In the world of stock sectors, consumer discretionary is like the cool older brother of the more safety-inclined consumer staples. When consumer staples stays home, consumer discretionary hits up the clubs and never looks at the bill before paying. Still, not many people know much about the consumer discretionary sector and its extravagant ways. Check out the rest of the article below if you’re one of those people!
Consumer Discretionary and the Joneses
Consumer discretionary and consumer staples are two sides of the same sector coin. They both revolve around consumers, but in different ways. While consumer staples focus on necessities, consumer discretionary is all about the non-essentials. We’re talking fashion accessories, hotels, restaurants, smart phones, and leisurewear, just to name a few. Basically, if it’s not necessary for survival, it falls under consumer discretionary.
To keep it simple, think of the Joneses. You know, that family down the street who bought all the cool stuff your parents never bought for you. They always had that year’s car model, along with the boat that never seemed to leave the driveway. The Joneses had money (or at least acted like it), and wanted you to know it. They weren’t buying things they needed. No, they were buying things they wanted.
If it’s still not clear what kind of products consumer discretionary companies sell, pretend the economy is in a recession. Money is tight. You could lose your job any day. What do you still buy every week? Odds are, you’re still buying groceries, paying utility bills, and covering your mortgage. Stopping by McDonald’s every day? Probably not. Going on an expensive vacation? I doubt it. Remodeling your kitchen? Nope. Those aren’t necessities. Those are discretionary purchases.
Another Term: Consumer Cyclical
Another term for consumer discretionary is consumer cyclical. Can you guess why? Well, think about the example I just gave about being in a recession. Do you buy certain products during a recession when money is tight? Not usually. Therefore, companies that sell those products tend to perform poorly during recessions. But, when the economy is good, they perform quite well. As a result, consumer discretionary companies move cyclically with the economy. When the economy performs well, so do those economies. When the economy is struggling, so are those companies.
How Well Does the Consumer Discretionary Sector Perform?
As explained in the paragraph above, the consumer discretionary sector performs great, sometimes. Typically, if the economy is not in a recession, this sector is seeing some very healthy returns. In fact, during an economic boom, consumer discretionary will tend to outperform consumer staples.
For example, between 2009 and 2018, consumer discretionary earned an annualized return of over 19%. During this same time, consumer staples earned just over 12%. Consumer discretionary even performed better than the S&P 500, which only saw an annualized 14% during those same years. That being said, This sector has high volatility. People should always consider volatility when making investment decisions. Higher returns don’t matter if you can’t stomach the volatility long enough to see those returns.
But, since consumer discretionary is cyclical with the economy, it can see some serious drops during a recession. From January 2008 through January 2009, the consumer discretionary sector dropped nearly 42%. This drop is significant, considering consumer staples only fell half that at 21%. These kinds of up and down swings are why the consumer discretionary sector has such high volatility. It’s fun to ride on the up-swing, but a little terrifying on the down-swing.
How to Invest in Consumer Discretionary
So, let’s say you want to invest in the consumer discretionary sector. High volatility doesn’t bother you. You think the market is healthy and has nowhere to go but up. How would you do that? Well, you’ve got three options: mutual funds, ETFs, and by hand.
Mutual funds are the oldest way to invest in a specific sector. They allow you to invest in a company who invests in stocks on your behalf. One example is the Vanguard Consumer Discretionary Index Fund (VCDAX). This fund has a bunch of consumer discretionary stocks, and you just buy shares of the fund. That way, if the stock values go up, your share value goes up too. The same happens if they go down. Unfortunately, mutual funds often have high minimums you need to keep up. That’s where an ETF can rescue you.
ETFs are newer than mutual funds, and very popular today. While you have to buy mutual fund shares from the mutual fund, you can buy ETFs straight from the stock market. When you buy an ETF, you’re purchasing a tiny piece of many stocks. Vanguard’s consumer discretionary ETF has the stock symbol VCR. At the time of writing this, one share of VCR is $166. This is much lower than the VCDAX’s minimum of $100,000.
Finally, you can make a list of consumer discretionary companies and buy their stocks one at a time. This will take more work than purchasing mutual fund or ETF shares but could give you more options. For example, maybe you don’t like some companies inside a mutual fund or ETF. You could check the list of stocks and buy the stocks you like, ignoring the ones you don’t like. This is an actively managed approach instead of passively managed.
Right now, the top stocks in the VCR ETF are Amazon (AMZN), Home Depot (HD), McDonald’s (MCD), Nike (NKE), Booking Holdings (BKNG), Lowe’s (LOW), Starbucks (SBUX), TJX (TJX), Target (TGT), and General Motors (GM). In fact, these ten stocks represent over 50% of all shares in this ETF. So, if you really wanted, you could invest in these ten and see similar results to the ETF itself.
Consumer discretionary stocks are for companies selling non-essential products. Examples include home improvement stores, restaurants, hotels, and sportswear stores. Another name for this sector is consumer cyclical, because the sector goes up and down with the economy. These companies do well during periods of economic growth and perform poorly during recessions. Stock prices in this sector are very volatile, but the annualized returns tend to outperform other sectors over enough time. Investors can add this sector to their portfolio through mutual funds, ETFs, or buying specific stocks in this sector.
What do you think of the consumer discretionary sector? Do you invest in these types of companies? Are the extra gains worth the extra risk? Let me know in the comments below!