“In the midst of chaos, there is also opportunity.”
— Sun Tzu, The Art of War
Our traditional rationale for rising interest rates is to opt for safer investments like bonds and savings accounts. However, the latest research, led by CU Denver Business School faculty member, Dr. Yosef Bonaparte and his co-authors, has unveiled a surprising trend. It suggests that households defy this norm, increasingly venturing into the stock market and allocating more risky assets as interest rates rise. This revelation challenges our conventional understanding of investment behavior.
A key indicator in this counter-approach to rising interest rates is inflation. When inflation increases, the value of assets like cash or bonds decreases, as their returns typically cannot keep up with the rapid devaluation of their currency. As a result, households turn to equities to mitigate this issue. As the study suggests, “If inflation is a salient concern for households, they may allocate a larger proportion of their wealth to equities,” which offer better protection against the loss of purchasing power.
Some sectors within a stock market, such as healthcare, energy, and commodities, are usually seen as viable inflation hedges. Households more heavily affected by rising inflation are increasingly shifting towards these sectors as they better protect their wealth against economic uncertainty.
The study also delves into the role of financial sophistication. It reveals that households with higher incomes and education levels are more likely to comprehend how cyclical changes, such as inflation, impact their wealth and investments. These financially astute households will likely bolster their stock market exposure when interest rates climb. As the research underscores, “Sophisticated households hedge against losses in purchasing power by investing more in risky assets.”
“Bridging the gap in financial education, especially during challenging times, is indeed crucial, “ Bonaparte begins. “One approach is through targeted financial literacy programs that are easily accessible, particularly to underserved communities.” Providing content for a specific target audience means these programs should focus on practical, real-life applications like budgeting, debt management, and long-term planning. “Leveraging technology—such as mobile apps or online platforms—can play a big role in delivering financial education more broadly.” He adds.
These findings must recognize the critical role that financial education plays in how people respond to economic changes—those who are better informed about how the market works can take calculated risks to protect their wealth. At the same time, other households turn to conventional tactics, often yielding a slight negative return on their efforts to protect their assets during economic downturns.
The implications of this behavior are severe. Usually, the Federal Reserve raises interest rates to counteract inflation, slowing down economic activity by encouraging people to invest in low-risk assets. However, research shows that the Federal Reserve employs people acting against their interests. The study explains, “Higher market participation and larger allocation to risky assets among U.S. households in response to a hawkish monetary policy implies a potential reduction in its effectiveness.”
Rather than avoiding risk entirely, households—and by extension, future investors—should consider strategically managing risk by identifying sectors that offer protection during volatile economic periods. This approach empowers investors to make informed decisions and confidently navigate economic uncertainty.