A Simple Guide to TIAA-CREF

by

David L. Debertin

Professor of Agricultural Economics
University of Kentucky


Dave's Words of Investment Wisdom
(With Thanks to Peter Lynch and Others)

Keep in mind...

1. Stocks have outperformed bonds for 8 of the 9 complete decades of the 20th century, and every indication is that the record will be 9 out of 10.

2. The real threat to retirement savings is not a short term market plunge like the one that occurred in October, 1987, but rather a period of malaise like what occurred between 1973 to 1979, when inflation was soaring.

3. The weak performance of equities in the 1970s had a lot to do with the fact that people were putting money in tangible assets such as real estate and even gold in an effort to cope with inflation. It's not surprising that people were unwilling to put their money in financial assets. We have to have some confidence that the Fed will not make the mistakes they made in the 1970s, when they chose to monetize the deficit.

4. Whether the stock market continues to do well depends heavily on the Fed's willingness to keep inflation in check, even though an interest rate rise may send the market lower in the short run.

5. For the long term investor who puts a few dollars away each month, market timing is of little consequence. According to Peter Lynch, if you had picked the best day each year (the day when the market is lowest) to invest in the stock market, you would have received an annual rate of return of 11.7 percent over the last 30 years. If you had picked the worst day (the highest market) the return would have been 10.6 %---a very small difference.

6. Timing the market is a fools game. If you had been out of the market for only 40 months of the last 40 years-- less than 10 percent of the time--your returns would have dropped from 11.4 % down to 2.7 % Those who attempt to time the market usually miss out on the really strong rallies too.

7. Corporate profits go up 8 percent a year and corporations pay dividends averaging 2.5 % over the long term. Dividends rise by 8 percent each year too. Thus, the total return is 10.5%. The performance of the stock market will likely return to this long-term norm...but the questions of when and how remain.

8. Stock market rallies don't always end with a significant downturn in prices--instead, stock prices often remain stable for a period of time while corporate profits catch up.

9. Baby boomer demographic trends fuel a continuing demand for stocks as retirement draws near.

10 Those of us who remain invested should be thankful for those willing to invest only if the market turns significantly lower. These "crows on the fence" buy into market dips and limit our losses.

11. If you wake up at night and worry about how your retirement savings portfolio is allocated, chances are, you don't have the allocation right. Get up the next morning, make the changes, and then get a good night's rest the following night.

12. The four major factors affecting stock prices are earnings, inflation, interest rates, and liquidity. Liquidity refers to the fact that some money remains to be invested in the market under the right set of circumstances. Which of these factors is most important depends on who you talk to.

13. For stock prices to continue to rise, there must not only be optimism about the future, but rising optimism. The latter occurs far less frequently than the former.

14. There is no shortage of people willing to forecast the next stock market crash. A good way to make money on this idea is to write a book. There is no shortage of buyers for such books either. These guys are every bit as good at their craft as the "end of the world" forecasters.

15. To make money in equities, the investor needs courage and patience. Courage involves having enough self confidence so that you believe in what you are trying to do. Patience means sticking with an idea so long as you are convinced of its validity. A little knowledge is also helpful.


Table 1. Closing Value and Earnings for the S&P 500 Index, 1957-97


Year  Closing  Earnings Percentage
       Value   for the   Change
        S&P      S&P      S&P    Inc.
       Index    Index    Index  Dividends
        (1)      (2)      (7)
1957   39.99    3.37    -14.3
1958   55.21    2.89     38.1
1959   59.89    3.39      8.5
1960   58.11    3.27    - 3.0
1961   71.55    3.19     23.1
1962   63.10    3.67    -11.8
1963   75.02    4.02     18.9
1964   84.75    4.55     13.0
1965   92.43    5.19      9.1
1966   80.33    5.55    -13.1
1967   96.47    5.33     20.1
1968  103.86    5.76      7.7
1969   92.06    5.78    -11.4
1970   92.15    5.13       .1
1971  102.09    5.70     10.8
1972  118.05    6.42     15.6
1973   97.55    8.16    -17.4
1974   68.56    8.89    -29.7
1975   90.19    7.96     31.5
1976  107.46    9.91     19.1
1977   95.10   10.89    -11.5
1978   96.11   12.33      1.1
1979  107.94   14.86     12.3
1980  135.76   14.82     25.8
1981  122.55   15.36    - 9.7
1982  140.64   12.64     14.8
1983  164.93   14.03     17.3
1984  167.24   16.64      1.4
1985  211.28   14.61     26.3
1986  242.17   14.48     14.6
1987  247.08   17.50      2.0     5.10
1988  277.72   23.76     12.4    16.61
1989  353.40   22.87     27.3    31.69
1990  330.22   21.34    - 6.6    -3.10
1991  417.09   15.97     26.3    30.47
1992  435.71   19.09      4.5     7.62
1993  466.45   21.88      7.1    10.08
1994  459.27   30.63    - 1.5     1.32
1995  616.00   N/A       34.13   37.58
1996  740.74   N/A       20.25   22.96
1997  948.00   N/A       27.98   30.00
(N/A = not available.  1997 Figures are to Sept 30 and Sept 30 
figures are approximate)

Performance of the S&P 500 Index Representing Stocks of 500 of the Largest US-Based Corporations Over the Past 10 Years


Dave's Simple Guide to TIAA-CREF


Year-To Date Figures for CREF Accounts


Unit Values for CREF Accounts

CREF Equity Index Account

The Equity index Account is indexed to the Russell 3000, a market capitalization-weighted index that includes stocks of 3000 US-based corporations. Since the index is weighted by market capitalization, it is dominated by the large S&P 500 companies representing perhaps 80% of the index. The approximately 20 % portion outside the S&P 500 companies gives it a small- and mid-cap component as well. It performs less well than an S&P index fund when small- and mid- cap companies are doing worse than S&P 500 companies, but better when small- & mid- cap stocks are experiencing faster gains than S&P 500 companies. With the strength of the S&P 500 stocks over the past 24 months, this account has underperformed S&P 500 index funds, but in recent weeks has been catching up as small- and mid-cap stocks strengthen while large-cap stocks show signs of weakness. This is considered an "unmanaged" equity fund and expenses are ultra-low.

Outlook:

Choose When:
1. The economy is gaining strength
2. inflation is low or coming down
3. corporate earnings are rising
4. The deficit is declining
5. interest rates are stable or declining
6. small- and mid-cap stocks appear to be gaining on large cap stocks
7. you believe an equity fund manager cannot boost stock fund performance

Avoid When:
1. The economy is weakening
2. inflation is showing signs of increasing
3. corporate earnings are weakening
4. The deficit is increasing
5. interest rates are rising
6. small- and mid-cap stocks are sluggish relative to large-cap stocks


CREF Growth Account

The CREF Growth account is a managed equity fund in which stocks are chosen for their growth potential. It consists primarily of large-cap stocks with a very small exposure to small- and mid-cap stocks. This fund did very well in 1996 but has shown some signs of weakening with the comparative weakness in the large-cap portion of the market in recent months. The term "Growth" is a misnomer, in that a portion of the stocks are selected on a value (low P/E) basis. The fund is conservatively managed, and tends not to overweight sectors in an effort to boost performance. In theory, a fund manager may be able to outperform an indexed fund by making excellent stock selections. Its expenses are higher than for the Equity Index Fund. The Growth Account manager is not limited to investing in stocks of US-based corporations and can allocate funds to non-US companies if he believes there is a greater potential for returns there.


Outlook:

Choose When:
1. The economy is gaining strength
2. inflation is low or coming down
3. corporate earnings are rising
4. The deficit is declining
5. interest rates are stable or declining
6. large-cap stocks appear to be gaining on small and mid-cap stocks
7. you believe an equity fund manager can boost stock fund performance

Avoid When:
1. The economy is weakening
2. Inflation is showing signs of increasing
3. Corporate earnings are weakening
4. The deficit is increasing
5. Interest rates are rising
6. you believe small- and mid-cap stocks will do better than large-cap stocks


CREF Global Account

The CREF Global account invests primarily in stocks of foreign-based corporations, but includes some US based multinationals as well. Conservatively managed, the fund invests primarily in major companies in Europe and Japan. It has only a small portion of the money in what could be termed "Emerging Markets". Most of the companies the fund invests in are quite large and well known.

Outlook:

Choose When:
1. The world economy is gaining relative to the US economy
2. The US economy shows evidence of weakening
3. Exchange rates favor companies in Europe & Japan over US-based firms

Avoid When:
1. The US economy is showing stronger gains than Europe or Japan
2. Inflation is showing signs of increasing
3. corporate earnings are weakening
4. The US deficit is increasing
5. Global interest rates are rising
6. You believe small and mid-cap stocks will do better than large-cap stocks
7. The dollar is weak relative to foreign currencies.


The CREF Stock account

The CREF Stock Account is the oldest of the CREF Equity accounts, begun in 1952. 60 percent of the CREF Stock Account is indexed to the Russell 3000, as is the Equity Index Account. Another 20% is actively managed and contains stocks of US-based corporations, similar to the CREF Growth Account. Approximately 15-17% more is also managed and contains stocks of foreign-based corporations. The remainder is in other than equities such as cash.

Outlook:

Choose When:
1. The economy is gaining strength
2. inflation is low or coming down
3. corporate earnings are rising
4. The deficit is declining
5. interest rates are stable or declining
6. you are uncertain as to whether small and mid cap stocks will be gaining on large cap stocks
7. you are uncertain as to whether the US or foreign economies will be stronger

Avoid When:
1. The economy is weakening
2. inflation is showing signs of increasing
3. corporate earnings are weakening
4. The deficit is increasing
5. interest rates are rising
6. you believe US-based companies will do better than large foreign-based companies


The CREF Bond Account

The CREF Bond Account invests primarily in US government debt and high quality corporate bonds. Bond funds in general are less volatile than stock funds, but tend to underperform stock funds over periods of 10 years or more.


Outlook:

Choose When:
1. The economy is sluggish and showing only weak growth
2. inflation is coming down
3. corporate earnings are showing signs of weakening
4. The Fed is moving toward lowering interest rates in an effort to stimulate the economy

Avoid When:
1. The economy is getting stronger
2. inflation is showing signs of increasing
3. corporate earnings are strengthening
4. The deficit is increasing
5. interest rates are rising


The CREF Social Choice Account

The Social Choice Account is actually a balanced fund, containing both stocks and bonds. It avoids investing in stocks of any companies thought to be socially irresponsible--ie tobacco companies. The Social Choice account will tend to do less well than the other equity accounts in a strong equity market, but will be less volatile. The fund is actively managed and will have higher expenses than the Equity Index Account.


Outlook:

Choose When:
1. Uncertainty exists with respect to whether the economy is slowing
2. inflation is coming down
3. corporate earnings are uncertain
4. You believe the Fed may move toward lowering interest rates in an effort to stimulate the economy

Avoid When:
1. The economy is clearly getting stronger
2. inflation is showing signs of increasing
3. corporate earnings are clearly strengthening
4. The U.S. deficit is increasing
5. interest rates are rising


TIAA Real Estate Account

The TIAA Real Estate account is invested in a portfolio of mostly commercial real estate. It is managed by TIAA personnel, not CREF. Unlike the TIAA annuity, money can be moved in and out of the Real Estate Account to the other CREF accounts (transactions limited to one per month, but with no other restrictions). TIAA has traditionally done an excellent job of picking commercial real estate properties. Compared with the equity accounts, returns will tend to be lower, on average, but less volatile.

Outlook:

Choose When:
1. You are risk averse and cannot tolerate the volatility of the Equity or bond funds
2. inflation is rising
3. corporate earnings are uncertain
4. the rental market for commercial real estate is strengthening
5. The outlook for the US and world economies is uncertain

Avoid When:
1. You want the highest long term expected returns--10 years or more
2. inflation is low or declining
3. corporate earnings are clearly strengthening
4. The commercial real estate market appears to be overbuilt


Inflation-linked Bond Account

This fund invests in the new inflation linked government bonds, which guarantee a rate of return above the rate of inflation.

Outlook:

Choose When:
1. You are risk averse and cannot tolerate the volatility of the equity funds
2. inflation is rising
3. corporate earnings are uncertain
4. The outlook for the US and world economies is uncertain

Avoid When:
1. You want the highest long term expected returns--10 years or more
2. inflation is low or declining
3. corporate earnings are clearly strengthening


CREF Money Market Account

This fund invests in short term bank certificates of deposit and other short term debt. It is designed simply to hold retirement money for a short period of time while you make choices from among the others.

Outlook

Choose When:
1. You are trying to decide among the other investment options

Avoid When
1. You have made your decision as to which other option you want to go with.


TIAA Fixed Rate Annuity

The TIAA annuity guarantees a fixed interest rate on funds invested in it. This varies depending on when the funds were invested, but recently has been in the 6% range. There is also a guarantee on the interest rate paid to retirees out of the annuity. The TIAA annuity is a very well run and low cost product. Compared with those offered by private insurance companies, TIAA has paid extraordinarily high rates-- recently 9% or more--to retirees. There is a good article in the most recent issue of "The Participant" discussing its performance. TIAA invests in a mixture of commercial real estate as well as government and corporate bonds. For example, it is the leading debt holder of the "Mall of America" in Minneapolis. Many of the commercial real estate holdings have been very profitable in recent years. The major problem with the TIAA Account is that transfers out of the account to the CREF accounts can only be made slowly, over a ten year period, so it is a bit like a retirement "roach motel," and offers less flexibility than is possible with the other accounts.

Outlook:

Choose When:
1. You are risk averse and cannot tolerate the volatility of the CREF funds
2. inflation is rising and future inflation rates are uncertain
3. corporate earnings are uncertain
4. The outlook for the US and world economies is uncertain
5. The interest rate outlook is uncertain
6. You want stability in your income from year to year when you retire, with some increase over time to keep up with inflation

Avoid When:
1. You want the highest long term expected returns--10 years or more
2. inflation is low or declining
3. corporate earnings are clearly strengthening
4. You want to manage your retirement savings by moving money between the various accounts
5. You feel comfortable about the future of the American (and world) economies.


Dave's Definitions Page--Types of Mutual Funds

Aggressive Growth Fund

A fund that chooses stocks of companies which have accelerating earnings, regardless of the Price/Earnings ratio. Examples include the 20th Century funds sold by American Century and available as an option for retirement funds for UK employees. Another firm specializing in these kinds of funds is PBHG. These funds do well in certain kinds of strong markets, but poorly in weak markets. They tend to be extremely volatile. For the past 12 months these finds have been weak, but show recent improvements.

Growth Fund

A fund that invests in stocks of companies that are growing rapidly in size and earnings. Some attention may be paid to P/E ratios in the fund manager's selection process. Generally these companies pay little if any dividends, so these funds are not a good choice if you need dividend income. There are many subcategories of growth funds and subtle variations. CREF Growth is not strictly a Growth Fund, but contains some "Value" components as well. Growth funds tend to do well in up markets but poorly in down markets.

Value Fund

A fund that invests in stocks that have been beaten down by investors such that their P/E ratios are very attractive. Often these stocks have a share price of under $25. A good example of a value fund is Fidelity Low-Priced. Value funds tend to underperform market indices in strong up markets, but do better than the market in total in down markets. They tend to be less volatile than growth and aggressive growth funds, and long term returns can be quite good. CREF Growth is partly a value fund.

Emerging Growth Fund

A fund that invests in stocks of primarily small companies with low current earnings, but thought to have outstanding prospects for long term growth. Fund managers are looking for the next Microsoft or Intel. These funds tend to be quite volatile, but expected earnings can be high.

Emerging Markets Fund

A Fund that invests in stocks of companies headquartered in developing countries or in emerging market economies. These funds are often very volatile, but very high returns (or losses) are also possible.

Sector Fund

A fund that invests in stocks in a specific sector--ie technology, health care, or food & agriculture. Fidelity offers over 35 sector funds, many of which outperform the market averages. Other companies offer some but have fewer choices.

Index Fund

An unmanaged fund designed to track a market index, most often the S&P 500. Vanguard offers an array of index funds tracking all sorts of indices. They are considered unmanaged funds since the selections are simply the stock in the index (or a statistical sampling of them). They tend to have low expenses relative to actively managed funds. The CREF Equity Index Fund is indexed to the Russell 3000 index, which is broader based than the S&P 500 index and includes smaller companies. Index funds tend to be tax efficient, since under ordinary circumstances they do little selling.

Income Fund

A fund that invests in stocks of companies that pay dividends, designed for people who need continuing income from their equity investments

Bond Fund

A fund that invests in a portfolio of bonds, there are many different subcategories based on corporate versus government bonds; bond maturities; quality of bonds (ie "junk" bond funds) etc etc.

Balanced Fund

A fund that invests in both stocks and bonds.

Asset Allocation Fund

Another name for a balanced fund (see above).

International Fund

A fund that invests in stocks of foreign-headquartered corporations. These may also include bonds from foreign companies or governments.

Global Fund

A fund that invests in stocks worldwide, regardless of the location of the corporate headquarters.

Region- or Country-Specific Fund

A fund that invests in stocks in one region of the world (ie Pacific Rim; Latin America) or a specific country (Russia; Germany). Fidelity offers over 20 of these for different regions or countries.

Open End Fund

A fund that does not have a specific number of shares. New shares are created as investors purchase them. Most Mutual funds are open end.

Closed End Fund

A fund with a specific number of shares. These funds are usually traded on a stock exchange such as the NYSE. Share price varies with the underlying value of the securities and the demand and supply of the shares. Closed End funds can sometimes be purchased at a discount to the underlying value of the securities they hold. They are traded like stocks. Many of the Templeton country funds are closed end funds.

Closed fund

A fund that has decided to limit its size and is no longer selling shares to new investors. Usually those who already own a share can still purchase more. Fidelity is about to close Magellan to new investors.