SCHW Charles Schwab Corporation

By Lisa Beilfuss 

When Walt Bettinger's 3 a.m. alarm sounds, among the first things the Charles Schwab Corp. chief executive does is check how much net new money his company has pulled in over the past 24 hours. Last year, that was an average of $624 million a day -- more than its three biggest Wall Street rivals combined.

Schwab was known mostly as a discount broker for amateurs when he took the helm in 2008 from founder Charles R. "Chuck" Schwab. Now it resembles something more like a personal-finance supermarket, offering services for the wealthy and budget-minded alike, at rock-bottom prices, spanning trading, banking and advice, both human and robotic.

Once barely noticed by the denizens of Wall Street, Schwab has amassed a stockpile of client assets that dwarfs those at Bank of America Corp.'s Merrill Lynch, Morgan Stanley's brokerage arm and UBS Group AG's Americas unit. Its stock is up 76% since the end of 2007, versus 26% for the Dow Jones U.S. Select Investment Services Index.

Schwab's blue-chip rivals are being dragged along in its wake. Forced to respond after years of ignoring the threat, they're moving down market and cutting fees across the board , eating into what was once a vital source of income and transforming the business of personal financial services into something that looks more like a commodity business.

Morgan Stanley recently published an Instagram post to market the idea its services aren't just for millionaires. JPMorgan Chase & Co. is giving away free trades. UBS in April launched an iPad app for its wealthy clients. Goldman Sachs Group Inc., adviser to billionaires, is targeting middle-class clients with its Marcus arm. Companies mentioned in this article were given an opportunity to comment on Schwab's effect on their business.

"What we have to figure out is how does this business grow more rapidly than Schwab's," said a wealth-management executive at a major Wall Street firm that competes with Schwab.

Mr. Bettinger's formula for attracting new money -- $228 billion in 2018 -- is rooted in Mr. Schwab's blueprint: Keep prices low and the rest will follow. Self-described "Schwabbies" at the company are obsessed by it. Jonathan de St. Paer, head of investment management, said that in his 16 years at Schwab, someone has asked at every meeting: "Can we do it cheaper?" In March, it introduced subscription pricing for financial planning that makes advice less expensive.

Schwab's task is to contend with the response from Wall Street incumbents as well as challenges from new low-cost entrants. Schwab has become big enough that, each time it launches a new product or slashes another fee, it sends ripples out among competitors who often are forced to respond in kind.

When in February Schwab doubled its lineup of commission-free funds, Fidelity Investments made a similar move with the hour. "You can see how other organizations have tried to become more like Schwab," said Robert Siegel, a lecturer in management at Stanford University.

Mom and pop

Mr. Schwab, born to a thrifty family in Sacramento, Calif., founded an $84-a-year investment newsletter in 1963. When regulators in 1975 abolished fixed trading commissions, he got $100,000 from an uncle and launched one of the first discount brokerages.

Schwab went public in 1987 and attracted clients through the 1990s, as mom-and-pop investors chased stock-market gains. E*Trade Financial Corp. and TD Ameritrade Holding Corp. followed over the next decade, but much of Wall Street stuck to its higher fees.

After the tech bubble burst in 2000, Schwab's trading volume suffered. CEO David Pottruck responded by raising prices. That hurt volume further, and he left after about a year. Mr. Schwab resumed control in 2004, slashing fees again. Mr. Pottruck didn't respond to requests for comment.

Mr. Bettinger recounts how Mr. Schwab continually found new ways to defy conventional wisdom about fees. In 2005, the company was about to offer its first checking accounts. Mr. Bettinger, who had climbed the ranks to president after selling his Ohio record-keeping company to Schwab in 1995, was armed with an 80-page presentation laying out pricing scenarios for clients withdrawing from ATMs.

Mr. Schwab interrupted on slide three, asking what clients would prefer. The answer: free withdrawals from anyone's ATM. "It was a pure eureka moment," Mr. Bettinger said. "Who cares what the competition does? Long term, it's the best decision."

Three years later, when bailouts were sweeping Wall Street and Mr. Bettinger became CEO, he quickly cut a fifth of Schwab's staff and slashed expenses. He worked to bolster its banking arm, launching a fee-free credit card in 2008 that paid clients 2% cash back -- generous at the time. The idea was to encourage more clients to open bank accounts and transfer money from traditional banks.

Wall Street was paying little heed to Schwab's moves. "People didn't give Schwab a great deal of credibility for many years," said Tim Oden, who joined Schwab in 1987 and is now senior managing director of its business catering to independent advisers. "A lot of firms looked down their noses."

Schwab's other businesses fed the bank: As its lowered and eliminated fees attracted new funds, it parked some of the funds in its bank and earned interest by investing or lending the funds out. So while it earned less off brokering and products by lowering costs on trading and fees, those cost reductions helped steer new money to the bank, where Schwab could earn growing returns on it.

Schwab's bank made more than half the company's overall revenue of $10.13 billion in 2018, up from 29% of revenue in 2009.

In 2009, Schwab executives felt the company was late to the market for exchange-traded funds, or ETFs, mutual funds that trade like stocks and generated profitable trading commissions for Wall Street brokerages. To make a splash in ETFs, the Schwab executives said, the company that year became one of the first in the U.S. to offer commission-free ETFs, coupled with lower expenses than rivals. "We thought we could differentiate ourselves," Mr. de St. Paer said, so "we took a revenue cut."

Within a year, Fidelity and Vanguard said they, too, would offer some commission-free ETFs. Much of Wall Street ignored Schwab, sticking to charging lucrative commissions on ETF trades.

Mr. Bettinger also sought to expand Schwab's business in providing personal financial advice, aiming to undercut Wall Street firms. When Schwab waded into advice soon after opening its bank in 2003, it had taken prodding to convince Mr. Schwab, who hated the idea of cultivating a high-pressure sales culture, Schwab executives say.

Robo advice

As CEO, Mr. Bettinger pushed Schwab further into advice-giving. In 2011, he began opening independent branch franchises to help attract financial advisers, some from Wall Street firms, and gather more assets with the pitch: "Drive down costs for your clients." Schwab formed partnerships to help build the business -- unusual at a time when it typically went it alone. "There wasn't a playbook, or a firm we could follow," said Mr. Oden of adviser services. "We had to innovate."

At the same time, Schwab was working to attract more independent financial advisers who would keep their client assets at the firm. Nearly half of Schwab's total customer assets are now managed by roughly 7,500 independent advisory firms that use Schwab as custodian.

Among them is Phil Fiore, who left UBS and opened his own advisory firm in 2017. He needed a place to put clients' assets. Now, clients at his Shelton, Conn., firm together have about $700 million at Schwab, which offered technology and research making it easier to leave a traditional firm, he said.

"It's a magnet for some of the larger teams across the country," he said, speaking of groups of brokers who tend to stick together when they leave Wall Street.

Wells Fargo & Co. is responding by trying to recruit independent advisers to a new platform. E*Trade in 2017 bought a custodial firm to get in on the business. Morgan Stanley and UBS that year made it harder for brokers to leave with their clients, slowing the pace of defectors Schwab attracted in 2018, Mr. Oden said.

In 2014, Schwab announced its "robo advice" service, a system that uses algorithms to provide portfolio-management services. Assets in Schwab's digital-advice offerings now total $38 billion. With it, Schwab has driven down fees for advice, for some clients to nothing.

Schwab's pitch lured Ryan Post, 34, an Indianapolis project engineer who last year moved his money from Northwestern Mutual. Schwab's robo service built him an ETF portfolio to fit his goals. "I said, 'look, the S&P made 22%, you earned me 8% and I had to pay you 1.2%,' " he said. "It was kind of silly to be paying all that money."

Northwestern Mutual said its number of wealth-management clients is up from a year ago.

Schwab turns clients like Mr. Post into more-profitable customers in part by putting them in funds run by its $400 billion investment-management arm. Some have small annual fees that add up to billions a year. And Schwab says in regulatory disclosures it may require robo clients to keep up to 30% of the account in cash. Doing so, Schwab earns money from interest and lending the funds to others.

Jon Stein, founder and CEO of robo-advising pioneer Betterment LLC, said these moves undermine Schwab's sales proposition. "Free advice is a sham, " he said. When the relatively high cash allocation and sweep of funds into low-yielding bank accounts are taken into account, "they are charging way more than we are."

Betterment charges 0.25% annually on assets. Betterment is also going after independent advisers and counts about 450 firms using its digital service.

"Cash plays an important role in a diversified portfolio," said Schwab spokeswoman Alison Wertheim. The service was designed to help investors get advice, she said, and "many investors understand and are comfortable with this approach."

Schwab's in-house advice is causing some tension as it overlaps with the services offered by independent financial advisers affiliated with Schwab. The tension was a popular topic during a forum with Mr. Bettinger at an October conference, where the CEO called any threat from its robo platform "pretty low."

Mr. Bettinger has also been driving Schwab further into wealth management for well-to-do clients who were once the turf of elite Wall Street firms. In 2015, he promoted Terri Kallsen, previously head of Schwab's branch network, to head of retail. She has overseen a 63% increase in the number of new retail clients opening managed investment accounts. New accounts receiving advice now average about $600,000.

There were clear signs Wall Street was finally waking up to the Schwab threat in 2016, when Morgan Stanley lured a Schwab executive to run its digital efforts. Morgan Stanley and other firms, including UBS and Wells Fargo, began launching robo-adviser services widely seen as a response to Schwab. JPMorgan Chief James Dimon in 2017 told analysts the firm's new self-directed trading platform, offering free trades, was a response to Schwab, said a person who was there.

Last October, Morgan Stanley lowered the maximum rate brokers can charge clients for advice. Executives and brokers at other traditional brokerages say they are discounting more to keep customers. Wealthfront Inc., a robo-adviser firm whose founding CEO once said he modeled the company on the early days of Schwab, recently made automated financial planning free to clients who download the company's app.

Robinhood Markets Inc., a Silicon Valley brokerage startup, has lured millions of new investors with commission-free trading. TD Ameritrade is expanding its independent adviser channel. Fidelity in August started offering index funds with no management fees after Vanguard let clients trade rivals' funds free.

Mr. Bettinger, who said he frequently consults with Mr. Schwab, still chairman, said he is unfazed. "The rest of the industry ends up having to copy us anyway."

Write to Lisa Beilfuss at lisa.beilfuss@wsj.com

(END) Dow Jones Newswires

April 28, 2019 14:10 ET (18:10 GMT)

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