Sector Funds:Investing Deep and Narrow

Question of the week:I've noticed in the mutual fund rankings that some technology funds have done extremely well over the last three months--way better than the market overall. Why not just put all my money in them? If they go down, then I can just switch to whatever is doing best at that time. --Max L. Dear Max, Be careful here. What you're talking about is chasing performance, one of the classic traps that many mutual fund investors fall into. Sector funds--mutual funds that specialize in one industry, like the technology funds you mentioned--will always tend to lead the performance charts. This obviously makes them very tempting for many investors. The problem is that sector funds can also be found at the bottom of the performance rankings. By the time you buy into last quarter's hottest sector, the market could have a new favorite sector and you may find your own funds in the basement. So you really need to look at much more than just performance when deciding if a sector fund is right for you. When we asked Armchair Millionaire community members about how they choose their funds, we found that most people look at a broad range of factors. This comment from Jeremy is typical: A mutual fund laundry list. "I first look for funds from well-established mutual funds companies with long track records of success. Next I look at the expense ratio. Also, the turnover in a fund is very important to me. Finally, I want to own a fund with competent managers who have been with that fund company and particularly that fund for a substantial amount of time and who done well against their appropriate benchmark." As long as you evaluate them carefully on their merits--and that means much more than just recent performance--sector funds can have a place in a common sense portfolio. If you choose to dive into these specialty funds, my guide will get you started. The Armchair Millionaire Guide to Sector Funds How to use them. Sector funds are useful for increasing your position in a particular industry, especially if you don't want to buy individual stocks in that industry. As always, however, you don't want to go overboard and reduce the diversification of your overall portfolio. For this reason, I recommend that no more than 10 percent of your portfolio be in sector funds. What's available. Sector funds span the entire breadth of the economy. For example, there are funds in the financial services, health care, real estate, and consumer services industries, to name but a few. Some funds may specialize even more deeply. A technology fund, for instance, might invest only in wireless services and products. How to buy them. The volatility of sector funds means you should pay special attention to how you buy them. You can even out this volatility and avoid the temptation to time the sector by making your fund purchases with monthly dollar cost averaging. What to watch out for. Sector funds tend to have some of the highest expenses in the mutual fund industry. Since these expenses come directly out of your returns, it pays to shop around for funds with lower expenses. Check the prospectus of any fund you're considering to find out its expense ratio. THE BOTTOM LINE: The beauty of mutual funds is the broad diversification they deliver to your portfolio. Because sector funds go deep and narrow, the concentration they offer has to be taken into consideration along with the rest of your portfolio. So make sure to consider sector funds as a part of your overall strategy and not the whole strategy itself .

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