(FORTUNE Magazine) – To anyone who lives in or sails the Caribbean, hurricane season is an annual reminder that paradise is not a permanent state. The recent low-pressure system on Wall Street (Hurricane Boris, was it? Or Hurricane Meriwether?) made much the same point. Falling interest rates, slowing inflation, and profits rising as far as the eye can see--the economic holy trinity that has sustained the bull market for the past 16 years--are not the only conditions investors will ever have to face.

Still, while the boat heeled over in the recent gale, it didn't capsize. After losing more than 15% in the third quarter, according to Lipper Analytical Services Inc., the average equity fund is now up 6.1% for the year. And as of Thanksgiving it appeared that the fall selloff may have been nothing worse than another brief interruption in this long bull market--another vindication, like 1987 and 1990, of the notion that stock funds are the only investments anyone needs to care about.

But can you say the same about the future? As the lead story of this investing report, "Why Investors are so uncertain," makes clear, there's good reason to think the next decades may not replay the past. The growing stability of prices means that corporate profits could lose the inflationary tail winds they've enjoyed since World War II. That would narrow the structural advantage stocks have held over bonds during that time. On top of that, equity investors are still paying upwards of 20 times anticipated earnings for the stocks of the Standard & Poor's 500 index. At best, such a high price/earnings multiple tends to limit the market's upside to the growth rate of corporate earnings (which seems to be slowing). At worst, it is an open invitation to the market to reprice stocks to a more typical P/E of 14 to 16. When that happens abruptly, it's called a crash.

All this ought to encourage you to reexamine your fund portfolio with an eye to reducing your risks. The winning strategy in the bull market has been to aim exclusively for capital appreciation. The best tactic ahead might be to turn some of the work over to income-oriented investments like bonds or dividend-paying stocks. That way your future security won't hinge solely on whether other investors will deign to relieve your fund of its stocks at ever higher prices. Instead, you'll be able to count on a stream of income protected by covenants (in the case of bonds) or by corporate boards and company prestige (in the case of dividends). That can exert the sort of calming influence any portfolio needs in uncertain times.

All we're talking about here, really, is diversification, that perennial staple of investment primers. Just as an example, the average equity fund slumped more than 15% in the third quarter; however, the average general U.S. government bond fund gained 4.6%. Had you gone into the quarter with 40% of your portfolio in bond funds, you would have cut your overall loss by more than half, to 7.2%. Okay, you already know how diversification works. But here and now, with this summer's market turmoil fresh in your mind and an unfamiliar economic climate on the horizon, diversification is an idea whose time has come again.

To help you apply it to best effect, FORTUNE went looking for mutual fund categories likely to balance a portfolio heavy with large-cap stock funds. With the help of the database compiled by the mutual fund research firm Morningstar, we settled on four types: general U.S. government and municipal bond funds, equity-income funds, and balanced funds. None of them tend to track the S&P 500 too tightly, which is ideal when you're looking to diversify. It increases the chances that when the large-cap funds zig, your other choices will zag, beneficially.

To cull the steadiest entrants from these already conservative groups, we eliminated any fund with a three-year standard deviation through the end of October that was above the average for its peers. Standard deviation is a measure of volatility or variability in returns. (For more details, see the box on risk.) Essentially, by focusing on funds with lower standard deviations, we biased our selections toward those with the most stability.

We also chucked funds whose three-year annualized returns came in below those of their peers. We then made sure that the manager who earned this performance was still at the helm. If not, that fund was cut too. (Because of the embarrassingly high turnover in fund managers, this hurdle eliminated a surprising number of contenders.) Also, because expenses play a critical role in bond funds' returns, we added an additional hurdle in the fixed-income category: all our bond picks had to have an expense ratio below their peer group's average.

The result: a list of 29 funds that have produced better than average returns at less than average volatility, that have stable management, and that aim to derive at least some of their return from income rather than from capital appreciation. They're exactly the sort you'll want to add to your portfolio in the uncertain times ahead.

BOND FUNDS

Two things make a bond investor's day: a slowing economy and low inflation. The benefit of having such an investment in a stock-heavy portfolio is obvious. When a whiff of recession sends equity markets into a panic, bond funds will be a rock. The rest of the time their regular monthly income payments will help stabilize your portfolio's overall returns.

But what type of bond fund? Stock fund investors get the best diversification by sticking with simple, high-quality funds such as Treasury bond funds or general government bond funds, which invest in a mix of Treasuries and mortgage-backed securities. Low-quality corporate funds, or junk bond funds, move more in step with the stock market. (See the box later in this story.)

Government bonds come in short-, intermediate-, and long-term maturities. Mary L.C. Flood, a planner for the New York-based investment advisory group Inverness Counsel, thinks the sweet spot is in the intermediates, those that keep their portfolio's average maturity at five to ten years. Longer bonds yield slightly more, but they would be much more at risk if interest rates were suddenly to jerk higher. With the five-year Treasury note yielding around 4.5%, compared with 5.25% for the 30-year bond, the risk-reward equation favors the note, agrees Robert Gahagan, manager of the $440 million American Century/Benham Intermediate-Term Treasury fund. The five-year security provides more than 86% of the long bond's yield but at a quarter of the risk.

Unless your government bond fund specifies that it buys Treasuries only, you can expect that it will have a portion of its assets invested in mortgage-backed securities sponsored by government entities such as the Government National Mortgage Association (Ginnie Mae). The mortgages provide higher yields than Treasuries, but they can make the fund's reaction to interest-rate movements a bit unpredictable. The reason is that, unlike Treasuries, mortgage-backed securities can be paid off at any time. This happens a lot, obviously, when interest rates fall and homeowners refinance. The problem for a mortgage-backed fund is that such refinancing waves shove the fund's principal back at the fund and force it to reinvest in a lower-interest-rate environment. As a result, funds with heavy commitments to mortgage securities tend to react less enthusiastically to interest-rate declines than pure Treasury funds.

Clever management, however, can alleviate that problem. Michael Brilley and Bryce Doty, managers of the $130 million Sit U.S. Government Securities fund, invest about 40% of its assets in Ginnie Mae mobile-home holdings. (Like all Ginnie Maes, they're guaranteed by the government against default, so credit quality isn't an issue.) These loans typically carry low balances--often less than $20,000--which give homeowners little incentive to refinance. That makes these Ginnies less vulnerable to prepayment than traditional varieties. Brilley and Doty's fund has rewarded investors with an annualized return of 7% over the past three years, with 40% less volatility than its peers.

There is one major drawback to government bond funds: taxes. All that monthly income is taxed at your highest tax rate (no capital gains break here), unless you hold the bond funds in a tax-deferred account like an IRA. If you plan to invest in bond funds outside such accounts, you should definitely consider municipal funds. Nationally diversified muni funds pay income that is exempt from federal taxes; if you buy funds that specialize in the state where you live, you avoid state taxes as well (except in Illinois, Iowa, Kansas, Oklahoma, and Wisconsin, which tax many of their own bonds).

Never one to leave a market niche unexploited, the mutual fund industry has at least one state-tax-exempt fund for most states--including, oddly, some with no state income tax, such as Texas and Florida. Our table lists nationally diversified funds only, but Fidelity, Dreyfus, USAA, and Vanguard all offer an assortment of single-state tax-exempt bond funds as well. (Because muni funds have low pretax yields, it's even more important than with other bond funds to minimize your investing expenses.) If you go the single-state route, though, stick with insured funds whenever possible. In these funds private bond insurance ensures that the income keeps flowing even in the case of a default. Also, a portfolio that holds insured bonds is less likely to be tarred by credit problems in neighboring municipalities--the way all uninsured California bonds were dragged down by the Orange County default of 1994. Because the insurance company promises to fulfill the bond issuer's obligation to pay interest, there's no reason for the bond's value to decline just because the municipality's credit is in doubt.

Munis right now yield about 95% as much as Treasuries, an unusually attractive spread. Because Treasuries are taxable and munis aren't, the narrow spread means that for investors in the 36% tax bracket, Treasuries would have to yield 40% more than they do to match the after-tax yields available on munis. But act now. These hair-thin margins won't last forever, explains Jim Cooner, who heads up the tax-exempt management division at the Bank of New York. Relative muni yields have been inflated by a temporary oversupply of the bonds, while Treasury yields have been artificially lowered by the "flight to quality" of foreign investors worried about their local currencies' safety. When these situations reverse, expect the muni/Treasury spread to return to a more normal 80% to 85%.

EQUITY-INCOME FUNDS

In your mutual fund boathouse, your large-cap equity fund would be your powerboat and your small-cap fund your racy Jet Ski. Your equity-income fund? That's your trusty old cabin cruiser. Which would you rather have out in a storm?

Equity-income funds invest primarily in stocks that pay out a relatively fat dividend. The yields, which vary in the equity-income universe from a high of 5.9% to a mere 0.16%, can provide a cushion when the stock market dives. "In rough markets, you'd expect equity-income funds to outperform stock funds that buy low- or zero-dividend companies," says David E. Homrich, CEO of Homrich & Berg, a financial planning firm in Atlanta. Indeed, in the third quarter of this year, the average growth fund tumbled 13.4% and the average small-cap fund slumped 21.5%. Meanwhile, equity-income funds fell a more bearable 10.2%.

A typical equity-income fund's portfolio is awash in large and well-established companies with strong cash flows and mature lines of business. Brian Rogers, manager of the $13.5 billion T. Rowe Price Equity-Income fund, currently finds what he's looking for in utilities, financials, telecom, and oils. "Stocks like BankAmerica, Corning, and Unocal are all yielding around 3.2%," he says. That's well above the average yield of 1.6% on the S&P 500 index.

Roger Newell runs about 65% of the $2.5 billion Vanguard Equity-Income fund. (The rest is split between two other managers.) Newell aims to buy stocks when their yields in relation to the market and their own history are at the high end of their historical range. As a result, during the third-quarter downturn, Newell snapped up some high-yielding capital-goods companies, brokerages, and money-center banks like Chase Manhattan. "Even after the run-up the banks have had since 1990, they still have high yields relative to their history," Newell says.

Rogers and Newell prefer traditional dividend-paying common stocks, but the search for income in today's yield-parched world has taken other managers further afield. High-income securities like convertible bonds, preferred stocks, and real estate investment trusts (REITs) show up frequently as yield enhancers in equity-income portfolios. Mark Riepe, head of the Schwab Center for Investment Research, says there's nothing wrong with equity-income funds that choose to invest in securities--as long as they don't overdo it. "You just don't want to get into a fund that's too concentrated in any particular industry."

BALANCED FUNDS

The beauty of balanced funds is that they give you equity and bond diversification in one swoop. The typical balanced portfolio has about 60% of its assets in equities and around 40% in fixed income. Some funds have pretty wide discretion as to how they divide up the shareholders' money, however. "You have to watch out for how much balance you're actually getting," says Riepe--another reason to read the prospectus before you leap in.

The Dreyfus Premier Balanced fund, for example, allows the equity allocation to slide between 40% and 75%, depending on lead manager Ron Gala's market outlook. "Valuations had gotten pretty high this summer," says Gala, who selects the stocks that go into the equity side of the fund. (His partner, Laurie Carroll, handles the bond picking.) "So when we went into the July-to-August downturn, we had only about 40% of the fund in equities." Since August, Gala has been edging back into the market, and he now has about 65% of the assets in stocks. All in all, it hasn't been a bad formula. Over the past three years, Dreyfus Premier Balanced has returned an average of 18.8% annually.

The true test of a balanced fund, says Susan Byrne, manager of the $150 million Westwood Balanced fund, is how it fared during periods of market turmoil. Those are the times when the fixed-income portion of the portfolio should smooth out the volatility. If the fund lags behind its peers, it might be a sign the manager had timed the market badly or had too much risk in the bond side of the portfolio. "If you had a balanced fund in the past year, and the bonds the manager owned were Russian or emerging-markets credits, it would have been immediately obvious," Byrne points out. The right guess on a set of dicey bonds can indeed boost a balanced fund's return--temporarily, anyway--but then again, taking on too much risk defeats the purpose of a balanced portfolio. Remember, these funds are supposed to help you weather the storms of global investing, not expose you to them even more.