Charles Schwab: How did the 'common people' rise up and create a financial red ocean?

The financial industry highly values scale effects. This leads to a severe 80/20 split in the industry, where once giants have a scale advantage, small and medium platforms have little chance of competing with the leaders on their own. Therefore, most changes in the competitive landscape of the financial industry are accompanied by horizontal or vertical mergers and acquisitions.

The reason $Charles Schwab(SCHW.US) has succeeded in becoming one of the top financial platforms in the U.S. is actually a unique form of overtaking on a curve. Besides its own business strategy of "making fewer mistakes," it also leveraged the "era dividend" of major industry transformations. Thus, through Schwab's transformation journey, one can clearly see the 50-year development history of the U.S. securities investment industry.

Dolphin Research chose to cover Schwab at the interest rate cut turning point, not to discuss the investment opportunities behind short-term fundamentals, but with a mindset of tribute, to think about how Schwab went from 0 to 1 to penetrate seemingly stable competitive landscapes and seize every opportunity for industry change, survive and grow, and the fundamental reasons for achieving 1 to 10.

I. User Mindset Established: Preferred Financial Platform

Charles Schwab can be said to be one of the preferred financial platforms for most American families. On Schwab:

(1) ToC (Investor service): Retail users can achieve a complete wealth management plan from trading stocks and bonds to purchasing funds, seeking investment advice, and handling deposits, loans, trusts, etc.

(2) ToB (Advisor service): Schwab also provides a series of support services such as trading, custody, and financing to external independent advisory consultants (RIA).

The two businesses are not isolated but complement each other. For Schwab, outsourcing RIA services allows it to enhance its wealth management business line in a "light asset" manner and even reach more quality clients from RIAs. Similarly, RIAs can leverage Schwab's reputation (safe and reliable fund custody, a wide range of trading varieties, etc.) to achieve their independent business goals.

Overall, Schwab operates these businesses through six subsidiaries. From its initial discount brokerage to today's comprehensive wealth management platform, Schwab has expanded its business while attracting more customer groups, enhancing its comprehensive strength, but also facing more competitors.

By the end of 2024, Schwab's total client assets under custody were nearly $10 trillion, with 99% being U.S. user assets (2024 Investor Day meeting: international user assets totaled $92 billion). This scale ranks among the top in the industry. Over the past twenty years, Schwab's market share has steadily increased to over 6% in the national wealth market of over $160 trillion. If we only look at the scope of financial assets (excluding housing and commercial assets from wealth assets), the financial asset scale on the Schwab platform accounts for 8% of the market.

In terms of client coverage, Schwab's high penetration rate is mainly reflected in brokerage accounts, corresponding to Schwab's investment trading and wealth management business as two pillar businesses. Although employee retirement plans and bank accounts are not large in scale, they have high linkage with trading and wealth management businesses and still have penetration potential in the future.

By the end of 2024, Schwab had 36 million brokerage accounts, excluding about 650,000 international accounts, equating to a maximum penetration rate of 10% of the U.S. population of 350 million (in reality, the same user can open multiple accounts).

Compared to peers, Schwab is not yet the number one in the U.S. in terms of user penetration rate, but overall, it is firmly among the industry TOP. Taking the data at the end of 2024 as an example:

(1) Established wealth management competitors Fidelity and Vanguard also have very high total accounts, reaching over 70 million, mainly due to having many corporate clients (401K retirement plans) and institutional accounts, but their personal investment account numbers are similar to Schwab's at around 30 million (e.g., Fidelity had 39.2 million retail brokerage accounts by the end of 2024).

(2) Among traditional investment banks, JP Morgan, with its banking business advantage, has a very high total account number of 84 million;

(3) The new brokerage star "Retail Revolution" Robinhood also has 25.2 million personal trading accounts, but Interactive Brokers is relatively average, with only over 3 million retail accounts.

Different platforms have different retail investment account scales, and the average asset scale per person also varies greatly:

According to the differences in average asset scale, Schwab and Robinhood's core users belong to the mass class (financial assets ranging from $100,000 to $1 million), different from Fidelity and Vanguard, which mainly target institutions, and comprehensive investment banks like Morgan Stanley, which mainly target high-net-worth users (financial assets exceeding $1 million). It also includes family offices targeting ultra-high-net-worth users (financial assets exceeding $50 million).

However, more specifically, even when facing the "mass class," Schwab's users are "wealthier" than Robinhood's. In other words, for the same user, more wealth is placed on Schwab, while a small portion is used for trading on Robinhood.

Just like Ameritrade, acquired by Schwab in 2020, due to its more trading-oriented positioning, Ameritrade users generally place 30% of their personal wealth on Ameritrade. But for Schwab users, they tend to place more than half of their wealth on Schwab.

This shows that there are significant differences in user mindset between different platforms. Emerging internet brokers like Ameritrade, E*Trade, and Robinhood have a heavier "trading attribute" in users' minds, naturally attracting younger groups. However, if users reach the critical age line of 40, they will have a deeper impression of Schwab's "wealth management" label due to its rich product services.

As shown in the figure below, most Schwab users are middle-aged and older users over 40 (corresponding to the baby boomers, Generation X, and millennial groups), but Ameritrade and Robinhood users are noticeably younger and have higher trading frequency.

This is actually very crucial. If new-generation "trading brokers" like Robinhood fail to change user mindset, when users grow and accumulate wealth to a certain scale, they may still tend to entrust more assets to "wealth management platforms" like Schwab.

It is precisely because the "wealth management" label has gradually become ingrained in people's minds that Schwab has followed the wealth accumulation of core users, continuously enriching corresponding product services, and can naturally penetrate into broader and wealthier classes without much additional promotion. In recent years, Schwab's customer acquisition cost has remained relatively stable, with $300 bringing in a net new user with an average deposit of $200,000. In the Q2 earnings call, management provided the current penetration rate of high-net-worth clients: "Among every six high-net-worth families with assets exceeding $20 million in the U.S., one family chooses Schwab."

Watching Schwab transform from an initially unknown investment information newspaper to today's financial giant, it is necessary to review Schwab's evolution from "disruptor" to "occupier."

II. Scale is the First KPI

Each generation has its own brokerage. In the in-depth study of Robinhood, we mentioned the characteristics of generational conversion among brokerage users. The transition of three generations of U.S. brokers—comprehensive brokers, discount brokers, internet brokers, zero-commission brokers—corresponds to the Silent Generation (born before 1945), Baby Boomers (born 1946-1964), Generation X (born 1965-1980), Millennials (born after 1980) becoming the main characters of society.

However, as internet brokerage benchmarks—E*Trade and TD Ameritrade—were acquired by Morgan Stanley and Schwab respectively, and the millennial generation, which does not have a population advantage, is still in the early stages of wealth accumulation, the baby boomers and Generation X mass financial platforms led by Schwab still maintain a dominant position.

Despite the current large scale, Schwab still maintains an average annual increase of 5%-7% in client assets (excluding one-time capital flows). As a comprehensive financial platform, the growth of Schwab's asset scale cannot be explained simply by marketing and customer acquisition, but mainly accompanies the long-term wealth growth of core users (Baby Boomers & Generation X).

Just like the management's breakdown of growth drivers: 5%-7% growth rate includes incremental deposits from existing accounts and incremental deposits from new clients bringing 2%-3%. It is evident that the impact of existing clients' own wealth accumulation is significant.

So how did Schwab "lock in" Baby Boomer users step by step? And how did it successfully break through to capture the favor of Generation X? Even now, despite facing fierce competition from the rise of zero commissions before and after the pandemic, Schwab, which has matured in development, can still maintain a relatively low annual brokerage account attrition rate of 7-8% under normal circumstances.

It can be said that Schwab's development history is a microcosm of the rise of American mass retail finance, but Schwab's ability to go from 0 to 1 and then become today's industry leader relies on the management team's ability to "focus on demand, timely transformation."

During the development process, "client asset scale" is the core KPI pursued by Schwab. Even today, net new assets remain the primary operational indicator that management focuses on. Its essence follows the inherent development trend of scale economies in the competitive red ocean of the financial industry.

To expand scale, Schwab broadens its business scope to address user pain points, timelymeet more user needs. But more importantly, it continuously utilizeslow-price strategies to attract traffic, taking "discounts" to the extreme.

1. Starting: Breaking the Fixed Commission

Schwab's origin stems from the collapse of the fixed commission system (non-market-based, the same across the industry, mainly based on a fixed rate of transaction amount + fixed amount based on the number of shares traded + minimum commission amount). Under market supply and demand competition, fixed commissions also contradicted the "low-threshold mass investment" development trend at the time.

At that time, traditional brokers' high fixed commissions often included research and consulting services, which institutional clients could use to negotiate a more favorable "research service + transaction commission" package price due to their transaction scale advantage. But for ordinary retail investors at the time, if they could complete transactions with lower commissions, they would rather cancel additional research services.

However, in the financial industry with significant scale effects, the advantages of leading players are often very large, and it is not easy for small and medium players to change the competitive landscape. Therefore, Schwab's early development also benefited from a major strategic mistake by traditional brokers after the cancellation of fixed commissions:

——Although they "lowered commissions" in line with the trend, they only reduced institutional commissions (most discounts were 30%, some reductions were as high as 50%), and out of consideration for financial balance, they "counter-trend" increased retail commissions, such as the then-leading broker Merrill Lynch, which increased retail commissions by 10% after canceling the fixed commission system.

At the same time, Schwab offered retail investors significantly lower discounts than traditional brokers (the maximum discount difference between the two could reach over 70%). The figure below is Schwab's commission flyer from the 1980s, showing the comparison of standard commissions, discount commissions offered by X company (peer benchmark), and discount commissions offered by Schwab for trading 100 shares at different stock prices.

But discount commissions cannot form a true competitive barrier. As more and more new and old peers, especially after entering the 2000s, internet brokers with lower marginal operating costs, such as E*Trade (E*Trade Financial), accelerated their growth with significantly lower commission costs (1/4 of Schwab's early costs), until the industry entered the commission-free era around 2018, Schwab's "discount" strategy, which it relied on for its early success, became unsustainable.

Although commission discounts later ceased to be a unique advantage, Schwab remained a leader among emerging discount brokers. The reason behind this, besides the "wealth management transformation" we will focus on below, also benefited from Schwab's "offline network" strategy that it never abandoned:

To enhance trust relationships with clients and meet the manual order needs of some elderly users, even in the internet wave, Schwab, which was the first to launch the online trading website Schwab.com, insisted on opening offline outlets while developing its business:

In the first five years of its establishment, Schwab gradually opened 18 outlets, then accelerated the improvement of its offline network. Today, Schwab has a total of 380 branches worldwide. In the early 1990s, Schwab's strongest competitor at the time—internet brokers—often naturally neglected offline outlets. But during the critical window period when users adapted to technological changes and bear markets spread, offline networks could provide users with more services and brand trust. It wasn't until the late 1990s that E*Trade and Ameritrade accelerated the establishment of offline outlets.

2. Development: Wealth Management Expansion

Dolphin Research believes that timely transformation into wealth management is a key step for Schwab to cross multiple generations of brokerage changes, remain unshaken, and continue to climb upward.

2.1 Why is transformation urgently needed?

It's simple, the situation is pressing. Besides the unavoidable trend of commission reduction, the conditions for the development of the wealth management industry have matured.

1) Demand side: Wealth accumulation, increased financial awareness

In the 1990s, the U.S. economy quickly recovered and developed after stagflation, the stock market prospered, and gradually rose to valuation bubbles under the early technological internet industrial revolution.

At the same time, the baby boomers had entered the age of 20-40, worked for a period, and began to have some savings. The growing consumption demand after forming families also made this group have a stronger proactive willingness for wealth appreciation. Meanwhile, the introduction of the Individual Retirement Account (IRA) in 1974, its expanded use in 1982, and the later introduction of the 401(K) corporate employee retirement account (part of the DC Plans in the figure below), which can only be used after retirement, further stimulated the long-term financial awareness of the general public. By the late 1990s, pensions gradually became an important component of household financial assets, accounting for 30%.

2) Supply side: Rise of product supply (mutual funds, ETFs) and service supply (independent investment advisors)

In the 1980s, mutual fund supply accelerated expansion (computer technology helped achieve automated management of fund back-office), asset management companies led by Fidelity, Vanguard, and Twentieth Century Investments provided investors with multiple mutual fund purchases under their brands, with the number of funds once exceeding the number of stocks.

Passive index fund ETFs also emerged in the 1990s, initially attracting users with lower management fees (1/4 of the active management funds at the time, some broad-based fees even dropped by 90%), but the long-term key drivers were technology and the long bull market environment of U.S. stocks. In 2015, smart investment technology matured, and related products emerged, quickly penetrating more investors with low-threshold, low-fee investment options.

Meanwhile, the trend of commission reduction left many investment advisors idle, who began to provide asset management consulting services to the general public independently of traditional institutions.

3) Finally, policy support: The U.S. Financial Services Modernization Act of 1999 was enacted, repealing provisions of the Glass-Steagall Act of 1933, officially moving U.S. finance from separate to mixed operations.

The disappearance of institutional constraints further accelerated Schwab's business extension speed—acquiring U.S. Trust Company in 2000 (focused on high-net-worth family office business, later sold in 2005), and establishing Schwab Bank in 2003. The initial purpose of establishing Schwab Bank was not to independently focus on banking credit, but to strengthen Schwab's comprehensive wealth management capabilities to reduce client asset attrition rates.

Under mutual promotion of supply and demand, the entire wealth management industry has developed explosively, maintaining growth for nearly 40 years to date, except during stock market crashes. During this process, key milestones—mutual funds, ETFs—have continuously increased in weight:

a. Mutual Funds

Looking at the decade from 1990 to 2000 alone, mutual fund scale grew fivefold, with the fastest growth during the recovery period after the 1987 stock market crash.

By the end of 2024, U.S. mutual funds reached a scale of $39 trillion (including FOF, it is $42 trillion), accounting for 26% of national wealth, and 30% of residents' financial assets. The industry has 10,678 funds (including ETFs), with mutual funds mainly consisting of equity funds, accounting for nearly 60%.

b. ETFs

Besides initially making a splash with the "cost-effectiveness" advantage, passive index fund ETFs have continued to thrive under the entry of pensions, the smart investment boom after 2010, and the long bull market environment of U.S. stocks, growing from 1990 to today's scale of $11 trillion, with a CAGR of over 20% for many years. Among them, the lowest-cost passive index ETF funds account for 30% of the entire fund asset pool.

2.2 Why did Schwab succeed in transformation?

Schwab's decision was faster and more thorough, closely following user demand, and making changes in line with trends at the first opportunity, even at the expense of short-term interests—facing traditional channels, playing the cost-effectiveness card; facing direct fund sales, relying on service innovation.

(1) Facing the "Price Revolution"

The two charts below list the fees related to U.S. mutual funds in the 1990s, as well as the money investors and fund companies need to pay out. Generally speaking:

1) Investors need to pay subscription fees, redemption fees, account maintenance fees (only some funds have these) and management fees to fund companies, while some funds also need to pay transaction fees to channel platforms.

2) When fund companies receive management fees, they generally give 40%-50% to channel platforms (commission sharing), which is the distribution fee (12b-1). They also need to pay custody and clearing fees externally.

As Vanguard launched commission-free funds, mainly exempting the 40%-50% channel distribution fee (or significantly reducing it to below 0.25%) and user subscription fees, aiming to promote the "direct fund sales model" and suppress channel bargaining power.

Vanguard was able to significantly reduce prices mainly due to its own operating model, where company equity is jointly held by fund investors, so there is no resistance to fund fee reduction, but rather it is widely supported.

But at this time, Schwab, as a channel party, faced greater pressure, but still quickly chose to follow Vanguard's fee reduction steps, even "super doubling" them:

Although Vanguard, such a major client, was lost, Schwab began to offer free subscription and redemption experiences to front-end users for other fund clients, while significantly lowering distribution fees, providing channel services to third-party fund companies at a lower comprehensive rate of 0.25%-0.35%.

As shown in the figure below, comparing traditional channels, Vanguard, and Fidelity, which is also a leading scale, Schwab is not only friendly in charging users (management fees are deducted from fund net value, allowing "free" to be promoted on the surface), but also offers more cost-effective channel operating costs to fund companies.

Leading players starting a price war naturally accelerates the industry's fee reduction trend. By the end of 2010, the average total fee rate for mutual funds was less than 1%, directly halving compared to 20 years ago.

(2) Product innovation remains the core competitiveness

Facing competition from direct fund sales, Schwab again addressed user pain points at the time, innovatively launching two key new products—Fund OneSource, RIA Advisory. The two products rely on each other and promote each other, forming a stable closed loop.

In the early 1990s, the rapid expansion of fund product supply gave users more investment choices while also bringing some "troubles":

a. Multi-account management is cumbersome

Under the fund company direct sales model led by Vanguard (users can freely purchase fund products directly from fund companies by phone), if users purchase multiple funds from different companies, they need to open multiple fund accounts, not only affecting the convenience of fund transfers but also requiring users to undertake the cumbersome work of repeated tax reporting.

Therefore, Schwab launched Fund OneSource and Fund Supermarket, allowing users to easily achieve fund conversion, unified tax reporting, and other operations.

b. Increased difficulty in product selection

The expansion of investment product supply also increased the difficulty for mass investors in selecting products, so the situation of "managed" accounts by registered investment advisors became more common. In this development trend, Schwab launched a custody platform for independent RIA advisors (Schwab Advisor Services), but the purpose was not to take a share of the pie, but to hope to achieve more user penetration and scale expansion through this "outsourced advisory" model.

Although Schwab also has its own advisory team, it is more known in the advisory industry chain for providing custody and tool solutions for third-party advisors in a light asset model.

"Free trading + unified account + RIA advisory", allows Schwab to balance the operational advantages of "seller channel" and "buyer advisory"—providing rich investment products, fund promotion is not affected by channel interest binding. During this period, Schwab's fund supermarket rapidly expanded: from 80 funds in 1992, it expanded to over 200 funds just a year later.

Today, Schwab's fund supermarket has nearly 5,000 funds (including mutual funds and passive index ETFs), and nearly half of the $10 trillion in total client assets are held in fund assets, while over $5 trillion has received ongoing advisory services, with over 90% provided by external RIAs (over 9,000) and the remaining 10% by company internal advisors.

Schwab's wealth management services basically cover the financial needs of ordinary families to high-net-worth income families. High-net-worth income families often require 1V1 services, and Schwab's "self-operated + outsourced" nearly 10,000 advisory consultants come into play here.

But besides "manual advisory," another excellent innovation is Schwab's leading market launch of smart advisory services in 2015, providing lower-threshold advisory services (free + low initial investment scale), binding most ordinary income families' wealth management needs.

Compared to peers, Schwab's smart investment products once again execute "cost-effectiveness" to the end: not charging advisory fees (Betterment, Wealthfront, Fidelity, E*Trade all charge 0.25%~0.35% advisory fees), and separately providing professional advisory phone customer service.

Currently, Schwab has become a leading platform in the U.S. smart investment field, with competitors including comprehensive financial institutions like Morgan Stanley, wealth management old rivals Fidelity, Vanguard, and emerging platforms Betterment and Wealthfront.

In the current market scale of $6,000-$10,000 trillion (different data sources), Schwab ranks fourth in the U.S., with a market share of about 10%-15%. With the product advantages and channel advantages of traditional businesses, Schwab is expected to enjoy industry growth dividends while capturing more market share.

Summary: Over 50 years, Schwab has completed a magnificent transformation, squeezing into the TOP list of U.S. financial platforms. In multiple industry changes, the founding team centered on customer needs and used customer satisfaction as a measure of business results—expressing satisfaction with real money, so client asset scale AUM is the explicit KPI pursued by the company team.

To achieve development goals, Schwab holds two key cards, one "cost-effectiveness" card, and the other "product innovation" card, both of which have successfully navigated through each industry change's turbulent waves. Although the reduction of commissions in securities trading and fund distribution inevitably drags down short-term performance, the characteristics of the financial industry determine that "price for volume" is a long-term trend. And the larger the asset scale, the higher the advantages in user trust, financial risk resistance, and backend fixed cost expense dilution, isn't this the core competitiveness of the platform?

But as the platform becomes a leader, the future expansion space of asset scale will gradually shrink, and relying solely on the "scale" driven logic will be somewhat limited. At this time, "opening up" is necessary, so the need for vertical business expansion arises.

Schwab also expanded into banking and asset management business targeting high-net-worth users, trust business, etc., after the U.S. financial mixed operation regulation was relaxed in the early 2000s. The establishment of the bank, besides being able to lend itself, also helps reduce the capital costs of other businesses, thereby expanding the scale of margin trading.

Currently, net interest income is Schwab's first pillar of revenue, including company deposit interest, bank credit interest, margin trading interest, bond holding interest and income, and interest income from segregated accounts under user financing transactions, after deducting certain capital costs.

Clearly, the upcoming interest rate cut cycle is not favorable for this part of the business, but not all of Schwab's businesses are negatively affected. The low-interest environment's push for the equity market helps enhance asset management and trading business.

Meanwhile, Schwab is also actively catering to new user needs, just as it has done for nearly 50 years, actively embracing user demand pain points and new changes. For example, trading and investing in crypto assets, including spot trading (expected to launch next year), crypto-themed ETFs (investing in companies in the cryptocurrency industry chain, launched in July), etc.

Therefore, the future interest rate cut cycle may not be entirely negative for Schwab. Under growth pressure in old businesses, it may stimulate "old Schwab" to innovate and transform, moving into a new growth stage. How to view this specifically? Dolphin Research will elaborate in the next article.

Risk disclosure and statement of this article:Dolphin Research Disclaimer and General Disclosure