We all have necessary expenses, like food and shelter. And then there are the things you don’t necessarily need, but that you buy anyway to make your life better or more enjoyable.
Those purchases might include a new car or dishwasher, the latest pair of kicks from your favorite sneaker store, or maybe an exotic trip. These are non-essential goods, services, or experiences that you may buy, more because you want them than need them.
When you spend money on these things, you’re supporting something called the consumer discretionary sector of the economy.
What’s consumer discretionary spending all about?
Consumer discretionary spending, also called consumer cyclical spending, refers to spending on non-essential items, and it depends on economic cycles. When the economy is in good shape, more people are generally working, wages tend to rise, and more money flows through the economy. As a result, people tend to spend more on discretionary items.
In contrast, when times are tough and the economy slows or is contracting, people will reduce their spending on discretionary items, while they continue spending on the stuff they need, such as groceries, toilet paper, and toothpaste.
Consumer discretionary purchases are frequently for bigger-ticket items, such as motorboats, jewelry, home appliances or a hard-earned vacation. That’s one reason they’re thought of as discretionary—because they require more excess cash.
But just as often, they can be for retail purchases, such as movie tickets, hotel stays, or eating at restaurants, among other things.
Some examples of companies operating in the consumer discretionary sector include:
- Dunkin’ Brands, producer of donuts and coffee drinks.
- Ford and GM, the car manufacturers.
- Expedia, the online travel purveyor.
- MGM Resorts and Hilton, the destination resort and hotel chains.
- Home Depot, the home improvement retailer.
The consumer economy
Consumer spending is a driving force behind the economy, accounting for about 70% of all economic activity in the U.S. But there isn’t just one type of consumer spending.
In addition to the consumer discretionary sector, for example, there’s also the consumer staples sector, which produces products like toothpaste, baby diapers, and canned food that you may use every day or every week. Big companies such as Johnson & Johnson and Procter & Gamble dominate the industry producing consumer staples. Their stocks are often known as “defensive stocks,” because people purchase these products no matter the economic environment. Hence, these stocks can provide investors shelter when the economy encounters difficulties, such as a slowdown or a recession.
How consumer discretionary stocks can help diversify your portfolio
When you build your investment portfolio, it’s important to diversify. Diversification means that you’re not putting all your eggs in one basket, by investing only in stocks, or stocks in one sector, for example. Consumer discretionary stocks can help you diversify the stock portion of your portfolio.
When you’re thinking about your portfolio, however, it’s important to keep in mind that each person’s situation is different, and there is no one way to diversify your holdings. A proper diversification strategy should be tailored to your own situation.
Good to know: A recent change in the way companies are sorted into sectors has made the consumer discretionary sector a bit smaller, as names like streaming content provider Netflix and cable company Comcast have been routed into a new sector called communications.
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1As of January 31, 2018.