Understanding the differences between retail and institutional investors is crucial for anyone involved in the financial markets. Retail investors are everyday individuals investing their own money, often in smaller amounts. Institutional investors, conversely, are large entities like pension funds or insurance companies managing vast sums. This article breaks down these differences and explores what each type means for the markets and individual investors.
Key Takeaways
Retail investors are non-professional individuals who invest smaller amounts of money in securities, often via online platforms like TD Direct Investing and Questrade. They benefit from the democratization of investment opportunities and have access to tools and information previously reserved for professionals.
Institutional investors are large entities, such as pension and mutual funds, that manage substantial capital and can significantly influence financial markets due to their buying power, sophisticated strategies, and access to exclusive investments.
Key differences between retail and institutional investors include the volume of capital, access to investment opportunities, research and knowledge, and associated fees and costs. Institutional investors generally benefit from more favourable conditions.
Understanding Retail Investors
Retail investors, also known as individual or private investors, are non-professional investors who purchase securities through brokers or other investment accounts. Typically investing smaller amounts, they often choose investments in companies they recognize from daily life, such as well-known ‘blue chip’ companies.
Retail investors typically place trades through either traditional brokerage firms or online platforms, allowing them flexibility in executing their investment strategies. Many prefer investing in Exchange-Traded Funds (ETFs) for instant diversification across various assets. The retail investment market has evolved significantly, with brokers eliminating fees for online trades, making investing more cost-effective for retail investors.
With the surge of financial information, investment education, and trading tools, retail investors are now better equipped to manage their portfolios and make informed decisions. They can now invest in markets once reserved for large institutions, such as real estate and art. This democratization of investment opportunities has narrowed the gap between institutional and retail investors, though differences remain.
Retail investors tend to exhibit a steady temperament for investing. Amid market volatility, they can thoughtfully evaluate the market, which proves advantageous during uncertain times.
What Defines an Institutional Investor?
Institutional investors are entities that pool money to purchase a wide array of investment assets, including securities, real property, commodities, private equity, and hedge funds. These asset managers handle significant sums on behalf of clients, such as mutual funds, pension funds, and insurance companies. Given their large-scale operations, institutional investors are often referred to as ‘whales’ on Wall Street due to their capacity to move markets with their trades.
Institutional investors include a variety of entities such as commercial banks, central banks, credit unions, government-linked companies, insurers, pension funds, sovereign wealth funds, and hedge funds. Some institutional investors operate under a GP vs. LP structure, which defines the relationship between general and limited partners in private equity and other investment funds. These entities are crucial to financial markets, providing capital, diversifying portfolios, and influencing corporate behaviours.
Institutional investors have access to unique investment opportunities like commercial real estate, currencies, and futures, which are often inaccessible to retail investors. Their sophisticated investment strategies and substantial financial resources enable them to significantly influence market prices and trends. With fewer restrictive regulations compared to retail investors, institutional investors are powerful players in the financial markets.
Types of Institutional Investors
Pension Funds: These large investment pools are designed to pay employees upon retirement, managing retirement savings and ensuring long-term financial security. In a defined benefit fund, an employee contributes a fixed amount of pre-tax income and receives a predetermined amount upon retirement, regardless of the fund’s performance.
Mutual Funds: Investment vehicles comprising a portfolio of stocks, bonds, or other securities, mutual funds offer diversification for investors by pooling money to invest in various asset classes such as equities, fixed-income securities, and money market instruments. Some individual investors choose mutual funds offered at work, while others prefer ETFs from online brokers.
Hedge Funds: Requiring high minimum investments and less regulatory oversight compared to mutual funds, hedge funds use complex strategies, including leverage and derivatives, to maximize returns. These funds are less accessible to retail investors, typically requiring accredited investors with at least $1 million in net worth.
Key Differences Between Retail and Institutional Investors
Investment Volume and Access: Institutional investors have significantly greater capital compared to retail investors, allowing them to buy or sell assets in large quantities, significantly impacting the market. They account for more than 90% of all stock trading activity and about 80% of the S&P 500’s total market capitalization. Institutional investors have access to investment opportunities with large minimum buy-ins, often unavailable to retail investors. In contrast, most retail investors invest smaller amounts, typically through mutual funds or ETFs, with limited access to certain financial products due to federal securities laws.
Research and Knowledge: Institutional investors have substantial resources for conducting extensive research, making careful investment choices. They have access to extensive market research, up-to-the-minute insights, and specialist feedback, giving them a significant advantage over retail investors. Although retail investors now enjoy increased access to information, they still lag behind institutional investors. Critics argue that retail investors often lack the knowledge, discipline, and expertise to thoroughly research their investments, impacting their decisions.
Fees and Costs: Retail investors often pay higher fees and commissions due to smaller trade sizes, which can erode returns over time. In contrast, institutional investors benefit from lower fees due to their substantial purchasing power and frequent large transactions. They can negotiate lower transaction costs and benefit from economies of scale, making their investments more cost-effective.
Advantages and Disadvantages
Pros of Being a Retail Investor: Retail investors, unburdened by the need to sell during market downturns to meet fund redemptions, can thoughtfully evaluate the market (although they may also need to sell to meet their own savings goals). This flexibility can lead to more strategic decisions during volatile periods. They can also invest in smaller, attractive stocks without worrying about competition from large institutional investors, sometimes leading to higher returns.
Pros of Being an Institutional Investor: Institutional investors have substantial buying power, enabling them to purchase large blocks of securities and influence investment terms. They benefit from economies of scale, reducing per-unit costs, and have access to exclusive opportunities like private placements, which are typically unavailable to retail investors.
Impact on the Stock Market
Institutional investors account for over 90% of stock trading activity and around 80% of the S&P 500’s total market capitalization. Their large positions can create supply and demand imbalances, leading to sudden price movements. This significant influence underscores the critical role of institutional investors in the stock market. Retail investors, while contributing a smaller portion of trading volume, significantly influence market sentiment, shaping the overall tone in financial markets, especially during volatile times.
Trends and Future Outlook
The investment landscape for retail investors is transforming due to the rise of FinTech platforms, which make investment tools and resources more accessible, narrowing the gap between retail and institutional investors.
FinTech and Retail Investors
Many online brokers have eliminated trading fees, reducing the fee gap between institutional and retail investors. Platforms like Robinhood in the US and Wealthsimple in Canada, offer commission-free (or close) trading, making market access easier for retail investors. Investment apps enable retail investors to manage their portfolios directly from mobile devices, providing greater convenience and control. The information gap has narrowed due to online brokers offering extensive research tools. Peer-to-peer (P2P) lending platforms provide retail investors with opportunities to fund loans directly, bypassing traditional banks. In 2021, 41% of retail consumers intended to increase their exposure to FinTech products. The rapid growth of FinTech has prompted regulatory adaptations to address new financial technologies and services.
Summary
Retail and institutional investors play distinct yet complementary roles in the financial markets. Retail investors, with their flexibility and thoughtful approach, contribute significantly to market sentiment and can uncover unique opportunities. Institutional investors, with their vast resources and substantial buying power, dominate trading volumes and have access to exclusive investments, driving significant market trends.
As the investment landscape evolves, the lines between retail and institutional investors are blurring, thanks to advances in financial technology. This democratization of investment opportunities promises a more inclusive future where both retail and institutional investors can thrive. Understanding these dynamics empowers investors to navigate the financial markets more effectively.
Frequently Asked Questions
What is the main difference between retail and institutional investors?
The main difference is the scale of their investments and access to exclusive opportunities. Institutional investors handle large sums for clients, while retail investors use their own funds.
How do retail investors typically invest?
Retail investors invest smaller amounts through traditional or online brokerage firms, often choosing familiar companies and ETFs for diversification.
What are some examples of institutional investors?
Examples include pension funds, mutual funds, insurance companies, hedge funds, and sovereign wealth funds, which pool large sums and invest on behalf of others.
How do institutional investors impact the stock market?
They significantly influence stock prices and market trends by accounting for the majority of trading volume and market capitalization.
How is Financial Technology (FinTech) changing the investment landscape for retail investors?
FinTech provides more accessible investment tools and resources, narrowing the gap between retail and institutional investors and revolutionizing market participation. In Canada, Midasboard provides direct investment access to retail investors in the private market.
