(MONEY Magazine) – With borrowing costs rising and securities markets roiling, it is easy to forget that there's a bright side to rising interest rates -- namely, higher yields on savings and income investments. Today, by carefully shopping around, you can find top-quality stocks, bonds and mutual funds that pay out a tasty 7% or more. "For those who are willing to take on a little risk and hold for the long term, now is a good time to look at higher-yielding investments," says John Rekenthaler, editor of Morningstar Mutual Funds ($395 a year; 800-876-5005). "After taking such big hits, many stocks and bonds now offer excellent values -- both high income and total-return potential." True, the Fed's four rate hikes last spring pounded interest-rate-sensitive investments: The average Treasury bond fund, for example, sank 5.23% in the first half of this year. The bruising has left many investors wondering if fixed-income issues are still right for their portfolios. (See the story on page 120 on how to diversify without bonds.) With the Federal Reserve Board likely to push up short-term rates to as high as 5% by the end of the year, anyone who can't stand the notion of a temporary dip in principal value should stick with ultrasecure investments, such as short-term CDs, money-market funds or Treasury bills. But for income investors, some combination of bonds and dividend-paying stocks is still the only way to earn steady yields. To shoot for higher returns without taking on too much volatility, Lewis Altfest, a self-employed financial planner in New York City, suggests this strategy: Keep a third of your income portfolio in supersafe, short-term investments, such as CDs and money funds; another third in high-quality intermediate-maturity issues of no longer than 10 years; and the remainder in higher-yielding bonds and equity income funds. The investments described below all offer yields of 7% or more, and are appropriate for the intermediate- and higher-risk thirds of your portfolio. We begin with the safest choices and conclude with higher-risk, higher-return issues: -- Treasury notes. Safety-conscious investors looking to beef up the intermediate portion of their income portfolio might want to opt for a 10-year Treasury note, which currently yields 7.3%. "Intermediate bonds, which have maturities of five to 10 years, are the best bet for individual investors," says Edward Martin, fixed-income manager at David L. Babson & Co., a Boston investment firm. "Over the long run, intermediates have provided 80% of the return of long-term bonds with only half the price risk." You can buy Treasuries directly from the Federal Reserve Bank without paying a commission. For information, contact your local Fed branch or the Bureau of the Public Debt in Washington, D.C. (202-874-4000, ext. 251); the minimum investment is only $1,000. -- Ginnie Maes. If you like the security of owning government bonds but prefer a bit more yield, you should consider investing in so-called Ginnie Maes, which are securities based on pools of mortgages and backed by the Government National Mortgage Association. For small investors, the best way to invest is through mutual funds, which are currently yielding an average of 7% and are expected to keep rising along with interest rates. They are not risk-free: In 1993 the average returns on Ginnie Mae funds lagged those of Treasury bonds of comparable maturity by almost four percentage points. That's because falling interest rates encouraged homeowners to refinance their mortgages, thus reducing the effective yields on Ginnie Mae issues. But over the 10 years that ended June 1994, the average mortgage fund has returned 9.9% annually, compared with 9.4% for the average Treasury portfolio. Two top no-load choices, according to Ralph Norton, managing editor of the Bond Fund Advisor newsletter ($95 a year; 800-343-5413): Vanguard GNMA (30-day yield: 7%; up an average of 8.4% a year for the five years that ended June 1994; 800-662-7447) and Benham GNMA (yield: 7%; up 8.3%; 800-472-3389). Another plus: Both funds avoid the exotic derivative issues that have caused steep losses in other mortgage bond funds. -- Municipal bonds. Investors in the 28% tax bracket or higher (taxable incomes of $38,001 or more for married couples filing jointly; $22,751 or more for singles) should take a look at municipal bonds, whose income is free of federal taxes. The average muni fund recently yielded 5.2%, which is equivalent to 7.2% for an investor in the 28% bracket and 8.1% for those in the 36% bracket (incomes above $140,000 for couples, $115,000 for singles). If you don't have the $50,000 or so you need to assemble a diversified portfolio of individual bonds, consider funds. Two sound no-load choices, according to Jim Lynch, editor of the Lynch Municipal Bond Advisory newsletter ($250 a year; 212-663-5552): Fidelity Limited Term Municipal (yield 5.4%; up 7.4%; 800-544-8888), which holds bonds with an average credit rating of AA and an average maturity of 9.7 years; and Dreyfus Intermediate Muni (yield: 5.1%; up 7.6%; 800-645-6561), which also holds mainly AA-rated bonds with an average maturity of 9.4 years. -- Utility stocks. This hard-hit sector now offers some compelling buying opportunities, according to Geraldine Weiss, editor of Investment Quality Trends newsletter ($275 a year; 619-459-3818). Rising interest rates and concerns over deregulation have helped push down the S&P utility index by 10% this year, and many electric companies now transmit high-powered yields of 7% or more. Furthermore, Roger Conrad, editor of Utility Forecast newsletter ($89 a year; 800-832-2330), predicts that utility stock prices will soon rebound, with the best of the bunch providing investors with total returns of as much as 15% over the next 12 months. If you have at least $20,000 to invest and time to do careful research, you might consider assembling your own utility portfolio. But pick cautiously and don't put any more than 20% of your money in this sector. Conrad recommends looking for companies that earn no more than 25% of their sales from industrial customers, since, unlike residential customers who can't choose among utilities, businesses are often able to switch to cheaper competitors. Also, steer clear of companies that pay out more than 90% of earnings on dividends, since they are more likely to cut their payout in tough times. Three sterling utilities that meet these criteria, according to Weiss: Dominion Resources (ticker symbol: D; recently traded at $35.75 on the New York Stock Exchange; yield: 7.1%), Potomac Electric Power (POM; NYSE, $20; 8.3%) and Baltimore Gas & Electric (BGE; NYSE, $22.50; 7%). -- High-yield bond funds. If you think that investing in a junk bond fund, which buys the debt of troubled or bankrupt companies, is a sure way to lose money, think again. Over the past five years this group has turned in solid 9.7% average annual gains. Currently, the typical junk bond fund boasts a lofty annual payout of 9.4%. "High-yield funds are particularly timely now," says Glen King Parker, editor of the Income Fund Outlook newsletter ($49 a year; 800-442-9000). Chief reason: The performance of junk bonds is tied closely to the strength of the underlying companies that issue them and to the overall health of the economy, and are less vulnerable to rising interest rates. Indeed, the average high-yield bond fund held up well during the recent Fed rate hikes, losing only 2.4% between January and April, compared with a 4.7% drop for the average Treasury bond fund. For safety's sake, however, you should put no more than 20% of your fixed-income stake in junk issues. To further minimize risk, Parker recommends dividing your allocation among two or more no-load funds. His top picks: Vanguard High-Yield Corporate (yield 9.8%; up 8.9% annually over the past five years), which typically keeps more than 20% of its portfolio in investment-grade bonds, and Northeast Investors Trust (yield 8.3%; up 10.8%; 800-225-6704), whose careful selection of the lowest-rated issues has helped maintain a low-risk record: So far this year the fund has actually gained 3.3%.