(FORTUNE Magazine) – TO THE DUTIFUL husbanders of wealth who scrimped in years past to help their capital appreciate and now want their capital to help them appreciate life, the fixed-income market seems downright rude. Income from bank CDs dawdles behind inflation even before taking the new higher tax rates into account. Interest rates on 30-year Treasuries hover near 6%, a 20-year low, making the 8% that you could get on long bonds less than 18 months ago seem like a yield of dreams. Squeezing high income from your investments is likely to stay tough. A low rate of interest -- like our love, as the Gershwin song goes -- is here to stay, at least for a few more bars. Fortunately, the same low yields that have made investing in the traditional fixed-income markets so difficult have helped make alternative markets, including those in high-yield bonds and convertible securities, look good. Now is also a good time to take advantage of high-yielding stocks. ; The core of your portfolio should remain in rock-solid U.S. Treasuries, despite the fact that yields are ungenerous. True, interest rates are lower now than they have been since the 1960s. But in a relative sense, that's not so bad. Back in the good old days when the Beatles were singing at Shea Stadium, interest rates had never been so high. If, as most experts expect, inflation stays low, Uncle Sam can still keep you ahead of the consumer price index. So far in the 1990s, the yield on ten-year Treasuries has stayed about three percentage points higher than inflation. That margin is wider than in any decade since World War II, with the exception of the 1980s. Bruce Ventimiglia, senior vice president of Quest for Value, the retail money management wing of Oppenheimer Capital, advises against locking yourself up in 30-year Treasuries even though they offer fatter yields. Instead, Ventimiglia suggests that you ladder your Treasury portfolio with bonds maturing in three to ten years. These bonds produce good current income. And if rates go up, investors won't have to wait too long for at least some of their portfolio to mature, allowing them to reinvest the principal at higher rates. Despite the unpleasant surprise that many municipal bond investors felt at having their high-interest bonds redeemed early, the tax-exempt market still deserves some of your cash. Because the muni market is awash with new issues, yields on tax-exempt bonds are very rich relative to Treasuries, says Pamela Hunter, who runs the top-performing Vista Tax-Free funds. Normally munis yield about 75% as much as Treasuries. Right now the yield on tax-exempts is about 86% of Uncle Sam's. The best way to play munis, says Hunter, is to stay with investment-grade bonds with maturities between ten and 15 years. Particularly good buys include the issues from U.S. territories such as the Virgin Islands and Guam. These bonds allow investors to diversify out of their home states without taking a tax hit from Main Street. Most state and local governments tax the interest paid on bonds issued by out-of-state municipalities. But income from munis issued by U.S. territories is exempt from taxation in every state in the union. A recent favorite of this type is the 5% Guam General Obligation bond due in 2005. It is yielding 5.16%. Hunter also likes revenue bonds such as the City of Plano, Texas, Water & Sewer Revenue bond due in 2008, which is yielding 5.1%, and the 4 7/8% Nebraska Public Power District bond due in 2008, which yields 5%. Hunter adds that with bond insurance so cheap, investors should favor insured munis. If you're grounded in supersafe Treasuries and investment-grade municipals, you can hike your returns with a mix of high-yield bonds. A modest portion of junk can help protect your portfolio if interest rates tick up, and under certain circumstances produce some growth in your capital. The alchemy is simple, says King Penniman, head of high-yield research at Duff & Phelps. Because the stated interest rate, or coupon, that junk bonds pay is so much higher than that of higher-grade corporate bonds, movements of interest rates have less effect on junk than on its blue-chip brethren. If rates move north, even Treasuries will head for the Mason-Dixon Line. But Penniman believes that junk as a class should hold up as long as we get continued economic growth. Prices for junk began to swoon in July, and are down about 1.3% from their high. Penniman says there could be continued weakness during October. The recent softening reflects more a temporary imbalance of supply and demand than a deep problem in the market. During the first eight months of the year, corporations sold some $42 billion in new high-yield bonds, about 50% more than during the same period of 1992. As interest rates fell this year, the demand for junk surged, driving yields down. ''Now,'' says Penniman, ''there is a better balance between supply and demand. It's a good time to be putting new capital into the high-yield market.'' Individual buyers should stick to the best of the junk credits, companies with a good chance of rising into investment grade. That makes the income safer and opens up the chance for a capital gain as the bond price rises to reflect its more respectable status. Among Penniman's favorites are Caesars World 8 7/8% senior subordinated notes. The Los Angeles casino company just reported record earnings -- $83 million. And the company is generating 3.5 times the cash it needs to meet long-term interest payments. The 9 3/8% senior notes of M.A. Hanna, a Cleveland plastics company, score high too. Sales are growing at a pace to reach $1.5 billion this year, up 15% from 1992, and profits are rising after slipping a hair last year. Another high-quality junk bond is Revco D.S.'s 9 1/8% senior note due in 2000, yielding 8.06%. The drugstore chain emerged from bankruptcy protection in mid-1992 and recapitalized in early 1993, cutting its long-term debt by $150 million to $253 million. Same-store sales are rising, and operating expenses are being tightly controlled. Result: The company earned $14 million in the fiscal year that ended in May. Even the stodgiest income-hungry retiree should have a small stake in equities. That thought may strike some investors as heresy deserving of the strappado. But the price of keeping faith with the conservative gospel of the past is steep. An investor who put $5,000 into, say, an AA-rated ten-year 8 1/ 4% muni in 1983, spent the income, and held on until it matured ended with principal worth only about $3,500 after taking inflation into account. That's effectively a $1,500 capital loss, which -- double whammy -- can't be deducted on your tax return. Combine the inflation hit with the lower rates on new issues and -- triple whammy -- the purchasing power of the income generated by the ten-year muni plummets 62%, from $413 to $156. Stocks may be more volatile than bonds and offer lower yields, but at least they will keep you comfortably ahead of inflation over time. For a first venture into the equity market, consider convertible securities. Convertible bonds pay a set rate of interest lower than that of a straight bond. But they allow you to trade in your bond for the common stock of the issuing company at a fixed exchange rate. The convertible thus enables you to benefit from the growth of a company, which a straight bond does not, and pays more for your patience than the common stock. But wait, there's more. Because these hybrids have a foot in both the equity and the bond worlds, their prices do not correlate with interest rates or stock prices. Adding convertibles to your portfolio can thus dampen the swings it takes when interest rates bounce and when stock prices jitter, says John Calamos, president of Calamos Asset Management in Oak Brook, Illinois. Historically, interest rates on convertible bonds have run between 2.35 and 4.5 percentage points less than straight corporate debt of equal credit quality. Overall, interest rates are so low now that the margin is only about 1.5 percentage points. Investors in convertibles are thus getting about 73% of the income they would get from straight debt. And on average, convertibles can pick up 75% of the growth of the underlying stock, says Calamos. On Calamos's buy list are the 5 1/2% convertible subordinated debentures of the Hechinger Co., which runs a chain of retail building supply stores along - the Middle Atlantic seaboard. The convertible, rated investment grade by Standard & Poor's, is yielding 7.6%. The company, in Landover, Maryland, is throwing off plenty of cash to pay its interest expenses, and earnings are headed up. Calamos also likes Albany International's 5 1/4% convertible debentures due in 2002, which are yielding 6.09%. The company, based in Albany, New York, has been making a fabric used in manufacturing paper since 1895. After closing two plants this year and paying down debt, it now seems poised to gain market share as the economic recovery continues. The stock has risen 19% this year. Convertible preferred stock is one step behind convertible bonds when it comes to claims on a company's cash, but it is also one step closer to the growth of standard issue common stock. Harry Miller, who manages the USAA Income Stock Fund, a top-rated equity income fund, likes the convertible preferred stock of Sears. It pays a dividend of $3.75 for a yield of 6.6%. Riding the back of the big retailer's turnaround, the price of the preferred is already up 22% this year. Calamos is also raving about Barnett Bank's Series C preferred, which yields 5.8%. The bank, in Jacksonville, Florida, is in a fast-growing area of the country, and it is saving more money than it projected from its recent acquisition of First Florida Bank.

For those ready to plunge into straight equities, Ventimiglia suggests a portfolio of high-yielding stocks of big companies. Philip Morris was smoked after announcing price cuts on Marlboro last spring, but as an income stock it still makes sense, he says. The company has lots of other businesses besides tobacco, and the yield, 5.6%, is steep. Another pet is Transamerica. Although the stock has climbed 28% this year, its $2 annual dividend still gives it a tempting yield, 3.3%. It has sold off a major stake in its risky property- casualty subsidiary, and all its remaining businesses look solid. Warner- Lambert's dividends have risen an average 17% annually over the past five years. But the drug company's present yield, also 3.3%, is well above the market's. Prospects for capital gains are bright. International business accounts for about 50% of the company's sales, so profits should rise as the global economy improves. Small stocks have provided plenty of capital appreciation over the years, but more volatility too. One way to capture some of those rich capital gains and collect spending money along the way is with high-yielding small stocks. + Jack Fockler, a portfolio manager for Quest Advisory, which runs the Royce family of funds, thinks National Presto Industries is a terrific buy. The company, in Eau Claire, Wisconsin, makes small kitchen appliances. It has paid a dividend every year for nearly half a century and has increased the dividend 25 out of the past 26 years. Since 1989, National Presto has also paid a special dividend related in part to Christmas sales. It hasn't announced plans for this year, but based on fiscal 1992's dividend, the stock is yielding 5.5%. (Based on its 1993 regular dividend, the yield is 3.4%.) Fockler also thinks that tiny Plenum Publishing, in New York City, deserves a read. The company puts out scientific journals and specializes in translating Russian treatises. Last year it had $54 million in revenues. Over the past five years the dividend has doubled to $1.04, which gives the stock, recently selling for $24 a share, a yield of 4.7%. But what investors might like most about Plenum is that it has an $87 million investment portfolio, $42 million of which is in cash and U.S. government securities. The portfolio alone is worth about $18 per share of common stock. The rest of the $24 buys about $3.50 of annual operating earnings, less than one-tenth what the stock market as a whole charges these days. To that price, one of Plenum's authors in the former Soviet Union would say deshovy. That's Russian for ''inexpensive.'' But the stock seems cheap in any language.

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