Meir Statman, a professor of finance at Santa Clara University in California, tells of a client who had promised his adult son he would pay for the college education of his grandchildren. After last year’s market downturn, those plans are no longer feasible. The client is now blaming his financial advisor for ruining the family.

Many financial advisors now face the challenge of helping their clients come to terms with the setbacks they have suffered during the market downturn and keeping them focused on their long-term goals. To retain these clients and get them back on track, say leading consultants and behavioural economics specialists, you will need patience and sensitivity to both your clients’ emotions and their financial needs.

Advisors who have hitched their wagons to investment performance above all else are most vulnerable to suffering damage to their client relationships when markets turn south. Some advisors have lost the confidence of their clients, Statman says, by promising things the advisors are unable to deliver.

For example, many advisors had promised their clients that, based on historical averages, investors could not lose money in stocks over a 10-year period. But for the 10 years ended Dec. 31, 2009, the S&P 500 index shows a 4.1% average annual loss. The Nasdaq composite did even worse, with an average annual loss of 8.7%. (While Canada’s S&P/TSX composite index fared better, showing an average annual return of 5.6%, the U.S. figures make a strong point.)

“Many advisors are feeling they have lost their expertise,” Statman says. “If they told investors they would never have losses, they are feeling a sense of guilt. There’s been a lot of fear, anger and disgust with themselves and the academics who educated them. It’s been a rough time.”

Although the markets have recovered much of their lost ground, clients who were heavily exposed to equities have still not come back to where they were before the market crash that began in late 2008 and bottomed in March 2009, wiping out almost half the value of key stock indices. In some cases, clients have had to bite a reality bullet and adjust their life plans, as the money simply isn’t there to finance them.

The key is not to lecture, Statman says. Underneath their anger or fear, your clients are ready to be guided.


> Dealing With Anger

Advisors may be at risk of losing clients due to unresolved emotions surrounding the financial meltdown of the past year, says Frank Murtha, managing director of MarketPsych LLC in New York, a consulting firm that specializes in financial psychology.

“Investors have been through a lot, and even with the market recovery of the past few months, many are experiencing negative emotions that will linger until they are actively discharged,” says Murtha, who holds a doctorate in counselling psychology and specializes in investor psychology and behavioural finance. “Unresolved emotions are like a stone in the shoe. And they tend to get worse with time, not better.”

Clients have suffered both psychologi-cal wounds and actual cuts to their financial wealth, Murtha says. Some harbour anger and resentment, while others are paralyzed by fear; still others are in the “denial” phase.

“When the client has suffered a wound, it’s best to make sure it does not get infected by an emotional reaction that will poison the relationship with the financial advisor,” Murtha says. “The goal is to get the client to a point of acceptance, and clear the way to move forward.”

Getting your clients to this stage involves having meaningful conversations about how they feel and determining whether there have been any changes in their life goals. Clients may previously have wanted to achieve specific goals — such as retirement, major purchases or travel — in certain time frames, and may now be going through an adjustment process based on the realities of their financial losses.

Alternatively, they may be re-evaluating their risk tolerances and their desired exposure to the volatility of equity investments. The key, says Murtha, is to let your clients talk and unburden themselves first. Then, discuss what can be done and the solutions that will get your clients where they need to go.

If you are dealing with an angry and upset client, let the client vent rather than trying to counter emotion with logic.

@page_break@“The worst thing an advisor can do is trot out charts and reiterate the benefits of a long-term time horizon when the client is upset,” says Barry LaValley, president of LifeFirst Approach in Nanaimo, B.C. “When clients are hurting, they don’t need charts. What they need is a coach or guide, and they want someone to feel their pain and help them through it.”

Clients will eventually need to hear about long-term returns in equities markets and the power of compounding, agrees Murtha, adding: “But you can’t force-feed them or reason with them when they’re distracted by intense emotions.”

You should strive to develop the relationship based on your ability to move your client through difficult times, he says, not on your abilities as an investment expert.

It’s also important to anticipate client roadblocks or areas in which they may be particularly sensitive or reactive, such as estate planning or their recent losses, and ensure you approach these issues with sensitivity.

Advisors need to be especially sensitive to where their clients stand on the risk spectrum, which often involves reading between the lines of what they actually say. People get more conservative and risk-averse as they become older — even if they become wealthier — and many advisors have not adapted to this mental change, LaValley says. If you fail to make the shift, the potential surprise for you is defecting clients.



> Empathy

“Advisors need to understand why a client is upset, and show their concern,” Statman says. “Empathy is very important.”

The key is to listen, then come back with a concrete plan.

With the panic in the markets now subsiding, some advisors are dealing with a few clients who had reacted emotionally at the height of the storm, having insisted on selling all equities and heading to cash despite their advisor’s efforts to dissuade them. One of the most helpful things you can do in such cases is help your clients understand why they reacted they way they did, so they can learn from the experience.

“We all make mistakes,” Statman says, “but we must carry on with life.”

When you see or hear an emotional reaction, show empathy rather than trying to minimize or dispel it, Murtha says: “It’s like putting your arm around your client and demonstrating that you see what they see. Give them the recognition they need. Once their emotional needs are met, then you can have conversations about concrete steps to take.”

Help your clients understand what actions they made purely out of fear, and show them that fear is a poor basis for clear decision-making. Avoid finger-pointing or smugness, Statman says: “The last thing an advi-sor should do is say, ‘I told you so’.”



> Rediscovery

This is also a good time to get to know your clients again. Their overall goals and attitudes may have changed — not only because of the market downturn but because other aspects of their lives may have changed since the last time you assessed their long-term plans.

“Advisors can no longer fall back on what worked in the accumulation stage of life for their clients,” LaValley says. “Baby-boomer clients in retirement, or moving toward it, are more concerned about hanging on to their wealth than increasing it.”

These shifting priorities mean investors’ time horizons become more psychological than chronological, LaValley says. The older people get, the less time they have to recover from any market losses. And when clients begin to experience declining health and the deaths of friends and family members, they become increasingly aware of life’s uncertainty and often become more anxious.

“The [conventional] client discovery process is flawed,” LaValley says. “It should not be just about financial goals and risk tolerance. There are a lot of psychological things that need to be understood before appropriate recommendations can be made, and planning must become more life-based.”

A client “rediscovery process” is needed for advisors to determine where clients should go from this point forward, and to enable advisors to tailor advice accordingly, LaValley says. Advisors who take a holistic approach, which includes helping clients manage such areas as insurance, tax planning and estate planning, will be able to demonstrate expertise in more than one area and deepen the client/advisor relationship.

Murtha offers a technique called the “future slide show” to help clients focus on the longer term and remain committed to a financial plan. It involves a heart-to-heart conversation about how your clients visualize their life down the road, with explicit details about the things they would like to achieve.

The idea is to develop images about what the future will look and feel like, thereby creating “points of light” that will help guide your clients through the fog created by market gyrations. The slide show helps keep your clients away from the gravitational pull of emotion-dictated behaviour, Murtha says, and leads them toward a more rational, long-term perspective.

Begin with conversations that have nothing to do with money or financial issues, but that focus more on feelings and challenges that your clients are facing in their lives. “Talking about money can sometimes sound mercenary,” Murtha says. “It can trigger mental cues that lead to defensiveness. The relationship is much stronger if it’s built at a level that is not compromised by unpredictable market behaviour.”

> “Bucket” Strategy

When the conversation does move on to financial issues, LaValley suggests a strategy that can give your clients psychological comfort while helping them meet their financial goals. It involves dividing your clients’ retirement money into three “buckets,” each designed to meet a specific need in retirement.

One bucket would cover essential expenses needed to pay the most basic living costs; a second bucket would provide for lifestyle enhancements, from travel to helping others; and a third, “nest egg” bucket would be for safe investments. The nest-egg category, which is included to help your clients sleep at night, could contain equity in the home, products with guaranteed minimum withdrawal benefits and fixed-income investments.

“A portion of retirement savings must be invested for growth,” LaValley says. “And if the stock market doesn’t co-operate, the client may have to postpone the annual trip to Hawaii, but everything else is covered.”

Each bucket should be invested with its own level of risk, depending on what each client wants to accomplish. That requires an emotional — rather than a logical — discussion, and you must be more of a communicator and educator than ever before, LaValley says.



> Risk

You have to explain that there is a risk of losing purchasing power if your clients lean so far toward safety that they fail to make an adequate return, Statman points out: “Risk is not a luxury; it’s a necessity and part of life. If you want to avoid all risk, you can never leave the house. If you put every penny in [government bonds], you could be as poor as a mouse. We take some risk because we must. And, in some cases, it simply doesn’t work out.”

Taking a middle-of-the-road approach that involves a balanced portfolio with a variety of asset classes and deployment of cash on an incremental basis will remove the fear of making the wrong move at the wrong time, and reduce the potential for regret, Murtha says. He likes to paint the image of the market as a seesaw that will stay level if weight is moved toward the centre rather than putting heavy weight at either end.

It may be easier for some clients to do nothing in the short term if they are paralyzed by fear. But, Murtha says, the nature of regret is that it is typically stronger regarding missed opportunities than regarding actions that were thoughtfully taken. Even making small changes to a client’s portfolio, or simply conducting a thorough review to make sure it still suits the client’s goals and risk tolerance, is helpful, he says.

“Investors can be overwhelmed by anxiety, and action can be an antidote because it gives a sense of control,” Murtha says. “It’s less important what the action is than it is to get some momentum happening.”



> Watering The Weeds

Murtha cautions against creating what he calls a “wicked garden” — by pulling the flowers and watering the weeds. It is a metaphor for taking profits on investments that have risen in value but still have good long-term growth potential (flowers), but hanging on to losers that haven’t recovered yet and show little promise of ever doing so (weeds).

“The most important determinant of investment success is investor behaviour,” Murtha says. “Many people are invested in good things, but they don’t stay in them and they miss out on long-term appreciation. They give in to the familiar itch to jump from lily pad to lily pad, and tend to abandon things at precisely the wrong time.”



> Remain Realistic

Resist the urge always to paint a positive picture, an easy tendency for salespeople. In good times, your clients must prepare for a time when the markets will turn down, and that often means rebalancing by taking profits and, thereby, lagging market averages.

“A good advisor typically gets complaints during a bull market because the client’s portfolio isn’t keeping up with the brother-in-law’s,” says Richard Thaler, professor of behavioural science and economics at the Chicago Booth School of Business at the University of Chicago.

But those clients whose portfolios were properly diversified across asset classes before the downturn now have something to show for it, he adds: “If you want protection against the downside, you’re not going to get all the upside.”

The aftermath of the downturn is what Thaler calls “a teachable moment”: every advisor should be pointing out that what happened in the past year can happen again, and portfolios must be designed to weather worst-case scenarios in various asset classes.

The goal is to use the experience of the past year for the client and advisor to understand each other better, Thaler says. If you made mistakes in positioning your client’s portfolio, admit it. Clients typically appreciate candour, he says, and honesty makes them more willing to forgive.

The unexpected can still happen. A good advisor tells clients they can’t know everything in advance, but can prepare by being properly diversified and by rebalancing systematically. Rebalancing automatically leads to selling high and buying low.

“You go shopping when there’s a sale,” Thaler says. “The best time to buy a turkey is after Christmas.” IE