(MONEY Magazine) – Guts led to glory in the first half of 1991 -- and not just in the Persian Gulf. Taking risks paid off big for armies of mutual fund investors as well. For starters, the average equity fund handily beat the average fixed-income portfolio in the six months to July 1, rising a solid 16.2% vs. 6.9%. And among both stock and bond funds the riskiest categories tended to walk off with the gaudiest gains. Small-company growth funds, for example, clocked the best return among diversified equity funds, with a 23.7% rise. (For a list of 1991's top stock funds, see the table on page 133.) Similarly, those risk- filled high-yield funds -- a.k.a. junk -- took first place on the bond side, jumping 21.1%. Unfortunately, investors may not see an encore of the first half anytime soon. The Desert Storm rally had largely petered out by 1991's second quarter, during which the average equity fund slid 0.9% and the average bond fund rose an unspectacular 2.3%. Moreover, many analysts now see signs of frothiness in stocks. Companies have been flooding the market with new equity issues -- $26 billion worth in 1991's first six months, compared with $19 billion for all of 1990 -- and the yield on the Dow Jones industrials has dropped close to 3%, historically an indication of an impending peak. Sure, stocks could rally again. But editor Norman Fosback of the advisory newsletter Mutual Fund Forecaster ($49 a year; 800-327-6720) warns: ''Conditions are more like the summer of 1987, just before the October crash, than like a classic post- recession rally.'' As a result, the prudent course now is to start gradually reducing the risk in your fund portfolio. This story outlines several defensive moves for stock and bond investors; weigh them carefully. In addition, take a close look at our rankings of 160 top five-year performers, which begins on page 138. All of these funds have proved themselves over a period that included some of the stormiest investing weather of the decade. The course of the market over the next few months will depend largely on the strength of any economic recovery. While most economists agree that the recession is ending, a weak rebound could lead to disappointing earnings and a 15% drop in the Dow to around 2360. (See Money Forecast on page 15.) Economist David Hale of Kemper Financial Cos. warns of a different but equally alarming possibility: a stronger-than-expected recovery accompanied by exaggerated inflation fears and soaring interest rates. Stock funds would be battered in that event, says Hale, as investors abandoned equities for the high yields available on bonds. One way to hedge against both scenarios is simply to reduce your equity holdings. For example, if you usually keep 60% of your money in stock funds, consider cutting back to 50% and moving the freed-up 10% into low-risk short- term bond funds, recently yielding 6.9%. If you normally hold a more conservative 50% in stock funds, again consider switching 10% into short-term bond funds. The second part of your hunkering-down strategy is to re-examine the individual stock and bond funds you own or are considering buying. The following tactics should help.

STOCK FUNDS -- Buy lower-risk funds. -- Hold selected small-company funds. -- Seek out value funds that could boom in a recovery.

You may want to consider exchanging some of your riskier funds for those likely to hold up better in a market retreat. Two conservative funds favored by editor Sheldon Jacobs of the No-Load Fund Investor ($95 a year; 800-252-2042): Twentieth Century Balanced (no load; up 12.5% for the year to July 1; 800-345-2021) and Financial Industrial Income (no load; up 18.2%; ! 800-525-8085), one of the select MONEY 20 funds tracked every month in our Fund Watch column. None of this, however, is meant to suggest that you should dump all your aggressive funds. Many of them are still solid long-term investments, like manager Edward Antoian's Delaware Group-Delcap I fund, which tops our midyear rankings of diversified equity funds with a whopping five-year gain of 142%. Another relatively risky category of funds worth holding is those that invest in small-company stocks. Prudential Securities analyst Claudia Mott believes that the little guys' solid showing in the first half is only a prelude to more gains. ''In the past, small-cap stocks have turned in their strongest performance in the 12 months after the end of a recession,'' she says. She adds, however, that small-stock funds have suffered setbacks of as much as 20% between their initial spurt and their post-recession rally. For worthy small- cap fund selections, see ''15 Investments That Could Double in Three Years'' on page 62. If the recovery features annual inflation-adjusted economic growth of 3% or less, expect the best gains from funds that specialize in high-growth stocks. Reason: in a sluggish economy, companies that can reliably boost earnings are in great demand. Antoian's Delcap I is one such growth-getter: the average stock in its portfolio has seen profits rise 44% over the past three years, twice as much as in the S&P 500. In a more vigorous recovery, however, value funds such as Gintel Capital Appreciation (see the box on the next page) could stand out because of their holdings in cyclicals -- stocks whose fortunes are closely tied to the economy. Another advantage of value funds is that many still have price/earnings ratios 20% or more below the lofty 17.7 of the S&P 500. That should make them less susceptible than the growth jockeys to a market sell-off. Gintel, for example, owns stocks with an average P/E ratio of 10.4. And fund ranking service Mutual Fund Values recommends Vanguard Wellington (no load; up 10.8%; 800-662-7447), a balanced fund with a P/E of 14.

BOND FUNDS -- Favor intermediates. -- Be wary of single-state municipal funds. -- Consider some safer high-yield funds.

As money-market rates dropped to 5.6% during the year's first half, investors went searching for higher yields and found them in bond funds -- where payouts range from about 8.6% on Ginnie Mae funds to nearly 13% on junk funds. All told, investors poured some $17.5 billion into long-term bond funds in the first half -- more than double the amount that they invested in all of 1990. But blindly chasing yields can prove dangerous to your wealth. A two- percentage-point increase in interest rates would knock down the value of 30-year Treasuries, for example, by a full 18%. Besides, income seekers needn't take that much risk to get higher-than- money- fund yields. Ian MacKinnon, head of fixed-income investments at the Vanguard Group of mutual funds, recommends sticking with intermediate-term funds with average weighted maturities of five to 10 years. Intermediates are only 60% as sensitive to interest-rate twitches as long-term bonds are. And surprisingly, their long-term total returns -- counting both income and price changes -- have been comparable, according to the Chicago research firm Ibbotson Associates. (For more on finding high, safe yields, see ''Beat Puny Money Fund Yields'' on page 52.) Among the funds that fit MacKinnon's prescription is our five-year bond fund winner, FPA New Income (4.5% load; up 8.2% in 1991; 800-421-4374), another member of the Money 20. Manager Robert Rodriguez mixes high-yield corporates and convertible bonds with Treasuries and Ginnie Mae mortgage securities and recently had an average maturity of nine years. The fund's recent yield: 8.1%. Even less rate-sensitive are shorter-term funds like Benham Treasury Note Trust (no load; 800-472-3389), with an average maturity of 3.8 years and a yield of 7%, and Federated Short-Intermediate Government Trust (no load; 800-245-5000), with a maturity of 1.4 years and a yield of 7.5%. For the same reason, intermediates also make sense for municipal bond investors. Ralph Norton of the advisory newsletter Muni Bond Fund Report ($95 a year; 617-721-4511) suggests two high-quality no-loads, Dreyfus Intermediate Tax-Exempt (800-782-6620) and Fidelity Limited Term Municipals (800-544-8888). For an investor in the 31% federal tax bracket, the funds' identical 6.25% yields are equivalent to 9.1% on a fully taxable bond fund. Be wary of municipal funds that invest solely in bonds issued in a single state. With a wave of budget problems sweeping cities and states, credit risk is a concern for all muni funds, but the single-state funds' lack of geographic diversification only exacerbates the problem. In fact, Norton advises investors against new investments in the single-state funds of Massachusetts, New York and Connecticut, where credit-rating agencies have downgraded $14 billion worth of state obligations in the past two years. You should generally steer clear of other single-state funds as well unless they outyield nationally diversified funds of comparable quality and maturity by at least 1.5 percentage points after state taxes. Otherwise, single-staters aren't worth the extra risk. This year's resurgence by high-yield funds has made junk respectable again -- and to many investors the funds' yields of roughly 13% also make them very tempting. But while junk funds may be good for some investors, says newsletter editor Jacobs, they aren't right for people who need dependable income. One reason: those mouth-watering yields may not last. Many weak junk issuers will continue to default, while stronger companies refinance to reduce their debt payments. Furthermore, Jacobs argues that junk bonds should be regarded more as stocks than bonds because their prices rise and fall with the fortunes of their individual issuers rather than with the general level of interest rates. He believes that well-managed, highly diversified junk bond funds like T. Rowe Price High Yield (no load; recent yield: 13%; 800-638-5660) and Vanguard Fixed Income-High Yield (no load; recent yield: 12.5%; 800-662-7447) could outperform equity income stock funds over the next 12 months -- and at half the volatility. But reserve no more than 10% of your bond fund allocation for the junkers, and make it money you're sure you won't need for five years or more.

BOX: HOW TO USE OUR FUND TABLES

Most mutual funds have a pleasing story to tell their investors for the first half of 1991 (see the accompanying article). But one year, let alone six months, doesn't tell you if a fund has staying power. So beginning on page 138, we rank the top performers in five stock and eight bond fund categories based on their five-year returns. We've divided diversified domestic stock funds into two broad categories: growth-style funds that aim for capital gains, and total-return funds that mix in dividend income. Overseas, sector and gold funds compete in separate categories. For each fund in our tables, you will find not only the manager's name, age and tenure at the fund but also additional significant facts about the portfolio, such as its yield, price/earnings ratio (for stock funds) and average maturity (for bond funds). We have also assigned each fund a risk- adjusted grade. Based on a formula designed by Nobel-prizewinning economist William Sharpe, MONEY's grade compares funds within broad groupings (equity, international, gold and sectors, taxable bonds and tax-exempt bonds), rewarding those with superior returns and punishing those with above-average risk. The funds get three other grades as well: the Lipper market-phase ratings. Lipper Analytical Services compares a fund's return with that of its competition during the current market phase (which, by Lipper's measure, still counts as a rising phase for both stocks and bonds) as well as the most recent down and up phases. In both Money's and Lipper's ratings, A's go to the top 20% in each grouping, B's to the next 20% and so on. Since low expenses tilt the odds in your favor, we give an expense analysis for each fund. Look especially at the five-year expense projection. It estimates what you would pay in total sales charges and operating expenses on a $1,000 investment that compounds at 5% a year and is withdrawn after five years.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: 1991'S TOP STOCK FUNDS THREE-YEAR STOCK CHAMPS 1991'S BOND FUND WINNERS

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: THE MONEY RANKINGS: TOP EQUITY FUNDS THE MONEY RANKINGS: TOP TAXABLE BOND FUNDS THE MONEY RANKINGS: TOP TAX-EXEMPT BOND FUNDS