Discretion is the better part of luxury.
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You have material needs in lifeâand also desires and wants. Companies in the consumer discretionary sector of the stock market make products that you may intensely covet but not need. For that reason, companies that offer goods and services subject to discretionary spending can (and do) see dramatic changes in demand, unlike the consumer staples sector.
Investing in the consumer discretionary sector involves some risk, mostly because these companies often see their fortunes wax and wane with the movement of interest rates and the health of the overall economy. But the sector also offers pockets of attractively valued stocks.
Key Points
- Consumer discretionary goods and services arenât necessary for human survival.
- Demand for consumer discretionary products is highly elastic, meaning itâs easily affected by changes in price or in consumersâ ability to spend.
- Various industries are classified as consumer discretionary.
What is the consumer discretionary sector?
Consumer discretionary is one of the 11 sectors defined by the Global Industry Classification Standard (GICS). Companies in this sector provide goods and services that arenât strictly essential: hotels, restaurants, cars, specialty retail, and leisure products are all classified as consumer discretionary.
The diversity of industries defined by GICS as part of the consumer discretionary sector is striking.
- Auto components: Producers of auto parts and equipment, including tires
- Automobiles: Manufacturers of cars, trucks, sport utility vehicles (SUVs), and motorcycles
- Household durable goods: Providers of consumer electronics, home furnishings, building supplies, appliances, and housewares
- Leisure products: Makers of products such as sports equipment and musical instruments
- Textiles, apparel, and luxury goods: Sellers of clothing, accessories, footwear, luxury goods, and fabrics
- Hotels, restaurants, and leisure establishments: Places such as casinos, resorts, cruise ships, leisure destinations, restaurants, and hotels
- Diversified consumer services: Providers of education services, like tutoring, and specialized consumer services, such as wedding planning or pet care
- Distributors: Businesses that help to get consumer discretionary products out to market
- Internet and direct marketing retail: Companies specializing in e-commerce, direct-to-consumer products, and digital- and subscription-based services
- Multiline retail: Operators of general merchandise and department stores
- Specialty retail: Companies that run a variety of stores, including clothing, electronics, home improvement, retail automotive, and other specialty shops
BNPL allows you to pay off purchases in installments over time, but there are risks to watch out for.
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Key sector characteristics of consumer discretionary
Each of the 11 GICS sectors features characteristics unique to the group of stocks represented. Consumer discretionary is no different. Its core traits include:
- Nonessential goods. The products and services consumer discretionary companies offer are nonessential or luxury items. High-end fashion, entertainment, and dining out are all enjoyable parts of life, but not strictly necessary purchases.
- Diverse industries. Online and offline retail shopping, cars, household goods, clothing, hospitality, media, and many other industries are part of the consumer discretionary sector.
- Elastic demand. Elastic or changing demand makes the performance of the consumer discretionary sector cyclicalâit fluctuates in correlation with economic cycles. Demand for consumer discretionary products is elastic because these goods (and services) are nonessential.
- Sensitive to economic indicators. The performance of a consumer discretionary company is generally sensitive to economic signals. Negative economic indicators can cause consumers to rein in their spending, impacting earnings for businesses that make nice-to-have products.
- Dependent on discretionary spending. Discretionary purchases are only possible if consumers have discretionary income. Consumer discretionary companies thrive most in places and times when consumers have extra income.
- Sensitive to interest rates. Many consumer discretionary companies extend credit to consumers, making them sensitive to changes in interest rates. A rise in rates increases financing costs and can reduce consumer spending.
- High marketing and advertising expenses. You may need to be enticed into spending on nonessential items, which is why top-notch marketing is critical for many consumer discretionary companies to ensure sales.
Some discretionary spending is seasonal
You probably arenât buying a snowboard in the middle of summer or shorts at the height of winter. Another quality shared by many consumer discretionary companies is the seasonality of the goods their customers demand.
Leading consumer discretionary companies
Their products may be largely nonessential, but many consumer discretionary companies are household names. This sampling of companies in the sector includes several familiar names.*
- Amazon.com Inc. (AMZN): The major online retailer Amazon is the quintessential consumer discretionary company because it offers a vast array of nonessential goods and services. Electronics, apparel, home goods, toys, and luxury items are just some of what you can buy on Amazonâwhich also provides subscription services, including Amazon Prime Video, Audible, and Kindle Unlimited.
- Booking Holdings, Inc. (BKNG): You may know this company for Booking.com, the travel website that lets you book your next flight, car rental, hotel, and more. Taking a vacation is perhaps the most iconic example of discretionary spending, even though many consumers would feel that getting away at least once in a while is pretty necessary. Other Booking brands include Priceline, KAYAK, Cheapflights, and OpenTable.
- General Motors Company (GM): You may argue that a car is essentialâbut automotive companies are grouped in the consumer discretionary sector. General Motors, whose brands include Chevrolet, GMC, Cadillac, and Buick, is among the largest vehicle manufacturers in the world.
- The Home Depot, Inc. (HD): Products that you purchase at Home Depot can help you improve your home, but they may not be strictly necessary, which is why Home Depot and other home improvement retailers are categorized as consumer discretionary. Power tools, appliances, gardening supplies, furniture, lighting, and decorative items are just some of what youâll find.
- McDonaldâs Corporation (MCD): Largely credited with developing the concept of fast food, McDonaldâs makes getting a bite to eat quick and convenient. But like dining at any restaurant, itâs not considered essential (in contrast to items purchased at a grocery store).
- Nike, Inc. (NKE): Nike is the iconic company that sells a variety of athletic and lifestyle products that are not required for basic living but enhance many consumersâ lifestyles. High-performance footwear, clothing, and fitness equipment may all help with pursuing your favorite hobbies.
- Starbucks Corporation (SBUX): Most famous for serving coffee made to customersâ tastes, Starbucksâ food and beverages are considered nonessential luxuries, as are its popular branded merchandise and coffee-related accessories.
- Target Corporation (TGT): As a mass retailer, Target sells essential goods, but it also offers a variety of nonessentials, including fashion apparel, home decor, electronics, toys, and seasonal items.
- The TJX Companies, Inc. (TJX): If youâve ever shopped at T.J. Maxx, Marshalls, or HomeGoods, youâre already familiar with this company. Its offerings appeal to consumers looking for value. Still, as discounted as they may be, the purchases are considered discretionary spending.
Investing in the consumer discretionary sector
If youâre looking to add stocks of companies in the consumer discretionary sector to your portfolio, it pays to do your research. Start by creating a short list based on your interests, then analyze financial statements and other relevant fundamental factors. When it comes to ways to invest, you have several options:
- Buy stock. Let your research guide you to individual stock picks, some of which may pay dividends.
- Invest in bonds. Some consumer discretionary companies issue bonds, which provide more stability than stocks and provide income.
- Buy shares in an ETF. If youâd rather get exposure to a bundle of consumer discretionary companies, then buying shares in an exchange-traded fund (ETF) is a viable option. Funds like the Vanguard Consumer Discretionary Index Fund ETF (VCR) or Fidelity MSCI Consumer Discretionary Index ETF (FDIS) provide targeted sector exposure.
- Invest in mutual funds. If youâd prefer to invest in a fund thatâs actively managed, then a mutual fund focused on consumer discretionary may be an attractive option, such as the Fidelity Select Consumer Discretionary Portfolio (FSCPX) or Rydex Leisure Fund (RYLSX).
Stocks provide the most targeted exposure, but also pose some risk. Bonds may be the most conservative investment approach. Fundsâboth ETFs and mutual fundsâoffer the most diversification, but also charge fees. And if youâre looking for an active manager, then your fund selection is more limited.
Making informed and responsible investment decisions requires due diligence, so donât skimp on your research.
The economic sensitivity of consumer discretionary companies canât be overstated. Thatâs because these purchases arenât necessary, so theyâre at the mercy of consumersâ whims. Traveling, buying cars, dining out, shopping for new clothes, and participating in leisure activities are some of the best parts of life, but they can be skipped if you simply donât have the money. When the economy is booming and many consumers feel flush with cash, thatâs when discretionary spending is likely to be at its highest, and when most of these companies are typically logging some handsome profits.
*Specific companies and funds are mentioned for educational purposes only and not as an endorsement. The lists in this article are representative and not intended to be comprehensive.
This article was most recently revised and updated by Allie Grace GarnettThis article was most recently revised and updated by David Schepp
