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byline: Carol Hazard

Reality bites

Gen Xers are next in line for retirement, and most are far from being prepared financially for their golden years. They face a substantial shortfall of funds needed for retirement and the largest savings gap of any generation.

“As the first generation to head into retirement largely without the safety net of a defined benefit pension plan, the stakes are higher for Generation X and the margin for error is lower,” according to global asset management company Schroders’ 2023
U.S. Retirement Survey.

Born between 1965 and 1980 (ages 44 to 59), Gen Xers represent 64 million Americans and make up nearly 20% of the population. Their financial fears and challenges are greater in general than the generations immediately preceding (baby boomers) and following (millennials) them, according to the report.

“You are speaking my language,” says Jeff Kelley, principal of Kelley and Co., a Richmond-based public relations and communications firm. Born in 1981, he’s technically a millennial, just outside the Gen X definition, but considers himself on the cusp of both generations.

“I love my job, but I don’t want to be 70 and still having to work,” Kelley says. “My wife and I think we are on track, but there’s a lot to consider. There’s no way to save for everything. We have three kids, ages 10, 8 and 5, and we are putting away whatever
we can for college.”

Gen Xers estimate they will need $1.1 million-plus for a comfortable retirement, but most expect to have about $660,000, a gap of more than $440,000, according to the Schroders report.

More than 60% of Gen Xers are not confident in their abilities to achieve a comfortable retirement. More than 8 in 10 are concerned about the prospect of not receiving regular paychecks.

An average 45% haven’t done any retirement planning. And 66% worry that their workplace retirement plan won’t grow as much as they will need. “The result: The Gen X dream retirement may be slipping away,” the report says.

Social Security? Nevermind

“My focus has been on growing the family business,” says Matt Dozier, 47, vice president of Dozier Tank & Welding, a tank and trailer repair shop with offices in Chesapeake, Richmond and Selma, North Carolina.

Dozier says he never gave any thought about retirement until he reached his 40s, but even now saving money for later in life is not a high priority. He doesn’t have children, so that’s not a factor. He might want to slow down eventually, he says, but as a blue-collar worker, the prospect of not working is not part of his DNA. “I don’t know how not to work.”

His late grandfather, who started the business in 1966, and his father, now president, never took vacations. Dozier broke that tradition. He enjoys sports car racing and recently spent a week camping in his RV next to a racetrack in Florida.

He and his peers are not as worried about retirement as perhaps they should be, he says. “If we have money, we might as well enjoy it now. We see plenty of people who die five years after they retire.”

Dozier admits he has better financial prospects than many of his friends, since he could become an owner in the family business. But he has no guarantees, nor is he relying on Social Security benefits to supplement his income. “It would be great if Social Security is there, but we’ve been told for 20 years that we won’t see it.”

A more likely scenario for him, he says, would be to pool funds with a few buddies and buy property where they would build tiny houses to live in, sharing a large garage.

“Yeah, I might need $1.1 million, but it’s not going to happen,” Dozier says bluntly.

He’s not alone in his thinking. The Schroders survey shows that 47% of Gen Xers believe Social Security will run out of money by the time they reach the full retirement age of 67, compared with 38% of not-yet-retired baby boomers. Only 10% of those who do believe in Social Security’s viability plan to wait until age 70 to receive the maximum benefit payment.

An average 32% of Gen Xers’ retirement plan assets are in cash; 63% fear losing their money, according to the Schroders report, and 24% are not sure how to invest their savings.

Dozier can relate. His maternal grandfather invested poorly, he says, and lost everything before he retired in the late 1980s or early 1990s.

Reckoning

Typically, people don’t get serious about saving for retirement until they get into their 40s or early 50s, experts say. That means Gen Xers still can close the retirement wealth gap, but it won’t be easy.

“Fortunately, even the oldest Gen Xers have some time before reaching their full retirement age,” says Deb Boyden, an author of the Schroders study and head of the company’s U.S. defined contribution division. “Using this time to develop a retirement plan, increase their savings rate and invest more appropriately is crucial to improving their retirement readiness before it’s too late.”

Schroders’ findings are supported by a fall 2023 Bank of America Workplace Benefits Report, which stated that only 17% of Gen Xers feel confident that they’re financially ready for retirement.

“On a more positive note, looking within the 401(k) plans that Bank of America administers for its corporate clients nationwide, 16% of Gen Xers increased their 401(k) contribution rate in the fourth quarter of 2023, compared to just 3% who decreased their contribution rate,” says Matt Card, a Northern Virginia-based media relations executive for Bank of America.

Generation X is the first modern generation to experience the full effect of a societal shift in retirement planning from defined company pension plans to defined contribution plans such as 401(k)s, transferring financial responsibility from employers to individuals.

Defined contribution plans offer tax benefits. Employees choose how much to contribute, subject to annual limits, and some employers match their contributions.

“Corporate-defined pension plans started to decline in the 1980s with the advent of 401(k) plans and are now rare and have been for the past 15 to 20 years,” says Michael Joyce, president of Agili, a financial planning firm in Richmond.

Most government employees still have pension plans, Joyce notes, some with cost-of-living increases but most without. However, only 14% of working Gen Xers have defined benefit pension plans, according to a 2023 report from the National Institute on Retirement Security.

The way that Gen Xers, the original latchkey kids, deal with self-reliance for retirement planning will set the precedent for generations to follow, experts say.

“Clients in the [Gen X] age group are approaching their peak earnings years,” Joyce says. “It is very important to save at least 10% of their earnings and take advantage of company retirement plans — 401(k), 403(b), 457 — as well as maximizing other potential corporate perks, including nonqualified deferred compensations plans [tax-deferred payments made at a future date to allow for certain events], Health Savings Accounts and restricted stock awards.” He recommends they also take advantage of 529 plans for college savings.

Stop making sense

Donte Smith, a Richmond-based vice president and financial adviser with Merrill Wealth Management, calls Gen Xers “the sandwich generation,” taking care of children (either in college or with college on the near horizon) while caring for one or two aging parents. “They have significant demands on both sides,” he says, “and barely have time to take care of themselves.”

This generation also weathered three major market corrections — the 2000 dotcom tech bubble, the 2007-2009 Great Recession, and the COVID-19 pandemic in 2020. “All of that has impacted their investments and their confidence and ability to save at the level they should,” Smith says.

Throw in rising health care costs, soaring inflation over the past couple of years, along with high interest rates and lagging wages — and saving money becomes even more difficult.

Gen Xers with access to matching defined contribution plans should at minimum invest the percentage matched by their employers, Smith advises.

A 5% match is common, he says. For example, an employee makes $100,000 a  year and puts $5,000 annually into a 401(k). A 100% company match would turn that into a $10,000 investment. Those over age 50 should, if possible, also take advantage of any catch-up provisions, allowing them to sock away even more.

Gen Xers, Smith says, tend to fit into three main groups:

One bunch hasn’t thought much about retiring because they’re too busy rearing their families and paying down debt or saving to buy their first homes.

Others have saved some money but haven’t created retirement plans and don’t know where or how much to invest, he says.

The third group theoretically has done the right thing by saving and investing for retirement since early adulthood. They feel in control of their retirements but don’t have customized plans.

Everyone needs a plan to make sure they’re making the right investment decisions, Smith says. Tactics, whether saving or investing for retirement, should never come before the plan. “You start with a plan,” he says, “and everything you do has to line up with the plan.”

Say, for example, you want to save $1 million and retire in 20 years, Smith notes. How much money should you save each week or month, and how should it be divvied among stocks, bonds and saving accounts? How much risk is the investor willing to take?

“In [your] 40s, all of a sudden you see the end of the track and know you have to get serious about retirement planning,” Smith says, adding that most people in this age group have enough time to realize the benefits of compound interest growth in their investments.

Smith suggests Gen Xers modify their spending habits — cutting back on streaming subscription services or dining out — to increase their retirement savings.

My so-called life savings

The typical Generation X household (with half saving more and half less) has only $40,000 in retirement savings, according to the National Institute on Retirement Security report.

More than half of Gen Xers (55%) participate in employer-sponsored retirement savings plans, according to the 2023 NIRS report, which analyzed 2020 data from the federal Survey of Income and Program Participation and found large discrepancies between average and median amounts of retirement savings.

Everyone needs to “start with a plan” for retirement savings, says Donte Smith, a vice president and financial adviser with Merrill Wealth Management. Photo by Matthew R.O. Brown

The average account balance in private retirement accounts (individual retirement accounts, Keogh plans for the self-employed, defined contribution plans) among working Gen Xers was $129,994. However, the median account balance, with half saving more and half less, was only $10,000. Also, 40% had accounts with zero balances.

“Most Gen Xers, regardless of race, gender, marital status or income, are failing to meet retirement savings targets,” according to the NRIS report.

“Shoring up the Social Security trust fund is critical for assuring Generation X of its retirement security,” the report adds, noting that policy actions such as increasing plan access for part-time workers and reforming a saver’s credit (a federal income tax credit) also would help.

Unlike many of his peers, Kelley has mapped out a savings plan. He and his wife, Cristin, rolled over their 401(k) accounts from previous employers into IRAs, preserving their tax-deferred status with no early withdrawal penalties.

They have a Simplified Employee Pension (SEP) IRA, which allows contributions up to 25% of compensation. And they have Virginia 529 college savings plans for their three children.

Their cash savings is invested in a high-yield bank account. Plus, they have a taxable brokerage account or “robo-adviser,” an online platform that automatically manages and allocates investments based on risk tolerance and targeted returns. “This could be retirement someday but is really a place to park accessible funds if ever needed,” Kelley says. “I try not to touch it.”

Social Security doesn’t figure into their strategy at all.

“We try to save as much as we can, but we also want to live our lives,” Kelley says. “My goal is A) Be with my kids as much as possible, and B) Make as much money as possible.”

The family likes to go on a vacation once a year. They go out to eat but only occasionally. They don’t go to Starbucks. Nor does Kelley go out to lunch during workdays.

“Our cars are paid off. Our house is within our means,” Kelley says. “Am I rich? No. Smart with money? Hopefully.”

Out of balance

Kate Austin had a job waiting for her when she graduated last year from Christopher Newport University with a bachelor’s degree in business administration.

“I love it,” she says about her work as a tax associate at Keiter, a certified public accounting firm in Henrico County.

Unlike two of her friends, who are still looking for work — one with a degree in marketing and the other in graphic design — Austin, 22, is gainfully employed within her chosen career path.

“Outside of accounting, it’s very hard to find jobs, so I am very lucky,” she says.

While the tech industry is busy laying off workers, accounting firms are hustling to find people to fill their ranks, an ongoing problem.

According to the American Institute of Certified Public Accountants, the staffing shortage of CPAs has been brewing for more than a decade, driven by an aging workforce and fewer young professionals entering the industry. In April 2023, the institute reported that 75% of CPAs working then were expected to retire in the next 15 years. What’s more, the number of CPA exam candidates dropped 36% from 2010 to 2021.

Upping the ante to entice more people into accounting jobs, firms are offering higher wages, flexible work options and financial assistance to pass the notoriously difficult professional licensing exam.

Austin took accounting classes in high school and worked as an intern during college, cementing her future. She had a full-time job offer before starting her senior year of college.

Although her goal is to become a CPA, Austin needs to complete extra college credit hours and pass the Uniform CPA Examination. Keiter has reimbursed her for study materials to take the exam. In the meantime, she plans to pick up extra coursework at a community college.

“It’s not unusual to hire people who haven’t passed the exam,” says Gary Wallace, managing partner at Keiter, adding that in the past, however, workers were typically hired only after earning the extra credit hours. Now, Wallace says, “we are more flexible.”

Keiter has one office, where most of its 200 employees work, except for 15 remote workers across four states, including Virginia.

“We have been very aggressive in hiring,” Wallace says. Keiter employs two full-time recruiters: one for entry-level associates and the other for experienced CPAs.

‘Still critical’

Wallace tells students contemplating accounting careers that it’s “a great profession that offers job security and the opportunity to learn a lot about business.” He notes that the heads of two Virginia-based Fortune 500 companies — CarMax President and CEO William D. Nash and Markel Group CEO Thomas S. Gayner — are CPAs.

Accounting “is just as prestigious as other marquee professions such as law and medicine,” says Jennifer Wold, Virginia managing partner for Forvis. Photo by Shandell Taylor

The staffing shortage has been challenging for years, says Stephanie Peters, president and CEO of the Virginia Society of CPAs (VSCPA). “We’re seeing a little more stability,” she says. “It’s less of a crisis of capacity, but still critical.”

The number of newly issued CPA licenses in Virginia has slid about 35% since 2008, when 1,434 licenses were issued, compared with 940 licenses in 2023, according to the Virginia Board of Accountancy. During the same time period, the number of first-time CPA exam takers in the state fell nearly 49%, from 1,823 to 931 candidates.

Despite the drop in Virginians becoming CPAs, licensing requirements remain basically the same. CPA candidates must pass a four-part, 16-hour exam within a 30-month period (extended from 18 months in December 2023). They also must accumulate 150 college credit hours, the equivalent of a master’s degree (30 more hours than needed for a bachelor’s degree). Starting this year, CPA candidates will also choose a specialty category within the exam: tax, audit or information technology.

About half of all first-time test-takers fail the exam.

“The CPA exam is really difficult to pass,” says Gary Thomson with Richmond-based Thomson Consulting. “Your first couple years [in the workforce] are consumed with not only trying to learn a new job but getting the CPA exam passed.”

Austin hopes to complete her exam by 2025 and accumulate the necessary course credits by 2026.

The accounting industry staffing shortage stems not only from fewer students pursuing degrees in accounting — a problem exacerbated by a persistent false image of accounting as boring or nerdy — but also by the wave of retiring baby boomers, shrinking the pipeline at both ends.

The problem is so acute that some public companies have disclosed potentially weakened internal controls in their financial reports, including Raleigh, North Carolina-based Advance Auto Parts (formerly based in Roanoke). The car parts provider said it had identified a potential material weakness in its internal financial controls because of accounting staff turnovers during the fiscal quarter ending April 22, 2023.

Payroll spikes

The short supply has led to high demand.

According to a January report of the top remote jobs in the nation from hiring site FlexJobs, more companies were advertising remote jobs for accountants in 2023 than any other position, with employers willing to pay $100,000 to $200,000 salaries for more experienced workers.

In Virginia, the mean salary for entry-level accountants was $51,121, according to the Virginia Society of CPA’s 2020 Compensation & Benefits Survey, which was conducted before more recent wage spikes. “Salaries increase from there,” the report states, “with first-level supervisors making a mean of $75,110 and partners a mean of $210,780.”

The payoff comes from working a few years and gaining experience, industry experts say. But all levels — from entry to experienced — are seeing wage increases.

The profession has awakened to higher wages, Thomson says. “Payrolls are up 38% over the last three years.”

Respondents worked in tax services, followed by audit, consulting and outsourced accounting or bookkeeping (a growing field in response to shortages)

“A lot of accounting firms are offshoring work,” says Peters. Most offshore workers hail from India, South Africa and the Philippines, she adds, and firms are putting safeguards in place to protect clients’ financial information.

While the accounting industry is seeking to fill employment gaps, it is also wrestling with “the age-old ‘all-they-do-is-taxes’ assumption,” according to a 2023 Stockton University report. 

“A major challenge we are working on is the image that the profession is boring,” Peters says. “That image isn’t true, and we are trying to counter it with new messaging.”

Dozens of programs have been implemented in the past couple years at the state and national levels — including a VSCPA scholarship program — to attract more students into the profession. 

Jennifer Wold, managing partner in Virginia for Forvis, one of the nation’s largest public accounting firms, says accounting is a noble occupation. “It is just as prestigious as other marquee professions such as law and medicine.”

However, it is misunderstood.

“We have not done a very good job of explaining what accounting is all about,” says Royce Burnett, professor and chairman of the School of Accountancy at Old Dominion University.

“Trust me, accounting is not about math,” he says. “It is about connecting the dots. It’s taking data, transforming that data into information and providing that information to stakeholders so they can make value-oriented, social- and business-related decisions.”

Accountants are not solely number crunchers as they were in the past, experts say. Technology has taken over a lot of the grunt work. Rather, today’s accountants are data analyzers, business consultants, risk advisers, financial records managers and tax preparers.

Entry-level salaries may be low compared with what workers might see in other sectors, such as technology, “but they grow exponentially compared to other majors,” Burnett says.

The message is difficult to convey when college graduates see their peers in other jobs initially making more money, though.

“The historical perception of the type of work and how we work — 70 to 80 hours a week during the peak tax season — is not necessarily the coolest picture to someone in high school,” Thomson says.

“It’s much more advisory in nature,” Thomson says. “Being a CPA is like being a priest or rabbi for a firm. You know the inner workings and become trusted advisers and, in many cases, close family friends.”

Accounting firms are heavily invested in technology, automation and process improvements, which may be more attractive to younger workers and help bridge productivity gaps among a reduced workforce. Artificial intelligence in particular will play a part in the industry going forward, experts say.

It may redefine roles, but it will not replace CPAs, Peters says. AI will be used in accounting to gather more information and analyze large amounts of data.

“It will help with expectations of regulators and others who want more and better information,” she says. However, “you still need human beings to make judgments, look for anomalies and make sure programs are doing what they are supposed to be doing.”

Recruitment drive

The question remains, nevertheless, about where the industry is going to find those human beings.

Academia is reaching out to students who may be looking at other career fields, Burnett says, even to liberal arts and STEM students. “We are engaging in ways never done before to reach individuals and go beyond traditional business students.”

Mark Lehner, who grew up in Chesapeake, had his sights set on becoming a lawyer. As an undergraduate at Bob Jones University in Greenville, South Carolina, he sought courses to develop skills in preparation for law school. He vacillated between taking engineering classes or general business classes but settled on something more technical — accounting. He hasn’t looked back.

“I enjoy the logic of it, the puzzle-solving,” he says. In effect, he applies financial rules in a business setting as opposed to legal rules in a courtroom.

Lehner, now 24, graduated in 2021 with 150 credit hours for his bachelor’s degree in accounting; he then passed his CPA exam in less than a year. He works as an audit associate for Forvis in Norfolk. “I enjoy the analysis,” he says. “There is an art to business.”

For many, the barriers to becoming a CPA are daunting, considering the extra time and cost on top of a college education and, in many cases, a heavy student debt load.

“The economic price to get 150 hours can be a barrier when you compare it to other industries,” Thomson says.

Rather than tacking on a fifth year of college as many did in the past, candidates often can work for a firm while taking classes.

Lehner took a different approach. He crammed as many credit hours as he could into each semester. “It was a packed schedule, but you get into the rhythm.”

Forvis, which employs about 6,000 people in 38 states, hired 500 people nationwide in January, including 350 interns — who will stay with the firm through mid-April during the busy tax season — and 150 associates.

Wold credits Forvis’ stepped-up recruiting efforts and rapid growth among the reasons for its success in attracting talent. Created from the 2022 merger of BKD CPAs & Advisors and Dixon Hughes Goodman (DHG), Forvis is acquiring Paris-based Mazars’ U.S. operation in June to become Forvis Mazars, a top 10 global professional services network.

However, Wold allows, recruiting still “is not easy in this environment” of heated competition for top talent. Forvis has particularly relied on internships as an outreach vehicle to give students an opportunity to experience public accounting firsthand while the firm can evaluate their performance and build a relationship with them.

“Our goal,” Wold says, “is for everyone to be successful and return to campus with a full-time job offer of employment after graduation.”  

Surge of credit card defaults ahead?

Americans owe an all-time high of nearly $1 trillion on their credit cards, setting the stage for a possible surge in consumer delinquencies and defaults.

“There are nascent signs of trouble brewing,” investment firm Glenmede Trust Co. warned in an April research note. “An ever–larger share of credit balances have transitioned to early stages of delinquency, consistent with past periods of recession.”

Lenders are feeling the losses, including McLean-based Capital One Financial Corp. The credit card giant reported a 60% drop in profits to $960 million in the first quarter from the same period a year ago, largely due to customers defaulting on their credit cards and car loan debts.

Like other large banks, Capital One is pumping up provisions for credit losses, as it set aside $2.8 billion in the first quarter, up from $677 million in the year-earlier period.

Not only are more customers at least 30 days late on their payments (at Capital One, 3.66% of total U.S. card holders in the first quarter were late, up from 2.32% a year ago), but companies are racking up more for write-offs — debts they never expect to collect (4.04% of total loans in the first quarter, up from 2.12% a year ago at Capital One).    

Capital One CEO Richard Fairbank told analysts in April that he “feels very good about the business,” given that defaults remain low by historic standards. However, he stated, profits could take another hit this year as rising delinquencies segue into actual losses.

Americans are piling on debt in the face of high inflation and rising interest rates.

Total credit card debt surged $61 billion at the end of last year to a record $986 billion and stayed at that level through the first quarter of this year, surpassing the pre-pandemic high of $927 billion, according to the Federal Reserve Bank of New York. Auto loan balances increased by $10 billion in the first quarter. 

Consumers typically pay down debt in January after the holidays, but not this year.

“Rising living costs and stagnating wages caused savings to decline, creating excess demand for credit card debt,” financial analyst Harrison Schwartz writes in a March report on financial news site “Seeking Alpha.”

“Initially, this situation was great for Capital One as demand for its products rose,” Schwartz continues. “However, the rapid decline in consumer sentiment and savings over the past year has caused default rates and expected loan losses to increase.”

In all, 46% of U.S. cardholders carry balances from month to month, up from 39% last year, according to January data, the most recent, from financial information provider Bankrate.com.

The average credit card balance per consumer this year is $5,733, up 14.4% from a year earlier, according to credit reporting agency TransUnion.

“We’re seeing three big trends with respect to credit card debt,” says Ted Rossman, senior industry analyst with Bankrate.com. “More people are carrying more debt and that debt costs more than ever (an average APR of 20.37%), the highest since we started measuring in 1985.”

Also, it’s the first time in the central bank’s 20-year report on household debt that credit balances failed to fall during the first quarter, which “could foreshadow trouble for later in the year,” Rossman says.

Interest rates likely will remain high for the foreseeable future, he adds, saying, “My top tip would be to sign up for a 0% balance transfer credit card (still widely available).”

The economic story facing consumers is straightforward, Schwartz says. “Rising living costs and excessive consumer spending on credit have caused many households to suffer significant declines in stability.”  

Staying the course

A tanking economy. Rampant inflation. Whiplash in the stock market. What’s an investor to do?

Look for opportunities to rebalance portfolios but, in general, hang tight, wealth management professionals say. Or, as one adviser says, buckle up for a roller coaster ride.

The economy is likely to worsen, experts say, and despite dickering among economists over whether the U.S. entered a recession this summer, investors can expect recession conditions to linger in 2023.

“The greatest threat to investors’ financial health is their own behavior,” says Stephan Q. Cassaday, chairman and CEO of Cassaday & Co. Inc., a McLean-based wealth management firm.

“Market declines do not destroy wealth; how we behave when markets decline is what destroys wealth,” Cassaday says. “Selling when we are uncomfortable and buying when we are comfortable is the opposite of what history shows we should do.”

Jeffrey S. Grinspoon, managing director and partner of VWG Wealth Management in Vienna, advises clients to essentially put their money into two “buckets”: One for funds needed within the next three to five years, the other for investments beyond five years.

It could be another two or three years until the Fed starts a campaign to lower interest rates, cautions Jeffrey Grinspoon of VWG Wealth Management in Vienna. Photo by Will Schermerhorn

Short-term investments include cash, certificates of deposit, Treasurys and short-term bond funds. The long-term horizon includes stock and alternative investments such as real estate, pharmaceutical royalty streams, private equity and/or venture capital.

“The purpose for this approach is to have less volatile and more liquid investments available when you need it, with diminished risk to the principal,” Grinspoon says.

“We don’t pay a lot of attention to the macro environment — geopolitical events, inflation, pandemics,” Grinspoon says, adding that five years is long enough to go through an economic cycle, including the downspin we’re in now.

Also, forget the old advice about putting 60% of investments in equities and 40% in bonds. “That was created many years ago when interest rates were going down,” Grinspoon explains.

The Federal Reserve has aggressively hiked interest rates this year in an effort to tame inflation — now at a 40-year high — and slow consumer spending in an attempt to bring supply in line with demand. In November, the Fed raised interest rates by 75 basis points to a range of 3.75% to 4%, the fourth such hike this year. Economists expect that rates could reach 5% by March 2023.

Grinspoon says the economy likely will worsen, but that doesn’t mean the stock market will crash. He hopes instead for market stagnation until the economy cycles out of its current downturn.

“It could be two or three years before the Fed embarks on an interest-lowering campaign,” he cautions.

Be prepared

Economic uncertainty is always present, Cassaday says, adding that big events that cause market declines are inevitable and can never be predicted. “Investors need to prepare themselves emotionally for scary markets. More money is lost attempting to avoid market declines than has been lost in any market decline.”

He points out that the S&P 500 has seen 10 declines of greater than 20% since 1957. Those who remained invested through those downturns saw average returns of 39% after three years, or 11.33% on an annualized basis.

“Our guidance is to remain fully invested and broadly diversified across asset classes based on investors’ risk tolerance and return requirements,” Cassaday says. “Volatility is often an opportunity to rebalance a portfolio, taking advantage of distortions and mispriced investments. Rebalancing is therapeutic for a portfolio, as it results in buying low and selling high.”

All portfolios should have target allocations tied to historically produced risk and return outcomes, Cassaday says. “With the market being so volatile and suffering an historic decline, certain sectors in the portfolio can be significantly above or below their targets.”

Eileen O’Connor, CEO and co-founder of Hemington Wealth Management in Falls Church, says recessions are as erratic as they are necessary.

“The thing about recessions is that we only for sure know that we were in one and for how long after the fact — hence the current debate about whether we are in [a recession] or not,” O’Connor says.

Traditionally, according to the National Bureau of Economic Research, the U.S. economy enters recession after two consecutive quarters of negative gross domestic product growth, which happened this summer. However, there has also been a strong labor market, low unemployment and corporate earnings growth during the same period, and there’s no historic precedent for that. Therefore, experts have disagreed over whether the economy has truly been in a recession this year.

“That said, recessions are a healthy part of the economic cycle and, because we cannot reliably predict when they will occur or end, we do not tailor our investments to accommodate them,” O’Connor says.

She defines recessions as contractions in the economy that adjust to shocks such as the pandemic. They are healthy because they set the stage for expansionary periods, O’Connor says, noting that the U.S. has been through 13 recessions since 1945.

“I don’t make predictions about how hard or soft this one may be, because it’s impossible to predict and the stock market is not correlated to recessions or expansions,” O’Connor says. “Said another way, stocks can move up in recessions and down in expansions.”

She notes that 68% of economic growth is based on consumer spending, but the stock market is based on a lot more, including corporate earnings, profitability and profit expectations.

“Typically, capital markets recover in advance of a recession ending, so we remain disciplined through all market cycles and control what we can control — our allocation to stocks versus bonds, taxes and fees,” O’Connor says.

While impossible to predict, this recession most likely will continue into the second quarter of 2023, since recessions historically last an average 10 months, she says.

Cassaday says no one has ever consistently predicted the onset, duration or magnitude of an economic event. “This includes stock market declines and advances, interest rate changes, inflation and recessions.” Attempting to make such a prediction “is a waste of time,” Cassaday adds.

By raising interest rates, the Fed is trying to slow the economy to avoid bubbles and reduce inflation. “We believe this is prudent and necessary,’ Cassaday says.

Play the long game

Investors should ignore heated debates about the level of slowing and stick with their long-term plans, wealth managers advise.

“Markets are already reflecting a pretty dismal situation and we believe that a recession is likely already baked into stock prices,” Cassaday says. “Historically, markets bottom and begin to advance before recessions are officially announced. … Although risks exist, our view is that we are closer to a bottom than a top.”

Joseph W. Montgomery, managing director of investments for The Optimal Service Group of Wells Fargo Advisors in Williamsburg, says the U.S. economy’s dip into contraction probably began around midyear and steepened as the year progressed.

“We expect the recession to end in mid-2023,” Montgomery says. “Near-term capital market volatility should continue, while investors grapple with the crosscurrents of [government] policy and economic outlook.”

Most investments are designed to be long term, while making sure any given portfolio has the appropriate amount of liquidity, Montgomery says. “Our single and consistent message has been to play defense in portfolios, which … means making ‘patience’ and ‘quality’ the daily watchwords.”

A dividend-paying stock, for example, could be a reflection of a patient investment, Montgomery says. Quality equates to buying stock in companies whose products have endured and will continue to do so.

For investors, according to the August edition of Investment Strategy Monthly Insights, “defensive sectors like health care, utilities and consumer staples might be the least vulnerable to upcoming rate shocks and economic slowdown.” Meanwhile, the publication pointed out, cyclical sectors such as material and industrials, particularly European industrials, could be more vulnerable to rising energy prices.

“Patience is more than a virtue; it’s a discipline,” Montgomery says. “Patience is revealed over a long period of time if you are adequately diversified. … Achieving wealth over time demands patience. Those who bail out fail.”

That said, it’s important to reassess data to make sure original precepts for making investments are correct, he says. “You can’t just buy it and forget it. … Data is important, but correct data is imperative. You have to be willing to adjust, allocate and diversify.”

Exposure to a broad mix over time provides the best opportunity to control risk, Montgomery says.

However, he points out, those who heavily invested this year in riskier propositions such as bitcoin or internet trading platform Robinhood Markets Inc. saw their investments tumble considerably in value: “Wow, talk about a wild ride!”   

Related article : Navigating metaverse investments

Navigating metaverse investments

Investors itching to get in on the latest tech trend are zooming in on the metaverse — a presumed future virtual or mixed reality iteration of the internet in which users would navigate 3D environments for working, shopping, socializing and entertainment.

By some estimates, the metaverse market could balloon to $5 trillion in annual revenue by 2030.

Beware the hype, though, professional money managers warn. It’s a fledgling technology that is anything but certain. 

“The metaverse — whatever it actually turns out to be — will impact many sectors, so investors are investing in it,” says Eileen O’Connor, CEO and co-founder of Falls Church-based Hemington Wealth Management. But, she says, her firm “would never target [the metaverse] as an allocation separately because, at this point, it’s just a concept.”

No one yet knows who the major metaverse players will be. Sectors likely to benefit include software, gaming, multimedia, social media and cryptocurrencies, experts say.

“Early adoption of a new trend in the investment world can mean great success — or you may lose all of your money,” cautions Rachel Boyell, director of investment strategy and operations for Cassaday & Co. Inc.

“Metaverse ETFs [exchange-traded funds] are extremely new; the oldest of the handful out there just began trading a little over a year ago,” Boyell says. “Investors should proceed with caution on such new products,” she adds, since those funds have not been battle-tested.

ETF rollouts include those from fund companies Fidelity Investments, ProShares and Horizons, enabling investors to gain exposure in the metaverse through an index made up of a basket of stocks.

As of early October, seven metaverse ETFs reported total assets of $438.2 million, according to Morningstar Direct. Top stock holdings are in companies such as Microsoft Corp., Alphabet Inc., Nvidia Corp. and Meta Platforms Inc.

Facebook’s parent company, Meta, changed its name in October 2021, indicating CEO Mark Zuckerberg’s belief in the metaverse as the next technological frontier. But a little over a year later, the company’s stock plummeted 73%, losing more than $700 billion in market value — making it the worst performing stock in the S&P 500 this year. In November, Meta announced it would lay off 11,000 employees, about 13% of its workforce.

Many analysts chalked that up to Meta’s expensive and risky bet on the metaverse and virtual reality. The company spent more than $9.4 billion on metaverse research in 2022, and, as of October, its virtual reality platform, Horizon Worlds, had fewer than 200,000 active users — far below its goal of 500,000 users.

“Trying to predict which stocks will be winners and losers in this amorphous tech universe can be difficult for the average investor,” The Wall Street Journal remarked in an October article about the metaverse.

Driving interest among unafraid investors is the fact that some online gamers are already utilizing virtual reality headsets. Additionally, advancements in artificial intelligence could facilitate and expedite establishment of the metaverse in time.

“Similar to many other disruptive technologies, we are likely decades away from the full implementation of the metaverse at scale,” stated an April tech sector report from Wells Fargo Wealth and Investment Management.

“The reality is the metaverse is yet to evolve,” says Joseph W. Montgomery, managing director of investments for The Optimal Service Group of Wells Fargo Advisors in Williamsburg. “There are not a lot of specifics beyond speculation, and fear of missing out is rarely solid investment logic.”

Metaverse ETFs are tracking high-growth tech-stock ETFs, which makes sense, says Boyell, adding that, “no surprise, they have sold off this year as inflation was a headwind to high-growth valuations.”

Jeffrey S. Grinspoon, managing director and partner of VWG Wealth Management, says metaverse ETFs will have trouble increasing assets. “Putting the technology and probability of success in the future aside … high-growth, long-term horizon investments will continue to struggle in an increasing interest-rate environment.”

Most investors in this economy continue to favor investments that provide cash flow such as dividends, Grinspoon says.

“That doesn’t mean the metaverse won’t continue to gain traction, albeit slower,” he says. “I simply would prefer to look for growth managers who include these types of investments in the overall portfolio, as opposed to a narrow focus like a specific ETF.”  

Related article : Staying the course

Regional biz mentorship program jump-starts startups

Ruth Rau started her business as a hobby. Now, seven years later, her Winchester-based toy company — Mouse Loves Pig — is on track to generate revenue in six figures. The entrepreneur’s toys for babies and young children are sold in more than 250 stores in nine countries, and she’s partnered with a manufacturing company in Turkey that employs women refugees.

Her success has blossomed in part from her participation in Startup Shenandoah Valley (S2V), a business mentorship program that Staunton-based nonprofit Shenandoah Community Capital Fund administers. SCCF has helped 35 entrepreneurs and is set to run its fifth cohort Sept. 5 through Oct. 27.

“Starting a business from scratch is hard, but the tools that S2V helped me develop has made it less hard,” Rau says.

Mentoring is customized to the entrepreneur, says SCCF Executive Director Debbie Irwin. Participants take assessments to pinpoint their businesses’ riskiest aspects, and SCCF matches coaches and mentors with mentees based on their needs.

The mentorship — free to participants — goes beyond the program, during which entrepreneurs spend five to 10 hours a week in peer meetings and coaching sessions.

“We expect to work with them anywhere from nine months to three years,” Irwin says.

Irwin says budding businesses are plentiful in the region.

“We’re changing the way people think about entrepreneurs in rural America,” Irwin says.“Great ideas and great companies exist across the United States, but especially here in the Shenandoah Valley.”

Ventures to date include an organic flower farm, a cybersecurity software firm and an agricultural drone operation to spray pesticides.

Participants have created hundreds of jobs since the nonprofit started the program in 2020. The program is for companies with scalability — the ability to grow.

“I’ve hired help, trusted my manufacturers more and expanded my product line, thanks to the advice and ideas that S2V helped me develop in just those short eight weeks,” Rau says.

The nonprofit receives about 20 applications for a cohort and accepts between seven and 10 entrepreneurs into each. 

“Starting a business can be incredibly lonely,” Irwin says. “When you are at the same place or close to the same place as someone else, it’s easier to connect and grow.”

SCCF launched S2V in 2020 with $1.2 million from the state’s GO Virginia economic development initiative. An additional $1.5 million from the U.S. Economic Development Administration has aided the mentorship program’s expansion.  

Shenandoah University creating tech hub

Shenandoah University is connecting the future to the past.

It’s renovating an armory on its main campus in Winchester where National Guard soldiers once trained before D-Day, turning it into a Hub for Innovators, Veterans and Entrepreneurs — the HIVE.

“This building will be a game changer for economic development in the Northern Valley and for Shenandoah University and its partners,” says Shenandoah’s president, Tracy Fitzsimmons.

The HIVE will house a veterans’ center, job training, a business incubator and community gathering areas, all centered on technology fields ranging from cybersecurity to augmented and virtual reality to data analytics and artificial intelligence. It will create pathways to “emerging technologies and jobs that we can only imagine in a space with a deep history,” says Provost Cameron McCoy.

The HIVE will serve as the information technology anchor for the area, building on partnerships already in place, says Frederick White, an executive fellow at the school and an analyst with the U.S. Department of Veteran Affairs.

The university already converted the armory’s detached garage into an e-sports arena.

The $8 million to $10 million renovation of the main armory building should be completed in 2024, with work to begin late this summer or in early fall. Through private donations and local, state and university funds, SU has raised about $3.5 million. It’s seeking a $5 million state grant through Winchester city government.

A ceremonial groundbreaking is planned for Veterans Day to mark the armory’s historic significance. The brick structure — once Virginia’s oldest active armory — opened in 1940 and housed the Virginia National Guard unit (116th Infantry Regiment, 3rd Battalion) that participated in D-Day.

“From this armory, guardsmen served in World War II and every major international conflict since then,” Fitzsimmons says. “It’s where you dropped off your loved ones to serve our communities and country.”

The university acquired the armory in 2006 from Winchester and allowed the National Guard to continue using it until a new armory opened in Frederick County in 2009. 

The renovation includes a yearlong effort to stabilize the 18,000-square-foot building, remove asbestos and install new systems. The design will feature open, flexible spaces with glass cubicles to encourage collaboration and will preserve architecture and historic pieces.

“The design will honor the past and cast a vision to the future,” says Wendell D. Brown, lead architect on the armory project and principal with Nashville-based ESa. 

Editor’s note: This article has been amended to correct Shenandoah University’s sources of funding for the project. The earlier article stated county and state funds.

Frederick solar farms move forward

Frederick County is on the verge of seeing its first solar power farms. Three facilities are in the works, with another in the pipeline. That’s not to say Virginia’s northernmost county is exactly embracing fields of solar panels.

“Solar farms change the character of the land from rolling fields and animals grazing in pastures to a sea of glass panels and glare,” says J. Douglas McCarthy, vice chairman of the Frederick County Board of Supervisors.

The loss of valuable farmland is always concerning, he says. However, solar is less intrusive than housing, which changes the landscape forever. “Theoretically, the land used for solar panels could be reversed back to farmland,” he says.

Until recently, the county saw little economic value in solar farms, McCarthy says. However, solar companies now offset their developments’ impacts by offering incentives such as revenue sharing or upfront fees.

Boulder, Colorado-based Torch Clean Energy’s Bartonsville Energy Facility, which received a conditional-use permit in January, will make a one-time $750,000 payment to the county within 30 days of construction. It plans to build a 40- to 60-megawatt facility on a maximum of 430 acres.

Hollow Road Solar, a subsidiary of Leesburg-based Blue Ridge Energy Holdings LLC, requested a permit to build an 83-acre, 20-megawatt solar farm on a 326-acre parcel, but the county denied it in March 2021. However, this January, Hollow Road won approval on its second attempt by placing land (now primarily used for orchards) into a conservation easement and eliminating the transfer of development rights, essentially preventing residential development on the parcel, McCarthy says.

Also on the books is Stevensville, Maryland-based Foxglove Solar LLC’s 75-megawatt facility on 668 acres, for which the county approved a conditional-use permit in July 2020, as well as Pittsburgh-based Redbud Run Solar LLC’s approximately 263-acre facility, which the county approved in April.

Proposals take about three years to move through county and state approvals. 

“There is no definite timeline on any of them getting started or finished, but they are working to get plan approvals now,” says Karen Vacchio, spokesperson for Frederick County.

However, don’t expect to see many more solar farms in Frederick, McCarthy says. The “gold rush for solar” is largely over, since the prime areas where those operations can feed into transmission lines have been taken. 

Supersize means

Watch your nest egg, particularly if it is extra-large.

As Congress scrambles to hike taxes on the wealthy and fund trillions of dollars in social spending, legislators see a potential goldmine in so-called mega individual retirement accounts.

Mega IRAs, defined as individual retirement accounts containing at least $5 million, are being touted as a hot new trend in wealth management for high net-worth clients. But their use is not new for the wealthy or, for that matter, people of more modest means — for whom the once-humble IRA was designed.

“What’s changed in the public domain is news about the enormous amount of money that has accrued in some accounts,” says Jeff Grinspoon, managing director and partner of VWG Wealth Management at Hightower Advisors in Vienna.

Nearly 29,000 Americans hold more than $279 billion in mega IRAs, according to Congress’ Joint Committee on Taxation. Of these, nearly 500 individuals have accumulated $25 million or more in their accounts.

In November, House Democrats passed the $1.75 trillion Build Back Better reconciliation bill, which eliminated so-called “backdoor Roth” loopholes that allow the wealthiest Americans to hold money in Roth IRAs. The package also limits IRA contributions to $10 million. The Senate could still make changes to the legislation, with a vote likely to come in December.

The matter went back and forth among House Democrats, who were looking at placing caps on IRA holdings and giving the Internal Revenue Service more authority over IRAs. One option Democrats were exploring would force Roth IRA account holders to withdraw half of any amount over $10 million annually. If they have more than $20 million in Roth IRAs, they’d have to withdraw enough to get below $10 million. Retirement industry firms lobbied against the measure, and Democrats had backed off on the attempt in late October before placing IRAs back in their crosshairs barely a week later. By one estimate, the mega IRA crackdown would generate $7.3 billion in federal tax revenue over a decade.

“Congress sees it as, ‘This is not what these accounts were meant for, so let’s put limits on what can be put into an IRA,’” Grinspoon says, adding, however, “I always recommend to my clients to utilize any investment tool that the tax code allows to save money.”

That includes using IRAs to save for retirement while receiving tax benefits, whether it’s a traditional IRA, which offers tax deductible contributions, or a Roth IRA, for which contributions are never deductible but grow tax-free. Taxes are deferred in a traditional IRA until withdrawals are made, while they are paid upfront in a Roth.

“The focus on the mega IRA suggests that something is wrong or that only the rich can play and benefit,” says Joseph W. Montgomery, managing director of investments for The Optimal Service Group of Wells Fargo Advisors in Williamsburg.

“Of course, it takes money to make money, but it’s a very equal playing field if you are a qualified player with proper advice,” Montgomery says.

“Investors have an obligation to do the best they can within the guidelines of the law,” he adds, adding that no one is bound by patriotic duty to pay more than their due share.

Lightning rod

Placing any limits on IRAs — a solid technique to save for retirement — could backfire and provide a disincentive for saving, financial experts say.

“Congress is looking at ways to raise additional revenue and taxes and ultimately [may] discourage people from investing in IRAs,” Grinspoon says.

A $10 million limit on IRAs wouldn’t affect the majority of people, he says, “but once Congress places a limit, it opens the door for government to continue to lower the bar.”

Grinspoon’s firm caters to high net-worth people — “some who have accrued a good amount of wealth mostly because they have invested wisely, not because they were able to shove it into an IRA.”

Gregory Smith, managing director and senior financial partner of The Wise Investor Group at Robert W. Baird Co. in Reston, asks, “Will Congress crack down on mega IRAs? Break the Roth promise? Find a way to tax Roth IRAs? Institute Roth IRA account limits?” Maybe, he thinks. “Just about every certified public accountant I speak with thinks one or more of those outcomes is inevitable,” he says, even though he personally thinks lawmakers would likely pay a political price for trying to tax constituents’ retirement funds.

Smith encourages diversification of retirement funds in after-tax individual or joint investment accounts; tax-deferred — traditional IRAs or 401(k) — accounts; and tax-free — Roth IRAs or Roth 401(k) — accounts.

“You’ll benefit the most from having saved into all three types of accounts for maximum flexibility, balance and choice,” Smith says. “Tax policy and rules around saving, contributing and investing will invariably change over the coming decades.”

A rule change in 2010 allowed anyone — regardless of income level — to convert holdings from a traditional IRA into a Roth. A win-win, it allowed the federal government to collect more money upfront instead of waiting years for disbursements, and investors could still get tax-free growth in their accounts.

The same rule has become the latest lightning rod, however, after ProPublica reported in June that billionaire Peter Thiel amassed $5 billion in a Roth by placing PayPal shares, valued at $1,664 when the company was private, into his account in 1999. Within a year, the fund’s value climbed to $3.8 million. An extreme example of using the Roth to create a mega IRA, Thiel employed the same lucrative strategy to invest in Meta, formerly known as Facebook Inc.

Using a Roth as a tool to avoid taxes and pass wealth on to heirs tax-free for 10 years is not as much of a hot trend as it is a hot topic, financial advisers say.

“Just because it’s come to light that billionaire Peter Thiel has $5 billion in his Roth IRA, this example is by far the exception rather than the norm,” Smith says. “I don’t believe in catering to the exception. The Roth is a great strategy for anyone who has the opportunity available to them in their retirement plans.”

Montgomery says he has read about “the Peter Thiels of the world. People get all [worked up] over that and I kind of get it, but he had the capacity to pay the taxes and the sense to see it through.”

Some investments go up more dramatically than others. “People play by the rules and some do better than others,” Montgomery says.

Thiel’s experience is nearly impossible to replicate, experts say.   

“People who put private company stock into an IRA could just as easily see the value fall to zero,” says Michael Joyce, president of Agili, a financial advisory firm in Richmond.

Not just the 1%

Legislators want to accelerate distributions from retirement accounts of more than $10 million and see even greater accelerations for accounts with $20 million or more, says Aashish Matani, a wealth management adviser and senior portfolio manager at AHM Wealth Management Group of Merrill Lynch in Norfolk.

“It’s important now to consider if an IRA to a Roth IRA conversion might be right for you,” Matani says, since rules could change again.

Grinspoon says he is concerned about the minutiae in proposed legislation, detailing what people can invest in and what they can’t.

Investors typically keep stocks, bonds and mutual funds in their IRA accounts. But accredited investors — those who earned at least $200,000 in the last two years or have $1 million or more in net worth, excluding their homes — also can put private investments into their IRAs. These may include real estate, venture capital, hedge funds and private equity.

One Congressional proposal would see IRAs with these investments lose IRA status, meaning these accounts would lose their tax benefits.

Congress would likely pay a political price for increasing retirement fund restrictions, says Gregory Smith with The Wise Investor Group at Robert W. Baird Co. in Reston. Photo by Will Schermerhorn;
Congress would likely pay a political price for increasing retirement fund restrictions, says Gregory Smith with The Wise Investor Group at Robert W. Baird Co. in Reston. Photo by Will Schermerhorn

The average investor might shrug at this proposal, Grinspoon says, but “not so fast. These investment vehicles may sound like the playground of the rich, but this couldn’t be further from the truth. These are the lifeblood of fledgling companies and entrepreneurs, which creates jobs, grows the economy and lifts all ships.”

Accredited investors constitute 20% of all investors, “not the 1 percenters that Congress wants to go after,” Grinspoon says.

As of 2020, qualified investment accounts such as IRAs and 401(k)s and defined benefit plans totaled $19.29 trillion, Grinspoon says. “Imagine taking this much funding away from investing in these vital companies.”

The proposal would provide a two-year transition period to remove these investments from IRAs. However, private investments are not freely traded like stocks or bonds. “The illiquidity is one reason they provide an opportunity for great returns,” Grinspoon says.

“Just the threat of this legislation will freeze investment opportunities and fundraising right when companies need it the most,” he says. “The point of the accredited investment rule escapes me, other than to argue that if everyone can’t invest in it, then no one can.”

Reducing the unknowns

Anyone with earned income — up to a limit — can contribute to an IRA.

Annual contribution limits may seem small — $6,000 per person for those under age 50 or $7,000 for people 50 and older — but combined with tax breaks and compounding, a savings plan can grow significantly over time.

If you make too much money, you don’t get a deduction for a traditional IRA. Too much for 2021 is income of more than $76,000 for a single person or $125,000 for a married couple filing jointly, according to the Internal Revenue Service.

“Investors have an obligation to do the best they can within the guidelines of the law,” says Joseph W. Montgomery with The Optimal Service Group of Wells Fargo Advisors in Williamsburg. Photo by Mark Rhodes
“Investors have an obligation to do the best they can within the guidelines of the law,” says Joseph W. Montgomery with The Optimal Service Group of Wells Fargo Advisors in Williamsburg. Photo by Mark Rhodes

Transactions in a traditional IRA — interest, dividends and capital gains — are taxed at the participant’s tax rate at the time of withdrawal.

“That’s why the IRS is so adamant about required minimum distributions [in the year you turn 72],” Montgomery says. The federal government wants the money.

While growth, income and distributions in a Roth are tax-free, if you make more than $140,000 as an individual tax filer or $208,000 as a married couple filing jointly, you can’t contribute to a Roth at all. 

That said, contributions are different from conversions and this is where it gets interesting, especially for high-net worth investors. 

“There are no income limits or floors [for Roth conversions], which would indicate inclusion for everyone,” Smith says. “Calling it a tax break is a misnomer. There is no upfront tax break whatsoever.”

With a Roth, “you eliminate an unknowable — what your future tax rate will be,” Smith say. 

It’s important to time conversions to reduce tax liabilities, Joyce says. “If you’re in the highest tax bracket, I wouldn’t recommend a conversion.”

Income stipulations for conversions were removed in 2010, “theoretically to encourage Roth IRA conversions to add to taxpayers’ taxable income and, therefore, to increase revenues for the U.S. treasury,” Smith says.

He notes that the government’s voluntary plan for retiring civilian federal workers under the Civil Service Retirement System allows workers to contribute 10% of their total lifetime government earnings into an after-tax plan and then roll every dollar into a Roth IRA after they retire.

“It’s a wonderful mechanism to be Rumpelstiltskin and spin straw into gold, sanctioned and blessed by the government, and available to all CSRS workers, regardless of income levels,” Smith says.

“For workers at places of employment that offer after-tax contribution plans and allow for immediate conversions to a Roth, it too is a great way to reduce unknowables into your future planning — while at the same time sleeping better at night knowing you are better insulated from future tax-rate fluctuations.” 

SPAC-ulative finance

One of the hottest investment tools in the past year and a half has imploded. But don’t give up on special purpose acquisition companies, or SPACs as these peculiar financial structures are called, industry experts say.

Also called blank-check companies, SPACs are here to stay, but not necessarily at the high-flying levels of 2020 and early 2021.

In Virginia, the practice of going public via SPAC has had mixed results. Most notably, Herndon- and Seattle-based BlackSky Technology Inc. and IronNet Cybersecurity Inc., a McLean-based tech firm that debuted in late summer, have seen strong returns on investment. But other Virginia-based companies have backed away from SPAC deals before completion, and Richmond-based CarLotz is being sued by investors after its stock price fell dramatically.

“The SPAC market is a little saturated, but I wouldn’t write it off,” says Derek Horstmeyer, professor of finance at George Mason University’s School of Business. “While the crazy hype we saw nine months ago is down, a lot of money is sitting in SPACs, waiting to acquire companies.”

An alternative to a traditional public offering, SPACs are public shell companies that function as holders of investors’ cash for the sole purpose of merging with private companies and taking them public with less regulatory scrutiny than a typical initial public offering. In 2020, more SPAC deals were completed than IPOs, and SPACs outpaced IPOs at a rate of 2 to 1 early this year, Horstmeyer says.

The practice also benefited from a little celebrity sparkle, with tennis star Serena Williams and NBA Hall of Famer Shaquille O’Neal investing in SPACs. In March, the Securities and Exchange Commission issued an alert to potential investors: “SPAC transactions differ from traditional IPOs and have distinct risks. … Sponsors may have conflicts of interest, so their economic interests in the SPAC may differ from shareholders.”

The SPAC surge ended soon after the alert was issued, and the market has yet to recover. 

“Yes, there was some aggressive risk-taking and speculation, but on the other hand, there were and are many quality companies coming public through this structure,” says Chris Pearson, a senior vice president and portfolio manager at Davenport & Co. LLC, a Richmond-based investment company.

“The great ‘SPAC-ulation’ was followed by the ‘SPAC-ocalypse,’” Pearson says, referring to speculative excesses that swept through the market only to be met with an apocalyptic drop. “A lot of investors were unfamiliar with this structure but saw the performance and were enticed by the opportunity to make a quick and substantial buck. Not all SPACs are created equal.”

In a traditional IPO, pricing can change until the night before shares start trading.

“A SPAC is more efficient because the money has already been raised and held in a trust,” says Kristi Marvin, CEO and founder of SPACInsider, a data and research provider for the SPAC asset class.

“Not all SPACs are created equal,” says Chris Pearson, senior vice president and portfolio manager with Richmond-based Davenport & Co. Photo by Matthew R.O. Brown
“Not all SPACs are created equal,” says Chris Pearson, senior vice president and portfolio manager with Richmond-based Davenport & Co. Photo by Matthew R.O. Brown

Companies could spend months getting ready for a traditional IPO, she says, only to have something unrelated happen in the market that delays the deal on the night it’s supposed to be priced.

“That is partly why SPACs were so popular [in 2020 and early this year] during COVID,” Marvin says. “The traditional IPO window was shut, but the SPAC window was still open.”

However, Pearson notes that some merger deals involved subpar companies with overly lofty projections.

In turn, some investors got burned. Now, regulators are looking more closely at SPACs, clamping down on the accounting procedure, and 19 class-action lawsuits concerning SPACs have been filed this year, including a high-profile suit questioning the legality of a proposed SPAC deal sponsored by hedge fund billionaire William Ackman.

Ackman, founder of the largest-ever SPAC, Pershing Square Tontine Holdings Ltd., said in August that he will return the $4 billion in investments in the stock deal between his company and Universal Music Group N.V. He claims the lawsuit is meritless but adds it is unlikely to be resolved quickly.

Industry insiders are watching how this lawsuit will play out, since it could have a significant impact on how SPACs are structured in the future, experts say.

Meanwhile, several blank-check deals announced this year have not been completed. Most companies are looking for deals that are trading below their listing prices — typically $10 a share. At the height of the boom, stock prices almost always rose after SPAC deals were announced. That’s not the case anymore.

Faster and easier

One benefit of the SPAC arrangement over IPOs is flexibility for investors, who can choose to pull their money before a merger is completed. They are more likely to do so if the stock is trading below list price, experts say.

Hundreds of SPACs are searching for private companies to buy and take public. They typically have two years to find and merge with private companies or they must return money raised from investors.

A SPAC consists of two basic transactions — the IPO of the SPAC itself and its subse-quent merger. The acquired company takes the SPAC’s place on the stock market.

Year-to-date as of mid-September, 435 SPACs had gone through the IPO process, raising a total of $125.9 billion for an average public offering of $289.3 million, according to SPACInsider.

By comparison, only 59 SPACs became public in 2019, underscoring the sharp rise in their numbers in a short period of time, the trade publication reported.

The SPAC strategy is often quicker than a traditional IPO. Once a target company is found, a merger can be completed in months versus a year or more with a traditional IPO. Also, in a SPAC deal, the company going public can make business projections, which is not allowed in a traditional public offering. 

Up until March, “the market was really robust, with almost 100 SPAC deals landing every month,” says George Geis, law professor and expert in corporate law and finance at the University of Virginia. “Now we’re down to nine or 10 a month.”

Although SPACs have been around for years, the recent enthusiasm built on its own momentum, Geis says.

“The flavor of the day — where people rushed in for chances to get quick gains on their investments — has fallen a little out of favor,” says Brent Allred, business professor at William & Mary’s Raymond A. Mason School of Business.

“Tighter regulatory oversight has added a level of complexity,” he adds, but it could provide greater shareholder protection and awareness.

“SPACs are not necessarily the utopia mechanics for going public,” Allred says. “Without the scrutiny [of traditional IPOs], some SPAC deals turned out well, but others came back to bite the shareholders.”

Despite the pullback this year, Pearson sees continued opportunities for SPAC deals. Success will be company-specific going forward, he says. “It comes back to what wins in the long term and what creates value for shareholders.” 

There’s also considerable demand. A total of 452 SPACs, including some that completed public offerings in 2019 and 2020, are searching for new target companies — typically young startups with potential but unproven track records in hot sectors like tech or green energy. The firms tend to be smaller and potentially riskier than those going through a traditional IPO.

Some, especially those with no revenue, typically would stay private longer, but with a SPAC, they can tap into public markets earlier to raise capital and fuel growth.

A mixed bag

In Virginia, Tysons-based Cvent Inc., an event management company, said in July that it plans to merge with San Francisco-based SPAC Dragoneer Growth Opportunities Corp., which trades on Nasdaq. The deal — expected to close in the fourth quarter — values the private-equity-owned company at $5.3 billion.

Other Virginia deals include BlackSky Technology, a geospatial intelligence and global monitoring firm, which debuted Sept. 10 on the New York Stock Exchange after merging with Osprey Technology Acquisition Corp., a Philadelphia-based SPAC.

NavSight Holdings Inc., a Reston-based SPAC, merged in August with Spire Global Inc., a San Francisco-based data and analytics firm. Shares started trading on the NYSE Aug. 17 under the “SPIR” stock symbol.

Richmond-based used-car consignment retailer CarLotz went public via SPAC in January, but saw its stock price fall by 65% by mid-September. Photo by Scott Elmquist
Richmond-based used-car consignment retailer CarLotz went public via SPAC in January, but saw its stock price fall by 65% by mid-September. Photo by Scott Elmquist

Also in August, McLean-based IronNet closed its deal — announced in March — with LGL Systems Acquisition Corp. The stock, trading under the IRNT ticker symbol, opened above the $10 listing price and flirted with the $40 range by mid-September.

Richmond-based CarLotz, a used-car consignment retailer, has not fared as well since going public in January by partnering with Acamar Partners Acquisition Corp.

Its stock price, which hit $11.25 on the first day of trading on Nasdaq, fell in mid-September to the $4 range. Analysts say CarLotz faces headwinds — including a global shortage of semiconductors — that make it difficult for the company to operate. But investors are not pleased. They have sued in the Southern District of New York federal court, claiming the company violated federal securities law. 

Other Virginia deals have fallen through in light of adverse market conditions and the dwindling appetite in general for SPACs.

These include Los Angeles-based SPAC Tailwind Acquisition Corp. and QOMPLX Inc., a Tysons-based risk management company for cybersecurity and insurance industries. The companies, citing market conditions, agreed in August to terminate their merger. 

And a proposed merger between Arlington-based digital news company Axios Media Inc. and San Francisco-based sports media publication The Athletic fizzled this spring. The companies had sought to join forces by forming a SPAC, The Wall Street Journal reported in March, but by May the deal had stalled.

“SPACs are highly cyclical,” says Marvin of SPACInsider.

The current downcycle was exacerbated by a regulatory change — where warrants (a contract that allows a shareholder to buy more shares in the future at a given price) had to be treated as liabilities instead of equities, she says. That change was followed by uncertain conditions, created in part by the emergence of more contagious coronavirus variants, and the pending fourth quarter, which can be dicey for the stock market.

“We are in a protracted downcycle,” Marvin says. “There are plenty of good target companies out there. The problem is the environment.”