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Individual investors and institutional investors are the two major groups of investors:
- Individual investors are individuals investing on their own behalf, and are also called retail investors.
- Institutional investors are large firms that invest money on behalf of others, and the group includes large organizations with professional analysts.
While this is perhaps the biggest distinction, there are many smaller differences between individual investors and institutional investors, which we’ll break down here.
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, in which 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 larger sums to invest than all but the largest individual investors. They use that money to buy large blocks of securities, and their large size means that institutional investors’ trades can have a powerful impact on the market.
Institutional investors tend to have more experience in the market and more knowledge. They may have access to investment research that retail investors do not and have financial resources that allow them to conduct their own research. In addition, they might have access to investments individuals do not, 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 tend to be more knowledgeable and experienced than individual investors, the Securities and Exchange Commission (SEC) sets out different regulations from what it requires of individuals.
What is an individual (retail) investor?
An individual investor, or retail investor, is a person who invests their own money, usually through an online broker, bank, or a mutual fund. They invest to meet their individual investment goals, such as to save for retirement, a child’s education fund, or to build wealth generally.
Individual investors usually invest smaller amounts more frequently than institutional investors. For example, they may have money withheld from each paycheck for an employer-sponsored 401(k) plan. Or they might automatically invest money in an IRA every month.
Retail investors tend to be less experienced and less knowledgeable than institutional investors. This, in addition to the fact that retail investors trade with their own money, might help explain why they are more prone 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.
Institutional investors, on the other hand, tend to buy or sell in bulk, because they usually 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 does come with some downsides, too. Large investors are unable to invest in the market’s smaller stocks, because it just won’t “move the needle” on their performance. In contrast, individual investors can buy many smaller, still-attractive stocks without fear that all the good bargains will be purchased by institutional investors.
Institutional investors tend to have a significant advantage over individual investors in investment knowledge and research. Institutional investors have more resources, allowing them to conduct more detailed research and therefore make more informed investment decisions. While the information gap has narrowed somewhat in recent years, institutional investors still tend to be better informed than individual investors.
Institutional investors have also had the advantage when it comes to fees. Institutional funds, for instance, tend to have high minimum investments but also come with lower fees. Fortunately, this gap has also narrowed in recent years as index-fund fees have plummeted for individual investors.
While many individual investors are impulsive or think only about the short term, the best individuals have a clear edge over institutional investors because of a superior temperament. For example, when the market falls, many institutional investors such as mutual funds have to sell to meet redemptions in their funds, as their investors run for the exits. In contrast, even-tempered individual investors don’t face this imperative, and can more thoughtfully evaluate the market, find attractive investments amid the rubble and continue to think long term.
Additionally, institutional investors may have a decision-making process that involves several people or investment committees, which can slow down decisions and lead to a herd mentality. Individuals only have to answer to themselves, which may be an advantage during periods of volatility when the investment landscape is changing quickly.
Individual investors and institutional investors are the two major groups that invest in the market. Both types of investors have their own advantages, and a sharp investor will try to make the best use of their own advantages, whether that’s size, agility or knowledge, to outperform.