Institutional Investors and Retail Investors: What Is the Difference?
Investment discussions often focus on institutional investors, but few average Americans understand this group. Institutional investors are large institutions. They can include banks, insurers, pension funds, hedge funds, private equity firms, investment companies or endowment funds. Retail investors, on the other hand, are individuals. They typically make investments through their retirement or education plans, but they might also invest some of their disposable income in taxable trading accounts. From this perspective, it’s easy to overlook the fact that larger-scale investment entities account for the majority of stock ownership.
Although most retail investors are unlikely ever to engage in institutional-level investing, understanding this group of investors and how they trade can help you understand some of the forces that drive your own investments.
What Is an Institutional Investor?
Institutional investor is a blanket term for larger organizations like banks, insurance companies, pension funds and exchange-traded funds that make a wide variety of investments. The Securities and Exchange Commission imposes fewer regulations to protect these investors compared to individual retail investors. This is because the SEC assumes that institutional investors open positions with both greater investing knowledge and more ability to protect themselves.
Institutional investors have driven most of the growth of the stock market. Such investors made up only about 7% to 8% of stock investments in 1950. By 2010, institutional funds in the market had risen to 67%.
Some high-net-worth individuals can operate under the same trading rules as institutional investors. These individuals are called accredited investors, though this can also include the entities listed as institutional investors. For a natural person to get this accreditation, their net worth must exceed $1,000,000. They must also have earned more than $200,000 per year over the last two years if single. Married couples filing jointly must have earned more than $300,000 per year in each of the previous two years. They must also hold a reasonable expectation that they can match or exceed that income level in the current year.
What Is a Retail Investor?
Retail investors refer to natural persons who engage in investment activity. They usually purchase securities in much smaller amounts and with less frequency than an institutional investor.
The SEC imposes strict rules on the entities that work with retail investors. These rules can include assessments of risks, fee disclosures and safeguarding of client assets. This helps beginning investors, who, as noted in GOBankingRates’ Investing for Beginners: What First-Time Investors Need To Know, might lack the confidence, the investing knowledge or the influence to assess risks and protect their assets adequately.
What Is the Difference Between Retail and Institutional Investors?
Institutional investors differ from retail investors in the size and frequency of their trades. The size of these trades — which currently comprise about 82.5% of the market — gives institutional investors power not available to smaller investors. Another key difference is that institutional investors act as stewards of their clients’ funds, like when a bank works to safeguard deposits or a pension fund ensures that it can fund the retirement of its clients.
Retail investors tend to be individuals who more than likely earn middle-class incomes. And unlike institutional investors, they typically manage their own money, often in retirement or education funds.
Such investments allow retail investors to reap the benefits of stock market gains. The SEC helps by playing a role in educating these investors and enforcing securities laws minimizing the chance that high-risk activities or fraud will wipe out retail investors’ positions.
How Institutional Investors Impact the Market
Because they control large pools of capital, institutional investors can have a more significant influence on the market. Also, keep in mind that exchanges must match every buyer with a seller. While it’s a relatively easy task to find 100 shares of an equity at prevailing market prices for a retail investor, it’s significantly more difficult to find the millions of dollars’ worth institutional investors often purchase.
When an institution places a large order for shares, the exchange might have a relatively small number of shares available at the current market price. For this reason, institutional firms often have to make multiple smaller transactions to obtain the needed shares at the desired price.
Investors should also note that institutional investors often act on behalf of retail investors, buying assets that smaller investors cannot buy on their own. One example is mutual funds and exchange-traded funds that invest in foreign stocks that do not trade on U.S. exchanges. Another example is a real estate investment trust. The retail investor usually lacks the resources to buy multiple commercial buildings on their own. But they can buy a REIT, which owns the real estate and is required by law to return at least 90% of its net income to shareholders. Such strategies can help the average investor buy into assets usually available only to larger players.
How To Get Started With Investing
Opening an investment account to begin stock trading is an easy process nowadays, and there are many brokerages to choose from. Examples include Charles Schwab, E-Trade and Fidelity, all of which made GOBankingRates’ list of Best Brokers of 2019-2020. To reduce barriers even further, many brokers have eliminated fees for processing transactions.
Because very few investors have reached “accredited” status, brokerage companies usually gear their services toward retail investors. But individuals can still invest in a wide choice of stocks, bonds, mutual funds and ETFs. Those just starting out can find many stock recommendations for novice investors.
Retail investors with specific goals such as building wealth for retirement or saving for their children’s education might consider working with a financial advisor who can devise an overall strategy. In How To Find the Best Financial Advisor for You, GOBankingRates suggests that you consider a fiduciary financial advisor. Regulations require fiduciaries to act solely in their clients’ best interests.
The SEC differentiates between retail investors, institutional investors and the individual institutional investors known as accredited investors. But regardless of income level, investors need to understand both investment types. One reason is that they serve as a lesson in risk. Although retail investors can buy securities that might eventually go bankrupt, safeguards imposed by the SEC can mitigate the risk. The securities available to institutional investors offer no such assurances.
That said, retail investors can profit indirectly from institutional investments. For example, you can buy a mutual fund or a REIT with holdings normally reserved for institutions. Furthermore, institutional investments provide retirement income for the millions of workers who contribute to pensions.
Though many Americans don’t understand the role of institutional investors, these investors have both a direct and indirect influence on the lives of most people. Through their large, frequent trades, institutional investors not only help to indirectly boost the investments of retail investors, but they also make possible the investments that can fund critical milestones in retail investors’ lives.