Financial intermediaries are significant to the efficient functioning of the financial markets as they act to bring the borrowers/companies and lenders/equity providers together. Financial intermediaries comprise pension funds insurance companies' retail and merchant banks and unit trust companies. In relation to private investors their functions comprise:
(i) the provision of investment advice as well as information.
Financial intermediaries tender investors with advice and information on the range of investment opportunities available and the associated risks and returns. Right of entry to such expert information and advice saves the private investor a great deal of time in searching for the investment most suited to his/her needs.
Stockbrokers are able to act on client instructions to buy/sell stocks but may as well offer an advisory service which offers suggestions on investments to add to a portfolio. Several brokers as well offer private investors hands-free investment management whereby the investor leaves all the decisions on investment selection in the hands of the broker in return for a management fee. The investor is confined from the risk of loss through negligence or mismanagement on the part of the intermediary by the regulatory systems which govern the financial markets.
(ii) Reduction of risk by means of aggregation of funds
Intermediaries serve to decrease investment risks for individuals by creating an investment portfolio. Unit trusts are a good instance of how the process works. An individual investor will typically lack the funds to own an equity portfolio but by investing money in a unit trust the trust can aggregate all the small individual investments and invest in a wide spread in stocks across the whole market. In this means the returns to the individual investor are less volatile than if they invested in the equities directly on a small scale.
(iii) Maturity transformation
It will frequently be the case that there isn't a perfect match between the time period for which a company needs funds and the time period over which a private individual is willing to invest. Financial intermediaries play a job here in performing the function of maturity transformation. For instance a building society will lend out money for periods of 20 or 30 years but their investors will still wish to be able to withdraw cash that they have in deposit accounts at random intervals. By taking benefit of the constant turnover of cash between borrowers and lenders the building society can lend long-term whilst holding short-term deposits. It is this procedure which is referred to as maturity transformation.
Financial intermediaries are able to therefore be seen to be extremely useful to the private investor as they may provide useful advice and make it easier for the individual to take advantage of the returns that can be earned in the financial markets (by means of for example personal pension funds) whilst at the same time leaving investors with a wide range of opportunities for the reason that of maturity transformation aggregation and reduced risk.