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How to Pick a Solid Sector Fund

A seven-point checklist for making money in a treacherous arena.

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Investing in sector funds seems deceptively easy, but history has shown that investors usually make a mess of things. Many sector fund investors have lousy timing, and their choice of funds isn't all that great, either.

To understand why, it helps to begin by considering the motivations of fund companies in offering sector funds and of investors in buying them. All too often, the common denominator is greed rather than a convergence of long-term profit maximizing by the two parties.

On the one hand you have investors who read about all the good things going on in an industry. They see business is booming and long-term macro trends are supporting that growth so that it looks like the trend could last a long time. At about the same time, stocks and funds focused on that industry are putting up big returns. This triggers envy because investors wish they had been there and greed because they figure they can get rich, too, by hopping on the bandwagon. In fact, the longer a trend goes on, the greater the inflows into a sector's funds becomes.

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Russel Kinnel does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.