What defines a retail investor?
The term ’retail investors’ generally refers to non-professional investors who invest in assets, such as stocks, bonds, securities, mutual funds, and exchange-traded funds. Retail investors usually purchase investment products through third parties, such as a brokerage firms, investment advisors, investment managers, or other financial professionals. These investors invest with theintention to preserve and enhance their personal wealth.
Retail investors usually have weaker purchasing power, compared to institutional investors, due to the difference in their earning ability. In addition, retail investors tend to invest in smaller amounts, less aggressively, and less frequently, compared to institutional investors.
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Why become a retail investor?
Retail investors usually invest with their own money, where they have full autonomy of the use of funds. They are able to invest in things that they are interested in and will be more likely to monitor and nurture their investments closely. Institutional investors are investing on behalf of other investors for the sole purpose of better returns; so their focus would not be on the investment preferences or goals of individual investors.
Generally, investing as a retail investor has a low barrier to entry because you can invest in any amount, in any investment vehicle you are comfortable with and have access to. Different individuals have different risk appetite; as a retail investor, you may choose your investment according to your risk tolerance. On the other hand, large institutional investors are limited by the types of investment they can consider because of the large funds that they have.
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What is an institutional investor?
An institutional investor is usually an entity that uses funds from individuals and makes investment decisions on behalf of them. These types of investors are generally called the ‘market maker’, as they trade in high volumes and in large amounts, where their movements could influence the financial markets. Institutional investors also have access to investment products that are not available to retail investors because of the purchasing power they hold. These investments include commercial real estate, currencies and futures. Institutional investors are professional money managers who are supported by large resources and new technology to assist them in research and financial analysis. Some examples of these investors are hedge funds, mutual funds and banks.
Hedge funds use a pool of capital sourced from investors to invest and are generally exclusive to accredited investors only. These funds are built on the principle to ‘hedge’ against financial losses in the overall stock market.
Mutual funds, or unit trusts, is an investment portfolio that is made up of stocks, bonds, index funds, or other securities. Investors realise their returns through dividend payouts, capital appreciation, or the sale of actual mutual funds. Mutual funds are subject to stricter government regulations than other institutional funds, such as hedge funds.
Commercial banks like JPMorgan Chase & Co, Wells Fargo, and Bank of America, are considered institutional investors, as they help facilitate investment access to capital markets and help companies with their financing needs.
Why become an institutional investor?
Access to securities
Large institutional investors have exclusive access to investments that are not readily available to other types of investors, due to government securities regulations for financial products. One such example would be Initial Public Offerings (IPO). Institutional investors have access to the first offering price of an IPO product, whereas a retail investor can generally only buy the stock, once it starts trading in the open market at the opening price.
Lower trading efes
Economies of scale apply to stock purchases as well. Generally an institutional investor pays a smaller fee for trades, compared to the retail investors, because institutional investors are buying securities in bulk and this allows them to negotiate for better fees with the dealing firms. Retail investors would not have such negotiating power because of their small trading amount; so, they are subject to higher transaction fees and other related fees.
To sum things up, retail investors are just like you and me, who invest for the sole purpose of growing our own wealth. Our investment quantum is directly influenced by our risk appetite and earning ability. Institutional investors, on the other hand, are made up of professional traders who are experts in different industries, and they invest on behalf of a group of individual investors or shareholders.