Investors need to consider many factors in the process of choosing investments. One at the top of the list is an investment’s tax cost. In fact, for some individuals, this issue may be among the more influential factors when selecting investments.

The following are some points to consider about the tax efficiency of different investments you may hold in taxable accounts. Effective Jan. 1, 2013, Congress implemented a new Medicare surtax of 3.8% on net investment income. The tax will affect taxpayers with modified adjusted gross income in excess of $200,000 for single individuals and $250,000 for married couples. The appeal of some of these investments may change depending on whether you are subject to this additional tax.

<b>The appeal of stocks, bonds, and mutual funds</b>

<b>Stocks. </b>If your goal is tax efficiency, consider stocks geared more toward growth with a low dividend yield to reduce your current taxable income. The growth is tax-deferred until you sell the stock. This ability to defer tax provides some flexibility because you can manage your gains and losses based on when you sell your stock. If you hold the stock for more than one year, the gain will be eligible for a lower long-term capital gain rate as opposed to the ordinary income tax rate.

If you need an income-producing stock, consider one that will pay dividends that qualify for the reduced qualified-dividend rates versus ordinary income rates. The rate for qualified dividends is the applicable capital gains rate. Bear in mind, dividends are not guaranteed. A company may reduce or eliminate its dividend at any time.

Qualified dividends are paid by U.S. corporations and some foreign corporations. A qualified foreign corporation is one incorporated in a U.S. possession, eligible for tax-treaty benefits with the United States, or traded on an established United States securities market. Income from preferred instruments qualifies to the extent it represents an equity instrument rather than a debt instrument. Mutual fund dividends do not qualify unless the dividends passed through are from qualified corporations, as described above. It’s important to note that real estate investment trust (REIT) dividends do not qualify for the reduced rate.

Keep in mind, the return and principal value of an investment in stocks fluctuates with changes in market conditions. Upon redemption, it may be worth more or less than the original investment.

<b>Bonds. </b>Municipal bonds, which state and local governments issue, pay interest that’s exempt from federal income taxes – although some may be subject to the federal alternative minimum tax (AMT). The interest is also often exempt from state taxation if you purchase bonds issued by either the state in which you reside or a local government within that state. Although the interest income is tax-free, capital gains, if any, are subject to taxes.

Before purchasing a municipal bond, you must consider whether the tax-free interest is a big enough advantage to overcome the potential for higher yield a taxable government or corporate bond may provide. To compare a tax-free versus a taxable bond, consider the taxable-equivalent yield.

Generally, a municipal bond with a 4% yield, for example, would compare to a corporate bond with a 5.3% equivalent yield (assuming you are in the 25% income tax bracket and excluding state tax). A decision between these two bonds might still favor the tax-free bond because the taxable bond would add to adjusted gross income (AGI) and the calculations related to AGI and AMT.

In addition, tax-free municipal bond interest is not included in investment income for the 3.8% Medicare surtax. Interest from taxable bonds is included for the tax computation.

Investing in fixed income securities involves certain risks, such as market risk, if sold prior to maturity and credit risk, especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.

<b>Mutual funds.</b> You may be able to reduce your taxes by choosing funds historically managed with low turnover and minimal yields. The yield will provide an indication of the amount of interest and dividend distributions. The turnover ratio measures the fund’s trading activity. Funds with higher turnover ratios typically distribute more capital gains, which are taxable to the investor whether they are paid out or reinvested.

To help evaluate the effects of taxes on mutual fund returns, use Morningstar’s Tax Cost Ratio, which represents the percentage reduction in an annualized return resulting from income taxes. This can provide an estimate of how much of your investment return you would lose to taxes. This type of planning can provide some guidance on the taxability of the annual distribution.

However, the fund manager’s actions will ultimately determine the capital gains distributions for the year. This can have significant tax implications. Of course, as with any financial decisions, investment considerations should take priority over tax issues.

There are risks associated with investing in mutual funds. Your investment return and principal value will fluctuate, and you may receive more or less than your original investment when you redeem your shares.

<b>Look at the whole picture</b>

Though our focus here is on tax-efficient investing, remember: just because an investment offers tax advantages doesn’t mean it’s appropriate for your portfolio – look at the whole picture. However, it’s a factor to consider – especially if you’re in one of the higher tax brackets.

Before you invest, you need to consider your goals regarding return and risk as well as your time horizon. Only by taking all of these factors into consideration can you determine whether a particular investment is right for you.

Wells Fargo Advisors is not a legal or tax advisor. You should consult with an attorney, accountant and/or estate planner before taking any action.

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.

<em>This article was written by/for Wells Fargo Advisors and provided courtesy of Ashley Dando, Vice President, Beaufort, SC 843-524-1114.</em>

<em>Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE. Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo &amp; Company.</em>

<em> ©2015 Wells Fargo Advisors, LLC. All rights reserved. </em>