Learning from Charles Schwab

Many of the great Investors have left their mark on our investment world. Some have been innovators, others have been pioneers and all have been performers. And unsurprisingly, all have posted consistently outstanding results because of it. Each in their own way has crafted individual legacies which can teach us new ways of thinking when we trade. When it comes to the business of trading one man stands out from the crowd and has significantly changed the way Americans buy and sell investments.

And that one man is Charles Schwab.

In doing so, he built a Fortune 500 company whose value compounded at an average rate of 19% a year since IPO in 1987; twice the growth rate of the S&P500. Central to his belief; the customer was at the heart of everything Schwab did. He entered a race that for fear of revenue loss, the large incumbent brokers didn’t want to be involved with, a lucrative niche providing customers with cut-price stock transactions which he exploited and expanded with new technologies.

Charles Schwab tells his story in a recent book, ‘Invested - Changing Forever The Way Americans Invest’. On the dust jacket, Warren Buffett notes, ‘I’ve admired Chuck Schwab for a long time. When you read this book, you’ll understand why.’

In many ways Charles Schwab epitomises the ‘Scale-Economics Shared’ model employed by many of the great enduring companies. In a recent investor letter, IP Capital Partners noted, ‘Throughout its history, Schwab has continually cut the cost of investing through its platform and kept its competitors under constant pressure.’ Lower prices = more customers & increased revenue. Lower costs = increased profits. Return profit to customers via even lower prices. Repeat.

“Never underestimate the power of a low-cost structure: if you can make a profit by offering consumers good value; it’s a great business plan.” Francois Rochon

Charles Schwab vs S&P500 - 1987-2020 [Source: Bloomberg]

As a veteran of markets for over forty years, Charles’ reflections on the 1987 crash and the Global Financial Crisis are timely reminders of the need to remove emotion and maintain an investment plan in times of panic. I’ve collected some of my favourite quotes from the book below, but don’t be surprised to see many of the common themes we’ve seen with the other great businesses we’ve studied.

Competitive Niche

“Everybody said to me, ‘Wait until Merrill Lynch decides to go into your business. You are going to be crushed.’ I was worried, but Merrill was an entrenched member of the Wall Street establishment. It was still beholden to its many commissioned brokers, and its highly profitable investment banking and research business. It couldn’t just chuck all that out the window.”

“I thought if I could strip away all the fluff surrounding the purchase and sale of stocks - the tainted research, the bogus analysis, the flimsy recommendations, all the ways that Wall Street had historically justified high commission - and sell just the plain-vanilla service of executing trades, I could slash overhead, focus on efficiency, cut prices dramatically - by as much as 75% - and still make a profit.”

“How would my firm differ from the kind of firms that had ruled Wall Street for so many years? For one thing, I meant to serve an entirely new client base, composed of what we now call independent investors.”

“We were the common enemy of every big firm that had ever prospered under the old, protected system (regulated commissions).”

“If you take brokers out of the equation - as I was proposing to do - how then do you sell stocks? Well, you don’t sell. You market. My big aha! was when I realised I didn’t have to sell at all. All I had to do was market the discount brokerage service and then provide the best possible customer service.”

“Recognising a business opportunity is only one part of succeeding as an entrepreneur. The key is acting on your business insight and following through.”

“Our business was based on finding ways to break compromises. That was the magic behind lower trading costs, 24-hour phone service, local branches, no-fee IRAs, and internet trading.”

“A business like ours comes down to two things; a big idea that makes a difference in people’s lives, and people who believe in it and will see it through to fruition day after day, despite what may get in the way. You have to get both right.”

Leverage Change

“I was starting Schwab hoping to take advantage of the significant changes that would come from the deregulation of the brokerage industry.”

Low Costs

“Our whole business plan revolved around keeping costs low. No lavish expense accounts, no fancy digs, no high salaries or fat commissions for our brokers.”

“I wanted to cut out all the frivolous costs so that I could make the price to the investor substantially lower than had ever been seen before - as much as 75% lower than traditional firms were charging. It would be a fact that practically jumped off the page at independent investors when we began advertising.”

Technology

“We paid a price early on by automating well ahead of our competitors, but the leverage we gained for later growth was enormous.”

“People often ask why Schwab got into technology so early and in such a big way to make it a defining part of who we are and how we operate to this day. In some ways, necessity is the mother of invention. We had to get more efficient or we were dead in the water. When I first started Schwab and slashed commissions by 75%, I had just a vague idea that I could make it work. I knew it would take volume.”

“I’m no technology expert, but I have always been willing to invest in technology, and not just because it lowers our costs and gives us a competitive advantage. The way I see it, every time we make another advance, we strip away one more layer of intermediation between the masses and the markets. That’s always good.”

“With each new technological advance, we provided a level of service a cut above other discounters; and we brought our clients one step closer to my ideal of direct, unmediated participation in the market.”

“We were trying as many things as we could to get ahead in technology. Not all of them were working but we kept pushing forward - knowing the future was coming at us fast, and the future was all about technology.”

Culture

“[We had] an entrepreneurial culture that was big on creativity and imagination and not so big on structures, details, and planning.”

Path to Freedom

“Today, I remain more convinced than ever that investing is the individual’s path to financial freedom.”

Be An Optimist

“I’m an optimist. And investing has always seemed to me to be the ultimate act of optimism. You’ve got to have confidence that the money you invest today is going to grow; otherwise, you might as well stuff it under the mattress. You have to believe tomorrow will be better than today.”

“I believed it then, I believed it when I started Schwab against so many odds, and I still believe it today. To be a successful investor, you have to be optimistic.”

Approach to Money

“Trying to build a life in the wake of the Depression had an enormous impact on my parents’ attitude toward money, saving, and risk that lasted their entire lives… So much of a person’s attitudes and habits towards money get formed when they are young. We see it with clients at Schwab every day.”

“A person’s approach to money, his or her saving and spending habits, and comfort or discomfort with risk are all deeply ingrained, and more emotional than rational.”

Reciprocation

“I’m sure one of the reasons for my success over the years has been that people generally like me - and the secret to that is just human nature: I pay attention to them. I listen to their stories and take a genuine interest. And it’s made for a richer life. People are endlessly fascinating and their stories are motivating.”

Reading

“I read a lot of biographies of people who had accomplished great things, people such as John D Rockefeller, J.P. Morgan, Charles M Schwab, the steel magnate (no relation), and many others. I saw the importance of determination, or passion and fighting hard for what you believed in, and the importance of optimism and believing good things are possible. All the people I read about had a maniacal focus on growth.”

Public Speaking

“To this day I encourage young executives to get training in public speaking. No matter how good they are, mastering those moments in front of an audience is crucial to leading others, and it rarely comes naturally.”

The Stock Market & Investing

“With the stock market, there are no guarantees. You can guarantee service, costs, quality, and certainly integrity. But you can’t guarantee performance; Risk is just part of the deal.”

“I don’t think human nature deals very well with the patience and strong stomach investing requires. We’re wired for fight or flight.”

“I have now seen nine crashes in my life, and it still troubles me that investors react this way [sit on the sidelines], because it always ends the same. The market roars back and leaves too many investors sitting on the sidelines missing out. Sometimes I wish I could just tie them to their chairs to help them ride out the temporary storm. To this day our advice is the same: ‘Panic is not a strategy, stick with your investment plan, and don’t let emotions get the better of you.’ Heeding that advice when you’re in full panic mode is just not easy. People aren’t wired to be good investors.”

“The most natural instinct is to run for the door. To sell. Sell everything,’ I said [in 2008 when reaching out to clients]. ‘You’ve got to fight that emotion because you want to be able to hang on for the recovery. Which has happened every time we have had an experience like this in my career .. and that goes back now some 40 years … nine different cracks in the market like this. Smart investing is about taking it year by year. It is a little bit of a nightmare, but we handle those by living through them and looking forward to better days.’ Did I get the timing right with my advice? Not exactly. You never do. And that’s exactly the point… Timing the market is impossible. As the saying goes, it’s not timing the market that counts, but time in the market.”

“Successful investing is not easy, that’s the bottom line. It involves so much of your emotions, your sense of self-worth, your ego.”

The Unexpected

“To be fair, every worst-case scenario at the time [prior to 1987 crash] assumed a sudden market decline of 5%, not 25%. What happened on Black Monday was a previously unimaginable event, which, after the fact, becomes a calculable risk against which responsible parties take steps to protect themselves in the future. It’s those extreme moments when things come out of a dark closet and into the light so that you see them… [One account] exposed a hole in our defences. Today, we take those measures to new heights, running crisis scenarios that are far out of the realm of any prior experience, trying to make the unknown, if not knowable, at least manageable.”

Decisions & Process

“You control your decisions and you control how well you execute them; you don’t control the environment.”

“Don’t panic and overreact to the economic environment or the stock price; stay focused on what works.”

Mistakes

“I’ve always felt that when you make mistakes, if you stand up and admit them, people will give you the benefit of the doubt. Acknowledge and own up to problems and people will trust you. That will be helpful the next time. If you blame somebody else or try to sugarcoat the problem, you may get away with it once.”

Encourage Ownership

“Experiencing how powerful and motivating that sense of ownership is, I’ve always encouraged and helped my employees over the years to be owners in our company as well.”

Reward Staff

“I paid people what I thought they were worth, regardless of seniority, and I used perks and bonuses to reward my stars.”

“Employees are your most important resource. Helping them take care of their health is simply good for business.”

People

“Business is all about people and you need to find those who share your vision and values, who will bring their own passion and strengths to the task. And you need that at every level of the organisation, from the mailroom up to the boardroom.”

“An entrepreneur who is afraid to hire people who can do something better than he can is doomed.”

Growth

“I always wanted our company to be a growth company.”

“In my experience earnings follow growth, and stock prices follow earnings. My philosophy is that with growth, everyone wins: clients get better service; investors get a better return; employees get jobs and rising pay; the community gets support; and, of course, the government gets taxes.”

“I believe it is incumbent on every leader of a company that the number one thing on their mind is growth. You don’t prosper without it.”

“We are growth junkies - people who thrive on change and adaptability and the next new thing.”

“It’s an irony: growth is a sign of success and shows you’re on to something that people want, but with a young company like ours the growth outpaces your sources of capital. You’re reinvesting every penny of profit you can, and it’s not enough.”

Source: Schwab.com

Risk

“Gamblers like taking risks, not entrepreneurs. Entrepreneurs start with a vision and accept, reluctantly, that no vision was ever realised without risking something important. But a true entrepreneur seeks to control his risks as much as possible.”

“Taking and managing risk is a critical part of any successful endeavour. In business particularly, you have to have an appetite for it or you stagnate and don’t do things that delight the customers and keep them coming back.”

“My role was to embrace risk when I saw an opportunity for a huge reward. I’ve always tried to encourage my operating people to make big leaps that could have a significant impact on the company’s bottom line.”

“You’re never gambling the whole house, you take calculated risks. You’ve thought things through, and experience and maturity and intuition and the tests you go through give you incrementally better odds each time.”

Innovate & Accept Mistakes

“You have to be willing to embrace client-focused innovation, even when it competes with your own existing business. Sometimes the most important competitor you confront is yourself. That’s how you stay a step ahead of everyone else. You can’t think just because you’re big, just because you’re successful, that you can’t disrupt yourself. You can - and in fact in today’s world, you have to.”

“We tried a lot of things that didn’t work. For a while it was one failure after another. But that never worried me. Innovators should expect failure, it’s part of the process. As head of the organisation, it was my job to encourage experimentation, not punish it.”

“We had a history - a culture of innovation - that helped prepare us for the internet.”

“You try a lot of things as an entrepreneur. You learn as you go. And sometimes you wind up with something that works that wasn’t planned.”

“The work, the innovation, is never done. There’s always another new idea, another convention to challenge, a million ways to make investing better. We just need to do it.”

Help the Customer

“Our clients have always been the heart of our business.”

"I always believed that profits were something that come naturally at the end of the line, if you got the first part right - finding new ways to help the customer succeed."

“We had a lot to learn on the way to becoming a company that could be proud of its customer service, which was the goal, and it took us a long time to get there.”

“All I ever set out to do was build a firm that serves the customer the way I’d want to be served myself.”

“We have never been the cheapest discount broker, but we have always tried to offer our customers the most value.”

“Every client interaction changes our company’s future - either to the positive or negative.”

“It was really one thing that bought us success: a zealous team of people on a mission that I fondly refer to as ‘Chuck’s secret sauce', all of them in lockstep pursuing a simple innovation, total empathy for our clients: make it better, easier, more successful for the investor. I call it the mother lode of our innovations, more important than any single technology or new product. It was building a company from a basic belief; view your decisions through your clients’ eyes.”

Nuisance Fees

“[In 2004] we were struggling to grow, and Schwab has always been a growth company. Now we were doing things to solve our problems that created difficulties for our clients. Our prices weren’t competitive, and we’d let some nuisance fees creep in. Walt Bettinger, who was then leading the branch network, called them gotcha fees, which we tried to avoid. We’d gotten harder to work with. We made our struggles into our clients’ problem, and that couldn’t stand.”

Walk The Floors

“I had never paid much attention to what my competitors were doing. I did not waste time thinking about how to exploit their weaknesses. Instead, I was always keyed into my own clients. To me the trick was coming up with products and services that satisfied investor needs before anyone else did. Get out ahead and others would be playing catch up. .. The only way that works is if you have first hand knowledge. I got mine spending a lot of time in the branches - talking to customers, watching what they were doing, trying to understand what they were thinking.”

Cost Cutting

“You can’t cut a company to greatness.”

Branch Offices

“It turns out there is something about having a nearby presence that helps persuade people to do business with you.”

“The branch offices turned out to be spectacular growth engines.. We opened somewhere and, boom, our business exploded by a factor of 15. Here, I saw, was the key to growth on a grand scale - the kind of growth I had been seeking ever since I founded Schwab.”

“It took roughly four years on average for a branch to become profitable. Opening branches is expensive, it eats into profits. But not forever - that’s the key.”

Debt

“We face enough risk and uncertainty every day in our business, not just normal operating risk, like any other company, but also stock market risk. To compound that double uncertainty with a mountain of debt strikes me as unwise. Plus I spent too many years as a young man having to scratch and claw for money. If that means we keep more cash around than some analysts think is appropriate for maximising shareholder value, so be it.”

“[We’ve] always been conservative with the balance sheet.”

Wall Street

“When it comes to telling tales aimed at garnering sales - as I know from hard experience - brokers are the best. I suffered my share of bubbles as a young investor.”

“Our employees weren’t compensated in a way that encouraged them to persuade clients to do more trading.”

Advertising - Social Proof

“The biggest obstacle we had to overcome was a perceived lack of credibility. Most of our customers knew us only as a telephone number… One way we fought that perception was the same way McDonald’s did - by counting our customers and bragging constantly about our growing numbers; ‘16,000 investors can’t be wrong,’ we said in one of our early newspaper ads.”

“Nothing compares to the word of mouth that results from good PR. It was true then, and is truer today, with the explosion of social media.”

“[Our agency] floated the idea of using my picture as the centrepiece for all our print advertising .. We had to find a way to personalise our clients relationship with the firm, or we were just a phone number and a mailing address.”

Acquisitions

“A lesson about acquisitions: understand the culture you’re buying, really figure that one out. Is it compatible with yours? Or do you have an opportunity to transform their culture so it aligns with yours?”

“You get so confident about things, willing to do anything to acquire companies, but you still have to do your analysis to see, ‘Does it really fit?’ In my experience, the biggest potential problem, is always culture.”

Summary

Schwab’s initial competitive advantage exploited the changes in regulated commissions at a time the incumbent brokers refused to compete for fear of lost revenue. Like Amazon’s AWS in cloud computing and Starbucks’ Coffee Shops, this provided a long runway for growth before like-minded competition entered.

A culture of continuous innovation coupled with an unrelenting focus on satisfying customer needs fed Schwab’s unbridled demand for growth. The willingness to adopt a longer term view allowed the business to sacrifice near term profits as technology spend ramped to further automate and scale. This provided the opportunity to cut prices and grow volume, dissuading others from entering the market while widening the company’s competitive advantage. Investors, whether employee owners, shareholders, or customers of the Charles Schwab company have been amply rewarded.

Finally, Charles Schwab is an optimist. After more than forty years witnessing investor behaviour and umpteen markets dislocations, he vehemently maintains optimism is the right mindset for an investor. Self awareness is another key component. For as Chuck says, in good times or bad:

Sometimes the most important competitor you confront is yourself.

Further Reading:
Ip Capital Parters Letter [No Association]

Reference:

‘Charles Schwab - Invested. Changing Forever The Way Americans Invest’, 2019. Penguin Random House.

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