Why Are Investments Important For Economic Growth?

Many factors contribute to economic growth within an economy, but one that plays a role that isn’t always as apparent is that of investment. While those buying investment bonds may not immediately consider the wider impact they could be making, they are in fact contributing to a carefully balanced system. An increasingly important part of growth, companies and governments are relying more on more on the money they obtain by issuing bonds. Investment bonds explained can provide the clarity needed to make the best decisions, so having an awareness of how they impact on the wider company is a good idea.

Why is the money obtained from investments especially important?

Within the economy, the growth of companies is vital. Providing taxable revenue and employment opportunities, it is important that they have the opportunities needed for expansion and development; they are essentially the engine that drives a healthy economy. How they obtain the finances needed to push themselves forward is a major concern for them. Many companies will, of course, be funded by stored revenue they have from previous success, bank loans, or wealthy individual donors with a vested interest in seeing the company do well. Alongside this, they may choose to issue bonds to generate any finances they need. There are many advantages for them to do this over other methods of funding.

Predictability, security and stability

Companies consider bonds as predictable cash flow; they know exactly what bonds they can issue, how much this will bring in, how much they will repay, and when. This provides them with fantastic opportunities to schedule any growth and expansion around access to finance. Those buying bonds could also experience the same levels of predictability; they know what they are buying, how much it will cost, what returns they can expect and when. The problems that may be encountered by other methods of accessing financial credit such as fluctuating market and interest rates are largely removed. Stability is further provided in the notion that investors buy to maturity; meaning once again that there is an awareness of when and how money will be repaid.

Cost savings

In general bonds also work out cheaper for companies, who find themselves repaying less than they would via other options, meaning that they inevitably have more opportunity for expansion and development. As investment bonds are in constant competition with other sources of capital, a continuing drive to reduce the costs of issuing is present. Because of a more direct link between issuers and investors (i.e. a removal of any ‘middle men’) and competition between brokers and underwriters, investor funds can be far more efficiently allocated. Essentially the end result is increased financial access, which feeds heavily into economic growth.

Flexibility

The flexibility that investment bonds provide to companies is hugely valuable. As they offer an alternative to relying on finance from banking institutions, so companies are freed from the various shackles that come from dealing with the banks. The major advantage of this is that companies can operate free of the whims of banks, who fluctuate depending on other influences. Bank lending is always compromised or reduced by periods of economic turbulence for example. Investing in bonds means that companies can continue to expand and develop, away from these influences. As banks are also their own businesses, issues can also arise that are nothing to do with the economy; a decision not to loan money could be made simply on the fact that a bank is altering its lending policy. It may simply be that a bank is unwilling to lend a company the financial capital they need and require. Removing the need for a bank to dictate how a company can develop and grow offers new flexibility and options.

Development

Using the finances created by the issuing of investment bonds can allow a company to develop in many ways that are important to the economy on a wider scale. Alongside expansion and development, as mentioned above, things such as mergers and acquisitions might become possible. As events like this require a spike in available finance, companies can issue bonds to coincide with this. Likewise, maturity of the bonds can be timed to coincide with a suitable point in the future where the rewards that come from the mergers or acquisitions becomes apparent, something that would not be possible with a loan from a financial institution such as a bank. International expansion and development can become a major part of a company’s activity with the aid of investment bonds. Alongside getting access to finances in their home country, a company can look to international bond markets, where they may be able to seek funding in other currencies, thus avoiding exchange rates. In this way, any materials that may be needed can also be sourced efficiently internationally and cost savings felt in the profitability of a company, as well as the wider economy.

Hoarding cash is less required

Many companies may choose to hoard cash for their own business as a way of staving off any difficulties they may experience in lending in a difficult economic climate. However, this can in fact help to create tough economic climates; a healthy economy has cash flowing freely. Investment bonds can reduce the need for companies to hoard, as the fear that they may not be able to access finances needed for their own progress are alleviated.

How is an investor helped by a healthy economy?

As shown above, the role of investment bonds is pivotal in the development of a healthy economy, in terms of how companies use the finances created to enhance themselves. There of course also advantages to the investors, who see increased yields in good economic climates. As bonds operate in somewhat of a competition with other methods of obtaining finances such as shares or investment from private capital, when the popularity of one goes up the other must compensate somehow. Therefore, as in a good economic climate shares and private capital investments are an attractive prospect, bonds become less attractive and hence yields go up to accommodate this. The reverse is true in a tough economic climate; people seek out the security of bonds as they avoid the more risky prospect of shares or similar, and yields fall. In an economy where interest rates are cut, yields also usually fall. This is due to the fact that with interest rates low on their bank accounts, people look elsewhere for places for their money, and often towards bonds, meaning that they have less need to attract people with higher yields.

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Provided for informational purposes only. Not designed as advice. Speak to your IFA or tax advisor for advice tailored to your individual circumstances.