MONEY Master the Game: 7 Simple Steps to Financial Freedom (79 page)

TR:

Everyone knows the name
Charles Schwab.
They know the institution. But most people don’t really know your story. I wonder if you would just share a few highlights? I understand you started becoming interested in investing as early as thirteen?

CS:

That’s right. When I was thirteen, it was right after World War II, and the world wasn’t too rich. My dad was a small-town lawyer in California’s Sacramento Valley, and certainly our family wasn’t very rich. I thought I’d be better off in life if I had more money, so I had to figure out how to make money. I talked to my dad about it, and he encouraged me to read biographies of the famous people in America. And they all seemed to do something about investing. So I said, “Man, that’s for me!”

So when I was 13, I started a chicken company. Raised chickens and all that. And then I did a bunch of other little business kinds of things. So I knew a lot about business and started thinking about how businesses function and operate.

TR:

What was your original vision? And what were your first real practical steps? Give me highlights, if you would, to give people a sense of your journey.

CS:

Well, I was quite lucky early in the journey. I started out as a financial analyst, and I had some ups and downs along the way. I was about 35, and I had a lot of experience before I really started the company in 1973. And as a result, I knew some of the handicaps of the financial business. Including why they didn’t treat people well enough. It was because they were really focused on making
themselves
money—but not on giving the investor a fair shake. They always thought about their institution and making money first. I said, “
Aha!
There’s gonna be a different way!”

TR:

What has been the
competitive advantage at Charles Schwab
over the years? I mean, if you look at the size of the North American investment market, I think it’s about $32 trillion. And you guys have to represent a sizeable amount.

CS:

We’re probably 5% to 10% of the retail market. Something like that. But you know, as I got into business,
I wanted to look at every product, every service that we offer clients,
through clients’ eyes
. We would design a product like a no-load mutual fund. We did it in a big way. We made it
free
for people to buy no-load funds through us, years ago.

People would say, “Well, how are you gonna make money at that?” So we figured out a way to make some money at it. We worked with the mutual fund companies and convinced them to pay us a little fee out of their management fees. And our clients would benefit from it. And it flourished. So the individual got a great advantage by buying a plethora of no-load mutual funds for no fee. We did the same kind of analysis along the way for other things that we did. We looked at it first through the clients’ eyes.

But
Wall Street did just the reverse.
They always made a decision: “How much money can we make on this first? Okay, let’s do it. Let’s go sell it, boys.” That’s the way they made decisions. We were completely the opposite.

TR:

Has that shifted? Or is it still the same?

CS:

It’s still the same. And that’s why it’s a pretty interesting market for us. You know, we have sort of an unlimited destiny, I think, to continue to treat the client as the king. And make sure we do everything that’s in
their
interests first. Yes, we will make a little bit of money. Which we do, of course. We’re a profit-making organization. But first, we think about the client.

TR:

What do you think are the two or three myths that you try to point out to them to pay attention to so they don’t get sucked in when they think about investing?

CS:

Well, it’s so easy. I’ve watched it in Wall Street so many times. You see the abuses that come about. Some really fancy broker comes along and says, “Ma’am, would you like to make some money?” Of course, we all say, “
Yes!”
And then you get engaged in the conversation. “These guys have the best widget you’ve
ever seen in your life.
And it’s gonna be just like another Apple.” So we all, naturally, sort of listen to the story, then say, “Okay, I’ll put some money into that.”

Well, the probability of that working out is about 1 in 10,000. It’s like, why don’t you just go to the horses? Or buy a lottery ticket that day? That’ll satisfy your speculative thing. Put the real money you have into an index fund, where you know the outcome is going to be highly predictable and returns will be really quite good.

TR:

So many people will get hurt because they don’t know things and they don’t ask questions. And you’re one of the first people to say, “Ask questions.”

CS:

Right.

TR:

But very few people know the questions to ask. You know, they see a mutual fund, and they see its return. And they think that’s the return they receive. And as you and I both know, that’s just not true.

CS:

It’s just not true. It’s never. Anything of the past is never promised for the future. But there are reasons why we put out a pamphlet, a white paper on index funds. We talk about the reason why stocks are the greatest place, really, to have long-term investments. And the reason why is that companies are in business to grow. Every board I’ve ever been on—and I’ve done six or seven different Fortune 500 boards—every conversation at the board meeting is about growth. How can we grow this company? If you don’t grow, you fire the management. Get a
new management team in.

Now, that building over there is a beautiful building. But you come back 100 years from now. That building would still be the same size. Or be knocked down. But it doesn’t grow. Only companies grow. And that’s why it’s a fantastic thing to go to stocks. And, of course, in our case, we try to encourage people to go into index funds, so they get a broad blend of industries and stocks and so forth. Then they have—

TR:

—the lowest costs.

CS:

The lowest costs, and they get a high degree of certainty that they’re going to do as well as the index will do. And if you look at any industries over the last 100 years, they’ve done extraordinarily well over time and brought great returns to clients.

TR:

If you listen to Vanguard’s Jack Bogle or somebody like David Swensen from Yale, they all say passive management is the way to go. Because 96% of all mutual funds do not match the index over a ten-year period of time. But how do you feel about it for the average investor: passive versus active?

CS:

Well, I’m a mixed investor. I invest in a lot of individual stocks. But I have the time. I have the expertise. I have the education. But 98% of people
don’t focus on that.
They have other things in life to do, rather than fuss around with investments as I have done, or Warren Buffett has. You know, they are professionals, and they’re doctors. Or lawyers. They’re whatever. We need all those people to make a successful society. And maybe 2% of us really know about investing. So the rest of the people need some help and advice. That’s what I learned early on, and that’s what we do today.
And the 98% should really predominantly go into index funds, in my view. They have the most predictable outcomes.
Better than they would ever do by trying to pick different things, which is very difficult to do. And
then
do their other job too. You can’t do both.

TR:

The other part is, people just don’t realize what the cost is, as Jack Bogle points out. For every 1% over the lifetime of investing, it’s 20% of your money you’re giving up.

CS:

Yeah. It’s over.

TR:

Give up 2%, that’s 40%. Give up 3%, that’s 60%.

CS:

That’s a whole lot. And on an after-tax basis, it really mounts up.

TR:

Every major investor that I spoke to talks of the fact that
asset allocation
is the
single most important investment decision a person can make.
You deal with so many different
types of investors.
What philosophy do you try to have your team apply to help people understand what their asset allocation should be?

CS:

Well, it’s actually pretty easy today. It wasn’t that true 40 years ago. Now we have index funds that we mentioned. And ETFs. So you can get different slices of the market so you can have plenty of diversification. You want energy stocks? You can get an energy ETF. You want medical devices? You can do that. And, of course, I tend to believe you should be diversified among the very biggest and ten biggest industry groupings. And that’s what you generally get in a general index fund. You get all of them, because you never know. Sometimes electronic equipment will be going, zooming right up. Oil might not be doing so well. But next year? Oil is in demand, so oil prices are going up. And that does well. And so on and so forth. But it allows you to get the balance of the benefits of each of these sectors.

TR:

How do you feel about investing in America versus international, when you’re trying to create that asset allocation?

CS:

That’s another level of sophistication, which I think everybody should have in their portfolio. Some chunk devoted to international, because the very simple fact is, America is growing at about 2% to 3% per annum now. There are many other countries that are beginning to, from China to Indonesia to Japan, have better growth than America. So that’s where you’re gonna get your returns, where there is better growth, frankly.

But even though the American economy is only growing 2%, there are some parts of our economy that are really growing quite fast. So obviously you want to be attracted to them too.

TR:

Where do you see the
world going in the next ten years
? What do you think those opportunities and challenges are for investors?

CS:

I think there are enormous opportunities ahead of us still. Despite how slow things are going right now. It will explode once we get the kind of policies I think will eventually get back in. Because there’s no way you’re gonna take the growth component out of America. The innovation going on in this country is profound. I mean, I live in the San Francisco area, where it’s just going, busting at the seams wherever you walk. It’s there.

TR:

Are we in a market bubble with the Fed controlling rates the way they are? Where you would have to take significant risk to see rewards? The market seems to be the only place for the money to go. How long does that last?

CS:

Well, I’m not a great fan of the present policy of the Federal Reserve. I think manipulating rates, as long as they have, is really not the right decision. And I guess it does create the potential and the possibility of some kind of bubble. It won’t be forever. We will probably pay a price for it. But it’s not a permanent issue. And so there’ll be some high inflation or down markets. There will be a consequence for what we’re doing now. But we’ll get through it. As we do every time there’re bad decisions made by policymakers.

TR:

They all have a different language for it, but for every single major investor in the world, one of their competitive advantages is asymmetric risk/reward. They take a little risk to try to get a big reward. How does the average investor do that today? Is there any insight you can give them?

CS:

Well, I think it’s all coming back to the answer:
Where can you get the best growth? Understanding the fundamentals of growth is crucially important to get long-term returns.
Now, in the case of Warren Buffett, he learned that at a young age. He just buys companies, and he never sells. Why? Companies keep growing. They just keep growing. And he gets richer and richer.

TR:

He doesn’t pay taxes.

CS:

And he doesn’t pay taxes. If you don’t sell, you don’t pay taxes!

TR:

That’s pretty awesome.

CS:

That’s his mystery. The myth has been solved!
He doesn’t sell!

TR:

I believe you have five children.

CS:

And twelve grandkids.

TR:

Twelve grandkids! Tell me: If you could leave none of your money to your children, but you could only leave a set of investment principles and maybe a portfolio, what would be your advice to them?

CS:

Well, I think it really starts with earning your own money. Having success in that. And the concept of putting some money aside.

• Make sure you get the right education. And hopefully it fits into the marketplace, where jobs are being created.

• You’ve got to have a well-paying job, which are not that plentiful today.

• And then putting the money aside in your 401(k) or IRA. It takes giving up things. Not buying that car. Giving up that vacation. Having something set aside.

• And then you could begin doing the proper investing.

It’s a pretty simple formula. Lots of people don’t realize it, but hopefully you can teach people to do that.