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Investing can be a complex world, with many different players, strategies and goals. Two of the main types of investors are individual investors and institutional investors.
- Individual investors are individuals who invest for their own account and are also called retail investors.
- Institutional investors are large companies that invest money on behalf of others, and the group includes large organizations with professional analysts.
These two groups approach investing in very different ways, and understanding these differences can be helpful to anyone trying to get into the market.
Here’s what you need to know.
What is an institutional investor?
An institutional investor is a large organization that invests money on behalf of others. These investors come in many forms, such as pensions, mutual funds, banks, hedge funds, insurance companies and more. For example, one type of institutional investor is a mutual fund, where a fund manager buys and sells securities on behalf of the individual investors who buy the fund.
Institutional investors pool money for individual investors or organizations. Because they pool money, institutional investors have much more money to invest than all but the wealthiest individual investors. They use that money to buy large blocks of securities, and their sheer size means that institutional investors’ trades can have a powerful impact on the market.
Institutional investors usually have more experience in the market and more knowledge. They may have access to investment research that private investors do not have, and have financial resources to conduct their own research. Additionally, they may have access to investments that individuals do not have, such as institutional index funds with very high minimums. These large institutional funds often have lower fees than those available to individual investors.
Because institutional investors generally have more knowledge and experience, they must comply with different Securities and Exchange Commission (SEC) rules than individual investors.
What is an individual (retail) investor?
An individual investor, or private investor, is a person who invests their own money, usually through an online broker, bank or a mutual fund. They invest to achieve their individual investment goals, such as saving for retirement, a college fund for a child, or to build wealth in general.
Individual investors generally invest smaller amounts more often than institutional investors. For example, money can be deducted from each paycheck for an employer-sponsored 401(k) plan. Or they automatically invest money into an IRA every month.
Private investors are generally less experienced and less knowledgeable than institutional investors. This, in addition to the fact that retail investors trade with their own money, could explain why they are more sensitive to emotional trading decisions than institutional investors.
Key differences between individual and institutional investors
We’ve highlighted some of the differences between these two types of investors throughout, but now let’s compare them side by side.
Investment volume and access
Individual investors tend to invest small amounts of money, as with any paycheck. They often invest through mutual funds at work or purchase exchange-traded funds (ETFs) from an online broker.
Institutional investors, on the other hand, tend to buy or sell in bulk because they typically have much more money to trade than retail investors. This amount of money gives them access to institutional funds with minimums that put them out of reach for most individual investors.
But having a huge amount of money also comes with some disadvantages. Large investors are unable to invest in the market’s smaller stocks because it simply won’t impact their returns. Individual investors, on the other hand, can buy much smaller, still attractive stocks without fear that all the good bargains will be bought by institutional investors.
Knowledge and research
Institutional investors typically have a significant advantage over individual investors in terms of investment knowledge and research. Institutional investors have more resources, allowing them to conduct more detailed research and therefore make more informed investment decisions. The information gap has narrowed somewhat in recent years, as many of the top online stock trading brokers now offer comprehensive research tools for everyday investing. However, institutional investors are still generally better informed than individual investors.
Cost
Institutional investors have also had the advantage when it comes to fees. For example, institutional funds typically have high minimum investments, but also come with lower costs. Fortunately, this gap has also narrowed in recent years, after a majority of online brokers eliminated trading fees and some of the best index funds cut their expense ratios to near zero.
Temperament
While many individual investors are impulsive or think only about the short term, the best individuals have a clear advantage over institutional investors because of their superior temperament. For example, when the market falls, many institutional investors, such as mutual funds, have to sell to meet their fund redemptions while their investors run for the exits. In contrast, equanimous individual investors are not faced with this need and can assess the market more carefully, find attractive investments amid the rubble and continue to think long-term.
In addition, institutional investors may have a decision-making process that involves multiple people or investment committees, which can delay decisions and lead to a herd mentality. Individuals are only accountable to themselves, which can be an advantage during periods of volatility when the investment landscape is rapidly changing.
In short
Individual investors and institutional investors are the two main groups investing in the market. Both types of investors have their own advantages, and a smart investor will try to make the most of their own advantages, whether that be size, agility or knowledge, to outperform.
