Quick: Name the hottest area of the market over the past 12 months.
If you said "energy," give yourself a pat on the back, and then pass Go and collect your $200. These days, you're probably going to need it to keep your fuel gauge closer to "F" than "E."
Contrarian's corner
But you know what? With gas prices in many parts of the country crossing the $3 mark and continuing their upward trajectory -- and with energy-industry titans like ExxonMobil (NYSE:XOM), BP (NYSE:BP), ConocoPhillips (NYSE:COP), and Schlumberger (NYSE:SLB) all putting up double-digit returns again so far this year -- now isn't the time to ramp up your exposure to the sector, at least not in a concentrated way.
Hot areas of the market, after all, have a habit of cooling off when investors finally decide that better bargains lie elsewhere. Just ask folks who took the tech plunge in early 2000. Ouch.
Now wait a minute
Yes, I realize there are big differences between the kinds of earnings-free tech companies that investors bid up back in those pre-millennium days and the buttoned-down energy concerns mentioned above. Each of those energy sector giants, in fact, sports a solid long-haul track record, not to mention boatloads of fat and happy shareholders who've hitched their portfolios to the energy wagon and come along for the joyride.
And yes, I also realize that the preceding sentence probably sets a record for mixed metaphors. The important point, however, is this: You're likely one of those lucky shareholders, too. Indeed, if you own an S&P 500 index fund, more than 9% of the money you have plunked down there is already invested in the energy sector. How much more than that do you really want -- or need?
If you can't answer that question by way of what Peter Lynch calls a "two-minute drill" and explain your investment case in straightforward terms, your best bet is to move on to your next idea.
Which just might be.
. a mutual fund that favors the energy industry but doesn't dive headlong into it. At least one such fund has made the cut for Motley Fool Champion Funds, the Fool newsletter service that I head up.
This fund -- which, like more than 80% of our recommendations, has handily outperformed the market since receiving the newsletter's nod -- had nearly 23% of its assets stuffed into energy names at the end of February.
That's a sizable figure, to be sure, and the fund has certainly benefited from the tailwind that allocation has whipped up. For the three years that ended with March, its annualized return of nearly 27% crushes the S&P and lands near the pinnacle of the fund's Morningstar peer group.
Thing is, though, the fund hasn't bet the farm on energy. Its portfolio includes roughly 70 names, and the likes of Merrill Lynch (NYSE:MER), Caterpillar (NYSE:CAT), and Countrywide Financial (NYSE:CFC) have all recently appeared among its holdings.
That broadly diversified orientation should help take the sting out of the energy sector's all-but-inevitable slowdown when it occurs.
Hit a gusher
If "playing" a sector while hedging your bets strikes you as a sensible approach, I encourage you to take a risk-free guest pass to Champion Funds. Your pass provides 30 days of access to our service, and as you'll see, the newsletter's, um, gusher of outperformance has come amid far less volatility than you'd experience with a portfolio of stocks alone -- energy or otherwise.
There's no obligation to subscribe, so go ahead: Click here to give it a spin.
Shannon Zimmerman runs point on the Fool's Champion Funds newsletter service and, at the time of publication, didn't own any of the securities mentioned above. You can check out the Fool's strict disclosure policy by clicking right here.
