Close Close

Portfolio > Portfolio Construction

How an Ex-Customer’s Complaint Shook Up Schwab

Your article was successfully shared with the contacts you provided.

Walt Bettinger, CEO of Charles Schwab, told a story: Back in 2004, when Schwab stock was languishing at around $6, he and Charles Schwab decided to survey customers who left the firm and find out why. One of the customers who had a million-dollar account said something that stuck with Bettinger: He was tired of all the nuisance fees. When Bettinger pointed out to the former customer that with his size account he wasn’t subjected to them, the man said he didn’t care: He just wouldn’t do business with anyone who did that to their customers.

“So we went back to the drawing board and got rid of nuisance fees and cut commissions to $8.95,” Bettinger told an audience of RIAs attending the Morningstar annual conference in Chicago. “Our board pointed out that we had just lost 40% of our revenue due to the internet bubble burst, and now we were recommending cutting out another 30% — how were we going to make that up? And we said, by the goodness of human nature. That if we do the right thing by our clients, they will simply choose to do more business with us.”

And they were right; business did take off, at least until the financial crisis hit in 2008, which because the firm was largely invested in U.S. Treasuries, didn’t impact them as harshly. In fact, they grew market share. The stock traded around $50 in mid-July.

Bettinger emphasized that customer theme throughout his interview with Tricia Rothschild, Morningstar’s chief product officer. He noted that investors “were no different than any other type of consumer. There is an expectation on the part of investors that they aren’t used to making trade-offs: in experience, quality of service, timeliness and cost. Any client’s last great experience is their minimum expectation of every experience going forward.”

That means customers are going to expect digital quality of service and an immediate real-time response. “We need to leverage technology to deliver better value to our clients,” he said.

He added that for Schwab, regardless of the state of conflict-of-interest regulation, “our approach has been if someone is compensating us to provide advice to them, their interest should come first and we should be a fiduciary.”

When asked about what type of fee model should be used, Bettinger said that “clients should have a choice. I’m not an advocate to say one model is better than another, but clients deserve transparency and should be able to make up their own mind [to the kind of fee] whether it’s hourly, flat, AUM or AUM with cap; consumers have to be given a choice.”

He added that he hasn’t seen a “meaningful downside pressure on advisor fees, but am seeing a meaningful upward pressure on the depth and breadth of services provided.” Regarding the rise of ETFs, Schwab found in its research that 90% of millennials view ETFs as the primary manner they will invest to meet their goals, Bettinger said. Schwab also is strict about charging everyone the same fee, no matter their account size. The firm also has been successful with its robo technology, Schwab Intelligent Portfolios, which have roughly $30 billion invested to date by largely self-directed clients.

“What the robo does is leverage technology while subverting the human element so advice is at a lower fee,” he said. “I don’t see that as a long-term winning growth strategy. Subtracting something and adding something to charge less doesn’t really work.”

When asked about lessons for our times, Bettinger said Schwab’s guiding principle was “trust is earned over time, and lost in an instant. No matter what environment we’re in, a bull or bear market, we always have to challenge ourselves to make sure we use our professional knowledge to better serve clients…. Trust is the currency we operate in.”

How to Minimize Investors’ Regrets Also during the Morningstar Conference, Nobel Prize winning behavioral economist Daniel Kahneman discussed if regret-proof investing was possible, in his keynote conversation with Sarah Newcomb, senior behavioral scientist at Morningstar.

Kahneman told the crowd about a period when he was working with a team that did what he described as “sort of planning, financial advising for very wealthy people.”

“The idea that we had was to develop what we called a ‘regret-proof policy,’” he explained. “Even when things go badly, they are not going to rush to change their mind or change and start over,” he explained.

Kahneman described this idea as “regret minimization.” The optimal allocation for someone who is prone to regret and the optimal allocation for somebody who is not prone to regret are “really not the same,” he said.

Kahneman explained that this kind of “regret-proof policy” or “regret minimization” idea allows advisors to bring up “things that people may not be thinking of, including the possibility of regret, including the possibility of them wanting to change their mind, which is a bad idea generally.”

In a sense, Kahneman was using loss aversion to create this measure of projected regret. “We had people try to imagine various scenarios, in general, bad scenarios,” Kahneman explained. “The question was, at what point do you think that you would want to bail out? That you would want to change your mind?”

It turns out, according to Kahneman, that most of the people — even very wealthy people — are extremely loss averse.

“There is a limit to how much money they’re willing to put at risk,” he said. “You ask, ‘How much fortune are you willing to lose?’ Quite frequently you get something on the order of 10%.”

Kahneman helped come up with a solution for this, which he said is now in use at Guggenheim Partners, whom he was working for at the time.

The solution is people “actually have two portfolios — one is the risky portfolio and one is a much safer portfolio,” Kahneman explained. The clients decide on the allocation between them. The two portfolios are managed separately, and people get results on each of the portfolios separately.

“That was a way that we thought we could help people be comfortable with the amount of risk that they are taking,” he said.

Newcomb added that this solution “seems to be a good way” to put a wall in between the money that the client wants protected and the money that the client is willing to take risks on.

“The [two portfolios] don’t touch each other, and just that psychological distance between the two allows them to feel safer even though they’re in the same portfolio, really,” Newcomb said.

Kahneman added that one of the portfolios will always be doing better than the market — either the safer one or the risky one.

“[That] gives some people sense of accomplishment there,” he said. “But mainly it’s this idea of using risk to the level you’re comfortable. That turns out to not be a lot, even for very wealthy people.”

DOL Bulletin No Threat to ESG Wave: Hale Guidance released in April by the Labor Department might have a chilling effect on ESG investments for ERISA products, Jon Hale, head of sustainability research at Morningstar, said during a press conference at the 2018 Morningstar meeting.

However, he pointed out that a more comprehensive interpretive bulletin was released in October 2015, stating that environmental, social and governance criteria had to show “proper components of the fiduciary’s primary analysis of economic merits of competing investment choices.” That said, it gave leeway to fiduciaries to use ESG strategies.

But Labor’s April guidance in Field Assistance Bulletin 2018-01 doesn’t appear to have much forethought put into it and does “muddy” the waters, Hale said. That bulletin said that ESG investments weren’t always a “prudent choice” and that such factors shouldn’t “too readily” be considered as economically relevant by fiduciaries.

Still, he contends, the age of Trump won’t change companies’ responses to the ESG drive, which is accelerating dramatically.

Ginger Szala is executive managing editor of Investment Advisor. She can be reached at [email protected] Staff reporter Emily Zulz can be reached at [email protected]