Rating the TIAA-CREF Returns

Pension giant disputes critique of its performance, but even critics of findings say study raises key issues for colleges and employees.
February 1, 2007

The press release's headline is enough to make any of the 3-million-plus people with TIAA-CREF retirement accounts take notice: "Drucker School Researchers Find That Millions of TIAA-CREF Investors May Be Losing Up to $1 Million of Their Terminal Wealth."

The details are a little more complicated. There is a new, peer-reviewed study about to appear in a financial journal that suggests that TIAA-CREF participants at institutions with a limited set of TIAA-CREF options may lose out significantly compared to colleges that offer more options. And for some of those participants, the study says that the gap could reach $1 million. Needless to say, the findings are being much discussed (with much of the discussion private) in the highly competitive world of higher ed retirement plans. But TIAA-CREF says that the findings are skewed beyond the point where they have any value -- and the study's authors acknowledge some limitations of their research.

At the same time, TIAA-CREF agrees with the authors of the study and other experts that the findings point to the need for colleges to more frequently evaluate the retirement plans open to their employees -- and that some employees may not have enough options.

The paper setting off the discussion -- "What's in Your 403(b)? Academic Retirement Plans and the Costs of Underdiversification" -- was prepared by two economists at Claremont McKenna College, and by a business school professor and a mathematics professor at the Claremont Graduate University. Their findings will appear in the spring issue of Financial Management, and a version of their work is available through the Social Science Research Network.

They took the performance of eight TIAA-CREF funds and compared performance over a nine-year period with a series of funds offered by Vanguard. A series of scenarios were explored to consider the different investment patterns of people willing or unwilling to tolerate risk, and the extent to which people generally take fewer risks  as retirement approaches.

Based on these analyses, the study found that people in TIAA-CREF funds, for whom similar contributions were being added to retirement accounts, could end up after 40 years of work with anywhere from $350,000 to $1 million less than someone making comparably risky choices through Vanguard. (Risk-averse investors would have the smaller gap while gutsier investors would have the larger gap.)

Richard L. Smith, a professor of financial management at Claremont Graduate University and the lead author of the study, said that the work was prompted by the realization that changes in federal laws about the responsibilities of employers that provide pensions might discourage colleges from offering their employees more retirement options. The researchers wanted to see how big a difference it makes to have more options. (There was no outside financial support for the project from anyone in the higher ed retirement business, or from anyone, he said.)

It's vital for college leaders to understand those differences, Smith said, because the choices they make determine the choices of their employees. The employees may decide which combination of funds to use, but only among those a college has selected. Some institutions include choices from TIAA-CREF and other companies like Vanguard or Fidelity. Even among the many institutions that restrict choice to TIAA-CREF, employee options can vary widely, with some institutions giving their employees many more options from among the TIAA-CREF portfolio than others do.

Given all of that variation, the key question is why the Claremont analysis found such a gap between TIAA-CREF and Vanguard and whether the comparisons show what the study says they show. Smith and his colleagues attribute the gaps to the relatively small shares of the TIAA-CREF funds they compared that were focused on certain classes of assets that happen to have been big winners in recent years -- categories like international investments and small businesses. Smith said that the comparison group was based on actual choices that have been offered at many colleges, and so are valid.

TIAA-CREF thinks the opposite. "This paper's flaws are really misleading," said Brett Hammond, chief investment strategist at TIAA-CREF. "You can't understand diversification if you don't have a complete fund lineup." What that means is that he questions whether many people have the choices the Claremont professors believe exist. And even if they did have those choices, Hammond questions whether people would make their investment choices the way the Claremont scholars projected.

With several dozen additional choices that were left out, and with increasing attention being given by investment managers to some of the asset categories Smith and his colleagues saw as valuable, Hammond said that any college that wanted could have viable TIAA-CREF options that place more of an emphasis on those areas.

He said he was absolutely certain that a fair comparison would not show any gap. Hammond said he was not criticizing Vanguard, which he called a "wonderful company," but the comparison made by the professors. "This was a selective use of Vanguard funds and a selective use of TIAA-CREF funds," he said. "The study absolutely fails to accurately portray TIAA-CREF."

Hammond said that there are numerous other problems with the comparison as well, most notably a relatively short time frame (nine years), which he said is not appropriate for considering the impact of investment tools that are designed for use over decades, a time frame means that there will be multiple economic cycles that won't be evident in nine years.

Smith said he wasn't surprised by TIAA-CREF's criticism and said that it responds that way to any analysis that shows it behind others. He said that many of the institutions that trust TIAA-CREF as the sole choice for employees use just the choices he did -- they are the choices he used to have at his college, in fact. That some other combination of TIAA-CREF funds would yield a better return, he said, does not negate the legitimate concern of those who don't have those choices.

Why, he asked, should it be considered OK for some colleges to offer a portfolio that could lead to employees not enjoying the maximum retirement nest egg? Many colleges need to realize, he said, that "their menus are not competitive."

Andy Brantley, chief executive officer of the College and University Professional Association for Human Resources, has in previous jobs helped put together such menus. He rejects one central premise of the Claremont study (the comparison of TIAA-CREF and Vanguard) and endorses another (more choices are needed at many colleges). 

"Any sweeping generalization that any retirement service provider would cause an employee to lose money is ridiculous," said Brantley. He said that there are too many factors at play -- employees' choices, institutional choices, changes in the market, world events that lead to changes in the market -- to link performance to one company. (CUPA-HR's members are key people for TIAA-CREF and its competitors, all of which work in various ways with the association.)

But if people are unhappy with a portfolio like the one examined in the Claremont study, Brantley said, colleges might be at fault for failing to revise its list of choices. "Most institutions will implement something, and let it sit there for years," Brantley said. "Most universities have not done a good enough job of managing their defined contribution plans, and of actively and regularly engaging people with expertise to review plan options to determine how many plans to offer, what funds are available, why they are available, what mix makes sense, and so on."

Brantley said that there is so much change in the investment world right now that he would recommend such a review every two or three years. Some reviews might not yield any changes in the choices offered, he said, but it's important to be sure.

Smith speculated that one reason colleges hesitate to offer more choices is fear of being responsible for unwise investment decisions employees could make. Any mix of college employees will include professors with the economic background to make sophisticated choices and non-professional employees who may have no financial training. Smith said that colleges fear situations where employees in the latter group hear someone in a college office talk up an Asia-Pacific fund and then they transfer everything in there.

Brantley said that the issue Smith raised is a real one, and that colleges differ on "how parental" they want to be in offering many choices for retirement planning. He said that there needs to be "a balance," based on the employees' wishes, the factors associated for the university of offering many plans, and the philosophy on the role of the institution in retirement planning.

While Brantley thinks that a review of these plans would lead many institutions to offer more options, he does not advocate going too far. "You could throw the door wide open and have more problems," he said. "In my experience, most employees don't want 50 or 60 options."

Hammond of TIAA-CREF agreed, saying that research has found that when the options pass a certain point, "some employees tend to throw up their hands." He also endorsed the idea of institutions more frequently reviewing the plans they offer. He said that individuals -- even those who aren't seriously involved in finances -- tend to review their options when their lives change: getting married, having kids, thinking about paying for a child's education, and so forth. There aren't the same prompts for institutions, he said.

It's unclear whether the Claremont study will prompt many institutions to rethink their offerings, but it has already had some impact of that sort. The authors of the study are all at institutions that are in the Claremont Consortium, which, in part prompted by the research, recently added new TIAA-CREF options for its employees.


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