Advantages & Disadvantages of Investing Alongside Institutional Investors
One of the most important aspects of finding success within any investment class is being informed about all the inner workings of the entity that you’re investing in. The process of doing due diligence on a company doesn’t just include looking at what sector the company operates in and their financial history. Instead, it’s also important to look at the other investors who hold a large portion of a company’s shares. Even if you can’t assess every investor in a certain company, it’s important to determine if you’re investing alongside institutional investors. Understanding what institutional investors are and the pros and cons of investing alongside them is crucial for making your personal investment portfolio what you want it to be.
What is an Institutional Investor?
In the world of investing, there are two different groups: retail investors and institutional investors. Don’t let the terminology fool you, as the term “retail investor” simply refers to individual investors. If you’re just entering the world of investing, you’re a retail investor. While there is certainly nothing wrong with your position in the world of investing, there are benefits associated with being an institutional investor.
Conversely, institutional investors are a group of investors, a company, or another large entity that trades shares or other securities in larger quantities than retail investors have access to. Since they have the ability to purchase more shares, institutional investors receive preferential treatment such as receiving shares at a discounted price. Institutional investors also have the benefit of experience and professional traders on their side. Since institutional investors are generally companies, they have the ability to hire analysts and other professionals who ensure that these investors are getting the most out of the benefits associated with their status as preferred investors.
Pros of Investing Alongside Institutional Investors
One of the biggest benefits of investing in a company that has a heavy institutional investor presence is found in the fact that you essentially get to take advantage of the research that their analysts have done. The entities that are financially successful enough to put themselves in a position to be an institutional investor don’t get there by investing in companies that aren’t successful. When you find a company that has a large institutional investor presence, you’ve found a company that has been thoroughly researched by professional financial analysts. Obviously, no investment is free of all risk, but these companies are generally considered a safer option than many others.
Cons of Investing Alongside Institutional Investors
As is the case with any type of investment, there are also drawbacks associated with investing alongside institutional investors. First of all, the presence of an institutional investor within a company limits the number of shares available to you as a retail investor. This is especially troubling since retail investors often want to purchase shares in large, successful companies which is where institutional investors have created a strong foothold for themselves. According to the US Securities and Exchange Commission, only 8% of the shares that were owned in 1950 were owned by institutional investors. By 2013, institutional ownership had taken over 67% of the shares owned in the United States. Additionally, a survey of the 1,000 largest domestic companies in the United States indicated that 730 of them were institutionally owned in 2009.
Additionally, the presence of institutional investors can also create false increases in a company’s financials. As we’ve already established, institutional investors are able to purchase much larger blocks of a company’s shares. If they purchase all of these shares at once, the price of the shares would increase drastically, leaving the company in a position to pay more. However, if they purchase multiple smaller blocks of shares, the slow increase in price isn’t truly based on the value of the stock. Instead, it’s based on the institution’s buying activity. As a retail investor, this could lead to you receiving some incorrect information.
Savvy investors understand the importance of knowing who they’re investing with as well as who they’re investing in. That’s why understanding the role those institutional investors play in today’s market and how prevalent they are in companies that you’re considering investing in is important. Being as informed as possible ensures that you’re taking a strategic approach to increasing your own net worth, diversifying your portfolio, and setting up your loved ones for financial success for generations to come.