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How Schwab Got Robots to Play Nice With Humans

Walt Bettinger, Charles Schwab CEO, is bulking up its A.I. and other digital offerings. Stuart Isett—Fortune Global Forum

Charles Schwab schw , the discount brokerage, went public 30 years ago and has since ridden repeated waves of financial cycles and a thorough reordering of the personal finance industry. Its CEO, Walt Bettinger, calls the modern Schwab a “no-tradeoffs firm”: a low-cost brokerage that has high-touch service, with a human-plus-machine “robo-advisory” offering, and inexpensive passive investments including ETFs (exchange-traded funds). Bettinger, who still labors under the watchful eye of executive chairman Charles Schwab, has strong views on Schwab’s money-back guarantee, the firm’s pricing strategy, and how the renegade-turned-incumbent uses artificial intelligence. (Spoiler alert: to aid customer service, not to beat the market.) If he has a regret, it’s that American savers still lack the necessary financial literacy to secure their futures. We sat down with Bettinger this fall. Below, an edited transcript.

FORTUNE: What is Schwab’s overarching approach to financial services on behalf of clients?

Walt Bettinger: Our core strategy is around creating a no-­tradeoffs type of firm. Whether it’s offering pricing on commodity products like index mutual funds and ETFs that is as low or in many cases lower than anyone else in the industry, yet combined with hundreds of branches around the country. Two years ago J.D. Power ranked us No. 1 in full service for brokerage. Who would have thought 40 years ago Charles Schwab would be No. 1 in full-service ­brokerage?

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In each of your major business lines you have more narrowly focused competitors. Why is your comprehensiveness superior?

The main businesses we’re in are all complementary. We’re not building widgets and then marketing investments. They all leverage the same infrastructure. One of our greatest advantages is our scale. At $3.2 trillion in assets, we operate the firm on 17 basis points of cost.

Our nearest publicly traded competitor, TD Ameritrade amtd , is about 10 basis points above that. And the wealth-management divisions of traditional full-service firms, Bank of America bac and Morgan Stanley ms , are about three times that. That’s why we’re growing so much faster, because we’re leaving more money in the pocket of the client.

You speak about challenging the status quo. What do you mean by that?

Let’s play a word association game. I tell you that you want the lowest cost index fund, who do you say?

Vanguard.

Okay, but that’s not right. Our index funds are as low or lower. Here’s another. I say you want the absolute premier service and advice in the industry. This time I’m not going to have you say a name because whatever name you say, we [add more assets each] year than that firm. This is challenging the status quo. When you work in an industry you’re going to have more knowledge about how the sausage is made than the person who buys the sausage. The internal expense rate of an ETF is the same no matter how much you buy. So why is it that when it comes to index mutual funds, if you go with $500 you will pay the biggest names in the industry four and five times what you would pay for that index fund if you bought $5 million? It’s an example of taking advantage of knowing how the sausage is made to extract more from the client.

We looked at that and made the decision earlier this year to eliminate all the share classes on our index mutual funds [in other words: to charge the same price no matter the volume purchased].

Walt Bettinger, Charles Schwab CEO, is bulking up its A.I. and other digital offerings. - Stuart Isett—Fortune Global Forum
Walt Bettinger, Charles Schwab CEO, is bulking up its A.I. and other digital offerings. Stuart Isett—Fortune Global Forum

This must have been a painful decision.

In 2017 we’ve given up just under $400 million in annualized revenue via price reductions to clients. And we did just under $2.2 billion of revenue last quarter. So this year alone we’ll give up somewhere between 4% to 5% of our gross revenue in terms of delivering a better value to the consumer.

Why give up easy money?

We have a long-term time horizon, which means we’re looking to continue to build our scale. This causes consternation on Wall Street, but there’s nothing I would like more than to see the 27 or 28 basis points that we take from clients in revenue today and go down to 24 or 22. We’ll keep lowering our cost because that’s going to continue to grow our overall top line, because more consumers will want to do business with us. And it’ll continue to improve our profitability because we’ll use technology to become more and more efficient.

How do you think about investing in technology?

When you’re responsible for custody of $3.2 trillion, technology has to be at the forefront of virtually everything you do. And not just for efficiency, but also for minimization of errors and processing, for protecting clients’ information, security of their personal information and their assets. Then you have to back it all up with a guarantee. If you’re unhappy with any experience you have at Schwab, we’ll give you your money back. Commission, fee, even your advisory fee if you’re using us for advisory services and you’re unhappy with the advisory services we provide. We give you your money back.

That’s a nice human touch. But aren’t the robots going to take over eventually, particularly at giving advice?

Digital advice is a credible product. People will put money into a digital advisory solution. Our clients are putting in about a billion dollars net every month into [what we call] Intelligent Portfolios. But it is just a product. What our clients tell us is that to have a real relationship, it’s going to be more than just technology. That’s why from the moment we introduced Intelligent Portfolios we said the product is going to have 24/7/365 access to speak with live licensed professionals. We never believed that the notion of people staying with a plan during difficult times in the market was a given.

- Nicolas Rapp
Nicolas Rapp

How are you using artificial intelligence?

Artificial intelligence is utilized much more for service experiences. We have a saying at Schwab that we use our data to serve, not to sell. That’s the greatest opportunity for artificial intelligence. I’ll give a very simple example: You call up one of our call centers, and you have a concentrated position in XYZ stock because you worked there for 35 years. Our computers can listen to that call, interpret what you are saying, and reach right back out to you with an option strategy that gives you some downside protection in the event that that individual stock runs into problems.

And your contention is that the computer is a better listener than a person?

How can you listen to tens of thousands of phone calls every day in real time and be able to rapidly offer a strategy? You were simply just expressing an issue to us and now we can come back and give you a potential solution that would make sense for you.

Did you design or buy that?

There are components of it that you buy, but the overall concept and approach are things that we built ourselves. That’s where I see intelligence creating value. Anyone telling me that they’ve got the latest and greatest way to time the market, beat the market, outperform the market, I say, Come on, people have been selling us those stories for a hundred years.

But aren’t you like a pharmacy that also sells cigarettes? Stock pickers can’t beat the market, yet you still sell individuals stocks.

If I have a grocery store and I think a certain brand of ketchup is better than another brand, I’m not going to just completely refuse to give the second one any shelf space. I might not put it on the end of my aisle, but I’m still going to allow you to pick the kind of ketchup you want.

Charles Schwab. After setting up shop in San Francisco in 1971, Schwab built his namesake company into an investing behemoth, pioneering the discount brokerage concept in the U.S. - Daniel Acker—Bloomberg/Getty Images
Charles Schwab. After setting up shop in San Francisco in 1971, Schwab built his namesake company into an investing behemoth, pioneering the discount brokerage concept in the U.S. Daniel Acker—Bloomberg/Getty Images

Let’s shift to the economy. We’re eight years into a bull market. What’s the game plan for its inevitable end?

From a client standpoint, it’s really about planning. It’s about asset allocation and keeping your costs low. We don’t believe it’s possible for people at scale to beat the market and predict the market and know when to get in and out of the market. Where most individual investors get in trouble is when the market goes down and they can’t stand the pain so they leave. Then they either don’t get back in or they wait until the market’s turned and gone way up and then get back in. That’s what really crushes individual investors.

Now from a firm standpoint, our business model is designed with natural hedge. When the market is going up as it has been of late, we generate more revenue from our advisory fees. When the market goes down, clients tend to move money out of the market, despite our best recommendations, into cash. And we can make money on the [moving back to] cash side.

But that didn’t stop 2008 to 2009 from being an incredibly painful and disruptive time for Schwab, right?

ZIRP, the time of “zero interest rate policies,” was incredibly painful for us because interest rates went so low and clients moved to cash in record numbers. In order to ensure that they weren’t getting a zero yield or a negative yield on their money funds, we waived all our fees. That’s the one environment that is very difficult for us, although we still maintained profitability throughout the entire time. In those three years, after the financial crisis we grew our assets by $530 billion. Merrill Lynch, Morgan Stanley, E*Trade, Ameritrade added together grew by about $320 billion. So you’re also preparing for down times in the way you run your firm in good times. It’s why our balance sheet is 70% U.S. Treasuries and government-backed paper today. Because we don’t want to take credit risk. Our clients know that in tough times we’re a safe port.

Let’s end on an existential note. For all of Schwab’s and the financial industry’s success, people still don’t save enough, and they’re still financially insecure.

It’s probably one of the biggest and most complex questions in the investing industry. In our capitalistic society owners are rewarded to a greater extent than lenders. And yet, we as a society have not created a system that encourages the masses of our population to be an owner rather than a lender.

Are you using “lender” to refer to workers?

Yes. People who don’t save, aren’t able to save, or whatever little they do save goes into a passbook or a CD or something. They’re lending their wealth to people who are owners. We as a society haven’t done a good job of educating people on the opportunity differences between the two approaches. And we have an enormous issue that just has to do with teaching people about finance.

I think we would all agree, at least all of us who work in this industry, that these should be required programs in school. When I was in school I had home economics. I learned how to make a vest, and I learned how to cook macaroni and cheese. Now the vest part I’m not so sure about, but the macaroni and cheese benefited me in college. Still, I would have probably been better off to understand, How does a credit card work? How does compound interest work? Why is it not a great thing to have to pay someone 19% interest because I spent more than I had? There is so much we can do around financial education from a societal standpoint that I think would have a tremendous impact. But we haven’t yet been able to get that on a broad scale through our academic institutions.

But what can Schwab do?

We can try to make it part of our corporate strategy, the education going on in schools, in workplaces, things we do in the Boys & Girls Clubs of America, which we’re a national sponsor of. Ideally you want an ever-shrinking percentage of the population who can’t come up with money needed to live. It’s very difficult from a corporate standpoint to change where society is unless we start at the beginning. And start with people at a younger age.

A version of this article appears in the Dec. 15, 2017 issue of Fortune with the headline “How Schwab Beat Back the Robots.”

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