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June 2017 Positioning your portfolio for rising interest rates Article highlights WW A rising interest-rate environment should spur you to think about the potential impact on all of the investments in your portfolio. WW While history shows that fixed-income performance has been resilient following rate increases, other factors may also affect results. WW For stocks, past performance shows positive returns are possible when inflation is under control, as it is today. Stocks may also benefit from an expected modest improvement in economic growth. WW Stronger economic and job growth should support demand for commercial real estate and the potential for attractive returns, but with lower expected property appreciation. WW Rate increases can also impact payments from fixed and variable annuities. Investors should consider what rising interest rates could mean for an investment portfolio with long-term objectives. We do not foresee extreme market shifts in a rising rate environment. Because the current environment is different from previous ones, however, you should weigh the potential impact of rising rates. Here are some factors to ponder as you look at your portfolio of stocks and bonds in the weeks and months ahead. Considerations for fixed-income investments 1. Make sure your fixed-income portfolio is diversified. Bond sensitivity to interest-rate movements is based on several factors, including credit quality and the type of security. You should examine the bond funds in your portfolio to see how well-diversified they are. They should include a good mix of corporate bonds (both investment grade and high yield), emerging markets debt and shorter-term issues. These sectors may provide greater protection from potential losses during periods of rising rates. 2. Active management may offer advantages over indexing. Active management can help you achieve appropriate levels of exposure to various areas of the bond market during changing cycles, with greater flexibility to avoid some risks currently reflected in broader market indexes. In contrast, passively investing in an index bond strategy could leave you overexposed to U.S. Treasury debt and underexposed to higher-yielding, non-Treasury debt instruments, for example. 3. Maintain a strategic allocation to fixed income. Fixed-income losses may occur in a rising interest rate environment, but you should avoid the temptation to tinker with long-term strategic allocations based on short-term movements. A TIAA analysis shows that bonds tend to be resilient during rising rate environments. This is why you may be best served by maintaining a consistent exposure to fixed income over time. Positioning your portfolio for rising interest rates 4. Interest rates overall are likely to rise. The Federal Reserve (Fed) sets the federal funds rate— which is the interest rate that banks charge each other for overnight lending. The theory holds that when this rate increases, other rates follow. We expect the short-term federal funds rate to reach a target range of 1.25% to 1.5% and the 10-year Treasury to hit 2.75% by the end of 2017. Considerations for equity investments 1. Expect volatility and manage expectations. Investors should expect higher volatility due to uncertainty over the pace of rate hikes, the new administration’s economic policies and the risk of global conflicts. However, even with greater volatility, equity markets are not expected to decline significantly in response to rising rates. An improving economy and the Fed’s policy of keeping rate hikes moderate in size may be supportive of stocks. 2. Diversify your portfolio with enough exposure to non-U.S. markets. Although U.S. stocks have performed well in recent years, valuations in overseas markets appear more attractive— that is, less expensive—than in the U.S. This, along with expected improvements in non-U.S. earnings growth, could lead to outperformance in foreign developed and emerging equity markets. 3. Diversify income sources to avoid the potential negative impact on dividend stocks. The search for yield over the past few years bid up prices for high-dividend-paying stocks and related funds, which suffered the most as rates began to rise. These stocks, such as real estate investment trusts (REITs) and utilities, can also lag as investors shift to bonds for steady income. 4. Consider tactical reallocations—carefully. Given few lasting patterns in equity returns and the widely variable nature of interest-rate cycles, investors may carefully consider tactical changes. Technology, consumer discretionary and small-company stocks seem likely to benefit from the changing environment, while high-dividendpaying stocks are expected to underperform. Commercial real estate returns remain attractive despite rising rates Investor fears about the potential impact of rising interest rates on U.S. commercial real estate (CRE) property values and total returns (income return and property appreciation) are likely overdone. Analysis of historical data by TIAA found no statistically significant relationship between CRE performance and changes in interest rates. While we don’t believe moderately rising interest rates will hurt CRE performance, we do expect returns to be lower and closer to long-term averages. With several years of strong returns during the recovery—and the rising property values embedded in them—there is likely limited potential for further CRE appreciation, especially for higher-quality properties in more desirable locations. Nonetheless, with forecasts of continuing economic and job growth, CRE prospects remain promising in 2017. Overall we expect real estate performance to remain attractive and believe that real estate should remain an important part of a well-diversified portfolio. For annuities, rising interest rates may affect payments Rising interest rates may affect income payouts from both fixed and variable annuities. If you’re currently receiving retirement income from a fixed annuity, rate increases will not likely change the income you are receiving. However, higher interest rates in the marketplace could result in higher payouts in the future for new annuitants. Therefore, if you are considering purchasing a fixed annuity, talk with your financial advisor about the best course of action. If you are currently working and saving into a fixed annuity through your workplace retirement plan, higher rates may mean your money will earn a higher rate over time. Variable annuities invest your savings in both fixed-income and stock-based accounts whose values change depending on the performance of their underlying investments. If you’re receiving retirement income from a variable annuity, market volatility could affect your income payments. If you are working and saving into a variable annuity, you may also experience volatility in the underlying value of the account as rates rise. However, it’s important to put any volatility in the context of your long-term investment goals before changing your investment strategy. Positioning your portfolio for rising interest rates 2 Positioning your portfolio for rising interest rates Conclusion We anticipate the Federal Reserve will continue to raise short-term interest rates in 2017 and 2018 in response to stronger economic and job growth. While rising rates have the potential to cause volatility, investors should avoid the temptation to make significant changes to their long-term investment strategy. A strategic allocation to fixed income, equities and real estate continues to offer compelling benefits for diversified, long-term investors. If you have questions about the role of different investments in a diversified portfolio, contact your TIAA advisor for more information. Read more about TIAA’s perspective on rising interest rates. This material is prepared by and represents the views of Nuveen, LLC. These views may change in response to changing economic and market conditions. Past performance is not indicative of future results. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Financial professionals should independently evaluate the risks associated with products or services and exercise independent judgment with respect to their clients. Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, are not bank deposits, are not insured by any federal government agency, are not a condition to any banking service or activity, and may lose value. Please note that equity and fixed-income investing involves risk. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 877-518-9161 or go to TIAA.org for product and fund prospectuses that contain this and other information. Please read the prospectuses carefully before investing. Nuveen, LLC, formerly known as TIAA Global Asset Management, delivers the expertise of TIAA Investments and its independent investment affiliates. Nuveen Securities, LLC, Members FINRA and SIPC, distributes securities products. ©2017 Teachers Insurance and Annuity Association of America, 730 Third Avenue, New York, NY 10017 173196-INV-Y06/18 717818_822352 (06/17)