wodmarach: I think the people who you've been talking to have been taking something to cause those psychedelic colours (actually it's usually just you have too many colours all you do is set the palate to 256/high colour in compatability options)
At least for me that doesn't solve the issue.
To fix the funky color issue, I use the task kill workaround, e.g. a bat file for running a game (in this case KKND Extreme):
taskkill /F /IM Explorer.exe
KKND.exe
Start explorer.exe
Too bad though that killing explorer kills also the ability to change Windows sound volume during the gameplay, so it is a bit shitty workaround. There are other workarounds though.
wodmarach: Or just install a virtual machine and then you can play your win98 games in win98!
I'd love to hear how to do that. I tried it a couple of months ago with VMWare Player, and my verdict is that it can't be done.
Sure I was able to install and run Win98SE on VMWare Player, but you can forget about using it for games, especially for 3D accelerated games. Googling for it revealed that VMWare does not support e.g. 3D acceleration for Win9x, and probably never will. I think I couldn't get sounds to work either.
I think VMWare isn't even interested in trying to make Win9x to work good, their interests are obviously in modern OSes (Linux distros, running Win8 beta in VM etc.), not in retrogaming.
I have some games that I haven't been able to get to run satisfactorily on Win7, or even XP. Heavy Gear (1) is one such game, I'm currently playing it on a laptop which has also Win98SE installed on it. I had different kinds of problems if I try to run it on XP, even on that same machine. (The funny thing is that 1.0 version of HG seemed to work on Win7 and XP, but as soon as I applied any official patches on it, it broke down).