Retail Investors vs Institutional: Key Differences Explained

In the financial market, investors can be categorized into retail investors and institutional investors. Both are different in terms of behaviors and their impact on the market.

In Indonesia, the number of investors in the stock market has skyrocketed over the past few years, reaching a total of 10.3 million in 2022 — a staggering 9 times higher than in 2017. Of these investors, 44.9% are retail investors, who dominate the daily trades.

Retail investors, sometimes referred to as non-institutional investors are individuals who allocate their own money in the market, typically through brokerage accounts or investment applications.

This article will examine retail investors, their importance to the market, and the significant differences from institutional investors.

What is a retail investor?

Retail investors are individuals who participate in the financial market using their own money. They buy and sell securities in small volumes, such as stocks, bonds, exchange-traded funds (ETFs), and cryptocurrencies.

Retail or non-institutional investors spend based on their financial objectives and willingness to take risks.

Retail investors are typically motivated by personal goals related to significant life events, such as preparing for retirement, saving for their children’s education, buying a home, or financing other large expenses.

Generally, the average retail investors look for low-risk assets such as government bonds. However, some take on higher risks to achieve higher returns, such as going “all-in” on cryptocurrencies.

The Securities and Exchange Commission (SEC) acknowledges that retail investors may lack knowledge and resources in the market. To protect them, the SEC enforces regulations that require accurate information from companies, regulates broker-dealers, and provides educational resources for informed investment decisions.

Despite their perceived lack of expertise, retail investors play a significant role in the market and are important contributors to overall market liquidity.

The past few years have seen a significant increase in retail investors in Indonesia. Notably, 81.2% of investors in the Indonesian market are under 40 — millennials are becoming the majority of investors.

According to the Center of Economic and Law Studies (CELIOS), the growth can be attributed to various factors, including the Covid-19 pandemic, which has given people more time to participate in the financial market.

Additionally, the rise of mobile investment platforms with low investment fees and partnerships with banks and other payment providers has contributed to the surge in retail investors.

What are institutional investors?

Companies or organizations that invest a substantial amount of money on behalf of others are known as institutional investors. These entities include banks, mutual funds, pension funds, hedge funds, and insurance companies.

Institutional investors are recognized as the major players in the financial market, often purchasing or selling significant blocks of stocks, bonds, or other securities. These big investors usually buy and sell large shares at once, typically 10,000 or more, earning them the nickname “whales” on Wall Street.

Because of their more extensive capital base, institutional investors tend to have longer investment horizons. This enables them to hold investments for extended periods, potentially riding out short-term market volatility and benefiting from long-term market trends.

Many people consider institutional investors more sophisticated in their investment approach than non-institutional investors. This is because they typically have access to a team of experts and analysts who assist with decision-making.

Institutional investors have a significant impact on the stock market. Due to their large purchasing power, they can acquire the most sought-after securities. Additionally, the sheer bulk of their transactions can cause significant fluctuations in prices and market dynamics.

Retail investors vs. institutional investors

The table below shows the general differences between non-institutional investors and their institutional counterparts. Keep in mind that these may not reflect every investor in either category.

The importance of retail investors in the market

Financial analysts and experts tend to overlook and undervalue retail investors, but their numbers have increased substantially since the pandemic began in 2020. This trend has disrupted the traditional market, which institutional investors previously dominated.

Here are some ways retail investors can influence the market:

Liquidity

A 2021 study by the Karlsruhe Institute of Technology revealed that retail investors are vital to the stock market because they offer liquidity, which helps prevent steep declines during economic hardship. Unlike institutional investors, who tend to withdraw from the market during crises, retail investors usually purchase lower-priced stocks, thus providing stability to the market.

Market sentiment

Retail investors can impact stock value through market sentiment. Optimistic buying creates positivity, driving up stock prices. Pessimistic selling creates negativity in the market, which can lower stock prices.

Volatility

The ease of access provided by trading apps has contributed to higher market volatility as non-institutional investors engage in short-term and emotionally-driven trading activities. GameStop’s short squeeze in January 2021 caused significant losses for institutional investors who had shorted the stock due to retail investors’ buying activity. The resulting market turbulence was characterized by dramatic fluctuations in the stock price over a brief timeframe.

5 tips for retail investors

Retail investors benefit from making informed decisions and adopting effective strategies to enhance their investment outcomes. The following tips offer guidance on developing and implementing better investment strategies:

Have a clear strategy

Investing without a financial goal is like going on an adventure without a map and a compass. Financial goals provide a roadmap for investment decisions, guiding investors toward the most suitable avenues for achieving them.

Divide financial goals into three parts:

• Short-term: This ranges from six months to a year. It includes vacation or emergency funds; consider investing in liquid funds or bank fixed deposits.
• Medium-term: This ranges from three to five years. It includes accumulating funds for a house down payment; consider investing in aggressive hybrid funds.
• Long-term: This ranges from 15 to 20 years. Invest in pure equity funds for long-term goals like children’s education and retirement, as they offer the potential for inflation-beating returns.

Do the research

Before investing, analyzing different financial products and understanding their working mechanisms and associated risks is crucial. This allows individuals to assess if a product aligns with their risk tolerance and objectives.

Conducting research reduces the likelihood of reacting emotionally in the market. Emotions often lead retail investors to make regretful decisions.

Diversify investments

In investing, diversification is crucial as it provides balance and enables taking advantage of various financial instruments and assets. Concentrating on a single asset class or product can result in a loss if it underperforms.

Spreading investments across multiple asset classes mitigates risks and preserves gains. However, it’s crucial to avoid over-diversification, which dilutes returns.

Avoid herd mentality

Herd mentality is prevalent in the financial market. Blindly following the investments made by others without giving them a second thought can have disastrous consequences. There is no standardized approach to investing.

Be wary of scams

Due to the growth of retail investors in the market, the number of trading apps available also increased. Many new trading apps offer get-rich-quick schemes for prospective investors, such as using algorithms.

These trading apps also charge investors when they want to withdraw their earnings. Therefore, retail investors must check if their trading tools are registered with the financial authorities.

Conclusion

Retail or non-institutional investors use their money to participate in the financial market through brokerage accounts or investment applications. Personal goals usually drive their motivation to invest, and the average retail investor takes on low-risk securities.

In the past, institutional investors typically dominated their non-institutional counterparts. However, in the past few years, there has been a surge of retail investors in the market. Their numbers have caused their influence to grow, contributing to liquidity and volatility in the market.

Advancements in technology and increased accessibility of investment tools will fuel the continued growth of retail investors, significantly impacting the financial market dynamics.

As such, it will be necessary for regulators and market participants to continue to provide education and resources to retail investors to help them make informed investment decisions.

Impact Insight Team

Impact Insights Team is a group of professionals comprising individuals with expertise and experience in various aspects of business. Together, we are committed to providing in-depth insights and valuable understanding on a variety of business-related topics & industry trends to help companies achieve their goals.