The Difference Between Investment Banks, Stock Brokerages And Hedge Funds

Difference Between Investment Banks, Stock Brokerages And Hedge Funds

When it comes to wealth creation and profit-making in the financial markets, the options that the investors have are overwhelmingly high. While these options might all appear to be the same, each has its own unique set of characteristics.

Typically, the two most important genres in the field are trading and investing. These are completely different approaches as trading is a method of holding stocks for a short period of time, whereas investing is an approach that largely works on the buy-and-hold principle.

Among the prominent names that linger around when it comes to the above genres focused on business setup support and wealth-building are Investment banks, stock brokerages and hedge funds. In this post, we’re going to discuss the difference between these approaches based on the principles of trading and investing.

What is an Investment Bank?

Unlike regular banks, an investment bank is a large financial institution that works primarily in high finance. They help companies/institutions access capital markets that allow them to raise money for expansion or other business needs.

For instance, if a company wants to sell $20 million worth of bonds to expand their operations, an investment bank would help them find buyers for these bonds and make sure to handle the end-to-end paperwork supported by a team of qualified professionals.

Further, investment banks also work in facilitating initial public offerings (IPOs) when a private company goes public at stock exchanges.

What do Investment Banks do?

Typically an investment bank engages in some or all of the below activities –

  • Help in raising equity capital by launching an IPO or creating preferred stocks that can be placed with targeted investors such as banks and insurance companies
  • Launch new products (e.g., credit default swaps) or insure bonds
  • Assist in raising debt capital (by issuing bonds to raise money for business expansion)
  • Systematically engages in proprietary trading to invest or trade the company’s own money for its private account

What is a Stock Brokerage?

Stock brokerages or stock brokerage firms are the financial institutions that help investors buy and sell securities. They typically act as the middle man between the buyer and the seller involved in security trading.

Based on the type of brokerage firm that investors pick, they can either make stock buys and sales via the internet, telephone, or smartphone. Brokerage companies receive compensation in the form of commissions or fees that are charged once the transaction has successfully completed.

What is a Wash Sale in the Context of Stockbroking?

A wash sale is typically a financial transaction in which an investor sells a losing security to claim a capital loss, with an intention of repurchasing it within 30 days of the sale. This technique is used by some investors to try to realize a tax loss without limiting their security exposure.

There are several types of stock brokerage firms including –

  • Full-Service Stock Brokerages

Apart from allowing you to buy and sell securities, full-service brokerage firms also provide a range of other financial services such as financial planning, consulting, trust and wealth management services.

  • Discount Brokerages

This type of brokerage firm traditionally doesn’t provide any consulting or financial planning services. Discount brokerage firms charge less commission for handling transactions as compared to full-service firms but similar to full-service brokerages, investors can make trade over the phone.

  • Online Brokerages

Online brokerage firms give the investors  24-hour access to their account along with the opportunity to do research, track all the investments, and follow the latest market news online.

What is a Hedge Fund?

A hedge fund essentially refers to the money pooled together by a partnership of institutional or accredited investors. The accumulated funds can then be invested in a number of different assets, but they usually involve complicated portfolio construction and a certain degree of risk management to consider.

Characteristics of a Hedge Fund

Here are the key characteristics of all hedge funds making them a unique investment opportunity for investors –

  • Offer lots of options

Unlike other pooled investment options such as mutual funds, hedge funds aren’t just limited to investing money towards stocks and bonds. Instead, they can invest in anything including stocks, bonds, real estate, and currencies.

  • Exclusivity

Due to their exclusive nature, hedge funds are limited to accredited and high-net-worth investors only. What this means is that only the investors with a net worth exceeding $1 million or an annual income greater than $200,000 for the past two years can invest in a hedge fund as they are deemed qualified by the Securities s and Exchange Commission (SEC) to afford the risks associated with hedge funds.

  • Option of leveraging

Hedge funds are best suited to use financial leverage, or borrowed money that is invested, to earn a greater return on the amount invested.

  • Aggressive in nature

Being aggressive in nature, hedge funds come in the category of high-risk high-return investment. However, if the techniques used for investment work, the investors are sure to see a profit on a continuous basis.

  • Fee structure

Hedge funds charge both a performance fee and an expense ratio to investors. While the performance fee is a payment made to the hedge fund manager for the positive performance of the investment, the expense ratio is the money put towards management, administrative, and advertising expenses.

Summarize the Differences

Parameter Investment Banks Stock Brokerages Hedge Funds
Meaning An investment bank is essentially a financial intermediary that offers multiple services to organizations including investment and advisory Stock brokerages act as a middleman to connect buyers and sellers to facilitate security trading/ transactions. Hedge Fund is primarily an investment group that pools funds from niche people to invest in various financial products.
Investment mode Investment banks facilitate multiple investment plans such as finding an investing partner, stock selling, and more Brokerage firms mainly invest in the stock market Hedge funds investments are generally made in liquid assets
Objective Investment banks focus on various aspects such as growth, safety, and income of the company Stock brokerages focus on helping individuals and businesses secure their financial futures by involving in short-term (and long-term at times) trading options. The objective of a hedge fund is to increase the return for the investors in a very short period of time.
Risks Less risky when compared to stock brokerages and hedge Funds. Stockbroking transactions involves high-risk propositions. Hedge fund involves high-risk propositions.

To Wrap

The main difference between the three investment vehicles – investment banks, stock brokerages and hedge funds is their client base. While stock brokerages primarily focus on individual investors, hedge funds focus on high net worth individuals and investment banks on financial institutions.

Further, brokerage and hedge funds are for people who look out for quick money, while investment banks are largely about stability all the time.