(FORTUNE Magazine) – This year, beginning in our annual summer Retirement Guide and continuing in this year-end investment issue, we've introduced into our list of best mutual funds a statistical measure called "standard deviation." Even if you are only a casual follower of mutual funds, chances are you've heard of it, since standard deviation, which in this case gauges a fund's volatility, has become an increasingly popular yardstick of risk.

Simply put, standard deviation tells you how much a fund's short-term results vary from its long-term average; the higher the standard deviation, the more the fund's results jump around. If investing is like a roller-coaster ride--and that's as good as any analogy--then standard deviation tells you what to expect in the way of dips and rolls. It tells you how scared you'll be.

But that's not the only reason we've included it in our list, right alongside such information as past performance, fees, and the name of the fund manager. The fact is, standard deviation can be an important tool for investors--one that can offer some insight not only into how risky a fund is but even into how it might perform in a given market environment in the future.

That, at least, is what Morningstar found in a 1994 study that used standard deviation to examine risk and returns in successive five-year tranches. The study showed that a fund's past standard deviation was a very reliable indicator of its future standard deviation. The study also found that the higher the fund's standard deviation between 1984 and 1988--that is, the riskier the fund--the higher its return over the next five years. But all of this occurred within the context of the bull market, causing the study's author, John Rekenthaler, to note: "More risk doesn't always equal more returns--in a bear market just the opposite is true--but in one form or another, a discernible relationship between past risk and future returns usually appears. The same cannot be said of [past and future] returns."

How can standard deviation offer a clearer window into future performance than a fund's past performance can? Well, for one thing, as has long been known, you can't judge a fund solely on how it has performed in the past--which is why the SEC insists on that stilted disclaimer we've come to know so well: PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RETURNS. A fund at the top of the heap can quite often be there because the manager took outsized risks that paid off--and those same outsized risks could cause the fund to come crashing down the next year. And particular investment styles are not always in sync with market conditions. When, say, growth stocks slump--as they must from time to time--even the best growth fund managers are going to suffer. Yes, there are fund managers who manage to top the charts year after year. But they are rare.

Risk and volatility, however, are things a fund manager can control no matter what the investment climate. Especially in recent years, controlling risk has become an ever bigger part of what defines fund strategy. That's why, by and large, a manager's risk strategies--and hence the volatility of his fund--don't change from year to year.

This is a particularly important thing to keep in mind now, some 15 years into the bull market. During that time, many investors have largely forgotten about risk--and who can blame them? No matter what the experts say, it's easy to scoff at risk when the S&P 500 is rising at a rate of 20% and 30% a year. But someday--who knows when?--that's not going to be the case, and people will learn anew that investing is inherently risky. Sooner or later, you will lose money in the market--and not just for a few hours or a couple of days, as was the case this past October. And while you may think you have the stomach to swallow big losses, history suggests you don't. "Immediately following periods of serious market decline, mutual fund investors have become net redeemers," says David Katzen, who manages Zweig's domestic stock funds. "That's happened during every major bear market decline since they've been keeping statistics on this stuff. There are very few things that have occurred frequently in market history without exception. This is one of them." Can paying close attention to a fund's standard deviation help soften the blow--or at least help you prepare for it? In a word, yes.

Standard deviation is not, of course, the only measure of risk out there. Beta is another measure--it tracks how closely a fund hews to the broader market. A stock fund with a beta above 1 is likely to be more volatile than the S&P 500; below 1, less volatile. The problem with beta is that it only tells you how risky the fund was in comparison with a market index. If the index doesn't really apply to the fund, then beta can be terribly misleading. The classic examples are precious-metals funds, which have a beta of just 0.47--but that's in relation to the S&P 500. Yet metals funds mainly follow the price of gold and other commodities, not the stock market. So, low as their beta is, they still crash and burn with some regularity.

The beauty of standard deviation is that it's an absolute number. It has nothing to do with any index or benchmark. It therefore allows for perfectly valid volatility comparisons among funds and across asset classes. It can tell you, for example, that a corporate bond fund with a standard deviation of 10.8 (Smith Barney Investment Grade Bond B on our list) is more volatile than a high-yield bond fund with a standard deviation of 4.9 (Value Line Aggressive Income) and less volatile than a global stock fund with a standard deviation of 20.7 (GAM Global A). That's useful information. Knowing that, you can begin to make rational decisions about how much risk you're willing to accept for the returns you're trying to get.

The father of standard deviation is an obscure 18th-century mathematician named Abraham de Moivre. In Against the Gods: The Remarkable Story of Risk, author Peter Bernstein describes de Moivre as a "bitter, introspective, antisocial man" who died "blind and poverty-stricken." Unlike his friend Isaac Newton, who had a cushy academic post, de Moivre survived on fees from private math lessons. Afternoons, he retired to Slaughter's Coffee House in London's St. Martin's Lane, where he sold advice to gamblers and insurance brokers--people with a keen practical interest in weighing probability and risk.

De Moivre's calculations would be what we now call sampling or polling. The example he would have been most familiar with involves a jar containing thousands of pebbles--some black, some white. Short of counting every pebble, what's the best way to discover the true ratio of black to white? De Moivre showed that a series of random samplings very soon produced results that clustered themselves elegantly about the average, in a shape that resembles a bell (hence the bell curve).

We're not going to dive too deeply into the math here. Suffice it to say that, for our purposes, standard deviation defines a band within which a fund's total returns tend to fall. The higher the standard deviation, the wider the band. Take, for example, PBHG Growth--the top-performing fund on our list, with a five-year average annual adjusted return of 24.8%. The only problem is, to stick it out for the full five years, you would have enjoyed stretches when the fund performed brilliantly--up 50% or more in the space of 12 months--while enduring other stretches, just as long, when it has lost money for investors. (Indeed, over the past 12 months the fund is down 4.2%.) The bone-jarring nature of the ride that PBHG delivered is captured in the fund's dizzyingly high standard deviation of 29.0.

PBHG's standard deviation is derived by annualizing the fund's monthly returns over the past five years and comparing those numbers with its annualized average monthly return over the whole period. A standard deviation of 29.0 tells you that PBHG's performance was so uneven that the normal spread of monthly returns (that is, the band within which about two-thirds of them fell) ranged from 29.0 percentage points above--and below--the five-year average.

As a potential investor in PBHG Growth, it's that yawning range--at least as much as the average annual total return--that you need to pay attention to. You must ask yourself, as Catherine Voss Sanders, publisher of Morningstar Investor, puts it, "Is that the kind of variability I'm willing to deal with?"

But there's another question too: in order to have even a chance at that nearly 25% gain PBHG has delivered over the past five years, do you have to accept its extraordinarily high risk? Plainly, that's the theory--that investors willing to risk big losses are also the most likely to reap big gains. Fund manager Gary Pilgrim, as an avowed momentum investor, embraces risk. He looks for fast-rising earnings growth--finding it most often in skittish high-tech companies. He makes no apologies for the volatility of his fund. "What an investor has to figure out," Pilgrim argues, "is how hard does he want to try for higher returns?"

But examining our tables to compare the standard deviations of funds with similar returns suggests an appealing alternative: that over the long haul, some tortoises have been skillful enough to keep pace with the hares. Look at Legg Mason Value Trust, for example. With an average annual total return of 24.4%, it was the second-best-performing fund on our list, finishing just behind PBHG Growth. Over the past five years, both funds carried their shareholders to roughly the same happy place. Still, what a difference! Legg Mason Value Trust has a standard deviation of just 16.9--which means that its ride has been a whole lot smoother (see chart).

Legg Mason Value Trust fund manager Bill Miller has outperformed the S&P 500 for six straight calendar years (barring a blowup, he'll make it seven this year), in part by keeping a close eye on variables that affect standard deviation. Miller favors a value approach (his P/E is a modest 20, half Pilgrim's 40), takes on risk sparingly, and uses the whole portfolio to offset a handful of volatile selections. "For example, the computer storage stocks," says Miller. "They're getting crushed right now, but we happen to like them a lot. We know they're going to add volatility to the portfolio, and we don't want to do a lot of that. So we'll look around and see if there's a way to dampen that with something that may be correlated in a different way."

Will Legg Mason Value Trust ever zoom up without warning, the way Pilgrim's fund has? It's possible--but pretty unlikely. But will it stall suddenly and crash? Again, it might--after all, anything's possible--but it's much less likely to do so than PBHG Growth.

Is that important to you? It is if you're not sure how much volatility you can handle--especially if you happen to believe, as Miller does, that the stock market is entering a "new era." Not the "new era" of the optimists, which coincides with the longest-running bull market in history. "We think that's over," says Miller. "We're seeing it right now. The new era now is more volatility." And more reason to pay close attention to standard deviation.