Sector mutual funds are funds that allow you to invest in companies within a single sector. There are all kinds of sector funds available so all you have to do is pick one or more that piques your interest. Sector funds are an important addition to your portfolio to stay more diversified.

You can pick from hundreds of tech stocks or energy stocks as your sector. There are also subsectors within those sectors. Now do not let all this confuse you, a good broker who is worth their salt can keep things straight for you and explain any aspect that is confusing.

You haver been told that to be diversified in your portfolio is important but have you been told that if you invest in sector mutual funds and regular mutual funds there may be some overlap that could possibly increase your risk for loss. A good idea to minimize this chance is to combine an energy fund with a subsector fund like wind turbine energy.

Sector funds are also a good way to close any gaps you may have in your portfolio so you have all the bases covered. They can be used to capture growth in the area of choice. Just like when the stock market bottomed out a few years ago and the car companies stocks were very low. If you had a sector fund with car company stocks as the sector then you could have made a killing when the prices of the stocks started to rise.

Because they are so specific, sector funds are considered riskier and more volatile then regular mutual funds. You may want to limit the amount of sector funds just because of this. Every sector behaves differently at any time due to the ever changing economic indicators. Some sectors have been known to have higher highs and lower lows than some broad spectrum mutual funds and subsectors can be even more volatile. Sector funds have such a high turnover rate that you need to be tax conscious. The high turnover rate is an indicator that the fund buys and sells assets within the fund.

You need to keep in mind any and all tax implications of your very volatile sector funds. If you make some money and take it in payment then you will be taxed at the current capital gains tax rate which is about 15%. If you should lose money then of course you can deduct the loss as well.

You can also minimize your risk by considering sector spider funds or exchange traded funds. Both of these funds trade just like stock on the open stock market but offer the diversification of a sector fund. Spiders and ETFs have lower expense ratios and also have more investment options like short sales.

Always consult your financial advisor and get their advice on sector mutual funds. The two of you can go over your portfolio to see where there is lack and what type of sector fund is needed to fill any gaps in diversification and help with a suitable investment strategy to minimize your risk.