With nothing more than a passing glance, the two companies look quite similar. Brokerage firm Charles Schwab (SCHW 0.67%) has been around much longer and has expanded into other areas like banking and lending. SoFi Technologies (SOFI -0.28%) may be younger and founded on the student loan business, but it too has ventured into banking and brokerage. Both companies specialize in serving the online, self-service crowd. And both stocks more or less offer shareholders the potential for a reward that's commensurate with their risk.
If there's only room for one new financial stock in your portfolio, though, which should you choose?
Image source: Getty Images.
A closer look at each
If you're a reader of investing news then you're likely familiar with Charles Schwab.
Founded all the way back in 1975 as the discount broker most investors know it as today, Schwab largely pioneered the idea of online trading in 1996. Since then it's gotten into traditional banking services like mortgage loans and checking accounts, and it boasts $7.7 trillion in assets thanks to its ongoing growth.
SoFi Technologies arrived at the same destination by taking a different path. SoFi -- short for Social Finance -- launched in 2011 as a lender to college students and recent grads, helping them manage and refinance their debt. It's inched into other arenas in the meantime, like adding crypto investing in 2019 and debuting checking and savings services just a few weeks ago. It's still only a fraction of the size Schwab is, but given its age, that's as it should be. It's also growing faster than Schwab, which given its smaller size is also as it should be; its historical comparisons are set at much lower levels.
The question remains, though: Which is the better buy?
SoFi vs. Schwab
Charles Schwab is clearly the safer bet, but it offers less growth potential. SoFi Technologies is growing faster, but is currently unprofitable and will likely remain so for a considerable while longer. That's the trade-off. Would-be buyers of either must figure out their own risk tolerance and then weigh each company's unique risks against its particular rewards. Not every investor will necessarily come to the same conclusion.
On balance, though, most investors are better off owning Schwab than SoFi, for a couple of different reasons.
One of those reasons is impending interest rate hikes. While not etched in stone, the Federal Reserve's Open Market Committee is tentatively planning as many as 10 quarter-point increases in the Fed Funds Rate between now and the end of 2024 in its effort to curb what's become rampant inflation. While higher interest rates generally make lending a more profitable venture, it may also cause much of SoFi's lending business to dry up as consumers balk at higher borrowing costs.
Non-traditional lenders like SoFi have never been tested in a rising rate environment like the one we're about to see, and more than that, they've never been tested in a recession that Moody's says has a 1-in-3 chance of taking shape sooner than later. Indeed, SoFi might find itself undercapitalized and losing customers in such an environment. It's also carrying nearly $6.1 billion worth of loans on its books, which are stable and performing now but have also never been tested in a real recessionary environment.
In this vein, it's notable that the average credit score for SoFi's home loan and personal loan customers fell about 10 points between 2020 and 2021. And, curiously, while it's not a company-specific metric, mortgage and real estate market research outfit Black Knight reports that for the first time in nine months, February's mortgage delinquencies grew. Also bear in mind that the student loan forbearance put in place during the pandemic has not yet ended. If/when it does so at the end of August, student loan defaults could skyrocket.
Neither are potential problems Schwab faces. It's not in the student loan business, and it punts its mortgage lending customers to Rocket Mortgage, sidestepping the risk of managing a loan portfolio that could soon start to deteriorate.
The other reason Charles Schwab is a better buy than SoFi Technologies at this time? It's a far more established (and profitable) company that's growing faster than you might expect. While still not growing at the same clip as SoFi, analysts expect Schwab's top line to swell by more than 11% this year and accelerate to a pace of 15% next year. That's hardly the tepid growth other, stodgier financial stalwarts are seeing right now. The analyst community also foresees continued, steady profit growth that outpaces revenue growth through 2026.
Data source: Thomson Reuters. Chart by author.
Safer is smarter, for most
If you fully understand the risks of owning SoFi and have a grip on how the economic environment is on the verge of changing its risk-vs.-reward profile, have at it. You may be well rewarded for being bold.
For most investors, though, Charles Schwab is the smarter overall play. It's survived whatever the foreseeable future holds. And, its bank and brokerage accounts are -- generally speaking -- bigger, and owned by customers more likely to stay put and weather economic storms rather than jump ship at the first sign of trouble. Again, we just don't know if the same can be said of SoFi.
