When the economy is booming, consumers often splurge on non-essential items like new furniture, fine dining, vacations, and more. As a result, the companies providing these services benefit from people’s eagerness to spend beyond the basics. Wall Street analysts refer to such businesses as consumer discretionary.
They are discretionary because consumers don’t need a vacation to Bora Bora, for example. Instead, they want to experience something meaningful, and they have the money for it. So as consumers open their wallets, many retail investors start buying the public companies that could benefit the most.
But like any other type of investment, it can be challenging to pick winners in the space. Alternatively, investors hedge their bets and look for exchange-traded funds or ETFs. These popular investments allow you to buy a basket of stocks in any sector of your choice, including consumer discretionary stocks.
This beginner’s guide outlines some of the most popular ones.
What industries are in the consumer discretionary sector?
There are multiple industries under the consumer discretionary sector. These industries are essential for investors because they paint a picture of consumer spending.
For instance, consider the global pandemic when people were not traveling. Yet, they spent on big-ticket items like home renovations. With the increase in demand, many consumer discretionary stocks like Home Depot (HD) and Lowe’s (LOW) rose in value.
Similarly, now that the pandemic appears to have eased, more people feel comfortable experiencing indoor dining, heading to the opera, or traveling internationally, which brings us to the first industry in the group:
Hotels, restaurants, and leisure
From sit-down restaurants like Texas Roadhouse (TXRH) to hotel operators such as Hilton (HLT), these brands have a tight grip on consumer spending. They include cruise operators, resorts and casinos, and many others.
Internet and catalog retail
With increased accessibility to mobile devices, faster internet, and quick shipping, demand for online shopping has significantly grown. Some of the companies in this group include Etsy (ETSY), Chewy (CHWY), and 1-800-Flowers.com (FLWS).
Textiles, apparel, and luxury goods
This industry includes makers of specialty items such as designer clothing, fine jewelry, and luxury furnishings. Ralph Lauren (RL), Signet Jewelers (SIG), and Restoration Hardware (RH) are some examples.
Diversified consumer services
Companies in this industry provide legal or tax counsel, interior design services, specialized education and auctions, among other offerings. Examples include eBay (EBAY), Expedia (EXPE), and H&R Block (HRB).
Other industries within the consumer discretionary sector are household goods, leisure products, and multiline retail. While picking winning stocks can be challenging, there’s a potential for excellent returns over time.
The case for diversification through ETFs
ETFs provide a low-cost option for investors to diversify and access a wide range of investment themes, including consumer discretionary stocks. Through ETFs, investors leave the responsibility of choosing stocks to a professional asset manager.
There are two options for how fund managers select securities within the ETF sphere — passive and actively managed funds. In a passively managed ETF, a fund manager buys a basket of consumer discretionary companies with a broad index. Alternatively, fund managers can buy or sell stocks in a sector at their discretion with actively managed funds.
Of course, both options come with a fee, but it’s often minimal compared to the work involved. And the key is that investors remain diversified, potentially mitigating the volatility that comes with owning individual stocks. Plus, as economic factors change, such as a sudden spike in unemployment, active fund managers can tilt their holdings to take advantage of buy and sell opportunities.
Some examples of ETFs in the consumer discretionary space include:
Consumer Discretionary Select Sector SPDR® Fund (XLY)
XLY tracks an index of consumer discretionary stocks in the S&P 500. The fund has about $19 billion in assets under management and an expense ratio of 0.10 percent. Some of its top holdings include Tesla (TSLA), Nike (NKE), and Starbucks (SBUX).
Vanguard Consumer Discretionary ETF (VCR)
VCR provides exposure to a basket of about 300 companies in the consumer discretionary sector, excluding media and entertainment companies. This fund has about $6 billion in assets under management and has an expense ratio of 0.10 percent. Among its top holdings are Amazon (AMZN), Target (TGT), and McDonald’s (MCD).
ProShares Pet Care ETF (PAWZ)
ProShares has created an ETF that tracks global public companies delivering pet food, veterinary services, and other products for pet parents. The fund has about $230 million in assets under management and charges a management fee of 0.50 percent. Some of its biggest holdings include Freshpet (FRPT), Trupanion (TRUP), and Petco Health and Wellness (WOOF).
Retail investors have access to a plethora of ETFs through most online brokers.
Consumer discretionary vs. consumer staples: How they differ
Consumer discretionary stocks tend to perform well during economic expansions, making them attractive to investors who foresee an uptick in spending. However, these companies can be more sensitive to changes in the economy, especially if people hold back or postpone unnecessary purchases.
Conversely, consumer staples stocks can be more resilient to changes in the business cycle since they provide essential items like food and beverages. Companies like Procter & Gamble (PG), Coca-Cola (KO), and Hershey (HSY) belong to this group.
Investors often turn their attention to consumer confidence when deciding between these two sectors. This crucial economic indicator, tracked by the University of Michigan’s consumer sentiment index, closely monitors consumer spending habits and optimism about the economy. Combined with metrics like the unemployment rate and inflation, they help predict consumers’ willingness to spend.
As the pandemic slows, many consumers are itching to spend. The key is to monitor this spending behavior closely, particularly if geopolitical factors or higher inflation throws a wrench on the trend.
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Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.