What Is a Retail Investor? A Simple Guide to Start Investing

Financial markets are heavily linked with investors to help run the market. There are two common types of investors that people usually compare, institutional investors and retail investors. The institutional investor is represented by big financial organizations such as banks, hedge funds, pension funds, asset managers, and fintech firms. The transaction typically occurs on a large scale and in big market caps.

On the other hand, the explanation of retail investors will be explained in this article  This article will help the audience to understand more about what is retail investors. Other subjects that will be explained include key characteristics, comparison vs institutional investors, what assets typically they invest in, their impact on the market, and pros and cons of retail investors. 

What Is a Retail Investor?

To answer the question what is retail investors, understanding the broad context of investors in the financial market is needed. An investor is a party – either an individual or institution, that has the goal to earn profit through the action of investment. A retail investor is a type of investor that typically is an individual with small capital to invest.

To fully understand how people navigate the financial markets, it helps to look at the defining traits that separate the retail investors from other types of investors. There are several key characteristics of retail investors that will be explained in the paragraph below.

Key Characteristics of Retail Investors

Here will be explaining about the key characteristics of retail investors.

• Personal Capital

Retail investors use their money to make an investment. Unlike the institutional investors that utilize clients’ money, the capital for the retail investor relies 100% on their own money.

• Smaller Scale

Another key characteristic of retail investors is making an investment on a small scale. Because of the limitation of the capital, they invest a small amount of money and are often making investments in small market caps. 

• Easy Accessibility

Unlike institutional investors that use advanced algorithms that are not accessible for anyone, retail investors have easy accessibility to make transactions. Retail investors have increased accessibility to markets through online brokers, apps, and lower fees.

Also Read: Trading Psychology: How to Maximize Profit with Good Mindset

Retail Investors vs Institutional Investors

Retail investors are commonly being compared by people with institutional investors. Those two types of investors have their own characteristics and differ in some major subjects. The comparison between retail investors and institutional investors can be seen through the table below.

Table 1.  Retail vs Institutional Investors Comparison

What Do Retail Investors Usually Invest In?

There are a lot of financial instruments that someone can invest in. Some of them can be seen mostly in the retail investor’s transaction. Common assets that usually retail investors invest in will be described below.

Stocks and Equities

These two financial instruments are the typical assets that retail investors invest in. The assets represent the value of a company that can be traded publicly. Retail investors are often looking at stocks and equity of stable and sustainable companies. People in financial world usually call this type of stock a blue-chip stock. 

ETFs and Mutual Funds

These two financial assets are both investment vehicles that combine investor funds to buy a variety of stocks, bonds, and other assets. ETF (exchange-traded funds) offer great liquidity and trade on stock exchanges all day long, much like individual equities. While mutual funds are priced once daily at market close.

Low-cost index ETFs have become the standard for the typical retail investor who is focused on long-term success. It is because they provide an easy method to own a little portion of the whole global economy without having to investigate individual companies.

Bonds and Fixed Income

Bonds are loans that are provided by an investor to a borrower. The borrowers for this type of asset are commonly governmental organizations and corporations. When a retail investor purchases a bond, they are lending money for a predetermined amount of time in return for consistent interest payments. 

Bonds are a popular instrument for retail investors who want a stable income, commonly for older retail investors that have a close time to retirement. It is liked by those people because it is considered a less risky one rather than other assets such as stocks or equity. 

Cryptocurrency

Cryptocurrency exists as an alternative to digital assets that retail investors invest in. The reason is because cryptocurrency is easy to access and is accessible for everyone. Retail investors can be a successful one if can invest in the cryptocurrency with the right calculation and careful decision.

Also Read: What Is Trade Size? A Comprehensive Guide for Beginners

The Impact of Retail Investors on the Market

Although the retail investors carry a small amount of money in the market, the quantity of retail investors in the market is massive. So, the retail investors have several impacts on the market.

Impact on Market Liquidity

Liquidity is a measure of how easy or hard assets can be traded without affecting the asset’s price. The high quantity of retail investors that sign into various platforms and make transactions every day will result in good liquidity of the market. 

Because millions of retail investors are executing trades every single day, there is almost always a buyer or seller available on the other side of a transaction. This high level of participation actively tightens the bid-ask spread, which ultimately makes the market cheaper, faster, and more efficient for everyone involved.

Impact on Market Volatility

Besides its impact on market liquidity, the existence of retail investors is also affecting the market volatility. Volatility measures how quickly and severely the price of an asset changes over time. 

Retail investors rely on emotions and less risk management, so the behavioral biases, such as FOMO and revenge trading, will impact the price of the assets. The price change of several assets will result in high volatility of the market.

The Pros and Cons of Being a Retail Investor

Becoming a retail investor has its own good and bad sides. To understand more about what is retail investors, recognizing the advantages and disadvantages is essential. Here are several pros and cons of being a retail investor. 

The Advantages

• Total Autonomy and Agility

As a retail investor, someone does not have to write reports. Traders will have the full autonomy to make whichever investments that they want. Furthermore, because the portfolio is relatively small, traders are incredibly agile. Traders can liquidate their entire portfolio or shift assets in seconds. This is a certain advantage that institutional traders can’t do.

• Lower Barriers to Entry

A retail investor doesn’t need a large amount of money to start with. There is no entry requirement to start an investment. Generating a consistent profit for retail investors because it has no minimum deposit requirements and zero-commission trading.

• Investing Based on Suitable Value

With full autonomy, a retail investor can make a decision for themselves. They can choose or shift their investment choice based on their ethics and personal beliefs. For instance, if someone supports environmental value, he/she can avoid the assets that have a connection with environmental damage or destruction.

• Access to Small Market Cap Assets

When an institutional fund has $10 billion to deploy, it physically cannot invest in a tiny company with a $50 million market cap. If it tried, it would accidentally buy the entire company or severely distort the stock price. Retail investors can freely access and invest in these environments, while institutional investors can’t. 

The Disadvantages

• Emotional Decision Making

Retail investors are commonly not preparing risk management as strictly as institutional investors. Because of this factor, retail investors are vulnerable to behavioral biases. These biases can influence the investors to do emotional decision-making, such as revenge trading or fear of missing out (FOMO).

• Lack of Resources

Institutional investors rely on many resources and advanced algorithms, while retail investors rely on limited informational resources. This lack of resources is a risk that retail investors should take and try to solve. 

• Hidden Costs

While commissions are zero, retail investors often pay in other ways, such as through wider bid-ask spreads or Payment for Order Flow (PFOF). This hidden cost is not a big cost, but it can influence retail investors to decide which is the best financial instrument they will choose.

• Restricted Access to Private Markets

When an exciting new company goes public via an Initial Public Offering (IPO), institutional investors reserve the initial shares at the lowest prices. This is the type of private market that retail investors can’t access. Retail investors usually have to wait until the stock hits the open market.

Also Read: What Is Secondary Market? Key Features, Benefits, and Examples

How to Become a Retail Investor Today

There has never been a simpler way to enter the world of investing. A guide to become a retail investor can be found down below.

1. Select the Proper Platforms

The very first step into becoming a retail investor is by choosing the right platform. The right broker that suits your needs, financial power, and investing style. 

In addition, selecting a broker that allows its users to purchase fractional shares, has no account maintenance fees, and offers zero-commission trades is very essential for traders, especially for those who are still beginning their journey in the investing world.

After you are done selecting a suitable platform, you can open a brokerage account to hold all the transactions you will be doing.

2. Define The Risk Tolerance and Goals

Before making any deposit, you need to be very clear about why you are investing. The risk tolerance will be determined by these objectives.

If your goal is short-term investing, then you have low risk tolerance. It means you need to concentrate on high-yield savings or short-term bonds rather than volatile investments like particular tech stocks or cryptocurrency.

On the contrary, if your purpose is long-term, then you have a high risk tolerance. For this goal, you are strongly suggested to take stocks and index funds as investment assets. Typically, those financial instruments produced higher returns over extended periods of time.

3. Start Small and Diversify

As a retail investor with a small capital, starting with a tiny amount of money is common. Because of this limitation, retail investors need to be careful to decide which assets to invest in. 

Investing all of the capital in a single good asset is a common mistake for a retail investor. 

To avoid the mistake, diversification is needed. Diversification is a process where someone parts the capital into several different companies, sectors, and asset classes.

4. Invest Consistently

As a new retail investor, picking the right strategy is also an essential thing to do. Dollar-cost averaging, also known as “DCA,” is a strategy in financial investment that focuses on investing a certain amount of money at certain regular times. For example, you will consistently invest $200 monthly.

This strategy is suitable for newcomers as a retail investor. Over time, this will help the purchase price of your assets and build consistent wealth.

Conclusion

Fully grasping about what is retail investors started by understanding its definition. Essentially, retail investors are individual investors that utilize their own capital to make the investments. The retail investors are often making an investment in a small amount. Retail investors are typically compared with institutional investors that are heavily linked with advanced algorithms and large sums of transactions. 

There are several assets that retail investors typically invest in, such as stocks, ETFs, bonds, and cryptocurrency. To be a successful retail investor, a full understanding of the risks and benefits of retail investors is needed. Knowing how to do investment as a retail investor is also a must for people who want to be a successful retail investor.