“Our strategy is winning — and the best is yet to come.”
-- Walt Bettinger
President and Chief Executive Officer
To My Fellow Stockholders
Each year it is an honor to sit down and craft a letter to share my thoughts on Schwab with you, our valued stockholders. I strive to write this letter with a minimum of jargon, corporate speak and trendy business buzzwords. It isn’t written to compete with the latest bestseller on business strategy or how to be a better leader in changing times; it is written with the goal of simply discussing the current state of our company and the future we face together. The litmus test for this letter is: “Does it read as if I were corresponding with a business partner who has been out of touch for the past year?” As always, my hope is that you will share with me your feedback on whether this goal has been achieved.
This year’s letter takes on a special meaning to me because in late 2015, we saw an initial move upward in short-term interest rates by the Federal Reserve. It is difficult to overstate the impact that even modest increases in the federal funds rate will have on our company. After seven long years of ZIRP–or the “zero interest rate policy” implemented by the Federal Reserve–light may be starting to appear at the end of the tunnel. And the timing is perfect for our company to shine
But more on that later. Let’s first talk a bit about 2015. When I evaluate the year that just ended, three key themes
come to mind:
- 2015 was a year when our efforts as a challenger to the investment services industry gained strong momentum;
- The end of 2015 marked a potential inflection point as the Open Market Committee of the Federal Reserve took a first small step toward a more normalized interest rate policy; and
- Our future growth trajectory is exhilarating.
Let’s dive into each of these in some degree of detail.
Over 40 years ago, Chuck Schwab founded our company as a challenger to the status quo and to the traditional manner in which investment and brokerage firms operated. When most firms charged retail investors stock trade commissions in the hundreds of dollars, Chuck charged about 70 bucks. When investors looked for more efficient means to track their stock holdings, Chuck was one of the first to offer technology-driven access to information that saved investors’ calls to their brokers or a trip to the local branch office. And when mutual funds became a key solution for Main Street investors, Chuck revolutionized the industry by creating a one-stop place to buy and sell mutual funds from multiple fund companies–with no sales load.
Today, despite what you might hear in the press about “Silicon Valley disruptors” and “fintech,” Schwab remains the consummate challenger in the investment industry. Each day we ask ourselves a question consistent with our “Through Clients’ Eyes” strategy: “How can we use our deep knowledge of investing to help our clients be better investors, to deliver services to clients at a lower cost, and to ultimately help them achieve better outcomes and take ownership of their financial futures?”
There are few things we enjoy more than doing for clients exactly what we would want if we were the client. And it works for clients and stockholders alike! In just over 40 years, Schwab has become the largest publicly traded investment services firm, as measured by client assets, in the United States–surpassing Bank of America Merrill Lynch in 2015–proof positive that investors will reward a company that challenges convention on their behalf. And stockholders have been rewarded with a compound annual return of 18% from the day our company went public in 1987 through the end of 2015.
Here are a few examples of challenger actions we have recently undertaken and the results we have achieved:
Furthering the alignment of our interests with our clients’ interests
Most of you know that the Schwab of today is not the discount broker of yesteryear. Today we offer a fullservice investing experience, but at a value unmatched in the industry. Although we have always strived to align our interests with those of our clients, we recently took a groundbreaking approach to investment advice. One of the long-standing criticisms of investment advisory services in our industry was that clients paid fees to their investment firm regardless of whether the clients were satisfied with the advice received. It was akin to a “heads I win, tails you lose” concept. At Schwab, we broke this mold by offering a 100% money-back guarantee on advisory fees paid to us for the previous quarter if a client was unhappy with our advice or service for any reason–no questions asked!
The result, we believe, is that more investors are reaching out to Schwab for help. In 2015 we enrolled over 155,000 client accounts in one of our fee-based retail advisory solutions, an increase of 60% over 2014! And as proof of the quality of our advice and service, even in a very difficult year for investing, clients requested a refund of only 0.3% of all investment advisory fees we charged last year.
Fees matter for long-term investing
One certainty for investors is that fees matter. Few investors still believe the sales pitch of “the more you pay, the more you get.” Consider the case of a hypothetical 30-year-old investor with a $100,000 portfolio, earning average returns of about 6% a year, who plans to retire at age 70. If she pays annual expenses of 2% over the next 40 years, she’ll end up with about $458,000. However, cut that annual expense load to 1% and her portfolio would grow to $688,000, 50% more.1
As a direct result of this fact, several years ago Schwab introduced exchange-traded funds (ETFs) that offered the lowest operating expense ratio of any ETF in their respective Lipper asset categories.2 Why? Because the primary difference between two ETFs based on similar indexes is the level of their management fee.
The result is that Schwab is not only the largest custodian of ETFs for retail investors from multiple fund families, but our ultra-low-priced Schwab ETFs™ have gone from nowhere to make Charles Schwab Investment Management, Inc. the second-fastest-growing ETF manager among the top 10 issuers by assets (based on 2015 flows), and already number five among all firms in terms of new ETF flows industry-wide. In fact, in 2015 clients invested more money in Schwab ETFs than any other family of ETFs at Schwab, including BlackRock iShares or Vanguard.
Innovation isn’t just for Silicon Valley startups
One of the most over-hyped aspects of investing in the past year is the concept of “robo-advice.” A “robo-advisor” offers a user-friendly website and mobile experience where an investor can answer a few questions, have a complete investment portfolio built, and receive ongoing management with rebalancing and, in some cases, tax-loss harvesting. Now, I say over-hyped because the press has speculated that growth in “robo-advice” could jeopardize the desire for investors to want an in-person relationship–a suggestion that we see as folly. That said, there are real benefits to the concept of automated investment advice if it is combined with the availability of live professionals by phone, chat or in person. In the first quarter of 2015, we introduced Schwab Intelligent Portfolios™ the first digital advisory program in the industry that charges ZERO advisory fees. Rather, we generate sufficient revenue from underlying ETFs and cash investments to offer the service without charging an advisory fee. And, of course, Schwab professionals are available by phone or chat 24/7, 365 days a year.3
The result is rather remarkable. At the end of 2015, only nine months after its introduction, Schwab Intelligent Portfolios had grown to over $5.3 billion in assets. This total is about the same as the two largest early-to-market “robo-advisors” combined–after years of efforts on their part. Yes, innovation is alive and well at our company!
Serving as a fiduciary for advisory clients
Recently, the Department of Labor (DOL) proposed a complex set of rules that would affect anyone offering investment advice to investors’ individual retirement or 401(k) accounts. Although we have asked the DOL to make some changes to its proposal to protect the investment choices of large and small investors, the DOL’s core concept makes sense. If a client pays an advisor a fee for investment advice, the client should be able to have confidence that the advice they receive is in their best interest and not driven by the compensation potentially paid to the advisor or firm. This idea of acting in clients’ best interests is the basis for being a fiduciary. And it isn’t a foreign concept at Schwab. We serve 7,000 independent investment advisors and custody over $1 trillion for these professionals, whose business model typically revolves around being a fiduciary.
And for any client who pays Schwab a fee for investment advice, we already serve as a fiduciary. There is a reason so much of the investment industry is up in arms about the DOL proposal: in my opinion, too many business models in our industry are fundamentally based on selling clients expensive funds, annuities, hedge funds and private equity portfolios under the guise of “advice.” Our approach is unique and proven–putting the client at the forefront is the winning strategy.
The result is that as of year-end 2015, we served in an investment advisory role for almost $193 billion at Schwab directly–a long way from our discount brokerage roots. And we are as large as our next three competitors added together in serving independent investment advisors.
Being a challenger isn’t easy. It means making tough decisions. At times it means cannibalizing your own revenue streams. And it almost always makes you a target for competitors who prefer the status quo. But we are a challenger at Schwab because investors deserve it. They deserve a challenger who sits on the same side of the table as they do. And we see that as a winning long-term strategy for stockholders. Clients win and stockholders win. That is a virtuous cycle!
Punishing. There is no other way to describe the financial impact on our company from the unprecedented experiments taken by the Federal Reserve since 2008. While the Fed experimented with zero interest rates and printing money under the guise of a fancy term–quantitative easing–savers suffered, responsible people who had avoided large debt suffered, and our company suffered as well. In 2008, when client assets at Schwab were slightly in excess of $1 trillion, we generated revenue of just over $5 billion. In 2015, when client assets were in excess of $2.5 trillion, we generated revenue of just over $6 billion. Put more succinctly, during that period total client assets grew by about 120% while revenues grew just 24%. Punishing. And you can attribute virtually this entire scenario to the interest rate policies of the Fed.
In order to cope with this, we made many trade-off decisions to generate reasonable returns for stockholders while we tried to minimize passing on the pain from the Fed’s actions to our clients. In just one example, since the beginning of 2009 we waived about $4 billion of management fees from money market funds to ensure that our clients avoided a negative yield on their investments in those vehicles.
But on December 16, 2015, the Fed increased the federal funds rate by about 0.25%, beginning what is, hopefully, a process toward normalizing interest rates–albeit one that could unfold unevenly over several years. It doesn’t exactly sound earth-shattering, but given that almost 10 years have passed since the last rate increase, it is a step in the right direction. And the impact for our clients and stockholders should be positive. Clients can expect to begin earning a bit more interest on their cash and fixed income investments, while stockholders should see an increase in the rate of revenue growth at Schwab.
Most economists project modest growth in GDP over the next five to 10 years. As a result, top-line growth for companies is also likely to be challenging. But at Schwab, we are incredibly optimistic about our ability to generate substantial growth.
First, if interest rates rise over the next few years, we could scale back the previously mentioned waivers of money market fund management fees, and if longer-term rates do not decline precipitously, we could also earn a more reasonable return on clients’ short-term cash investments on our balance sheet.
Second, over the coming years we would be able to invest some portion of this incremental revenue in initiatives that should power our net new asset and client growth, which leads to organic revenue growth. These investments are likely to lead to some combination of more retail branches, more financial consultants who work with clients daily, enhanced technology that makes it easier for clients to invest and save with us, targeted pricing moves that deliver even better value to our clients, and even higher levels of service than the award-winning service we deliver today.
Growth matters–to both our clients and our stockholders. For clients, growth means we build scale, and with greater scale comes greater efficiency. And with greater efficiency we can deliver even greater value to clients. This is another example of a virtuous cycle. Our company already operates more efficiently, by a wide margin, than any publicly traded investment services firm. And we plan to leverage this efficiency to grow even more.
For stockholders, growth creates value. Using the simple example of supply and demand, we know that people will pay more for what is scarce. Putting this in terms of an investor trying to decide whether to invest in Schwab stock or the stock of some other company, the anticipation of profitable revenue growth can be the deciding factor. And with top-line revenue growth likely to be scarce in the coming years for many companies, your company should stand out for our ability to grow revenue and earnings—making Schwab an attractive company for investors to own.
Conclusion: Building on our competitive advantages
After seven long years of near zero short-term interest rates, it appears that the long-awaited inflection point might be upon us. And if interest rates continue to rise, you should expect to see an aggressive Schwab. We intend to leverage scale, efficiency, discipline, our “Through Clients’ Eyes” strategy, and a lift in revenue from potentially higher interest rates to apply maximum competitive pressure, to better serve clients, to gain market share and to grow revenue and earnings.
In just over 40 years, Schwab has grown from a small startup into America’s largest publicly traded investment services firm, as measured by client assets. And we have no intention of slowing down. It’s a simple formula: we serve our clients in exactly the same way we would want to be served, and they bring us their hard-earned money and refer us to their family and friends. Impressively, clients have entrusted our company with over $1 trillion of net new assets since the Fed last raised interest rates in 2006. That is a testament to their trust in us, and in our honesty and transparency.
In last year’s letter I mentioned that in 2015 I would be celebrating my 20th anniversary at Schwab. In those 20 years, it has been a privilege to serve our clients, stockholders, employees and the communities where we live and work. With our continued focus on challenging the status quo, our hope that the Fed’s actions from last December will prove to be the beginning of a more normalized interest rate environment, and the growth prospects ahead of us, I am more excited than I have ever been to serve all of you as my third decade at Schwab commences. We have made tremendous progress, but I truly believe the best is yet to come!
Thank you for your confidence!
March 3, 2016
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1 Schwab Center for Financial Research. The example is hypothetical and provided for illustrative purposes only. Not representative of any specific investment or product and takes no account of dividends, interest or taxes. Hypothetical performance is no guarantee of future results.
2 Based on expense ratio data comparisons between Schwab Market-Cap ETFs and non-Schwab Market-Cap ETFs in their respective Lipper categories. A Schwab Market-Cap ETF is determined to be the lowest in its Lipper category if its expense ratio is equal to or lower than the lowest expense ratio of any non-Schwab Market-Cap ETF in that category. Securities in Market-Cap ETFs are selected and weighted based on the size of their market capitalization. Expense ratio data for both Schwab and non-Schwab Market-Cap ETFs was obtained from Strategic Insight Simfund as of 12/31/15. Expense ratios are subject to change.
3 For program information and details about how we make money on Schwab Intelligent Portfolios™, see intelligent.schwab.com and the Disclosure Brochures. Schwab Intelligent Portfolios is offered through Schwab Wealth Investment Advisory, Inc. Schwab investment professionals are employees of Charles Schwab & Co., Inc.
2015 Top Workplace Recognition
We are proud of our culture of service, teamwork and seeing challenges “Through Clients’ Eyes.” Our culture truly differentiates Schwab and makes our company a great place to work. We place great value on the recognition we receive as an employer of choice, particularly those awards that are based on the feedback of our employees.
Gallup® Great Workplace Award
In 2015, Schwab received with distinction a fourth consecutive win of the Gallup® Great Workplace, placing Schwab among the top 40 companies recognized for having the most engaged workforces in the world. Schwab was also awarded the “Excellence in Outcomes” award, given to the company with the best “Total Performance.”
Since 2004, Charles Schwab has received a 100% rating on the Human Rights Campaign’s Corporate Equality Index. The index rates American workplaces on lesbian, gay, bisexual, and transgender equality.
Schwab received great workplace recognition based on employee feedback in seven major markets where Schwab has significant concentrations of employees: Austin, Chicago, Cleveland, Denver, Indianapolis, the San Francisco Bay Area, and the state of Arizona.
Schwab has been recognized as a military-friendly workplace and for its commitment to hiring veterans by G.I. Jobs, Military Spouse and Military Times EDGE magazines.