Sector Funds

Sector funds are mutual funds that invest only in one particular industry or sector of the economy. Examples of these sectors include technology, financial services and precious metals.

If you're thinking about investing in sector funds you should realize that, while they can produce great returns, because of their risk that can also produce just the opposite. A sector fund performs only as well as the industry it is invested in.

Technology funds are a good example of a sector that was producing extraordinary returns for a period of time, only to end up plummeting a couple of years later. Investors that chose to put their money into these technology funds over the long haul saw their gains disappear.

In addition, many of the sectors that produce the biggest returns also carry the biggest risks, as they typically represent the most volatile businesses. For example, precious metals such as gold often offer high short-term returns, but the returns fluctuate greatly over the long term.

Lack of diversification. The greatest risk inherent in sector funds is lack of diversification. A sector fund may invest in several different companies, but all the companies will be in the same line of business. Therefore, while it is possible for some companies to do better than others, the performance of the fund tends to go up and down based on how the industry is doing as whole.

Keep in mind that to invest in sector funds you should have a high-risk tolerance based both on the age and stage of your life and your investing personality. And no matter where you are on the risk meter of investing, you should always invest in other less risky investment vehicles to diversify your holdings.