If you were following the rise and fall (and rise, and fall, and rise, and fall) of Gamestop or other memestocks this year, you probably ran across a weird phrase: retail investors. If you’re clever, you may have figured out it has something to do with how normal people invest as opposed to big hedge funds. But what exactly is a retail investor? And while we’re on the topic, what’s the difference between a retail investor and an institutional one?
To understand this, we’re going to have to dive a bit deeper into how banks, hedge funds and other big financial institutions invest. Don’t worry though, we’ll keep it light and fun.
If you’re reading this, let me assure you: you’re almost certainly a retail investor. That means nothing more than you’re a person who invests your own money, whether that’s in shares, crypto, bonds, commodities or whatever. If you’re an institutional investor and you’re reading this, uh, welcome and what are you doing here?
There’s a few things that make out a retail investor:
This should all correspond to the way you understand investing: people buying and selling shares, crypto, or anything else. So why is it important to define what a retail investor is? Because of the other option: the institutional investor.
If all you’ve done is dabble in investing a bit, you might not be aware that there’s a huge world of investors out there that play by very different rules from the rest of us. They run pension funds, mutual funds, hedge funds, or maybe just work at a big bank and invest that bank’s money.
Here’s what makes out an institutional investor:
It’s easier to explain this with an example. Let’s imagine you suddenly find yourself with 2.5 million euros, which you want to invest. Instead of doing that yourself, you go to a big bank. They’re looking for new investors in a fund they’re opening up. You give them your money, and get a percentage of that fund.
The people at the hedge fund — the institutional investors — will buy and sell stocks and bonds in that fund, using your money. If they make a profit, so do you, and they get a nice cut of that profit, or a management fee, or most likely both. You’re still a retail investor in that scenario. The people who run the fund are the institutional investors.
Institutional investors, because of the amounts and the frequency with which they trade, get preferential treatment from brokers, as well as access to more exclusive deals, and getting to chat directly with the CEOs and CFOs (Chief Financial Officer) of the companies they invest in. It also used to be that they paid lower commissions, but with the rise of zero-commission trading apps — including the one that brought you this blog post — that’s changing in some areas.
That kind of fund we mentioned above is called a mutual fund, where a bunch of money from different investors is pooled together. There’s a bunch of other kinds of places where institutional investors work:
Alright, great, so now you understand the difference between retail and institutional investors. But why should you care?
Simple: the behaviour of institutional investors matters a lot more to markets than retail investors. In fact, institutional investors make up about 70% of the stock market. That, coupled with the large amounts of shares they buy and sell at once, means they are really the ones who decide when and how shares move. If you want to figure out where a stock is going, you’re going to have to think like an institutional investor.
Knowing that, you can also see how special something like the Gamestop effect is: it’s one of the first times we’ve really seen retail investors have the power to move shares. Thanks to apps like Vivid, regular investors now have more power to decide where markets are going. Don’t discount the big banks too quickly though. They still have the power for now.