Retail investor is a common term to describe individual investors that do not have a professional finance background. Retail investors are characterized by having a smaller portfolio than institutional investors. There are two main categories that define investors, institutional and retail.
Banks and different funds are considered institutional investors. They are more scrutinized and have to comply with different regulations. Retail investors on the other hand have fewer responsibilities. There are far more retail investors than institutional investors. However institutional investors account for a much larger percentage of all of the trades conducted in the stock market.
Pretty much every individual that has a savings account, bonds, or some type of investment is considered a retail investor.
Difference between institutional investors and retail investors
There are several differences between institutional and retail investors. The most significant is the size of the portfolio. Since institutional investors often represent entities, with a lot of capital. The size of their portfolios is significantly larger than the common retail investor.
There are more retail investors
|There are fewer institutional investors|
|A small percentage of the transactions||
A large percentage of the transactions
|Manages money for himself or his family||
Manages money professionally for clients
There are also several advantages, and disadvantages of being either a retail investor or an institutional investor.
Advantages of being a retail investor
Most retail investors believe that institutional investors have the upper hand when it comes to investing. In reality, retail investors have several advantages over institutional investors. Although sometimes they are not always aware of that.
The investment strategy of a retail investor
A retail investor's investment strategy is solely defined by himself. This is by far one of the greatest advantages of being a retail investor. When it comes to building your portfolio, you can choose whatever investment suits your goals the best. Institutional investors have more constraints.
Because they are managing money for clients their actions will always be reviewed. This limits their investment strategy. Retail investors, on the other hand, might choose to have a very concentrated portfolio or invest in high-risk high-reward situations. The freedom to conduct your investments as you wish can be a great advantage.
Another important aspect to consider is that a retail investor’s portfolio will usually be much smaller in size. This allows him to go unnoticed in the markets, and build up positions without moving the price. Retail investors might also choose to invest in illiquid securities. Institutional investors, depending on their portfolio size might be constrained by the funds they manage. This can force them to overlook small caps and illiquid securities.
Institutional investors are overseen by different entities. They need to comply with regulations and have paperwork to submit every month. Retail investors do not have the same scrutiny. This is obviously a great advantage and allows you to spend more time focusing on your investments.
A retail investor is able to choose exactly how much money he wants to invest, and when. Institutional investors do not have the same choice. The money they manage is dependent on several factors, depending on which type of institution they allocate capital for. They could be forced to sell or buy securities because they have outflows or inflows of capital. This is a constraint to the investment strategy they might want to use.
The only person that can put pressure on a retail investor is himself. Institutional investors, on the other hand, have performance goals that they need to achieve. They cannot wait around without deploying capital for a long time. Nor can they lose money consistently for their clients.
This is an advantage for retail investors, that might take more time to choose their investments carefully. Short-term underperformance also does not affect them, as they are able to freely conduct their investments.
Retail investors also have access to some tax benefits on their investments. Through a 401k or a Roth IRA, they are able to avoid being excessively taxed on their investments. This can be a great advantage. It allows investors to compound their money, in some cases tax-free.
Disadvantages of being a retail investor
Due to the smaller size of the portfolio, retail investors usually incur higher fees relative to the amount of their investment. This is certainly a disadvantage, and if you are starting with a very small portfolio some fees might represent a large percentage of your portfolio. Although Robinhood has been a controversial choice due to its use of payment for order flow. If you have a small portfolio, a broker who charges no fees and commissions is a good option.
Considering the larger portfolios institutional investors manage. Their ability to buy securities at large can mean they have access to lower prices than retail investors. Fees and commission, as well as price, can directly influence the returns you can achieve.
A retail investor has less access to information
Broadly speaking, institutional investors have more access to information and news than retail investors. This is a great advantage that comes with being an institutional investor. Another aspect is that institutions often have multiple employees working on any given investment. Thus, retail investors are on their own.
Overall being a retail investor is more advantageous than some would think. It allows you to go unnoticed in the markets, and that can be a great advantage. You can also look at different stocks without any restrictions. In general, retail investors are freer to make their investment decisions. Institutional investors are more constrained, due to oversight and regulations they need to follow.
Image source: Marketwatch