An investor is typically defined as any person or entity—such as an organization, company, or venture capital firm—that puts money into something to make a profit or gain an advantage. Investors will use investments to grow money or income through different investment vehicles, such as stocks, bonds, commodities, mutual funds, exchange-traded funds, options, futures, foreign exchange, and real estate. Investors also have varying risk tolerances, capital, styles, preferences, and timeframes. Some investors will prefer low-risk investments with conservative gains, while others will take on additional risk in an attempt to make a greater profit.
Investors are typically considered distinct from a trader, as an investor tends to look for long-term gain, while a trader seeks to generate short-term profits by buying and selling securities. And investors are not uniform. Besides varying in risk tolerance, investors will also have different capital styles, preferences, and time frames. A distinction can also be made between investor and trader in that investors typically hold positions for years to decades, while traders will generally hold positions for shorter periods. Scalp traders, for example, hold positions for as little as seconds, while swing traders hold a position for days to weeks.
Depending on who a person asks, there are various types of investors. These can be defined by the level of professionalism in their investment strategies; they can also be defined based on their attitude and experience. Most consider the two major categories of investors to be retail/individual investors and institutional investors, or, put another way, amateur or semi-professional investors versus professional investors. These can be subdivided as follows:
A pre-investor is someone who is interested in investing but is not yet doing so. The pre-investor is characterized by a lack of financial consciousness or awareness. These individuals typically have little in the way of savings or retirement plans. A business seeking investors may only have access to pre-investor investment funding from close personal contacts. Depending on these pre-investors, the amount of capital a business can raise from this kind of investment could be as little as $1,000.
Passive investors are generally individuals who have graduated from pre-investor status and have entered investment through a passive investment, such as through owning a home, opening fund tax-deferred retirement plans, and asset allocation. Generally, these are considered investors who have little time to develop an investment strategy, and often they delegate the responsibility and authority to their investment decisions to experts, such as financial planners, brokers, or money managers.
These types of investors are also commonly known as retail or individual investors who invest in securities and assets on their own, but typically in smaller quantities. The purchase of these securities is part of a portfolio and does not represent the portfolio of an organization. These types of investors can invest based on emotion, which can be difficult with the volatility of stock markets and the difficulty in predicting which direction a stock will move.
Angel investors are often considered a type of passive investors. These are high net-worth individuals searching for a new business and startup to invest in. Investments are usually businesses that are small and have not yet produced any profit, and the angel investors offer them the necessary capital for the promise of potentially high returns and some informal influence over the company's leadership.
Active investors are individuals or retail investors who take a more hands-on approach. These investors study the market and learn how to spot opportunities for investment returns. Those investors with an active strategy aim to make their money work hard for them rather than them working hard for more capital. This is considered an approach taken by those with enough time to learn market strategies.
An institutional investor is a company or organization that invests money to buy securities or assets, such as real estate. Unlike individual investors who buy stocks in publicly traded companies on an exchange, institutional investors purchase stock in hedge funds, pension funds, mutual funds, and insurance companies. They also make substantial investments in companies, frequently reaching millions of dollars in value. The institutional investor can act on their own behalf or on the behalf of others, but institutional investors are considered those who invest on the behalf of others.
Institutional investors have resources and specialized knowledge for extensively reaching a variety of investment opportunities not open to retail investors. These institutions move the biggest positions and are the largest force behind supply and demand in securities markets, perform a percentage of transactions on exchanges, and greatly influence the prices of securities. They tend to make up more 90 percent of all stock trading activity. Institutional investors tend to be entitled to preferential treatment and lower fees and are subject to fewer protective rules because they are more qualified than individuals. There are a variety of types of institutional investors:
- Credit unions
- Pension funds
- Insurance companies
- Hedge funds
- Venture capital funds
- Private equity firms
- Mutual funds
- Real estate investment trusts
Some classify and divide investors based on their attitude or strategy. This kind of taxonomy refers to the contrast between passive investors versus active investors. These are classified by the amount of activity the investor takes in the management of their portfolio. There are other types of delineations with respect to an investor's attitude or strategy. These attitudes or strategies can be applied to retail investors or institutional investors equally. These include the following:
- Growth investors—those who seek investments they believe will rise with a company's growth over time
- Value investors—those who invest in stocks believed to be undervalued based on fundamental valuation metrics
- Income investors—those who invest to develop a reliable source of income from a portfolio, often focusing on stocks providing regular dividend payments and bonds that offer regular interest payments
- Dividend growth investors—those with target investments that offer dividends consistently over time and suggest strong company growth over time
- Contrarian investors—those who invest based on the Wall Street adage "buy low, sell high" and look to buy quality investments during periods of market weakness and when investments are experiencing heavy selling pressure
- Traders—although sometimes not considered investors, these are investors who focus on generating a profit through the timing of an entry and exit from stock on different time scales, from within seconds, minutes, hours, days, to weeks
There are four main asset classes people can invest in with the hopes of appreciation. These include stocks, bonds, commodities, and real estate. There are also funds like mutual funds and exchange-traded funds (ETFs) that are combinations of these assets.
Companies will sell stock to raise money and fund their business operations. An investor is then given a chance to buy shares of stocks for partial ownership of a company, which allows that investor to participate in the company's gains and losses. Some of these stocks also pay dividends, which are small regular payments of the company's profits. Stocks come with inherent risk, as there is no guarantee of returns, and a company may go out of business.
Bonds allow an investor to lend money to companies and countries when those entities need to raise capital. A bond is a loan to the bond issuer for a fixed period of time, which returns a fixed rate of return along with the money initially loaned. Bonds are also known as fixed-income investments because of their fixed rate of returns and are considered less risky than stocks. However, some bonds are not "safe" investments, as they are issued by companies with poor credit ratings and are more likely to default on their repayments.
Commodities are agricultural products, energy products, and metals (including precious metals). These are generally raw material assets used by the industry and are priced based on market demand and potential supply. For example, if a flood impacts the supply of wheat, the price might increase due to scarcity. People do not invest in commodities by holding physical quantities of oil, wheat, or gold. Rather, it refers to the purchasing futures and options contracts on those commodities. An investor can also invest in commodities through other securities, such as ETFs, or buying the shares of companies that produce commodities.
Commodities are generally considered high-risk investments, as futures and options investing frequently involves trading with borrowed money, therefore amplifying an investor's potential for loss. This leaves commodity trading, generally, to experienced and institutional investors.
Investors can invest in real estate by buying a home, a building, or a piece of land. Real estate investments vary in their levels of risk depending on a variety of factors, which can include economic cycles, crime rates, public school ratings, and local government stability. Those looking to invest in real estate without having to own or manage the real estate directly can consider the purchase of shares of a real estate investment trust (REIT). REITs are companies that use real estate to generate income for shareholders and often pay higher dividends than other assets.
Mutual funds and ETFs invest in stocks, bonds, and commodities based on particular strategies. Funds like ETFs and mutual funds allow an investor to invest in hundreds to thousands of assets at once, offering easy diversification that tends to reduce the risk of mutual funds and ETFs compared with individual investments. While mutual funds and ETFs are fairly similar, they operate differently.
Mutual funds buy and sell a range of assets and are frequently actively managed. This requires an investment professional who chooses what the mutual fund invests in, with the goal of trying to outperform a benchmark index. The active, hands-on management means mutual funds are generally more expensive to invest in than ETFs.
ETFs also contain hundreds or thousands of individual securities. Rather than trying to beat a particular index, ETFs generally try and copy the performance of an index, which is a more passive approach to investing that means the returns in this kind of investment will almost never exceed average benchmark performance. However, because they are not actively managed, ETFs cost less to invest in, and meanwhile, actively managed mutual funds have outperformed their benchmark indexes and passive funds long term.
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