Types of Investors

The needs of investment clients vary widely, but we can group investors into two broad categories – individual and institutional investors. Different investors will have varying investment time horizons, tolerance for portfolio risk, income, and liquidity needs.

Individual Investors

Individual investors may be investing either for short-term or long-term goals. A short-term investment goal may be their children’s education or the purchase of a house. Long-term investment goals revolve around providing income for retirement. The implication is that some investors are focused on capital growth and look for those investments with the potential for capital appreciation, while retirees will want income-producing assets. The structuring of a portfolio for an investor will also be dependent on their financial circumstances, such as home ownership, employment prospects, and other financial obligations.

Institutional Investors 

There are many different types of institutional investors. Indeed, institutional assets constitute a major portion of the investment market. Pension funds, endowments, charities, banks, insurance companies, investment funds, and Sovereign Wealth Funds (SWF) are all classified as institutional investors. These institutional investors also have different financial objectives.

Endowments and Foundations

The typical objective of an endowment or foundation is to maintain the real (inflation-adjusted) capital value of the fund in perpetuity as well as generate income to provide financial support for its beneficiaries.

Banks

Banks hold deposits and make loans which can lead to excess reserves – in this case, a bank holds more deposits than the loans it has extended. Banks can invest these reserves, which typically have to be held in conservative and liquid assets like fixed-income and money market instruments. The bank’s objective is to earn a rate of return in excess of the rate of interest it pays on its deposits.

Insurance Companies

Insurance companies receive premiums from the insurance policies they write. They need to invest these premiums to ensure sufficient funds are available to pay for insurance claims when these arise. As such, their investments are also often conservative in nature and cognizant of the investment time frame over which claims may arise.

Investment Companies

Investment companies manage mutual funds, which are pooled investment vehicles. Mutual funds are seen as an efficient way for individual investors to gain access to a diversified portfolio and benefit from the skills of a professional investment manager. Mutual funds are managed according to the limits and restrictions of their investment mandates.

Sovereign Wealth Funds

SWFs are government-owned investment funds. Some governments operate with the objective of investing the revenues from the country’s natural resources (e.g., oil) for the benefit of future generations. On the other hand, others manage state assets.

Question

Excess reserves held by banking institutions are usually invested in:

A. Emerging market equities and other high-growth stocks.

B. Money-market and fixed-income instruments.

C. Real estate and other tangible assets.

Solution

The correct answer is B.

Banks invest their excess reserves in conservative and liquid assets such as fixed-income and money-market instruments.