What Is a Retail Investor?
A retail investor, also known as an individual investor, is a non-professional investor who buys and sells securities, mutual funds, or exchange traded funds (ETFs) through traditional or online brokerage firms or other types of investment accounts.
Retail investors can be contrasted with institutional investors.
- Retail investors are non-professional market participants who generally invest smaller amounts than larger, institutional investors.
- Individual investors are thought to be less knowledgeable, less disciplined, less skillful, and more prone to behavioral and emotional errors than professionals.
- Despite their lack of knowledge, the retail investment space is enormous with individuals investing through retirement accounts, brokerage firms, online trading accounts, and roboadvisors.
Understanding Retail Investors
Retail investors invest much smaller amounts than large institutional investors, such as mutual funds, pensions, and university endowments, and trade less frequently. But wealthier retail investors can now access alternative investment classes like private equity and hedge funds. Because of their small purchasing power, retail investors often have to pay higher fees on their trades, as well as marketing, commission, and other related fees. By definition, the SEC considers retail investors unsophisticated investors, who are afforded certain protections and barred from making certain risky, complex investments.
Critics say smaller investors do not have the knowledge, discipline, or expertise to research their investments. As a result, they undermine the financial markets’ role in allocating resources efficiently; and through crowded trades, cause panic selling. These unsophisticated investors are said to be vulnerable to behavioral biases and may underestimate the power of the masses that drive the market.
Retail investors do have a big impact on market sentiment. Predictors of investor sentiment include mutual fund flows, the first-day performance of IPOs and survey data from the American Association of Individual Investors, which questions retail investors about their expectations for the market. Sentiment is also tracked by stockbrokers like TD Ameritrade and E*TRADE.
The Retail Investment Market
The retail investment market in the United States is huge. Over 50 million households are retail investors of some kind and over 50% of households have savings accounts or investment plans like 401(k)s. And while Americans gravitated to savings accounts and passive investing in the aftermath of the financial crisis, the number of households which own stocks is rising again. According to the Federal Reserve’s survey of consumer finances, 54% of households owned stocks in 2017. Unlike institutional traders, retail traders are more likely to invest in small-cap stocks because they can have lower price points, allowing them to buy many different securities in an adequate number of shares to achieve a diversified portfolio.
Retail investors now have access to more financial information, investment education, and trading tools than ever before. Brokerage fees have fallen, and mobile trading is enabling investors to actively manage their portfolios from their smartphones or other mobile devices. A huge range of retail funds and brokers have modest minimum investment amounts or minimum deposits of a few hundred dollars, and some ETFs and roboadvisors don’t require any. That said, however democratized investing becomes, it is still all about doing your homework.
Institutional investors are the big guys on the block—the elephants. They are the pension funds, mutual funds, money managers, insurance companies, investment banks, commercial trusts, endowment funds, hedge funds, and also some private equity investors. Institutional investors account for about three-quarters of the volume of trades on the New York Stock Exchange. They move large blocks of shares and have a tremendous influence on the stock market's movements. Because they are considered sophisticated investors who are knowledgeable and, therefore, less likely to make uneducated investments, institutional investors are subject to fewer of the protective regulations that the Securities and Exchange Commission (SEC) provides to your average, everyday investor.
The money that institutional investors use is not actually money that the institutions own themselves. Institutional investors generally invest for other people. If you have a pension plan at work, a mutual fund, or any kind of insurance, then you are actually benefiting from the expertise of institutional investors.