent, or 10 times the interest paid by bank savings accounts such as Charles Schwab’s, according to Greg McBride, chief financial analyst for Bankrate.com. Cash in the Schwab bank “results in an opportunity cost that is hardly free for the client,” says Andy Rachleff, co-founder and CEO of competitor Wealthfront.

Charles Schwab executives defend making money from the bank, which was started in 2003, arguing it benefits clients who can get low-cost services such as overdraft protection and free ATM access along with Federal Deposit Insurance Corp. coverage. The company also encourages customers to move their money to safe but higher-yielding assets including money-market funds or bonds if they want to, Crawford, the CFO, said on a July conference call.

At Charles Schwab’s headquarters in San Francisco, a nine-member team composed of engineers, a product manager, a designer, and a user-experience researcher sits in a room papered with a rainbow of sticky notes. They’re all watching Allison Lane swipe a phone screen. The group was assigned to rapidly develop a mobile application for clients like Lane, a 38-year-old who is taking her financial health more seriously after getting married and having her first child. Lane was invited to join the “ideation session” when she attended a customer event in San Francisco.

As the team takes notes, Lane tests a prototype digital financial coach and is full of questions for the engineers and others in the room, such as how much time will it take her to engage with the app? “If I’m on the bus on my way home, I know I have finite time,” says Lane, a federal employee who lives in San Francisco. “Do I want to do this now? Or is this after the baby’s gone to bed?”

Lane is what the company’s researchers call a “guided self-directed” client, who can manage her money mostly independently, with the occasional bit of digital or human help. This is her second meeting with the “innovation accelerator” team. She spots comments from her last visit on the sticky notes and says she’s impressed by how fast the team turned a nebulous idea into something tangible. “The first time, I didn’t know the goal of the project,” she says after the session. “They were asking a bunch of questions. One month later, they’ve transformed it into an actual product.”

Charles Schwab has about 450 teams developing new digital interfaces and underlying technology. In addition to interviewing clients, they’re mining data from the company’s five-decade history of transactions, trying to better anticipate call volume or client questions as markets move, a use of technology that’s helped the firm slash the number of employees answering phones from about 7,000 in 2001 to 1,500 today. As early as next year, like a growing number of financial firms, Charles Schwab plans to use artificial intelligence for chatbots that offer natural conversations with clients in voice or text. These consultations will be able to occur over the phone, online, or via Amazon’s Alexa. The latter service is already being touted in an online video that shows the firm’s founder asking Alexa for a market update. “That is music to my ears,” Schwab says when the machine answers.

The tech push comes from the top, according to Neesha Hathi, who was named chief digital officer last year. “People assume because Chuck’s in his 80s that he’s not up on things,” she says. “But he’s all-in, and more importantly, he sees how technology can serve clients.”

A former investment banker who worked at tech startups and favors wearing a leather jacket, Hathi stands out among the many male execs in shirts and ties. She joined the company in 2004 and wore multiple hats before being promoted to her current role running platforms for retail and institutional clients. She talks about the “three Es” of her mission—ease, efficiency, and emotion. Technology enables the ease and efficiency for administrative tasks such as opening accounts or making trades, she says. But she says you can’t disregard the emotional component when people’s life savings are on the line, something the company strives to take into account in its drive for low-cost efficiency. “There’s a human aspect to the firm which runs really deep,” says Hathi, 45. “The ultimate manifestation is that the name of the firm is a person.”

While tech is becoming ever more dominant, Bettinger says the human element is what will help the company ward off the threats posed by online competitors. When it comes to financial services, he says, clients ultimately want to talk to a live person—in a web chat, on the phone, or at a branch office. In 2016, less than a year after introducing its robo-adviser, Charles Schwab began offering fee-based personal consultations for accounts of at least $25,000.

Companies such as Ant Financial or Amazon, which analysts have speculated will eventually move into finance, would be challenged to build those kinds of offerings at Charles Schwab’s scale, Bettinger says. “I’d like to think that we’re a blend of Amazon and Nordstrom,” he says. “You can get extraordinary value. You can get tremendous technology. You can have a breadth of choices. But you also have that person there to help you.”

For now, the man who gave the company its name is around to advise Bettinger. The CEO says he and Schwab get together whenever they’re both in the office, though that’s not as frequent as it used to be. “At this point, he’s earned the right to golf more than me,” Bettinger says

Schwab is, for the most part, happy to oblige. He owns an ocean-view home in the golf resort of Pebble Beach, Calif., and plays the world’s most prestigious courses, including the Carnoustie Golf Links in Angus, Scotland, site of this year’s Open championship. “Golf courses are treacherous,” he says. “Lurking out there all the time is something that’s going to snatch your ball, something like the trials and tribulations of life.”

Or like piloting a financial juggernaut through five decades of change. But right now Schwab has an indoor sport on his mind. He walks over to a closet and flings open the door to reveal a bowling ball engraved with the question: “Can the magic last?” The ball was a gift for speaking at Stanford in 1999, in the midst of the dot-com bubble. The speech had touched on Schwab’s days fresh out of business school in the early 1960s. In those years, bowling was viewed as the next big thing, and shares were skyrocketing for companies that made balls, shoes, and machines for racking pins. “And guess what happened?” Schwab recalls. “In ’63 they went straight down. The bubble popped.”

The magic didn’t last. But the power of markets to make money over the long term isn’t magic, Schwab says. It’s real. “The most important thing is investing over a long period of time,” he says. “Clearly, it’s the only way to really get high, high returns.”

For his company, the challenge is to keep clients believing it’s the best place to get those returns. So far, it’s done so by capitalizing on long-term trends such as the decline in fees and the growth of personal technology and independent advice. But what does this fintech pioneer see coming next?

Bettinger, the man Schwab chose to share his compass with, is embracing a “no trade-offs” approach: Give customers everything they want as cheaply as possible. Clients weaned on companies such as Amazon are demanding premium service at a low cost from their brokers, too. “You’re able to get extraordinary quality at extraordinary value now,” Bettinger says. “That’s where our industry is. And in reality, that’s where the whole economy’s going.”