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Retail Investors and The Financial Universe
The stock market is made up of several categories of market participants. From large institutions and hedge funds to small retail investors, there are several types of market participants in the financial market. While there are several different types of market participants, the end goal for everyone is to remain profitable and generate wealth from the stock market. While institutional investors and professional HNI investors have an edge when it comes to the resources they have, retail investors can also become successful investors with proper research and analysis.
According to Wikipedia “There are sixteen stock exchanges in the world that have a market capitalization of over US$1 trillion each. They are sometimes referred to as the “$1 Trillion Club”. These global exchanges account for more than 90% of the global market capitalization. We at Financial Education believe that the stock market is an enormous ocean of wealth where market participants from several different categories apply their own investment strategies in order to create profits and generate wealth. However, in order to succeed as an investor, it is crucial to be aware of the various market participants. In this article, we will understand the different types of market participants and explore who retail investors are. So, let’s get started!
Who Are Retail Investors
Retail investors are also known as individual investors. They are non-professional market participants who buy and sell funds and securities for their personal accounts. They generally invest in stocks, bonds, mutual funds, or exchange-traded funds. Retail investors use traditional brokerages or online brokerage firms to execute their orders and make investments on their own. Their accounts are drastically small when compared to institutional investors who manage millions of dollars. Retail investors have small accounts where they manage their own money and make investment decisions based on their own research and analysis.
Oftentimes, due to their small account size, retail investors tend to pay higher fees and commissions as some brokerages charge fees on every executed trade. Whereas some brokers also offer no-fee trading and low costs which are better for retail investors. Retail investors generally tend to buy and sell securities in the bond and equity market. They usually invest in small amounts and are nowhere near the investment positions of institutional investors. While there are some retail investors with ultra-high net worth who invest in alternative assets like hedge funds and private equity.
To protect and safeguard the interests of retail investors, The SEC or the U.S. Securities and Exchange Commission ensures that the stock market functions in a fair and orderly manner. The SEC ensures that rules and regulations are enforced and the general public remains confident and comfortable investing in the financial market. The SEC also helps retail investors by offering education and spreads awareness so that retail investors can safeguard their investments and stay away from financial scams.
While retail investors are a crucial part of the stock market, they usually tend to be less disciplined than institutional investors and do not have the expertise to research and analyze their own investments efficiently. While some retail investors are highly knowledgeable and experts in their craft, the majority of retail investors are “unsophisticated investors”, who often make irrational investment decisions and end up losing their capital. The retail investment market in the United States is significant in size and scope, and according to the SEC, in 2020, “American households own $29 trillion worth of equities—more than 58% of the U.S. equity market—either directly or indirectly through mutual funds, retirement accounts, and other investments.
Difference Between Retail Investors and Institutional Investors
Investing and trading in the financial market can be as simple as pressing the buy or sell button, but professional institutional investors go for complex and advanced strategies combined with risk management, which helps them find high potential investment opportunities. While retail investors on the other hand tend to make investments based on news or rumors they hear. This rumor-based-investing general causes investors to be gripped with the fear of missing out, thus they tend to make irrational investment decisions leading to losses.
Institutions and hedge funds employ highly skilled fund managers who carefully analyze every investment and take every factor into consideration to ensure risk management is followed. Additionally, institutional investors have access to a huge variety of resources and information that can help them make better and efficient investment decisions. Whereas retail investors generally rely on market news and research they conduct by themselves. So, let’s understand the differences between retail investors and institutional investors in detail –
1. Difference in Capital Size
The first difference between institutional investors and retail investors is the difference in their capital and account size. Large institutional investors and hedge funds have enormous capitals to deploy in the financial market whereas retail investors have small and limited capital to invest. This difference in capital gives institutions and hedge funds a huge advantage over retail investors as they can trade and invest in a variety of instruments and often have inside information, advanced and superior technology, and can work in large volume, which can impact share prices to a huge extent.
The investment a retail investor makes barely has any effect on the stock price. Whereas when an institution or hedge fund enters or exits their investment/position, the stock price tends to move drastically as they usually deal in very large quantities. According to Financial Education, this is the reason why many big players tend to enter and exit investments in a gradual and consistent manner, as their moves in the market have a huge impact on the overall price of the asset.
2. Difference in Psychology and Mindset
Institutional investors and fund managers take trading and investing as a serious business and master and learn the art of investing before they venture into the market with their capital. They have extensive knowledge, certifications, and tons of research and analysis behind every decision they make in the market. This helps them analyze every investment carefully and identify the crucial points that can make or break the investment. Additionally, they do not have any psychological pressure of earning a fixed or targeted amount of money from the market, as they do not rely on the income they generate from investing to fund their day-to-day lives.
On the other hand, retail investors generally are not that knowledgeable about the stock market and often make irrational investment decisions. Crowd behavior and fear of missing out often cause retail investors to enter or exit investments in a haphazard manner, causing nothing but losses. Retail investors generally just go online, open a brokerage account, and start investing from the next day without proper knowledge, research, and experience. This leads to huge losses and other market participants take advantage of this.
3. Motive Behind Investing
A huge difference between retail investors and professional institutions is that the pros don’t trade or invest to pay their bills. In other words, they are financially stable and perform in the markets with a peaceful mind and zero stress, whereas retail traders and investors often leave their jobs and rely only on the income that they make from the market. This puts huge psychological pressure on the person and it affects the decisions they make while investing or trading.
According to the founder of Financial Education, Jeremy Lefebvre, to succeed in the financial market, one has to be financially stable and not rely completely on the income they make from trading or investing; as earning consistent money from the market is uncertain and challenging. Therefore, it is advisable to always have sufficient funds or a consistent source of income to meet all your expenses. This allows you to make better investment decisions as your mind is relaxed and you can logically analyze every situation in the market.
4. Difference in Volume and Position Size
Professional HNI investors and institutions often trade with millions of dollars whereas retail investors usually have small accounts. So, when an institution or fund uses its capital to trade or invest in a stock, it can result in huge movies; which is not possible for a retail investor to do with his small capital. Therefore, many times institutions and funds tend to use their large capital size to manipulate stock prices and change them in their favor.
This causes an unfair situation in the market and therefore puts retail investors at a disadvantage. Additionally, institutional investors use sophisticated trading and investing strategies with proper risk and money management. They have the best professional traders and fund managers working for them, who are highly qualified in their craft.
Different Types of Market Participants
The financial market consists of several different types of market participants. They range from large institutional investors to small retail investors. Let’s explore some of them in detail –
Hedge funds are large pools of money that is collected from wealthy investors which is then managed by a fund manager. Hedge funds place the fund manager in charge of the capital and allow him to make investments according to his research and analysis. Hedge funds are usually managed aggressively and therefore they make use of derivatives like futures and options to generate higher returns for their investors. While investing in a hedge fund may seem attractive, they are generally accessible only to accredited investors with a high net worth.
Mutual funds are large pools of funds collected from various investors which are invested in a variety of investment vehicles like stocks, bonds, and other securities. A mutual fund is an investment class that consists of a portfolio of stocks, index funds, bonds, or other securities. Retail investors can purchase units/shares of a mutual fund based on the price of the security or the NAV (net asset value).
There are several kinds of mutual funds that are divided into categories representing the type of securities they invest in. However, they also charge a fee for managing your money, and generally, the returns they offer are not that attractive when compared to exchange-traded funds.
Insurance companies use the premiums paid to them and invest it in the stock market. Insurance companies are also a form of institutional investors. They collect the premium from their customers and deploy it in the stock markets to generate returns. As keeping their collected premium idle won’t help it appreciate in value, insurance companies often use their premiums as their investment capital in the stock market and use it to enter positions.
Proprietary Trading Firms
Proprietary trading firms or often known as “Prop trading” refer to a financial organization or commercial bank that trades directly in the financial market. These prop trading firms hire and employ several highly-skilled professional traders and trade in huge volumes as they have large account sizes. Prop trading firms generally trade and invest in stocks, commodities, bonds, futures, options, forex, etc.
Several commercial investment banks like JPMorgan Chase & Co., Wells Fargo, Bank of America, and Citibank are also considered as institutional investors. These organizations generally help facilitate access to capital markets and also assist large corporations with financing.
Now, after all the above-market participants, retail investors come in. Retail investors are also known as individual investors. They are non-professional market participants who buy and sell funds and securities for their personal accounts. They generally invest in stocks, bonds, mutual funds, or exchange-traded funds. Retail investors use traditional brokerages or online brokerage firms to execute their orders and make investments on their own. Their accounts are drastically small when compared to institutional investors who manage millions of dollars.
Benefits of Being a Retail Investor
- Small Account Size: Sometimes, having a small capital and account size can be beneficial for an investor as some stocks which hold potential are too small to absorb the position size of institutional investors. This allows retail investors to easily enter and exit positions as they only invest in small quantities. Whereas, institutions cannot enter and exit their positions easily and need to carefully plan their entry and exit into a stock.
- Less Monitoring Required: One benefit that retail investors have is that they do not have to monitor their investments every day. This is good for an investor as they can check and monitor their investments weekly or monthly and adjust their portfolio according to the market conditions. While on the other hand, institutions and hedge funds have to trade and adjust their positions daily. They need to monitor their investments every single day and keep track of their performance consistently.
- Less Risk On Investments: Another benefit that retail investors have is that in each investment they make, their risk is significantly low and a loss can be sustained without blowing their account. Whereas if an institutional investor enters a wrong investment/position, it is quite difficult for them to readjust and make corrections to their investment without being noticed and criticized for their poor performance.
- No Need To Disclose Investments: Large funds and institutions are regulated and have to disclose information about their holdings and other investment activities. This makes it difficult for them to outperform the market, whereas retail investors do not have to disclose anything and can invest as per their choice without informing or disclosing any information.
We hope that this article provided you with valuable information on the various market participants in the financial market. Using this information, you can prepare yourself better and make well-informed investment decisions. With proper knowledge and skills, anybody can master the art of investing, but one has to have the passion and determination to learn. However, before making any investment decision, always check the current market conditions and other factors that might affect the value of an asset class, as investments in the financial market are subject to market risk. If you liked this article, make sure to visit Jeremy Lefebvre’s YouTube channel “Financial Education” for more such informative content! Happy investing!