(MONEY Magazine) – Mutual funds that invest in small, fast-growing companies are nothing but trouble. Of all fund categories, small growth funds have plagued the greatest number of investors. Millions of people have bought them at high prices, then sold them a few years later for substantially less--the fastest possible path toward financial ruin, aside from burning $100 bills to light a crack pipe. Fortunately, small growth funds don't have to be a problem. As a matter of fact, they can be valuable additions to your portfolio. Just listen up.

Start by acknowledging that small growth mutual funds carry a dangerous appeal to your greed. Everybody knows that their securities are the most volatile stocks in existence, behind only those from developing markets like Latin America and Eastern Europe. And since, as the textbooks drone, risk goes hand in hand with reward, the logical conclusion is that small growth stocks will provide the highest returns over the long haul.

My guess is, you like the sound of that. Think again. When finance professors Eugene Fama and Kenneth French conducted their seminal research on the history of U.S. investment styles, they found to their surprise that small growth occupied the basement. Not only had it been the most volatile of the styles during the past 75 years--no surprise there--but it also was the worst performing. In the real world of funds, the same pattern prevails. For the past 15 years (through May 30), the average small growth fund lags the average fund in the large growth, large value and small value categories.

Worse, small growth funds tend to be purchased exactly when they are most overpriced, after a sustained period of impressive performance. During the past two decades, small growth funds have enjoyed three strong surges of fresh cash: in the early 1980s, in the early 1990s and then again in 1998-99. Each time, these giddy new buyers were promptly greeted by a market setback, including the spectacular recent Nasdaq tumble.

In light of the above evidence, I advocate overturning the conventional wisdom on small growth funds. Rather than buying and holding them for a couple of decades, trade them. Here's one good way to decide when you should get in and out of the category. If small growth has been the best performing of the "four corner" investment styles (small growth, small value, large growth, large value) over the previous five years, then avoid owning small growth funds altogether. If small growth has been the worst performer, pick up a fund. Finally, if the category's performance is in between, consider small growth funds, but tread lightly. Remember, the odds aren't with you.

When you do select a small-company fund, be careful that you don't choose one that has become too big. This is a common problem, since (naturally!) the funds with the top recent records tend to attact investor interest. But size kills. That's because small-company growth funds, more than any other kind of fund, benefit from active management. For one, they frequently "flip" initial public offerings--that is, they line up to receive an initial allotment of IPOs from an investment banker, then immediately sell these hot new issues to a less fortunate party. I don't condone the ethics of using one's market power to extract extra profits, but the strategy works.

Second, small growth stocks typically show price momentum, meaning that securities that are currently rising are likely to continue rising, and vice versa. Savvy fund managers with trading ability use this pattern to their advantage. But such strategies work only when you can move in and out of stocks quickly. If a fund has $5 billion in assets and the portfolio manager wants to own 100 securities, that means each position on average is $50 million. Have you ever traded a hot growth stock? If so, imagine doing it while accumulating a $50 million position. It's like maneuvering an elephant through a keyhole. So I seek small growth funds with modest asset bases. A useful cutoff is $500 million.

A final danger with small growth funds: They are, well, mutual funds. As a fund investor, you're not buying a bunch of companies that you have researched. You're putting your faith, somewhat blindly, in somebody else. There is no perfect protection from the possibility that your manager ends up having clay feet. You can't index, because unlike in almost every other investment arena, small growth indexes consistently trail the average small growth mutual fund. (The indexes don't flip IPOs and can't take advantage of the momentum effect.) But there is a way that you can protect yourself. Buy only small growth funds that invest in stocks with relatively moderate price/earnings ratios. My limit is 35. This way, if your manager does in fact err and fails to find the next Cisco or Juniper Networks, the fund won't completely collapse. Think of the P/E screen as your safety net.

So what would all my signals say? 1) Now is a pretty good time to buy because small growth has indeed been the worst-performing investment style over the trailing five years, and 2) there are some pretty good candidates. I searched for small growth funds that have finished in the top half of their category over the past five years, with assets of less than $500 million and P/E ratios of less than 30, and more than a dozen retail no-load funds appeared. On the larger side (right near the $500 million mark) are Baron Growth and Wasatch Small Cap Growth. If you wish to take more of a flier, consider Henlopen or Value Line Emerging Opportunties. All four funds have expense ratios of less than 1.5% a year as well. I think they're good bets in today's environment.