Charles Schwab is selling advice. Should you take it?

charles_schwab.top.jpgFounder and chairman Charles SchwabBy Lisa Gibbs, Money Magazine senior writer


(Money Magazine) -- "I hate to use this phrase, but we really are the Wal-Mart of financial services," says Charles Schwab. His hesitation is understandable -- when you are trying to persuade investors that your firm is the place to entrust $100,000 or $1 million of their savings, you don't want them associating you with cheap sweatshirts and dog food.

Certainly the view from Schwab's office, which overlooks San Francisco Bay, could never be mistaken for Bentonville, Ark. But the comparison really does get at the two big ideas driving his business: that it's a mass-market brand aiming to serve just about everybody who invests, and, of course, that it's cheap. "Low prices matter," adds the 72-year-old founder and chairman of Charles Schwab & Co (SCHW, Fortune 500). "Value matters."

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The commitment to cheap is in the DNA of his company -- it was among the very first to launch discount stock trading in 1975. But the idea of being for everyone? Not so much.

For much of its history, Schwab pitched its business at a niche of self-confident do-it-yourself investors -- the company was positively anti-advice. Now Chuck Schwab himself says that pure self-directed investing is "a very teeny market." The key to his company's continued growth, and to really becoming finance's Wal-Mart, is to get people to think of Schwab as the best place to go for investment advice.

But can wise counsel really come in bulk? A first-rate financial planner might have time to serve about 150 clients, and if he's paid a percentage of assets, he's unlikely to take on anyone with less than $500,000 -- or often $1 million -- to invest. Brokers who serve smaller customers may be glorified salesmen pushing high-commission investments. That's left a big, pent-up market for real help, one that's only grown after two market crashes. "The vast majority of investors who have tried to do it themselves are realizing how hard it is," says Anthony Ferreira of the consultancy Cogent Research.

If Schwab -- the company -- can get advice right, it will be the crowning achievement of Chuck Schwab's career. (He stepped down as CEO in 2008, but as chairman he continues to help shape strategy.) The firm was ahead of the curve on cheap commissions, no-load mutual funds, and online trading. Schwab's willingness to disrupt the status quo has not only made Chuck Schwab a billionaire, it's often changed the rules for the entire industry, making it more consumer-friendly. If Schwab can prove that solid financial planning can be done on a mass scale at low cost, you'll win too.

If the company can't? That's not great for you, or at least plenty of people you know: One need only look at the number of 401(k) accounts that were overallocated to stocks in 2007 to conclude there's a real need for good advice. Fact is, that need will only increase as baby boomers retire and their financial planning challenges grow more complex.

But the failure would be worse for Schwab, which is under attack from rivals at every price point and customer asset level. Fund giant Fidelity ($3.1 trillion under management compared with Schwab's $1.3 trillion) is going after the "mass affluent" advice market, too. The insurance industry is cranking out products to draw the assets of those retiring boomers away from brokerages. Meanwhile, Schwab has to offer planning without alienating some of its own best customers, the independent advisers who use Schwab for trading, record keeping, and referrals and who also, by the way, want Schwab's wealthiest customers for themselves.

And Schwab has to fight these battles while retaining its reputation for value, in an age when technology makes it easy for other players to cut prices too. Love Schwab's $12.95 stock trades? Plenty of brokers will charge you $7 or less. Schwab has had to constantly seek out new markets in which to cut costs, such as banking and index funds. In short, Schwab must continually prove it's the financial services company that's cheap and smart.

Jumping into the advice gap

For a time, Charles Schwab prided itself on shutting up and letting you make your own decisions. A 1980s television ad reflects this attitude. "I built this software business my way," says an actor wearing rolled-up shirtsleeves and a pocket protector. "And I make investment decisions my way." (Contrast this with today's "Talk to Chuck" campaign.)

The idea that investors could go it alone was still new and kind of liberating in those days. Before the law changed in 1975 to allow discount commissions, a broker's advice was an inescapable part of buying stocks. Schwab's promise was that you'd never deal with a pesky salesman. And it undercut the competition's trading costs by 30% or more.

As more investors started to give up on brokers altogether in favor of no-load mutual funds, Schwab had a way to cash in on that too, by selling funds through its no-cost "marketplace." (Fund companies paid for the shelf space, a cost arguably passed on to all shareholders.) Schwab's model then turned out to be a natural fit with online trading.

Then came the lean years. After the crash of 2000, trading revenues plummeted. Under co-CEOs Schwab and David Pottruck, the company made some strategic missteps, such as acquiring high-end wealth manager U.S. Trust, which it later sold. Meanwhile, many of the firm's core customers were leaving once they reached about $500,000 in investable assets, going to full-service brokers or planners. Schwab wanted those customers back.

After briefly leaving the CEO post to Pottruck, Schwab returned to the top job, alone this time, in 2004. By that point, advances in technology had allowed Schwab and his firm to rethink their long-held aversion to giving advice. Software and the web let the company generate model portfolios and strategies its consultants could use from Maine to Malibu. So controlling quality was easier. "We didn't want 10,000 forms of advice," he says. "I wanted one set of advice for everybody."

What can Schwab do for you now? If you have $25,000 in an IRA, you can join Managed Portfolios, a service launched in 2006. Schwab will invest your money in mutual funds based on a template of strategies -- from moderately conservative to aggressive -- and periodically rebalance for you. You'll talk to a Schwab "consultant" about your goals, ability to save, and risk tolerance. With $250,000 in assets -- whether or not you're in Managed Portfolios -- you'll be assigned to one specific consultant. With $500,000 you can get a customized plan and quarterly meetings to review strategy.

If talk is cheap, is it worth the price?

Schwab charges for most of this, of course. The managed IRA account, for example, costs 0.5% a year on top of the funds' expense ratios. The customized planning is 0.75% (0.5% for bond assets.) That beats the 1% or more that an independent, fee-only financial planner might charge. But you're probably not getting the same service either, or the expertise.

The best advisers are often certified financial planners. Many of Schwab's financial consultants don't have those credentials, though all are experienced, licensed stockbrokers. They might have 350 customers in various programs, not 150. In deciding where to put your money, they're working from those preset asset-allocation models. But if all you want is help creating a portfolio, you could just as easily buy a target-date mutual fund, which gives you a mix of stocks and bonds that gets more conservative over time. Or you could look up model portfolios on Schwab's own website and do it yourself for free.

But would you? Knowing which funds or stocks to invest in isn't really the hard part of investing, argues Seattle-based planner Bill Schultheis, author of The Coffee-house Investor. (He uses Schwab to manage his clients' money but not for referrals.) "What's important is the financial plan," he says. "If I reduce my monthly expenses, how does that affect me over the next 25 years? What if I work two more years?" This isn't rocket science, but lots of people could use help running the numbers. Others need the occasional check up or someone to talk to when markets are volatile.

Roy Davis is a retired engineer who showed up at a Florida seminar Schwab held for local customers, and he's a good example of the kind of investor Schwab is targeting. He likes the firm's low-key style. "I can get as much help or as little as I want," he says. For years he enjoyed trading in an account he had inherited, but he decided that managing his and his wife's retirement was too big a job to do alone.

"People are more complex than just to be characterized as 'self-directed' or 'advice-seeking' investors," says Walt Bettinger, the onetime boss of Schwab's retail investor division who took over as CEO in 2008. "There are parts of our financial lives where we're comfortable making decisions, and parts where we're more comfortable getting help."

Addressing both sides of this equation seems to be working for Schwab. While some of its full-service competitors lost customers, Schwab added 585,000 brokerage accounts in the first nine months of 2009. Advice offerings remain a small part of the business, with $60 billion in assets, but the number is growing. As of September, 30,000 more households signed up for help in 2009.

Schwab has clearly benefited from not having an investment-banking arm embroiled in the financial crisis. But it didn't entirely sidestep the debacle. New York's attorney general has sued Schwab's brokerage unit, claiming it misrepresented the risks of auction-rate securities, the market for which froze during the crisis. A Schwab spokesman says that it was the underwriters of those securities who hid the danger.

In another case, a class-action suit is pending over Schwab YieldPlus. This mutual fund, which had been recommended by Schwab consultants, invested in mortgage-related securities. The suit claims the fund was marketed as a conservative investment comparable to Treasuries or CDs. Bettinger responds that almost no one foresaw the meltdown in fixed-income markets. "We feel horrible" about customers' losses, he says.

Getting you in - and hanging on

The 300-pound gorilla in Schwab's neck of the forest is Fidelity. It sells advice products similar to Schwab's and has one formidable advantage. As one of the biggest administrators of 401(k) accounts, it gets to customers through their employers. "Those relationships put Fidelity in an exceptionally good position," says Don Phillips, managing director of fund researcher Morningstar. When you quit or retire and roll money over into an IRA, the Fidelity brand is already a known quantity. Schwab's footprint in the 401(k) business is smaller.

Schwab still tries to get you in the door with bargains. Schwab Bank's checking account pays 0.75%, with no minimums, and no service fees or ATM fees. The company cut the expense ratio on stock market index funds as low as 0.09% -- less than the price of Vanguard index funds, the old standbys for cost-conscious investors -- and dropped investment minimums to just $100. It's also eliminated the commission for buying in-house exchange-traded funds. Once you have an account, many Schwab reps you'll talk to have financial incentives to sell you on other services, including advice.

Schwab's next big push? Keeping your business through your retirement. The spend-down phase after 65 turns out to be even trickier than accumulating wealth. You have to think about safe rates of withdrawal, strategies to protect against inflation, and the risk that you'll outlive your money.

Schwab says it has products in the works to help, but it won't offer details. This much seems clear: Schwab's move into advice is part of the sell. Stacy Hammond, director of retirement services, says that you can't neatly divide the spend-down and accumulation phases. You have to be thinking about both along the way. You could expect to retire at 65 but get laid off three years early. You might get whacked in a bear market in your final year of work, or even end up with more money than you expected. Says Hammond: "Of course, we can help you generate income. But the real difference is the conversation that happens before that." Charles Schwab is betting you'll pay to have that talk.

Schwab looks ahead

A few more words from the chairman on markets and the future of investing.

Will the markets ever become less volatile?

No. You just have to develop strategies to deal with it.

Are investors finally getting a little less cautious?

Investors are getting -- certainly not aggressive -- just a little bit more willing to take on some element of risk. Of course, nobody knows what's lurking out there in terms of inflation risk, and, oh my gosh, that's really a fearful thing.

How should investors respond?

Inflation could really hurt you two or three years from now. Buying common equities is one of the greatest ways to defend against it. After a big drop in the market, people naturally go into the more liquid areas, like fixed income or cash, but those are going to be the worst areas.

You say that exchange-traded funds (ETFs) are the modern mutual fund.

They are a fantastic tool. You can get every slice of the asset allocation pie with them, and the management fees are unbelievably low. And they're tax-efficient -- with a mutual fund you never quite know what the manager has done to control capital gains exposure. It's a very scary competitive situation if you're a firm that runs mutual funds.

So do you use ETFs personally?

I have 50 different ETFs, and I cover everything from large-caps to commodities to emerging markets. You name it, it's in there. The account itself went down through the crash to some degree, but is now back up on an after-tax basis. That's what diversification and asset allocation do for you.  To top of page

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