Not all investors in the stock market are individuals who buy and sell their own hand-picked stocks and bonds. Some are large entities trading securities on a large scale, usually on behalf of individuals: Pension plans, mutual funds, commercial banks and more. Such entities are known as institutional investors, and they account for the majority of trades in the market. If you plan to be involved in the market, you should understand what institutional investors are and what role they play in the stock market.
Institutional Investor Basics
If you buy your own stocks and bonds, you’re what’s known as a retail investor. If you buy shares in a mutual fund, you’re giving your money to an institutional investor. Mutual funds, hedge funds, pension funds, index funds, commercial banks, REITs, endowments and insurance companies are all institutional investors. They make investing decisions on behalf of individual members or shareholders.
The sizable presence of institutional investors in the market means that corporations that are ostensibly competitors have many of the same shareholders. If you look up the largest shareholders of brands you’re familiar with, you’ll find that institutional investors top many of those lists. Some institutional investors buy shares in a company with the intent of becoming vocal shareholders, while other institutional investors (such as index funds) are passive investors and do not take an interest in the running of the companies in which they invest.
When you’re searching for a financial advisor, you might find some prominent advisors who primarily work with institutional clients – for instance, a firm that exclusively advises pension plans. If you’re seeking individual investment management and financial planning, you probably won’t be able to work with such an advisor. On the other hand, some advisors work with both individuals and institutional investors. You might take that as a sort of stamp of approval, as it means that organizations with many millions in assets have trusted this investment advisor with their money.
How Institutional Investors Affect the Market
Most of the trading that happens on the market is done by institutional investors. By some estimates, institutional investors account for 70% of stock trading volume. The percentage of corporate shares held by institutional investors has increased dramatically in the last 60 years. Today, the volume of trades by retail investors pales in comparison to the trading activity of institutional investors.
To some analysts, the rise of institutional investors – particularly index funds – is a cause for concern. At a time when roughly 20% of stocks are owned by index funds, some say that all that indexing is distorting the market. They warn that, if index funds ever dominate the market, the economy could suffer.
Why? Because if passive investing dominates, the majority of stocks will no longer be bought on the basis of rewarding companies that are profitable, productive, promising and well managed. A traditional method of reward, punishment and incentive for companies will have broken down. Market mechanisms for determining the prices of commodities could also be distorted, these analysts argue.
While you may not be an institutional investor yourself, chances are there’s one investing money on your behalf. If you’re saving for retirement in a 401(k) or you’ve invested your nest egg in mutual funds, your money is being handled by an institutional investor. If you’ve got a pension coming your way, those funds are invested by an institutional investor. That donation you gave to your alma mater? You guessed it: That money goes into an endowment that’s considered an institutional investor, investing in securities to maximize growth.
Tips for Smart Investing
- If you’ve decided to trust a financial professional with your investments, you should consider working with a financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- If you want to take advantage of institutional investors but you don’t want to sift through dozens of funds, consider a robo-advisor. Robo-advisors invest your money in a range of funds by relying on algorithms that ensure their investments are in line with your risk tolerance.
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