SECTOR FUNDS do what their name implies: They restrict investments to a particular segment -- or sector -- of the economy. A fund like Northern Technology, for instance, only buys tech companies for its portfolio. Munder NetNet cuts it even finer by holding only Internet-related stocks. Fidelity has a whole stable of sector funds from Fidelity Select Insurance to Fidelity Select Automotive. The idea is to allow investors to place bets on specific industries or sectors whenever they think that industry might heat up.

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 your 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 representation of stocks.

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Of course, such concentrated portfolios can produce tremendous gains or losses, depending on whether your chosen sector is in or out of favor. In 1998, for instance, Northern Technology soared 83% because Internet and computer companies were hot. Precious-metals specialist Scudder Gold, meanwhile, plummeted 16.7% because gold and silver plunged.

Because of this specialization, any sector fund carries more risk than a generalized fund. But some sectors are clearly more volatile than others. For example, Vanguard Utilities, which invests in staid electrical companies, has about one-third the volatility of Merrill Technology, which buys supercharged software makers.