Institutional vs. Retail Investors: Differences and FAQs
From: www.indeed.com
Institutional and retail investors have many similarities in their roles. Aside from those commonalities, there are numerous areas of distinction between them. If you’re interested in a career in finance, understanding the differences between institutional and retail investors can help you choose the right investing career for you. In this article, we define institutional and retail investors, examine the key differences between them and answer some frequently asked questions about both types.
Key takeaways
- An institutional investor trades large volumes of securities on behalf of an individual or shareholder. This large-volume trade motivates brokerages to offer them lower fees.
- A retail investor is an individual who invests their own capital, typically at lower frequencies and volumes.
- Both institutional and retail investors aim to maximize returns on investments, but they differ in terms of their capital source, motivations and access to information, among other factors.
What is an institutional investor?
Institutional investors, sometimes called accredited investors, trade securities on behalf of individuals or shareholders. They typically work within an organization, such as an insurance company, bank or endowment, offering them access to specialist knowledge and in-depth research. Institutional investors trade frequently and at a high volume, which provides a reliable stream of capital to the brokerages with whom they trade. Therefore, brokerages have the incentive to charge lower fees per trade with institutional investors compared to retail traders. Though their investments may vary widely depending on the goals of the organization they represent, they typically invest in:
- Hedge funds
- Mutual funds
- Real estate
- Stocks
- Fixed-income funds, such as government or corporate bonds
What is a retail investor?
Retail investors, also known as individual investors, invest their own money, usually on their own behalf. They have access to retail-specific information and conduct their own research. They’re usually long-term investors who trade less frequently and at a minimal volume. This combination of irregularity and moderate capital influences brokerages to charge higher fees per trade. Retail investors often invest their funds in:
- Retirement accounts, such as 401(k)s
- Stocks
- Bonds
- Cryptocurrency
Key differences between retail and institutional investors
Though retail and institutional investors both aim to maximize their returns on investment, there are numerous points of distinction between them. The following defining features best describe what separates the two types of investors:
- Ownership of the invested capital: Retail investors invest their own money, while institutional investors work with the capital of shareholders or organizations.
- Frequency of trades: While retail investors trade occasionally, institutional investors trade often.
- Volume of trades: Institutional investors trade large amounts of capital. Retail traders invest their own money in comparatively small amounts.
- Fees: Retail traders pay higher fees per trade on an infrequent basis, while institutional investors pay lower fees per trade on a regular basis.
- Information access: Retail investors perform their own research, using information available to all investors. Institutional investors are specialists—or work with specialists—who conduct in-depth research using information available only to accredited investors.
- Education background: Institutional investors typically have a degree in finance
or a finance-related major, quite often a master’s degree. Such an academic credential isn’t necessary for retail investors.
FAQs about institutional and retail investors
The following are frequently asked questions about institutional versus retail investors:
What types of institutional investors are there?
Common types of institutional investors include:
- Stockbrokers: While stockbrokers may target blue-chip stocks for low-risk investments and annual dividends, these institutional investors often use their high volume of capital to purchase enough shares to gain the controlling interest of a company. This means the institutional investor can influence the company’s daily operations to maximize profits and then pay their shareholders a portion of those profits.
- Mutual funds: Mutual funds are organizations that collect funds from shareholders and reinvest them over time. Examples of mutual funds include money markets, retirement funds, stocks and bonds.
- Hedge funds: Like mutual funds, hedge funds
- also gather capital from shareholders and reinvest it, with the one key difference being decreased regulation. According to the Securities and Exchange Commission (SEC), hedge funds feature illiquid periods during which redeemable shares are unavailable.
- Pensions: While pensions are funds
- to which retail investors can contribute, they’re also institutional investors. Like hedge and mutual funds, pensions combine their shareholders’ initial investments and reinvest the capital over an extended period.
- Commercial banks: Commercial banks
- provide customary banking services, such as checking and savings accounts, but also function as institutional investors that use the capital provided by account holders to fund their investments. Large banks may dedicate teams of investors to take care of international investments.
- Insurance companies: Following the model of other institutional investment organizations, insurance companies gather assets from shareholders with products such as fixed-life products, indexed-life products, variable-life products and annuities. Insurance investors often pledge to return shareholders’ initial investments and gains during an agreed-upon period.
- Endowments: Nonprofits hold most endowments, which invest funds and earnings related to the organization’s mission. The chief aim of an endowment fund is to help secure the future financial health of the organization and its beneficiaries, which may include libraries, museums, community learning centers and scholarship recipients, among others.
What types of retail investors are there?
Some examples of retail investors are:
- Retirement account contributors: Retirement funds, such as 401(k)s, are accounts that retail investors generally get through an employer. Retail investors can choose a portion of their monthly pre-tax earnings to contribute to these long-term accounts, which employers may match up to a certain amount.
- Stock traders
- Stock traders: Stocks are securities that give stockholders a share of the company, and retail investors generally invest in them to grow their capital and earn dividends. Value stocks, growth stocks, income stocks and blue-chip stocks are among the types in which they commonly invest.
- Bond buyers: When retail investors buy bonds, they’re investing, for a specific period, in an organization such as a government, corporation or municipality. At the end of this period, known as the bond maturity period, the borrower returns the initial capital plus interest.
- Cryptocurrency traders: Cryptocurrency is a virtual representation of value that professionals can trade online. Retail traders invest in virtual coins because they consider well-known coins a store of value or are interested in speculating with low-value investments, similar to penny stocks.
What are the advantages of working in institutional or retail investment?
Both institutional and retail investment offer numerous advantages to their practitioners. Some of the benefits that institutional investors enjoy include:
- A portfolio backed by access to industry and specialist information
- A greater number of assets, funded by shareholders
- Lower fees, which makes it possible to invest more capital
- The support of an organization, usually with a reliable salary
Meanwhile, retail investors benefit from:
- A diversified portfolio consisting of low-priced stocks
- Personal growth resulting from conducting their own research
- Increased motivation since retail investors invest their own money
- The freedom to invest in exactly what they want, such as companies they personally support
