Contents
Who’re they: Financial market investors are those who invest money in financial markets to earn returns. They may be retail investors or institutional investors. They trade various financial instruments such as stocks, bonds, derivative instruments, and commercial paper to earn returns.
Where does investor money come from? Some may put money out of their own pocket and invest it in various assets to accumulate wealth, as retail investors do. Others, such as banks and insurance, collect money from the public or other sources.
Investors are often distinguished from traders in terms of the investment horizon. Investors are long-term oriented. In contrast, traders are short-term-oriented and seek to profit from daily fluctuations. Therefore, a trader tends to trade more actively than an investor.
What is a financial market?
A financial market is where financial instruments are traded. It facilitates those who need capital – such as companies and governments – to meet with investors who have the capital to invest. In a broader definition, transactions may not involve those who need capital but only between investors, as in the secondary market.
Financial markets are broadly categorized into two, namely:
- Capital market
- Money market
The capital market trades long-term financial instruments such as stocks and bonds. Meanwhile, the money market trades short-term instruments such as certificates of deposit and commercial paper.
Transactions in the financial market can take place in the primary and secondary markets. The primary market deals with financial instruments when they are first offered to the public. For example, a company may offer shares through an initial public offering. Shares are sold to a few investors before they are available on the stock exchange.
Then, after being listed on the stock exchange, the shares are transacted by the public more broadly. Transactions on the stock exchange represent trading in the secondary market. In this market, trading may not involve the issuing company. Instead, transactions occur between investors unless there is a corporate action such as a share repurchase.
What is the role of financial market investors?
Investors have a key role in financial markets. First, they provide capital and liquidity in the economy. For example, they do this by buying debt securities issued by a company. Money changes hands from investors to the company. And the company can use it for capital investments such as buying new machines or building new factories. Finally, the financial resources in the economy are used for the most productive purposes. While investors earn a return on their investment (coupons), companies can increase their productive capacity to generate more products and profits.
Many companies raise funds through financial markets. For example, Apple sells its shares to the public to support its expansion. The company first went public in 1980 and sold 4.6 million shares at $22.00 per share, allowing it to raise more than $100 million. Likewise, Alibaba Group Holding Limited raised nearly $22 billion through an initial public offering in 2014.
Second, investors play a role in building wealth in the economy. For example, we invest money by buying some securities, such as stocks and bonds. As a result, our wealth increases when stock and bond prices rise. So, we are more confident in increasing consumption. Economists refer to this as the wealth effect, where higher prices for financial assets increase wealth and ultimately encourage increased consumption.
Third, investors such as banks also play a role in transmitting monetary policy into the economy. For example, the central bank uses expansionary monetary policy by buying government securities from commercial banks through open market operations. This policy aims to stimulate economic growth by increasing the money supply.
As compensation for buying government securities, the central bank hands over money to commercial banks, which can be used to make loans; every dollar lent will be multiplied in the economy through the money multiplier. Eventually, the money supply increases, pushing down interest rates and increasing credit availability. This situation encourages households to increase consumption and businesses to invest.
What are the types of financial market investors?
Financial market investors can be grouped according to various criteria. For example, they can be distinguished by their investment strategy:
- Passive investors
- Active investors
Passive investors buy financial instruments to own them in the long term. They usually buy index funds or other mutual funds. Thus, they are less involved in buying and selling.
In contrast, active investors engage more frequently in buying and selling. First, they try to find the right securities to profit from short-term price fluctuations. Then, after reaching the required profit, they sell the securities they hold and spend the proceeds on other assets.
We can also distinguish investors from their goals, namely strategic and financial investors. Strategic investors buy financial instruments to add value to the issuing company. Meanwhile, financial investors are trying to pursue profits in the short and medium term.
Then, we can also categorize investors based on their risk tolerance level. They are investors with conservative, moderate, and aggressive risk profiles. The latter dare to take high risks in pursuit of high returns.
Finally, we can also distinguish investors as individual investors and institutional investors.
Individual investors
Individual investors, sometimes also called retail investors, rely on the money in their pockets to buy financial instruments outright. So, for example, we save our income by buying stocks for dividends and capital gains.
Several reasons individual investors invest in financial markets. But, for sure, investing is their way to accumulate wealth. They can then use the wealth to meet future needs. For example, they provide children with a college education or retirement savings.
Starting a business might also be the reason. Individual investors expect their investment to continue to grow. So, when they have enough money, they can use it to fund their new business.
The need to invest usually depends on the wider financial situation. For example, younger investors tend to be more aggressive. They usually have fewer dependents and are, therefore, willing to take higher risks to earn high returns. So, their money is sufficient when they are old to meet their needs.
Meanwhile, older investors often pursue stability. Thus, they are less risk-tolerant. Instead, they seek to invest in instruments such as fixed income to generate steady cash inflows.
Institutional investors
Institutional investors refer to a company or organization which raises money from external sources for investment. Examples of institutional investors include:
- Pension fund
- Foundation
- Endowment fund
- Banks
- Insurance company
- Sovereign wealth funds
- Hedge funds
- Investment company
- Investment trust
Some institutional investors invest money on behalf of other parties or clients, as hedge funds, mutual funds, investment banks, and endowments do. They earn income from the fees they charge while earning a return on their own money invested.
Meanwhile, several other institutional investors collect money from external parties but earn returns for themselves. Banks and insurance companies are good examples.
Banks collect deposits from the public, mostly for lending. Then, if they have funds available, they invest them in generating returns. Likewise, insurance collects money from premiums paid by customers and invests it to generate returns, partly to cover claims and the rest for profits.
Different from individual investors, institutional investors manage large funds. Because of this, they often greatly influence the markets or companies they invest in. For example, a large fund allows them to buy a significant stake in a company. In addition, it allows them to influence the company, such as voting for or against management policies at shareholder meetings.
Likewise, institutional investors are also important to promote management accountability. They should manage funds wisely by investing according to the needs and requirements of their clients, not in their organizations’ interests.
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