Building a good portfolio of long-term stock holdings takes a lot of work. With so many different stocks to choose from, a lot of investors just give up and buy funds that give them exposure to the entire market. While that may ensure that you'll never miss out on the hottest parts of the market, it also means that the benefits of owning stocks in hot sectors will get watered down by the rest of your portfolio.

There's no denying that diversification can serve a very useful purpose for investors, especially those whose tolerance for risk is on the more conservative side. But if you're willing to go beyond index funds and weed out more attractive industries from the rest of the crowd, then concentrating your investments on one or two particular sectors of the stock market can boost your returns substantially.

The easy way to concentrate
Luckily, drilling down on a particular sector has gotten a lot easier since exchange-traded funds became more popular. Nowadays, there's a sector fund for just about any possible division of the market you could ever dream of. In addition to the more vanilla sector designations, such as energy, consumer stocks, and industrials, you can find some extremely narrow and focused funds. Here are some examples:



Holdings Include

Claymore Airline ETF (FAA)

Airline stocks

Southwest Airlines (NYSE:LUV), Delta Airlines (NYSE:DAL)

Claymore/Robb Global Luxury (ROB)

Luxury consumer goods stocks

Coach (NYSE:COH), Wynn Resorts (NASDAQ:WYNN), Tiffany (NYSE:TIF)

FirstTrust US IPO Index (FPX)

Stocks with IPOs in recent years

Visa (NYSE:V), First Solar (NASDAQ:FSLR)

Source: Morningstar.

Of course, if you can't find an ETF that suits your tastes, you can always just build a portfolio concentration out of individual stocks. Which avenue you choose is really more a matter of personal preference than anything else.

So with a number of choices, you don't have to worry much about how you'll make a concentrated sector bet. The more important questions, though, are why you should concentrate and when a concentration makes the most sense.

Concentrate and make big profits
There are several reasons why concentrating on a particular sector can lead to a more profitable investment portfolio:

  • Most people have a competitive advantage in understanding a particular industry or market sector. Sometimes that advantage comes from job training or real-world experience. Other times, you'll just find yourself gravitating toward particular types of companies that interest you. Whatever the reason, if you find yourself with expert knowledge in a particular field, it can pay off in better stock research and picks.
  • Particular industries go in and out of favor, so it can make sense to focus on a certain stock market sector while it's in the limelight. For instance, energy and commodity stocks got a lot of exposure in mid-2008 as oil climbed to record highs and other commodities, such as grains and metals, followed suit. Yet the energy example also shows how important it is not to overstay your welcome: as quickly as a sector can hit the top, it can come crashing down as well.

To see a good example of the sector approach in action, you can take a look at the Fool's Rule Your Retirement summer series, "Macro Matters." In this week's installment, Fool investing expert Shannon Zimmerman takes a look at one particular sector that he sees as being jam-packed with bargain stocks that include several "dividend dynamos." The sector includes both big, well-known names as well as tinier companies that don't show up on many investors' radar screens.

Give it a shot
If you're happy with earning average returns, then concentrating more of your portfolio in particular sectors isn't something you have to do. But if you're willing, concentration can open up possibilities of outperforming the broad market -- and you can take steps to get it done while limiting the amount of extra risk you take on.

Read more on investing for the long haul:

If you're curious to see which sector is featured in the latest Macro Matters installment, just tune into our Rule Your Retirement service. It requires a subscription, but signing up for a free 30-day trial is easy and gets you full access. Just click here and get started today.

Fool contributor Dan Caplinger made a sector bet on international stocks earlier this decade and did well, but he hasn't always been so lucky. He doesn't own shares of the companies mentioned.

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