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What is an 'Institutional Investor'

An institutional investor is a nonbank person or organization that trades securities in large enough share quantities or dollar amounts that it qualifies for preferential treatment and lower commissions.

BREAKING DOWN 'Institutional Investor'

An institutional investor is an organization that invests on behalf of its members. Institutional investors face fewer protective regulations because it is assumed they are more knowledgeable and better able to protect themselves. There are generally six types of institutional investors: endowment funds, commercial banks, mutual funds, hedge funds, pension funds and insurance companies.

Resources of Institutional Investors

Institutional investors have the resources and specialized knowledge for extensively researching a variety of investment options not open to retail investors. Because institutions are the largest force behind supply and demand in securities markets, they perform the majority of trades on major exchanges and greatly influence the prices of securities. For this reason, retail investors often research institutional investors’ regulatory filings with the Securities and Exchange Commission (SEC) to determine which securities the retail investors should buy personally. Retail investors typically do not invest in the same securities as institutional investors to avoid paying higher prices for the securities.

Retail Investors vs. Institutional Investors

Retail and institutional investors invest in bonds, options, futures contracts and stocks. However, because of the nature of the securities and/or the manner in which transactions occur, some markets are primarily for institutional investors rather than retail investors. Examples of such markets primarily for institutional investors include the swaps and forward markets. Retail investors pay brokerage firm fees along with marketing and distribution costs for each trade. In contrast, institutional investors send trades through to exchanges independently or through intermediaries; they negotiate a fee for each transaction and avoid paying marketing and distribution costs.

Retail investors buy and sell stocks in round lots of 100 shares or more; institutional investors buy and sell in block trades of 10,000 shares or more. Because of the larger trade volumes, institutional investors avoid buying stocks of smaller companies and acquiring a high percentage of company ownership. The investment cannot be sold when desired for little or no loss in value, and performing such an act may violate securities laws. For example, mutual funds, closed-end funds and exchange-traded funds (ETFs) registered as diversified funds are restricted as to the percentage of a company’s voting securities the funds can own. Conversely, retail investors find small companies’ lower stock prices attractive; they can invest more diversified portfolios in smaller price ranges than larger ones.

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