Maximize Returns: Consider Tax-Efficient Investments

In investing, it’s not what you make that counts, it’s what you keep. We’ve all heard that a million times. But with today’s lower investment return rates, it becomes more important than ever. You don’t want to drag down your investment returns with taxes that you could avoid. Tax-efficient investments are those that attempt to minimize tax liability while at the same time maximizing returns. They include the following:

Tax-deferred accounts. IRAs, 401(k)s, and other types of retirement plans. These funds aren’t required to pay annual taxes on earnings.

Individual stocks. These would include both growth stocks held long-term and dividend-paying stocks. Because of the preferred tax treatment given to long-term gains and dividends, the maximum tax rate on these investments is 15% (0% on taxpayers in the 10% and 15% tax brackets).

Municipal bonds. If you purchase bonds, either individually or in a mutual fund, that are obligations of your resident state, you’ll pay no taxes on the interest generated by those bonds, possibly making your after-tax return greater than with a similar taxable bond.

Tax-efficient mutual funds. These are funds actively managed by professionals who pay attention to the tax ramifications of their trading. Generally, turnover is low, and long-term capital gains are favored over short-term gains.

Index funds. These funds mimic a market benchmark. Since they don’t do much trading, most gains are long-term, and fund expenses are lower than normal.

Exchange-traded funds. ETFs are bundles of securities that track various indexes such as the S&P 500. ETFs trade like stocks, but act like mutual funds. Since they are passively managed, they tend to have low fund expenses.

You’ll also want to remember to rebalance your portfolio at least annually to clear out your losers (and offset them against gains), making your portfolio as tax-efficient as possible.

Phoebe Vausher-Frankeberger is a partner at Frankeberger Vausher + Co., CPAs, a full service public accounting firm. She is a Certified Public Accountant and holds a MS degree in Taxation. For more information, visit www.FVCPAs.com