An investor is an individual or entity who exchanges capital on the expectation that their investment will yield financial gains. Or, in simpler terms, an investor is a person, fund, or organization that gives or lends money in the hope they will make money in return.
Many people start investing to achieve a specific goal, such as building a college education or saving for retirement. With all investors, the prospects of becoming rich certainly tickle at the back of the mind.
Myriad opportunities exist for investors, with varying levels of risk and return involved. These opportunities – known as investment vehicles – include stocks and bonds, retirement plans, and various types of funds (mutual, ETF, etc.), among many others.
Each investor is different. Every person and organization has its own investment capital, risk tolerance, and security preference, and no two people invest for exactly the same amount of time. As a result, some investors will take more risk, while others less; some investors will rely heavily on aggressive stocks, while others will only go for blue chip companies.
With so many options on the table, there is more than one way to categorize an investor. For instance, a broad definition allows for two types: retail investors (individuals) and institutional investors (organizations).
However, there are other ways to categorize investors under these umbrellas. While the names for these types may vary, at the end of the day, there are four main “types” of investment styles.
These styles come juxtaposed to their opposites: active vs passive investors, and growth vs value investors. It’s important to note that these styles are not mutually exclusive – for instance, many passive investors are also long-term growth investors, while some active investors prefer short-term growth strategies. However, this isn’t always the case, which is why Qai is here to help you figure out your style.
There are several ways to categorize investors based on their investing style. We’ve broken down the basic “types” of investors into four categories:
- Passive investors follow “buy and hold” strategies to make small but steady gains over years or even decades. While this strategy comes at low cost and high tax efficiency, returns rarely outperform the market.
- Active investors are after high rewards on both short- and long-term investments. Many active investors are day traders seeking above-market average returns. However, these investors are less likely to turn a huge profit in the long run due to the costs of frequent trading and actively managed portfolios.
- Growth investors, like passive investors, are after long-term gains in the market. They do this by investing in companies they believe are valuable and have potential to see gains on stock prices in the future. This strategy can lend itself to returns above the market average, but the strategy can be risky, expensive, and time-consuming.
- Value investors focus on securities they believe to be underpriced in the market. Value investing strategies seek to make gains on securities when the market realizes their full value and the price increases. Typically, value strategies produce larger returns than growth strategies; however, what constitutes a “value” stock is up for debate.
The Distinction Between an Investor and a Trader
Before we cover the types of investors, we’re going to briefly touch on the distinction between an investor and a trader. Simply put, an investor is looking for long-term gains over the course of years or decades, while traders are after short-term profits.
There are distinct types of traders, and several ways to categorize these distinctions. For instance, scalp traders and swing traders are so named for how long they hold their investments – as little as seconds for scalp traders, while swing traders may sell within a few weeks.
Another common way to categorize a trader is by their specific investment strategy, most notably in the stock market. Do they prefer basing decisions on the fundamentals, or do they buy and sell based on trends? Furthermore, do they attempt to time the market? We’ll touch on this subject a bit more shortly.
Passive investors follow an investment strategy of “buy and hold” wherein they purchase securities or other products. Instead of selling their investments at the next opportunity, they hold onto them for years or even decades.
Passive investors subscribe to the underlying assumption of passive investing, which states that the markets will always perform – eventually.
The goal of passive investors is to minimize the costs and risks of investing while maximizing returns. Rather than trying to out-think the market, these investors select for a well-diversified portfolio (often composed of securities such as ETFs and mutual funds as well as individual stocks) that spreads risk as well as growth.
Passive investors typically ignore technical markers such as fundamentals in favor of the longer-term trends. While short-term gains of this strategy may be small, in the long run, this strategy can build great wealth.
Pros and Cons of Passive Investment Strategies
As we mentioned above, many passive investors turn to passively managed funds, such as ETFs or mutual funds, in order to invest their money into more stocks at once. These come with a few benefits compared to actively managed funds. Two of the biggest benefits include:
- Incredibly low expense ratios (costs). In a passively managed fund, the stocks are selected based on the underlying indices; no hands-on management required. Even if you don’t invest in a fund and choose the securities yourself, a passive strategy comes with lower costs due to trading less, which incurs less in brokerage and other fees.
- Tax efficiency. This ties into the low costs above. Because buy-and-hold strategies don’t return massive capital gains year to year, they can cost less in taxes (especially if you’re invested in a passive fund).
However, passive investing comes with one major downside: the returns year to year rarely beat the market. While some passive funds can outperform the market, this depends on the underlying indices or sectors outperforming the rest of the market.
In the case of investors who manage their own passive portfolios, they still may not see major returns, because passive investors frequently hold onto their securities even when the market takes a turn for the worse. In the long run, this can be a smart strategy; but in the short-term, this leads to smaller gains.
Active investors are in it for the big money. Whether they purchase shares in an actively managed fund or select their securities themselves, active investors have one goal in mind: to outperform the market’s average returns. They do this through a variety of strategies, but the overarching theme is taking advantage of short-term fluctuations as well as long-term trends.
Active investing is a time- and labor-intensive strategy that involves deep analysis of the market and each stock, bond, etc. within a portfolio. In the case of investors who purchase into an actively managed fund, the portfolio manager oversees clusters of analysts who examine various financial metrics and available data. Depending on the objectives of the fund, analysts may research a stock’s fundamentals, historical performance, project a future outlook, or take other measures such as using AI to examine all available data. (No comment).
For individual investors who prefer an active strategy, they have to do all of this work themselves. Thereby, many active investors turn to day trading. While not all active investors are day traders (as many active investors want both short- and long-term gains), all day traders are active investors by definition.
Day traders seek to buy and sell stocks for a profit as quickly as they can within their strategy. Some may choose to sell within seconds (scalp traders) for profits of pennies on the dollar. (Many computerized investors take this approach). Other traders buy and sell the same security with a few days or weeks between transactions (swing traders).
Pros and Cons of Active Investment Strategies
Whether you prefer to buy into an actively managed fun or actively manage your portfolio yourself, there are some commons pros and cons of active investment strategies.
The primary benefit of active investing is that this strategy, with the right technique and a little luck, can provide above average returns compared to the rest of the market. This can increase short-term gains drastically compared to a passive strategy.
However, studies have shown that many active strategies are only successful in the short term. Due to the high costs of an actively managed portfolio, as well as the higher costs of trading frequently, the strategy itself can be self-defeating and lead to less gains in the long-term than a passive strategy.
Furthermore, many active investors make calls on individual assets, which means that betting too much on the wrong security can lead to massive losses overnight.
The growth investing strategy works by building a portfolio of securities with high growth potential. Often, growth investors employ this method for assets they believe have strong underlying value, rather than just examining the fundamentals or other financial metrics to reach a conclusion. Growth investors frequently do a lot of research on their selections, taking into account factors such as the current and future health of the company, the industry, and the company’s direct peers and competitors.
Many growth investors are after long-term gains in the market. These individuals believe that a company has vast potential for growth over a period of years, rather than months, and will hold on through various market crashes and rebounds.
However, growth investors may also be short-term investors. Typically, these investors are interested in industries that exhibit rapid upward momentum before reaching a plateau or falling off a cliff. Such securities are common in emerging industries like technology and healthcare.
Pros and Cons of Growth Investment Strategies
Growth investment strategies come with high potential for returns, as the name implies. Depending on the exact stock, companies that fit the profile can see annual returns that exceed the market by several percent.
However, growth investors either have to pay portfolio managers or take the time to do the research. Furthermore, companies that are growing aggressively are more likely to be volatile than companies seeking long-term returns. This means that an investor has to either be risk tolerant or have the time to sell securities in the event of a market crash.
Moreover, because many growth assets reinvest their profits back into the company, they don’t pay dividends. This makes growth investing a risky strategy with no guarantee of returns for many investors – even the most experienced ones.
Value investors seek out stocks that fit the “value investing” strategy. Namely, these investors focus on securities that they believe are underpriced compared to their true worth. The allure for value investors is simple. When the market corrects to accurately reflect a company’s price, they can cash in on their returns quickly.
Value investors subscribe to the belief that the market is irrational. This leaves opportunities to see gains on securities that slip through the proverbial cracks. Value strategies focus on buying these assets at a “discount” now. Then they sell them for a profit potentially years down the line.
As a result, most value investors play the long game. The market may not correct its oversight for years to come. In order to be a successful value investor, it’s important to do plenty of research. Not only on the stocks you wish to purchase, but the larger markets as a whole. This means that many who prefer this strategy turn to professional portfolio managers. They can make the call for them, as the time and resources required can eat into an individual’s day substantially.
Pros and Cons of Value Investment Strategies
Studies have shown that, over time, value strategies tend to produce larger returns than growth strategies. However, these gains are not typically realized for ten years or more. This makes value investing an even longer-haul game than some growth strategies.
One of the biggest downsides of value investing is that what constitutes a “value” stock is subjective. It’s possible to make money on the right call. But the wrong call can lead to nothing but losses and headaches. Furthermore, many individuals don’t have the time to vet every security in depth. This means value investors might accept the risks of a half-researched investment. Or they might turn to a portfolio or fund manager in order to turn a profit.