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I'm about twenty years from retirement and I haven't given TIAA traditional much thought. I figured that it would be something that I would switch my money into only once I retired and set up my distribution plan from TIAA.<P>

However, I just read a very interesting post over on Bonds & Fixed Income Investments board: http://boards.fool.com/Message.asp?mid=23969138&sort=whole <P>

The relevant part is quoted below. Loki now has me thinking that I should be considering TIAA traditional in my 403b account for the Bond/Fixed Income portion of my asset allocation strategy. However, I'm confused about what TIAA traditional really is. Is there a benefit to beginning to drip money in now as opposed to waiting until near retirement? How are the interest rates deterimined? Does money that is in there longer get preferential treatment?<P>

Confused and Dazed,
Ken

I'm lucky enough to have TIAA-Traditional as an option, and it's great for the regular retirement portion. But for Supplemental, which is increasingly where the money goes, since they raised the limits, TIAA-Traditonal pays 75 basis points less (it's been as much as 150 basis points). There's a reason for this: with the regular portion, you can't take the money out until a drip during retirement, while for Supplemental you can switch the money around, so they use shorter maturities for Supplemental. I can't match the regular TIAA Traditional on my own with a Treasury ladder, but I can beat Supplemental by about 50 basis points, and probably beat the yield on their bond fund by 25 basis points (given the expense ratio). Speaking of expense ratios, I can see no reason why these retirement plans are defined as annuities, when all you are doing is putting money into a fund, and they charge at least an extra .25% expense ratio for the same thing as you would get in a taxable account, and that's TIAA-Cref, one of the good guys.
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Hi Ken,

Got your message. Need to get one of those anonymous email accounts so I feel more comfortable just replying, or else just reply to people, like you, I know are safe.

Anyway, probably better for general consumption.

I haven't yet figured out (or tried to) how TIAA-Traditional does its payouts after you start taking money out. It may be different for the regular retirement, where you are restricted as to how much a year, and Supplemental which I believe is unrestricted. During your accumulation phase, once you stick money into TIAA-Traditional in the regular retirement account, you can't move it out. In Supplemental, you can use TIAA-Traditional like a money market or stock or bond fund and move in and out at will. I presume that is why it consistently has a much lower interest rate (as I recall anywhere from .5% to 1.5%) than the regular retirement TIAA-Traditional. It seems to correlate with the yield curve, so when short rates were very, very low, the differential was high, since the yield curve was steep and long rates much higher. I'm guessing, because people can move money around, the Supplemental version uses mostly short term instruments.

My view of TIAA-Traditional is that it is a fixed-income/bond asset. If you are interested in rebalancing, it is useless in the regular retirement account (except if you permanently want to cash out of some portion of stocks, but you can't move money back into stocks). However, if you've reached the point, as I have, where you want a strong fixed-income allocation in tax-advantaged accounts (most of my stock holdings are now in taxable, except the pittance in Roths), TIAA-Traditional in the regular retirement account tends to be competitive with 5-year CDs, which aren't an option.

TIAA-Traditional in the Supplemental account is not competitive with what you could get for a fixed-income ladder in a taxable account (or IRA/Roth). What comes closer in yields is the Cref Bond fund. (Since I want to defer taxes on income, I'll take what I can get in the Supplemental rather than a taxable account.) TIAA-Traditional is not subject to interest rate risk: it pays you your interest and compounds it. The bond fund, like all bond funds, gets a return based on the value of its bonds plus its dividends. It's kind of invisible, because they get lumped into the NAV, unlike Vanguard's Total Bond Index Fund (same benchmark, lower expense ratio), where you can see the dividends and what happens to bond values as the NAV goes up and down. The reason the bond fund has been down this year is because interest rates are up. When interest rates are going up, even the low return on the Supplemental TIAA-Traditional will beat the total return on the bond fund. When interest rates hold steady or go down, the bond fund wins. This is why I am trying to "market time" when to switch money to the bond fund, by trying to understand inflection points. (I'll probably try a mix of the two and rebalance.)

Even if you're doing stocks and bonds and rebalancing in Supplemental, you still want to be in TIAA-Traditional for the bond allocation when interest rates are rising. I wish I had a crystal ball to tell you when rates will peak: my latest inflection point guess is 6% on 10-year Treasuries, but I'll probably change my mind tomorrow.
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Loki-
Thanks. That does clear a few things up.

I agree that the rebalancing issue is a problem for the traditional fund in the regular account but that it makes a very nice foundation investment for that account. I can imagine (once I get a little closer to retirement) shifting about half of my "fixed income" allocation into that fund there. The rest might be in the bond fund in the supplemental account or in 10-year treasuries through a taxable Fidelity account. I agree that 6% 10-years might be the top (but what do we know?).

Cheers!
-Ken
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"I agree that 6% 10-years might be the top (but what do we know?)."

Ken,

Not sure I think it is a peak, but might be a point where the the results of bond values over time will be neutral, so we can just get the yield. But it is a stab in the dark.
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Ken,

You still out there?

I was just looking at past numbers on bond fund versus the supplemental TIAA-Traditional. Traditional wins on 5 and 10 year returns, as well as last couple of years. I was surprised at 5 years, because interest rates are still down from April '01, and Traditional went through a very low period over the last 3 years.

Makes me think bond fund only likely to win if you get in with chance of solid capital gain.
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Of course I'm still here. I may be the only one who has this board on their "favorites"!

That is very interesting. Was that for the regular retirement account or the supplemental?

-Ken
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Hi Ken,

I'm talking about comparing supplemental with the bond fund. I would generally expect TIAA-Traditional in the regular account to outperform the bond fund, except when the bond fund is sitting on a substantial capital gain when interest rates get very low (if then). The regular TIAA-Traditional is basically a conservative pension plan that buys long bonds to cover future distributions, plus other tricks up its sleeve, so its yield ought to be higher than the Lehman total bond index, which the bond fund (like Vanguard's total fund) tracks. What will happen when boomers start retiring and maybe moving lots of money into TIAA-Traditional and then out is a different story. I think they have their bases covered.

But with supplemental, the comparison doesn't make sense. While I've been paying attention for the last few years, the bond fund has consistently had a higher yield than Traditional's interest rate (by more than .5%). And if we look at how interest rate risk is supposed to work, in reverse, duration multiplied by change in basis points, the capital return on the bond fund over 5 or 10 year periods should be significant.

I can easily find numbers for Vanguard, which tracks the same index, though I can't find historic durations, but if anything they used to be longer (more long bonds in the index), so I think a duration of 5 is minimum, but we could use 4 and draw the same conclusions.

On 7/18/96 the Vanguard fund had a yield of 6.58%; same day in 2001 the yield was 6.18%, this April 18 5.08%. (The Vanguard yields are slightly higher than Cref bond fund, because of lower expense ratio, but the difference is consistent.)

So based on interest rate risk formula, over 10 years, there should be a capital return of about 7.5%, .75% annualized. Over 5 years, capital return should be 5.5%, or 1.1% annualized. Because of higher yield, the compounding should be in favor of the bond fund, but I'll ignore it.

So bottom line is, I would predict the bond fund to have beaten supplemental Traditional by around 1.25% annually over 10 years and 1.6% for 5 years. In fact, it should have beat the regular Traditional, even if regular gets higher yields by .75% annually. But, in fact, over both 5 and 10 year periods, Traditional is winning.

Somehow, not only is the capital return vanishing into thin air, so is the higher yield.

This is what I've been trying to figure out on the bond board. Something is going on, at least with funds that track the Lehman total index, that is leading them to substantially underperform what income return plus capital return based on the interest rate risk formula says is supposed to happen.
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I may be the only one who has this board on their "favorites"!
  Not so!
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I may be the only one who has this board on their "favorites"!

Not so!

Right. It's on my Favorites, too!
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