SECTOR FUNDS do what their name implies: They restrict their investments to a particular segment or sector of the economy. No matter which sector you're interested in investing in, chances are there's a fund that tracks it. Fund companies create these to allow investors to place bets on specific industries or sectors whenever they think that industry might heat up. (Exchange-traded funds also can invest in certain sectors.)

While such a strategy might appear to throw diversification to the wind, it doesn't entirely. It's true that investing in a sector fund definitely focuses exposure on a certain industry. But it can give you diversification within that industry that would be hard to achieve on your own. How? By spreading your investment across a broad swath of stocks.

Such concentrated portfolios can produce tremendous gains or losses, depending on whether your chosen sector is in or out of favor. At any given period, tech stocks, healthcare stocks or energy stocks may light up the charts and then fizzle.

As you'd expect, sector funds carry more risk than generalized funds. That's why we suggest that you don't invest more than 5% of your total portfolio in a specific sector. But some sectors are clearly more volatile than others. For example, funds focused on utilities, which are generally income-producing stocks, have significantly less volatility than funds that specialize in biotechnology stocks.

The lesson here? Sector funds are a great way to spice up a portfolio. But like Tabasco sauce, a little goes a long way.