At first glance, growth stocks seem like the perfect asset for aggressive, long-term investors—high potential returns, long investment horizons, and exciting future prospects. But dig a little deeper, and the story becomes more complicated. One of the subtler—and more misunderstood—dimensions of investing is how different types of stocks respond to changes in discount rates and expected future cash flows. Growth and value stocks do not just differ in their characteristics and historical performance; they also behave differently under shifting economic and market conditions. These differences matter not only for asset pricing theorists but for real-world investors trying to build portfolios that suit their investment objectives, age, occupation, income, and goals.

In this post, we explore how and why growth stocks are more sensitive to changes in the discount rate, whereas value stocks are more exposed to changes in expected cash flows. We examine what this means for young versus older investors, and introduce the powerful distinction between good beta and bad beta, drawing on the research of John Y. Campbell, Luis Viceira, and Tuomo Vuolteenaho.

Discount Rates vs. Cash Flows: The Mechanics

Growth stocks, by definition, are priced for high expected future cash flows—often far out into the future. These companies reinvest heavily and are expected to deliver most of their value many years from now. This makes them long-duration assets, highly sensitive to changes in the discount rate—the rate at which future cash flows are brought back to present value.

When discount rates rise—whether due to higher interest rates, inflation expectations, or macro risk premia—those distant future cash flows become less valuable today. As a result, growth stocks tend to fall sharply.

By contrast, value stocks derive a greater proportion of their worth from near-term cash flows. These are often mature businesses with fewer growth prospects. A higher discount rate doesn’t hit them as hard, simply because there are fewer long-dated cash flows to discount.

But the trade-off is that value stocks are typically less nimble. A decline in expected cash flows—for example, due to a weakening economy or industry decline—can be difficult to offset. These firms don’t have a pipeline of new products or scalable projects ready to go. A hit to near-term fundamentals often sticks.

Growth stocks, in contrast, have more levers to pull: they can delay, accelerate, or pivot projects. Their value lies not just in their current earnings, but in the optionality of their future opportunities. As such, growth stocks are less affected by changes in expected cash flows, whilst value stocks are more exposed to this risk.

**Figure 2 from Campbell and Vuolteenaho (2004)**, showing the time-varying cash-flow and discount-rate betas of value and growth stocks.

Good Beta vs Bad Beta: Not All Risk Is Created Equal

In traditional finance, investors are taught that higher risk should come with higher return. But not all risk is equally painful. Campbell and Vuolteenaho (2004) introduce a vital distinction between ‘good beta’ and ‘bad beta’—a concept that sheds light on why value stocks can be both appealing and dangerous, depending on the investor.

Bad beta is risk that shows up when the economy is weak—when labour income, consumption, and employment are already under pressure. Stocks with bad beta tend to fall hardest during recessions but perform better in good economic times. This kind of risk is especially costly to investors because it shows up precisely when they are least able to bear it. Value stocks, it turns out, carry more of this bad beta.
Good beta, by contrast, is risk that emerges during good times—when the economy is strong and consumption is rising. Stocks with good beta may still be volatile, but they typically perform less well in good economic times but better in worse economic times. This makes them more tolerable for investors. Growth stocks generally exhibit more good beta, being more sensitive to interest rates and long-term expectations rather than to short-term economic conditions.

From a welfare perspective, bad beta is more dangerous—even if it offers a premium over time. That’s because it exacerbates already bad economic situations. And this becomes crucial in understanding who should own which assets.

In summary, value stocks are more sensitive to short-term economic conditions whilst being less sensitive to long-term expectations. Growth stocks are the opposite; they are less sensitive to short-term economic conditions whilst being more sensitive to long-term expectations.

John Y. Campbell’s View: Why Aggressive Investors Might Prefer Value

In a Rational Reminder podcast, economist John Y. Campbell offered a nuanced take on asset allocation for long-term investors:

‘The argument for aggressive long-term investors is actually you do want value. Why? Because by going away from growth, you preserve the value of your portfolio when discount rates go up… You want to have a portfolio that's valuable and available for reinvestment at those moments.’

The idea is simple but profound:

Growth stocks are more sensitive to rising discount rates.
Value stocks, being shorter duration, hold their value better when discount rates rise.
If you want to reinvest at moments when expected returns are high (often during downturns), your portfolio needs to have survived the fall.
Holding value stocks may help preserve capital when opportunities are most attractive.

Campbell turns the usual intuition on its head: long-term investors shouldn’t just hold growth and rebalance into value—they should already tilt towards value, because it drops less when expected returns spike. This protects capital for future deployment.

Reconciling the Risk: Welfare Costs vs Reinvestment Opportunity

At first glance, the distinction between good and bad beta might seem to contradict John Y. Campbell’s argument for favouring value stocks. If value stocks carry more ‘bad beta’—meaning they tend to fall hardest during recessions when investors are least able to bear losses—then why would long-term, aggressive investors want to hold them?

The key lies in recognising that these two perspectives assess risk through different lenses.

The ‘good beta vs bad beta’ framework, developed by Campbell and Vuolteenaho (2004), is grounded in consumption-based asset pricing. It focuses on how asset returns co-vary with macroeconomic shocks—particularly consumption and income. Value stocks exhibit more bad beta because their returns are closely tied to the economic cycle: they tend to suffer most when the economy is already under stress. From a welfare standpoint, this makes them riskier, even if they offer a return premium. Losses in bad times hurt more, not just financially but in terms of reduced consumption and well-being.

In contrast, John Y. Campbell’s more recent view—shared on the Rational Reminder podcast—comes from an intertemporal investment perspective. Here, the focus is on how an investor can preserve capital and reinvest when opportunities are most attractive, particularly when discount rates rise and expected returns improve. Growth stocks, with their longer duration and greater sensitivity to changes in interest rates, fall sharply when discount rates rise. Value stocks, being shorter duration, are less affected and therefore retain more of their value in these scenarios. This makes them attractive to long-term investors who want to maintain dry powder for reinvestment when the market resets.

These two frameworks are not in conflict—they simply highlight a trade-off between short-term pain and long-term gain. Value stocks may be more painful to hold during recessions (welfare risk), but they may also help investors stay invested and reinvest when it matters most (strategic risk management). Which perspective dominates depends on the investor’s time horizon, risk capacity, and goals.

Ultimately, consumption risk and discount rate sensitivity are two sides of the same coin. Understanding both is crucial to building a portfolio that fits your personal financial journey.

Young Investors: Growth as a Hedge Against Labour Risk

Young investors have one enormous asset: their human capital—the present value of future earnings. But how risky is that income stream?

If you’re a doctor or teacher, it’s relatively bond-like: stable and dependable.
But if you’re in finance, construction, or other cyclical fields, it behaves more like equity—it rises and falls with the economy.

This matters because value stocks also fall during economic downturns—the same periods when labour income is under threat. Holding value stocks whilst also having cyclical earnings introduces concentrated macroeconomic risk.

Growth stocks, on the other hand:

Are less sensitive to recessions and downturns.
Can therefore act as a hedge against cyclical income risk.

Campbell and Viceira (2002) stress that asset allocation should consider total wealth, not just financial wealth. For young investors with risky income, holding growth stocks may reduce overall risk—even if it looks aggressive on paper.

Older Investors: Time to Embrace Value

As investors age, financial capital overtakes human capital. Labour income becomes less relevant—especially in retirement. At this stage:

There’s no job to protect, so cyclical risk is less of a concern.
The portfolio must generate sustainable returns.
Value stocks, with higher long-term expected returns, become more appealing—despite their bad beta.

In fact, older investors can afford to take on more macro-sensitive assets, especially if paired with safe holdings like bonds or annuities. They may also benefit from rebalancing opportunities when discount rates are high—i.e. when value stocks have held up better than growth and capital can be redeployed.

Who Should Hold What?

The Big Picture: Lifecycle Beta Management

The distinction between good and bad beta is one of the most overlooked yet powerful tools in long-term investing:

Bad beta makes you poor when you’re already struggling. That’s what young investors with cyclical employment income should avoid.
Good beta may hurt returns during booms, but that’s a risk you can afford to take.

The best portfolios are not necessarily the most diversified by asset class—but by economic state. That is: how your wealth behaves across different macro-economic environments.

Final Thoughts

It’s a mistake to assume that young investors should always favour value stocks just because they have time on their side. Time horizon matters, but so does the nature of their income. Value stocks may offer higher returns, but they also tend to crash when investors can least afford it—when their jobs are at risk and economic uncertainty is highest.

Therefore, young investors with cyclical income should be cautious about concentrating too much in value stocks. Older investors, who no longer rely on labour income, may be better positioned to bear that risk—and earn the associated premium.

References

Campbell, John Y., and Tuomo Vuolteenaho. 2004. ‘Bad Beta, Good Beta.’ American Economic Review 94 (5): 1249–1275.

Campbell, John Y., and Luis M. Viceira. 2002. Strategic Asset Allocation: Portfolio Choice for Long-Term Investors. Oxford University Press.

Jagannathan, Ravi, John Y. Campbell, and Tuomo Vuolteenaho. 2001. ‘Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns.’ NBER Working Paper No. 8358.

Merton, Robert C. 1969. ‘Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case.’ The Review of Economics and Statistics 51 (3): 247–257.

Rational Reminder Podcast. 2023. ‘Prof. John Y. Campbell: Financial Decisions for Long-term Investors.’ Episode 250, April 27. https://rationalreminder.ca/podcast/250

Growth, Value, and the Long Game: Discount Rates, Cash Flows, and Who Should Own What