(MONEY Magazine) – After 18 years of marriage, Connie and Kel Saito still have their differences, even when they try to relax by playing mixed doubles on a tennis court near their San Jose home. "We'll have arguments over who's going to return the shot," laughs Kel, 51. "Being on the same team as your partner can be stressful."

When it comes to the stock market, however, these days the Saitos share the same outlook: nervous. Even though equity investments have helped swell their portfolio to $500,000, the Saitos haven't bought any stocks this year. As a result, their cash stake has grown to $50,000. "We don't want to put more money in equities," Kel laments, "but we also don't want to give up the solid returns we've been getting."

The Saitos are not alone. Says Marilyn Cohen, president of Envision Capital Management in Los Angeles: "I'm seeing more investors looking over their shoulders, wondering how much longer the stock market's performance can continue."

If you feel the same way, we sympathize. The question is, where can you find investments that are less precarious than stocks appear to be right now but still offer the prospect of double-digit returns? The answer: bonds--yes, boring old bonds. Investors have been wary of bonds since 1994, when a series of Federal Reserve interest-rate hikes dealt a blow to the market (bond prices fall when rates rise, and vice versa). But today's environment is almost ideal for fixed-income investments. Robust profits are giving issuing companies plenty of cash to pay their bills, sharply cutting the risk of default. Tame inflation reduces the likelihood that the Federal Reserve will raise interest rates. And with the federal government's budget deficit supposedly on the road to zero by 2002, Uncle Sam is borrowing less money, which means there are fewer bonds flooding the market.

But won't this summer's landmark cut in the maximum capital-gains tax rate make bonds much less attractive compared with equities? Not necessarily. "I don't think the tax change is going to have a negative impact on bonds," says Jim Floyd, senior analyst at Leuthold/Weeden Research in Minneapolis. "The factors affecting bond performance are still the same: inflation, the budget deficit and how the dollar is trading." And these factors have recently been working in bonds' favor.

For example, since March, the interest rate on the bellwether 30-year Treasury bond has fallen from 7.1% to 6.45%. That has lifted bond returns across the board: The Lehman Bros. aggregate bond index gained a sweet 6.5% from March through the end of July. Even better, Floyd believes these favorable trends should continue to pump up bond returns over the next 12 months. As a result, he expects the yield on the benchmark 30-year Treasury bond to fall an additional three-quarters of a point to 5.7% in the next year. That translates to a total return of roughly 18% on conventional 30-year Treasuries and 13% or so on 10-year issues.

To help you capitalize on this budding bond bonanza, we asked two dozen market strategists, financial planners and fixed-income specialists where investors might find the juiciest returns. They cited four investments that seem particularly attractive right now: mortgage-backed bonds, high-yield bonds, zero-coupon Treasury bonds and emerging markets debt. These exotic blooms are riskier than garden variety corporate and Treasury bonds. But the potential payoffs are pretty indeed: Our experts anticipate that these investments will produce total returns (income plus capital gains) that range from 7% to as much as 31% over the next 12 months.

Tempting, yes? But remember, we did say these are risky investments, so don't get carried away. The longer its maturity, the more a bond's price will gyrate with interest-rate changes; so, conservative investors should stick with intermediate-term maturities of five to 10 years. Whether you're conservative or aggressive, however, "invest no more than 20% of your total portfolio in these securities," says Michael Chasnoff, a financial planner in Cincinnati. "That way you'll limit the damage to your overall savings if you take a hit."

Moreover, in most cases it makes sense to buy bonds via mutual funds rather than directly. For a relatively modest initial investment, usually around $2,500, funds offer the advantages of instant diversification and professional management. By contrast, when buying individual bonds, you will generally need $100,000 to build a properly diversified portfolio of four or more separate issues. And as a small customer in a market dominated by giant insurance companies, banks and other institutions, you will have trouble getting the best prices when you buy and sell your securities.

Here are our pros' picks, listed in increasing order of risk. Consult the table below for performance data and 800 numbers for the recommended funds.

MORTGAGE-BACKED BONDS Estimated 12-month total return: 7% to 11%

When you invest in mortgage-backed bonds, you're buying into a pool of mortgages owned or guaranteed by government agencies like the Government National Mortgage Association (GNMA, or Ginnie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae). Ginnie Maes carry government guarantees against default; nevertheless, they yield half to three-quarters of a point more than Treasuries of comparable maturities. Because Fannie Maes and Freddie Macs don't have explicit government backing, they are not considered as secure as Ginnie Maes, and they yield about a quarter of a point more.

Default isn't a worry, but Ginnies, Fannies and Freddies are subject to a risk that is peculiar to the mortgage market. When rates fall, homeowners tend to refinance their mortgages; when that happens, bondholders get their money back sooner than expected and must reinvest it at the new lower rates. On the other hand, when rates rise, homeowners hang on to their loans longer; that stretches out the maturity of mortgage bonds, making them less valuable. But Earl Osborn, principal in the San Francisco advisory firm Bingham Osborn & Scarborough, predicts that if interest rates decline three-quarters of a point (as Floyd believes they will) the average mortgage fund, yielding 6.3%, could return as much as 11%.

Considering all the potential complications, mutual funds offer the best way to invest in mortgage bonds. Todd Porter, a bond fund analyst at Morningstar, the mutual fund rating firm in Chicago, recommends $8 billion Vanguard Fixed-Income GNMA, recently yielding 7%. Manager Paul Kaplan, 49, reduces the overall risk in his portfolio by having 35% of it in bonds with a maturity of seven years or less. But the fund's three-year annual average return of 9.2% still places it among the top 6% of mortgage-backed securities funds. One reason: a super-low annual expense ratio of 0.27%.

Another stellar mortgage fund is $9.5 billion Franklin U.S. Government Securities Fund, which invests almost exclusively in Ginnies and currently yields 7%. Manager Jack Lemein, 53, boasts a three-year annual average return of 8.9%.

HIGH-YIELD BONDS Estimated total return: 10% to 15%

Junk is the familiar name for bonds issued by companies with below-investment-grade credit ratings of BB or less. Because these firms are considered more likely to default, they must offer higher yields to attract investors. Thanks to the economy's sustained growth, corporate coffers are overflowing, and most junk issuers are having little trouble making their payments. The default rate on junk stands at 1.6%, well below the historical average of 3.6%. Moreover, junk bonds have had an annual average total return of 11.7% in each of the past five years, compared with an average of 7.3% for the Lehman Bros. aggregate bond index during that same time period.

While sharing bonds' general sensitivity to changes in interest rates, junk, like the stock market, is also highly dependent on the overall strength of the economy. "The biggest threat to the performance of junk is a recession," says Roger King, senior high-yield portfolio manager for Dreyfus Funds. But fortunately, he adds, "a recession isn't in most economists' forecasts." Furthermore, the plump yields in a junk portfolio, an average of 8.6%, vs. 6% for the average bond fund, often offset any temporary price declines. High-yield portfolios have experienced only three calendar years of overall losses since 1985: They dipped 0.7% in 1989, 10.1% in 1990 and 3.6% in 1994. So when King looks out over the next 12 months, he thinks that junk can enjoy total returns ranging from 10% to 15%.

That sort of favorable forecast led Richard Walker (pictured at left), 58, of Portland, Ore. to invest in junk bonds. When he retired in May after 34 years with the U.S. Forest Service, Walker shifted 30% of his portfolio from equities into a high-yield bond fund. "Richard was getting nervous about how high the equity market was going, and he also needed income," says Glen Clemans, Walker's financial planner. "Going into junk was a way of still getting high returns while cutting back his position in stocks."

One of the best ways to mine the junkyard is $4.1 billion Vanguard Fixed-Income Securities High-Yield Corporate, with a yield of 8.6%. Jim Pearman, a financial planner in Roanoke, notes that because the fund's expenses are a microscopic 0.29% compared with an average 1.36% for its peers, manager Earl McEvoy, 49, can take less risk than many rivals and still be a leader of the pack. Indeed, more than 40% of the portfolio is in bonds rated Ba or higher. Even so, McEvoy's three-year annual average return of 12.6% puts the fund in the top 30% of its peer group. Similarly, $1 billion Federated High-Yield Trust, a favorite of Osborn's, buys issues with a double- or single-B rating while paying 8.9%. Manager Mark Durbiano, 37, has tallied a three-year annual average return of 13.5%.

If you feel comfortable taking on additional risk in exchange for higher returns, Tom Grzymala, a planner in Alexandria, Va., suggests $1.7 billion Northeast Investors Trust, yielding 8.5%. Fund managers Ernest Monrad, 67, and his son Bruce, 35, like to walk on the wild side--26.5% of the securities in their portfolio are rated triple C or lower. But the portfolio's three-year average annual return of 15.1% ranks in the top 1% of all high-yield funds.

ZERO-COUPON TREASURY BONDS Estimated total return: 20% to 31%

Conventional Treasury bonds pay interest twice a year, but zeros don't. Instead, you buy them at a substantial discount to their face value and receive the full amount when they mature. Because of this structure, you know in advance the rate of return you'll earn if you hold the bond to maturity. You owe tax on the interest your bond accumulates each year even though it isn't paid to you, however, so it makes sense to hold zeros in a tax-deferred account such as an IRA.

Because they don't pay out any periodic income, zeros react far more violently to changes in rates than standard bonds do. That makes them the ideal investment when rates are falling. If the yield on the 30-year bond falls to 5.7%, for example, zeros recently yielding 6.45% would register a 31% gain. (Conventional Treasuries, by contrast, would post a more modest 18% profit.)

Last October, Caroline Toepfer Lewin (pictured at left), 53, a clinical psychologist in Columbus, Ohio, decided to diversify her retirement portfolio, which consisted entirely of stocks. So she began buying zeros for her Keogh accounts, and now has $26,000 worth in varying maturities yielding 6.6% to 7.05%. A drop in rates would be welcome to her. "But even if that doesn't happen, I'll still get a decent return," she says.

Like Lewin, you can buy individual zeros, but commission costs are extremely high. That's why funds like the five American Century-Benham Target Maturity funds investing in Treasury zeros maturing every five years from 2005 to 2025 make sense. If you are an aggressive investor with steady nerves and want to get the biggest bang out of falling rates, choose one of the longer-term portfolios such as the $888 million Target 2020 portfolio, which yields 5.3% and has a three-year annual average return of 16.6%. In 1995, as the 30-year Treasury fell from 7.88% to 5.95% over the course of the year, the fund gained 61%.

EMERGING MARKETS DEBT Estimated total return: 11% to 14%

Investing in the debt of developing nations certainly sounds risky--and it is. Should the government topple, the new regime may not have the resources--or the desire--to pay off existing obligations. Unstable currencies can also wreak havoc with your returns. After the devaluation of the Mexican peso in 1994 sent the Latin American stock and bond markets tumbling, for example, emerging markets debt funds fell 16.2%.

But over the past decade, Latin America has been experiencing a remarkable turnaround. Deregulation and privatization of industries, stable currencies and low labor costs are all helping to boost regional economies. For example, in 1989, Argentina's rate of inflation was an astonishing 3,000%; it's now just 1%. And Brazil has been whittling down its 2,000% inflation to an expected 7.2% this year. Several debt-laden countries of Eastern Europe, including Poland and Hungary, have been blossoming as well.

Fixed-income investors can cash in on the emerging markets boom by buying Brady bonds. (To learn about mutual funds that invest in emerging markets stocks, see Fund Watch on page 39.) Named for then Treasury secretary Nicholas Brady, who devised them to help developing nations get their finances in order, these 10- to 30-year bonds are mostly denominated in U.S. dollars. The U.S. Treasury essentially guarantees the repayment of principal--but not interest. As a result, "countries that were in default now have a BBB or BB rating," says Peter Wilby, head of emerging markets and high yield at Salomon Bros. Asset Management. "And right now, it's cheaper to buy a country bond rated BB than a bond issued by an American corporation with the same rating."

In the past 18 months, emerging markets bond funds have dominated every other fixed-income category. In 1996, the average emerging markets debt fund returned 39%, topping even the rip-roaring U.S. stock market. And Wilby thinks that over the next 12 months, emerging markets debt can still generate solid returns of 11% to 14%, thanks to the steadily improving health of the issuing nations. "These countries continue to show good economic strength, and their inflation rates are more under control than they've been in the past," says Cincinnati financial planner Michael Chasnoff.

That's why Chasnoff recommends $374 million Fidelity New Markets Income, currently paying 6.5%. With about 30% of his assets in Brady bonds--mainly from Argentina and Brazil--and another 16.3% in Russia, manager John Carlson, 47, has racked up an average annual three-year return of 25%. J. Michael Martin, president of Financial Advantage, an investment advisory firm in Columbia, Md., likes $357 million Scudder Emerging Markets Income, with its 65% stake in Latin America--29% of that in Brazil--and 7.9% yield. It also has 15% of its assets in Eastern Europe, most notably a 6% slice in Russia, where interest rates have fallen from 250% at their peak in May 1996 to a recent 17%. Over the past three years, the fund has returned an average of 23% annually.

When you start enjoying returns like these on fixed-income investments, you'll never think of them as boring old bonds again.

Reporter associate: Luis Fernando Llosa