"It probably shouldn't be your No. 1 investment criteria, but [taxes] ought to be in your top three or four," says Philip J. Holthouse, partner at Los Angeles tax law and accounting firm Holthouse Carlin & Van Trigt. "If you don't take the tax consequences into account, you are cheating yourself."

There are plenty of opportunities to combine investing and tax management in profitable ways. But the increasing array of choices is making the process complicated for the average investor. And that can lead to costly mistakes.

Holthouse has seen dozens of them. He's had clients--sophisticated, high-income types--fail to realize that they triggered taxable gains when they sold one mutual fund and bought another within the same fund family.

He's seen high-income individuals sell a stock one month too soon--within 11 months of the purchase, which precludes them from claiming preferential capital gains tax rates on the profit. Bottom line: Their federal tax hit jumps to 40% from 20% on the transaction.

He's seen people put variable annuities and municipal bonds in retirement accounts--an unnecessary and costly doubling up of tax-favored vehicles.

Worse still, he's seen individuals pull money out of retirement plans to pay off bills or buy luxury items. The hit--taxes and penalties--is crushing, usually about half of the amount withdrawn, and these individuals forever lose the benefit of allowing that money to grow for long periods on a tax-favored basis.

So what are the wise ways to combine taxes and investing?

* Invest in tax-managed accounts. Mutual fund companies are increasingly offering funds that promise to manage the taxable income passed on to you. One of the more effective strategies they use is simply to not trade shares often. Index funds, which buy and hold all the stocks in a particular stock index, are among the most tax-efficient. Generally, the only gains they pass on to investors are dividends and an occasional long-term gain from selling shares in a company that's been bought out or has otherwise fallen out of the index.

* Trade sparingly. The best way to manage your capital gains bills is to not trigger any gains. After all, you have to pay capital gains taxes only if you sell shares at a profit. If you buy stocks because you think the company has great long-term potential and nothing dramatic has occurred to make you change your mind, sit tight.

* If you must trade, trade in tax-favored accounts. There are options galore--Roth IRAs, traditional IRAs, Keogh accounts and 401(k)s, for instance--that shelter your gains from tax until you pull the money out at retirement. The first three types of accounts allow you to completely self-direct your investments. (You also self-direct your investments with a 401[k]--but your options are usually more limited.) You can buy individual stocks, mutual funds, bonds, certificates of deposit, etc. And if you decide you want to alter your investment mix, you can sell any or all of your holdings without triggering a taxable gain. Of course, you also can't use capital losses realized within a retirement account when figuring your taxes. So do your best to trade wisely.

* Fully fund any tax-favored account you have available, starting with your 401(k) plan at work. Contributions to 401(k) plans--and similar plans such as the 403(b) for teachers--are deducted from your taxable income, so they reduce your federal income tax.

Additionally, most employers match anywhere from 25% to 100% of their workers' 401(k) contributions, up to set amounts. So if you put in $100, the employer kicks in an additional, say, $50. You make 50% on your money before you've invested a dime. You don't pay current income tax on either the company contributions or the investment income you've earned on the account, either. It grows and compounds on a tax-deferred basis until you withdraw the money. It doesn't get much better than this.

What if you have a 401(k) plan at work, but are not contributing to it because you want to pay off your debts first? You may be giving up more than you know.

Let's say you're in the 28% federal tax bracket, like most working Americans. If you contribute $5,000 annually to a 401(k), or $417 per month, that reduces your taxable income by the same amount. The result: You pay $1,400 less in federal income tax that year. Or, to put it another way, your $5,000 contribution has a net cost to you of $3,600. Now, your employer kicks in, say, 25%, or an additional $1,250 a year ($104 a month). Then you earn an average of 10% on your money. At the end of year one, you have $6,545. Considering that your net (after-tax) cost was $3,600, that's an 82% return.

That beats saving the 20% or so interest on a credit card debt.

But if you want to be really smart, figure that you have $5,000 annually to spend. Because a $5,000 401(k) contribution is only going to cost you $3,600 after tax, use the remaining $1,400 to pay down your debt. Keep it up and you would pay off your $5,000 debt in less than five years. Your 401(k), assuming you keep earning that average annual return of 10%, will be worth a tidy $40,332.

What about about buying variable annuities and municipal bonds?

If you are very wealthy--paying income taxes at the nation's highest rates--municipal bonds can make sense for a good portion of the fixed-income portion of your portfolio. Unfortunately, many people with scant taxable income buy munis so they don't have to pay income tax on the investment income. But because municipals generally pay significantly less interest than taxable bonds, these people often get a lower after-tax return than they'd earn on a taxable-bond investment.

As for variable annuities, they work for high-income individuals who have maximized their other tax-favored retirement account options but still want to save more. But they're a sorry replacement for investing in a 401(k). And some tax advisors argue that they're less attractive than simply investing in stocks or tax-managed mutual funds for the long term. Annuities are less flexible than taxable investments, they note. And when you permanently withdraw money from an annuity, your investment gains are taxable at ordinary income tax rates, rather than at the lower capital gains rates.

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