What Is an Investor?
An investor is any person or other entity (such as a firm or mutual fund) who commits capital with the expectation of receiving financial returns. Investors rely on different financial instruments to earn a rate of return and accomplish important financial objectives like building retirement savings, funding a college education, or merely accumulating additional wealth over time.
A wide variety of investment vehicles exist to accomplish goals, including (but not limited to) stocks, bonds, commodities, mutual funds, exchange-traded funds (ETFs), options, futures, foreign exchange, gold, silver, retirement plans, and real estate. Investors can analyze opportunities from different angles, and generally prefer to minimize risk while maximizing returns.
Investors typically generate returns by deploying capital as either equity or debt investments. Equity investments entail ownership stakes in the form of company stock that may pay dividends in addition to generating capital gains. Debt investments may be as loans extended to other individuals or firms, or in the form of purchasing bonds issued by governments or corporations which pay interest in the form of coupons.
Key Takeaways
- Investors use different financial instruments to earn a rate of return to accomplish financial goals and objectives.
- Investment securities include stocks, bonds, mutual funds, derivatives, commodities, and real estate.
- Investors can be distinguished from traders in that investors take long-term strategic positions in companies or projects.
- Investors build portfolios either with an active orientation that tries to beat the benchmark index or a passive strategy that attempts to track an index.
- Investors may also be oriented toward either growth or value strategies.
Styles and Risk Tolerance
Investors are not a uniform bunch. They have varying risk tolerances, capital, styles, preferences, and time frames. For instance, some investors may prefer very low-risk investments that will lead to conservative gains, such as certificates of deposits and certain bond products.
Other investors, however, are more inclined to take on additional risk in an attempt to make a larger profit. These investors might invest in currencies, emerging markets, or stocks, all while dealing with a roller coaster of different factors on a daily basis.
Institutional investors are organizations such as financial firms or mutual funds that build sizable portfolios in stocks and other financial instruments. Often, they are able to accumulate and pool money from several smaller investors (individuals and/or firms) in order to make larger investments. Because of this, institutional investors often have far greater market power and influence over the markets than individual retail investors.
Passive Investors vs. Active Investors
Investors may also adopt various market strategies. Passive investors tend to buy and hold the components of various market indexes and may optimize their allocation weights to certain asset classes based on rules such as Modern Portfolio Theory's (MPT) mean-variance optimization. Others may be stock pickers who invest based on fundamental analysis of corporate financial statements and financial ratios—these are active investors.
One example of an active approach would be the "value" investors who seek to purchase stocks with low share prices relative to their book values. Others may seek to invest long-term in "growth" stocks that may be losing money at the moment but are growing rapidly and hold promise for the future.
Passive (indexed) investing is becoming increasingly popular, where it is overtaking active investment strategies as the dominant stock market logic. The growth of low-cost target-date mutual funds, exchange-traded funds, and robo-advisors are partly responsible for this surge in popularity.
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Financial investments have the very specific goal of buying something that (hopefully) appreciates in value. Consider other forms of investing such as returning to school to complete your degree or embarking on a diet to ensure good health in the future.
Types of Investors
Angel Investors
An angel investor is a high-net-worth private individual that provides financial capital to a startup or entrepreneur. The capital is often provided in exchange for an equity stake in the company. Angel investors can provide a financial injection either once or on an ongoing basis. An angel investor typically provides capital in the early stages of a new business, when risk is high. They often use excess cash on hand to allocate towards high-risk investments.
Venture Capitalists
Venture capitalists are private equity investors, usually in the form of a company, that seek to invest in startups and other small businesses. Unlike angel investors, they do not seek to fund businesses in the early stages to help get them off the ground, but rather look at businesses that are already in the early stages with a potential for growth. These are companies often looking to expand but not having the means to do so. Venture capitalists seek an equity stake in return for their investment, help nurture the growth of the company, and then sell their stake for a profit.
P2P Lending
P2P lending, or peer-to-peer lending, is a form of financing where loans are obtained from other individuals, cutting out the traditional middleman, such as a bank. Examples of P2P lending include crowdsourcing, where businesses seek to raise capital from many investors online in exchange for products or other benefits.
Personal Investors
A personal investor can be any individual investing on their own and may take many forms. A personal investor invests their own capital, usually in stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Personal investors are not professional investors but rather those seeking higher returns than simple investment vehicles, like certificates of deposit or savings accounts.
Institutional Investors
Institutional investors are organizations that invest the money of other people. Examples of institutional investors are mutual funds, exchange-traded funds, hedge funds, and pension funds. Because institutional investors raise large amounts of capital from many investors, they are able to purchase large amounts of assets, usually big blocks of stocks. In many ways, institutional investors can influence the price of assets. Institutional investors are large and sophisticated.
Investors vs. Traders
An investor is typically distinct from a trader. An investor puts capital to use for long-term gain, while a trader seeks to generate short-term profits by buying and selling securities over and over again.
Investors typically hold positions for years to decades (also called a "position trader" or "buy and hold investor") while traders generally hold positions for shorter periods. Scalp traders, for example, hold positions for as little as a few seconds. Swing traders, on the other hand, seek positions that are held from several days to several weeks.
Investors and traders also focus on different types of analysis. Traders typically focus on the technical factors of a stock, known as technical analysis. A trader is concerned with what direction a stock will move in and how to take advantage of that movement. They are not as concerned about whether the value moves up or down.
Investors, on the other hand, are more concerned with the long-term prospects of a company, often focusing on its fundamental values. They make investment decisions based on the likelihood of appreciation of a stock's share price.
One of the absolute easiest ways to become an investor is to sign up for your company's 401(k) plan.
How to Become an Investor
Many individuals naturally become investors, especially considering those that prioritize long-term savings and putting money away for retirement. Begin by learning the basics of investing such as the various types of assets (e.g. stocks, bonds, real estate), investment strategies (e.g. value investing, growth investing), and risk management. Early in your investing career, be mindful of your risk tolerance. Though greater returns are often had by taking on greater risk, there is also greater downside or loss of original capital.
To invest in stocks, bonds, and other securities, you'll need to open a brokerage account with a reputable broker. To invest in real estate or physical property, you'll want to be well-versed in local real estate law. Other specific assets will have specific requires as well, such as a digital wallet for cryptocurrency or physical protection for bullion or tangible precious metals.
Because investing is much different from trading, it's critical to determine your investment goals, such as your target return and time horizon. This will help you choose the right investments (such as a target date fund) and make informed decisions. For example, if your goal is to invest money for retirement, you likely have a much long horizon compared to if your goal for investing is to purchase a new car in several years. Depending on what you are trying to achieve, you will want to frame your investing strategy around your long-term target.
Last, it is important to keep up with market trends and news that may impact your investments. This can help you make informed decisions and adjust your strategy as needed. Depending on your holdings, this may be related to financial, political, international, or social news that may have a ripple effect on the valuation of what you own.
What Do Investors Invest in?
The basic philosophy of investing is simple: a person contributes capital towards an asset with the expectation that the value of that asset will be higher when it comes time to sell or liquidate the asset. For this reason, an investor can literally invest in anything may appreciate in value. This is evident by the lucrative deals seen by investors buying and selling tiny rectangles of cardboard (i.e. baseball cards). A more comprehensive list of traditional or common things investors invest in is below:
- Stocks: Investors can buy shares of publicly traded companies, which represent ownership in the company and provide a share of its profits. Many brokers now allow for partial share ownership, so investors are not necessarily required to own a full share of a company's stock.
- Bonds: Investors can buy fixed-income securities such as government bonds or corporate bonds, which pay interest and return the principal investment at maturity. The risk with bonds is the value of the investment will fluctuate based on prevailing interest rates.
- Real estate: Investors can buy properties, either directly or through real estate investment trusts (REITs), which provide rental income and may appreciate in value over time. In addition, landlords may collect cashflow from operations for properties being rented.
- Mutual funds: Investors can invest in a professionally managed portfolio of stocks, bonds, or other assets. The goal behind mutual funds is to have diversification and lower risk compared to investing in individual, specific assets.
- Exchange-traded funds (ETFs): Investors can invest in a basket of stocks, bonds, or other assets, similar to mutual funds. However, ETFs also have the added benefit of being traded on stock exchanges like individual stocks.
- Commodities: Investors can invest in physical commodities such as gold, silver, oil, or agricultural products, which may offer protection against inflation and other economic risks. This can be traded as physical items or derivative contracts. Most often, these assets have value because of their real-world use as tangible items.
- Alternative investments: Investors can invest in alternative assets such as private equity, venture capital, hedge funds, cryptocurrency, art, or collectibles. Though potentially riskier investments, the end goal is always the same: to own something increases in value over time.
What Are the 3 Types of Investors in a Business?
The three types of investors in a business are pre-investors, passive investors, and active investors. Pre-investors are those that are not professional investors. These include friends and family that are able to commit a small amount of capital towards your business. Passive investors are those that are professional investors that commit capital but do not play an active role in managing the business. An example would be angel investors. Active investors are those that commit capital but are also actively involved in the business. They make decisions on strategy, senior management, and more. Examples include venture capitalists and private equity firms.
How Do Investors Make Money?
Investors make money in two ways: appreciation and income. Appreciation occurs when an asset increases in value. An investor purchases an asset in the hopes that its value will grow and they can then sell it for more than they bought it for, earning a profit. Income is the regular payment of funds from the purchase of an asset. For example, a bond pays fixed payments at regular intervals.
What Qualities Make a Good Investor?
To be a successful investor, a certain set of skills are required. These include diligence, patience, acquisition of knowledge, risk management, discipline, optimism, and the setting of goals.
The Bottom Line
An investor is an individual or entity that utilizes its capital or the capital of others with the goal of receiving a return. Investors can range from a person buying stocks at home on their online brokerage account to multi-billion dollar funds investing globally. The end objective is always the same, to seek some return (profit) in order to build wealth.
Investors commit their capital to a wide variety of investment vehicles, such as stocks, bonds, real estate, mutual funds, hedge funds, businesses, and commodities. Investors encounter risk when they commit capital and walk a balance between managing risk and return.
