“I have always believed in giving investors choices, and with those choices the freedom and power to make their own decisions.”
– Charles Schwab, founder and chairman of Charles Schwab Corporation
Earlier this month, my wife, Jo Ann, and I had the pleasure of sitting down with one of the great innovators on Wall Street – Charles Schwab, the founder of the famous discount brokerage firm and No. 63 on the Forbes 400 list of the richest people in America. (He is worth $7.7 billion.)
We have a lot in common. We began our careers during the financial revolution of the 1970s as editors of investment newsletters when the stock and bond markets were in a decade-long bear market. It was the age of alternative investing in “gold, silver and Swiss francs,” collectibles, real estate, and money market funds. Along with the energy crisis and fear of runaway inflation.
Then Schwab went into the discount brokerage business and I stayed in the newsletter and teaching world. Today, I’m worth several million and he’s worth several billion! (But I have my freedom; there are always trade-offs in life.)
He no longer calls his brokerage firm a “discounter.” It’s a financial services company that not only offers commission-free trades in stocks, mutual funds and ETFs, but also offers individual retirement accounts (IRAs), financial planning, credit cards and banking services.
Schwab has released a new book that tells his incredible story: Invested: Changing Forever the Way Americans Invest. I read the book cover to cover and highly recommend it.
And his book raises an interesting question: Which is better, investing in a business or investing in the stock market?
They are not the same. As I say in The Maxims of Wall Street, the business of investing is not the same as investing in a business.
If you have $1,000, should you invest it in the stock market or in a new business venture? Some people are entrepreneurs who would love to start a new business; others are more conservative and would rather be passive investors in the stock market.
Schwab chose both by creating the first discount brokerage business. He’s a born entrepreneur and loves to run businesses – in this case, investing in the business of investing.
It turned out to be a smart move in the ’70s, when the financial revolution began. On May 1, 1975, the SEC deregulated brokerage commissions. Before that, commissions were fixed and investors often paid 3% to buy stocks and 8% or more to buy mutual funds.
Full-service brokerage house Merrill Lynch actually raised its commissions on “May Day,” and Schwab took advantage and started the first discount brokerage business. He eventually grew it into the largest independent brokerage in the world, with more than $3 trillion in assets.
He would see the day when his fledging discount brokerage firm out of San Francisco surpassed the power and prestige of Merrill Lynch, the original firm that brought Wall Street to Main Street. “The rejected stone became the chief cornerstone,” as the Bible says.
The Index Fund or the Company Stock?
Here’s an interesting exercise in the debate over which is better – the stock market or running a business. In Schwab’s case: Which has outperformed, the Schwab 1000 Index Fund (SNXFX) or Charles Schwab Corporation (NYSE: SCHW)?
In our interview, Schwab was enthusiastic about the Schwab 1000, which he started on April 1, 1991. “It’s returned an average compounded rate of return of 9.9% a year,” he exclaimed.
But guess what? His own company’s stock, Charles Schwab Corporation, has increased at a compounded rate of 19% a year when you include reinvested dividends – almost twice the rate of growth of the Schwab 1000.
His stock has gone up 21,000% since its inception in 1987 (a month before the ’87 crash).
Granted, the stock has fluctuated more violently during this period, often falling by half during bear markets and periods of creative disruption in technology. But if you held on and reinvested the dividends, you were far better off investing with Chuck than with the market as a whole.
Schwab the Innovator
What accounts for Schwab’s success? His company has always tried to stay ahead of the competition. It was the first to offer discounted commissions, the first to charge nothing to open up an IRA, the first to create an all-in-one banking service including credit cards and the first to offer zero commissions on stock market trades.
It also did something different in the brokerage business – it was the first to allow investors to decide for themselves what to buy and sell. As Schwab explained, “I have always believed in giving choices, and with those choices the freedom and power to make their own decisions.”
Even today, Merrill Lynch doesn’t get it, says Schwab.
They never modernized. They never let go of the old, broken model – selling stocks to make commissions. They never worked to reduce their costs. They never considered modern portfolio theory [recommending index funds]. They didn’t let customers choose for themselves.
In fact, the only reason Merrill Lynch is around today is Bank of America bailed it out during the financial crisis of 2008.
What Will Cause the Next Crisis?
I asked Schwab if a bear market is around the corner, given that we’ve enjoyed a 10-year bull market. In his book, he confesses, “If I had learned anything after years in the business, it was how little I could ever know about what the markets would do tomorrow.”
But he did hint at the answer to my question “When will we suffer the next crisis?” He said…
We’re fat and happy right now in the brokerage business. There’s so much money out there; that’s why interest rates are so low. Only a liquidity crisis and higher interest rates can cause stocks to collapse again. I don’t see it right now.
Democratic Capitalism: Much Better Than Socialism
Schwab is one of the greatest success stories in democratic capitalism. He’s an entrepreneur at heart. His employees get stock options and participate in the profits – and losses – of the company. His customers get the best service at the lowest cost. He has brought Wall Street to Main Street and improved the lives of millions.
I asked him, “Are you worried about the popularity of democratic socialism in politics and academia?” His response was emphatic:
Voters and students don’t understand capitalism in raising our standard of living. It’s a sad state. Socialism was a disaster. In the 1980s, I visited Moscow, Poland and the Iron Curtain countries, and life was worse for everyone.
He is hopeful that if someone like Senator Elizabeth Warren gets elected, she will moderate her anti-capitalist stance. He also talked about great economists – mentioning me at Chapman and Michael Boskin at Stanford – who are teaching the benefits of financial capitalism on college campuses.
What’s the Most Important Lesson in Life?
At the end of the interview, I asked Schwab, “You’ve lived a long life, what’s the most important lesson you have learned?”
He didn’t hesitate. “Never give up on your own education. Watch less television and read more! Be responsible for yourself.”
We exchanged copies of our books – he signed a copy of his new book for me and I gave him a sixth edition of Maxims of Wall Street. His eyes lit up. “Great idea. I’ll learn some new sayings!”
I’ve included some great quotes from Schwab above, but here are two more…
“Luck is almost never only luck, especially in anything having to do with the stock market or in building a business.”
“There is a central truth about investing: Time is on your side when there’s plenty of it; it can be your worst enemy when it’s scarce.”