This article originally appeared in Dagen's personal finance newsletter, The Save Safe Plan. For information on this newsletter, click here.

Picking mutual funds would be a lot easier if they just came with short warning labels:

  • Fund is concentrated in a few ridiculously expensive sectors.

  • Portfolio could lose all your money in a matter of months.

  • Manager spends the bulk of his workday reading up on a rotisserie baseball team on RotoWorld.com .

    Understanding a fund's risks will never be quite that simple. But thankfully, it isn't too hard either. A recent issue of the Save Safe Plan (please see the April 4 issue ) covered how to tell if a fund is treacherous or tame. A fund's standard deviation, which measures the range of its performance around its average, is a single number that will give you a good indication of how wildly a fund's returns might swing. The higher the number, the more volatile the fund.

    You can also look at a fund's short-term performance. Its fluctuations over a week, month or quarter say something about how much risk the fund is taking or how concentrated it is. A look at the fund's top holdings and sector allocation will tell you if the manager is making big bets on just a few names or industries, a strategy can also be a recipe for risk.

    You can use these tests to see if funds you already own are too volatile. But you can also use them when picking funds. Here's a blueprint.

    Choosing Wisely

    Let's start by looking at no-load stock funds with expenses on the low side, and then rank those by standard deviation. The lower the standard deviation, the lower the volatility will be. But a standard deviation that's too low will also tell you something.

    You're hanging out in bond territory if a fund has a single-digit standard deviation. Bonds are much less volatile than stocks, because their future cash flows are a lot more secure. Standard deviations will reflect that.

    Frankly, if a stock fund has a standard deviation below 10, it probably has a lot of its money outside of the stock market. It probably owns some bonds or is sitting on a big chuck of cash. There's nothing wrong with that. But if you want to buy a stock fund, you want one that's largely invested in stocks.

    Now most stock funds will have standard deviations that range from, say, 13 to 20. Insanely risky -- if not awful -- funds can sport standard deviations north of 40. The ( ATCHX) Amerindo Technology fund is a good example. Its three-year standard deviation is 45. And the wild fluctuations in performance are quite obvious when looking at its chart and returns.

    What about low-volatility funds? The ( FCNTX) Fidelity Contrafund ranks as one of the least-volatile U.S. stock funds out there. Its standard deviation comes in under 11.

    This large-cap fund, managed by Will Danoff for almost 13 years, is enormous, at $28 billion in assets. It used to buy more small stocks, which tend to be riskier, but now it has most of its money invested in large to giant stocks. And you'll get more than 400 stocks with this portfolio -- not too far away from the S&P 500 index.

    This fund's industry weightings are another factor that has kept volatility to a minimum. In particular, manager Danoff has shied away from lots of technology stocks for more than two years. Yes, that's hurt performance over the past few months. But it also makes this fund more tolerable to own. Another bonus: Fidelity is waiving the fund's 3% front-end sales charge until June 30.

    If you're a fan of Fidelity, its $27 billion ( FGRIX) Growth and Income fund is another low-volatility option. Manager Steven Kaye has been at the helm for more than a decade. And he doesn't buy overpriced stocks, which can crater at the first sign of trouble, and he doesn't make outsize bets on individual sectors or stocks. The result has been a steady, reliable -- albeit large -- fund.

    The FMC Select fund is much smaller than those Fidelity giants. But it's attractive for the same reason: very little volatility. (The standard deviation is just 12.3.) It has less than $200 million in assets and a low expense ratio. The managers like stocks that are on the cheap side and concentrated on how much dividend yield a company delivers. Alas, some of this fund's stability comes from a small allocation to bonds -- about 17% at last look. And you'll have to cough up $10,000 to get in.
    In keeping with TSC's editorial policy, Dagen McDowell doesn't own or short individual stocks, nor does she invest in hedge funds or other private investment partnerships. Dagen welcomes your questions and comments, and invites you to send them to Dagen McDowell.

    Interested in more personal finance help from Dagen McDowell? Check out her newsletter, The Save Safe Plan. Click here for a free trial.