What is a retail investor?

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A retail investor is a non-professional investor. Also known as individual investors, individual investors have an increasing impact on the market.

Anyone who does not make investing as a career is considered a retail investor. It’s a very wide range of skill levels and specialties. Let’s take a look at how the retail investment market works, its size, and the pros and cons of being a retail investor versus an institutional investor.

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Understanding retail investing

Retail investors typically invest in stocks and bonds, but primarily stocks, as bonds are notoriously difficult to trade on most trading platforms. Most retail investors use discount brokers or apps like Robinhood (NASDAQ: HOOD) or invest through a 401 (k) pension plan or other employer sponsored pension plan.

Recent innovations in brokerage technology and the business model have made investing much easier for retail investors. A process that was limited to 1% 40 years ago and people with the time and energy to fill out endless forms 10 years ago can now be completed in 30 minutes on an app.

Investors can now buy and sell stocks, options and funds with just one click. Retail investors can even use spreads or loans to buy stocks and other assets.

The entire process is governed by the United States Securities and Exchange Commission (SEC). The SEC sets strict requirements for which investors can trade for a day, use margins, or invest in asset classes such as hedge funds or private equity. The SEC also regulates the filing process for public companies offering shares to investors.

Advantages and disadvantages

Here are some of the pros and cons of being a retail investor:

Advantages

The inconvenients

Concentration

Costs

Stock size

Time

Liquidity

Access

Flexibility

Economies of scale

Competence circle

Competence circle

Table by author.

Concentration

Institutional investors are often required to hold hundreds of shares. Retail investors can choose the number of shares they wish to purchase. The more focused you are (up to a point since you need some diversification), the higher your potential returns.

Stock size

Small-cap stocks (that is, stocks with a market capitalization of less than $ 2 billion) typically outperform the market. Many institutions cannot buy these stocks because they have too many assets under management and are limited in the percentage of a company they can own.

Liquidity

A single retail investor is unlikely to ever move the market, but institutions holding billions of dollars need to be careful when buying and selling stocks to avoid moving stocks too far in the wrong direction.

Flexibility

As a retail investor, if you want to hold cash for a period of time, you can. If you want to sell US stocks to buy foreign stocks, you can. If you want to buy gold bars and load them into a safe just before you forget about the combination, you can.

Institutions have strict SEC regulations and their own prospectus guidelines. Many funds are created to buy only growth stocks or only large cap stocks. If these types of stocks are in a bear market, the fund should just try to get around it.

Competence circle

This is both for and against. As a retail investor, you are likely to have some level of skill in a specific industry.

If you work for a construction company, you may understand the dynamics of supply and demand for lumber, copper, and other materials. If you work for a bank, you probably have a good grasp of current interest rates and credit standards. The problem is, proficiency degrees can rank you.

Institutions can hire people to become specialists in each industry. They might not have the local knowledge that you have in your industry, and there may be a delay before they know it, but they at least have a basic knowledge of each industry. But if you’re a retail investor working in the bookkeeping of a dog food manufacturer, it’s harder to really understand a biotech stock.

Costs

There is a charge for everything. You pay a fee when you buy a stock and when you sell it. You pay higher fees if you do it on margin or if you buy options. You pay annual fees and expenses for any fund you buy. This is even true if you are using an app that has no commissions. The way these apps make money is by increasing the bid / ask spread, which means you pay more for the action through them than through a traditional broker.

Time

Professional investors have the luxury of spending their entire working day analyzing stocks and investing. Retail investors may have to find the time to do a proper analysis between lunch and picking up the kids from daycare.

Access

Large institutions have access to certain transactions that are not accessible to the public. It can be a private investment in public capital (PIPE), an investment in an initial public offering (IPO) or even an investment in a private company.

Economies of scale

Sometimes the size issue (as discussed in the section on liquidity) is a good thing, at least for institutional investors. When other institutions or even companies want to buy or sell a huge block of shares, they often offer a discount or premium for doing everything at the same time. Institutions that can handle this level of transaction can profit from it, while retail investors should still pay the market price.

The retail investment market

According to Morgan Stanley, retail investors account for about 10% of the daily market value of the top 3,000 US stocks. That’s about $ 38 billion a day! Where retail investors once had little or no influence in the market, they can now move stocks with billion dollar market caps relatively easily.

Morgan Stanley also noted that retail investors tend to focus on the consumer discretionary, communications and tech sectors. This goes hand in hand with the concept of the circle of competence. This means that a skill developed in a niche sector can lead to disproportionate gains in the future.

According to Charles Schwab, up to 15% of retail investors made their first trade in 2020. Being stuck at home during the pandemic (with stimulus checks in hand) with apps like Robinhood has made trading a lot easier. and cheaper (at least outwardly) and has led to a big jump in those interested in investing. You can probably also thank Reddit and its “memes actions” for much of this growth.

Much of the boom in retail investing has been good. The more than 10-year boom in tech growth stocks appeared to be over by the start of the pandemic, but it has come back in force. Many tech stocks have risen in the past two years. But there are also negative points. Retail investors tend to be more short-term oriented than institutions, and panic selling has resulted in a lot of volatility. More than ever, we must take market movements with a grain of salt.

Invest for yourself

Retail investors are unlikely to ever be the dominant force in the stock market. But innovations in trading technology, the many benefits of investing for yourself, and easy access to websites like this to learn more about investing make it easy for ordinary people to manage their own. purchases and sales of shares.

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