by Kathleen M. Gounaris, PsyD.
MBA
Maurice F. Prout. PhD
Abstract: The devastating impact of the economic cri-
sis, combined with examples of corporate greed and
hubris, has damaged client relationships and broken
trust for investors and the public. This article exam-
ines the role of psychology and emotions in the cur-
rent economic environment, using the lens of behav-
ioral finance to generate best practice guidelines. We
argue that a conceptual appreciation of behavioral
finance alone is insufficient to survive the Whitewater
ahead. It is imperative that financial advisors simulta-
neously repair client relationships through communi-
cation skills that rebuild trust. The integration of these
insights into practice creates a stronger, wiser practice
for the future.
This issue of the Journai went to press in June 2009.
Copyright S> 2009, Society of Financiai Service Professionais.
Aii rigtits reserved.
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS / JULY 2009
75
lotrodoctioo
n the fall of 2008, the nation witnessed the
crashing of our fmancial system with disbelief
and dismay. Reactions were immediate,
intense and emotional, as is typical when people are
confronted with a traumatic experience. For both fman-
cial advisors and their clients, the economic turmoil has
been a jumbled, overwhelming experience of adrenaline
and fatigue, optimism and hopelessness, panic and fear.
In its wake, the relationship between investors and the
fmancial services industry is badly damaged. Like the feel-
ings of betrayal following the discovery of a partners affair,
clients are experiencing a range of feelings: shock, anger,
resentment, despair, and shame. At the most fundamen-
tal level, basic trust in the relationship—with investment
advisors or fmancial institutions—has been broken.
The initial cracks in the ice were seen in the overnight
disintegration of a single institution such as Lehman Broth-
ers, which released the flood waters into the U.S. economy
and around the globe. Since then, the corporate roster of
faltering institutions and massive downsizing grows longer
and more impressive. The flood waters also sprang open a
Pandora's box of Wall Street deceit, revealing systemic
greed, hubris, incompetence, and sheer ignorance.
Investors are outraged at highly sophisticated Ponzi
schemes and bonus incentives revealed regularly by the
press. Most notably, Bernard MadofFis accused of carry-
ing out a $50 billion fraud over decades, while Allen
Stanford allegedly ran an $8 billion securities scam.'
Shareholders are aghast at perceived astronomical CEO
compensation packages that often reward dismal com-
pany results. Investors and the public are shocked and
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
terrified at the speed and ferocity of the economic col-
lapse. Moreover, they have lost confidence and faith in
the ability of formerly trustworthy institutions, leaders,
or government to protect them. While financial service
professionals work in a range of settings (e.g., independ-
ent practice to investment banking firms), their counsel
and investment decisions are interdependent and associ-
ated with declines of the stock market, and potentially
the behavior of other financial professionals.
Can This Relationship Be Saved?
Despite the pai.nful nature of affairs, people still seek
to love again and to be in a meaningful relationship.
Similarly, clients may still have the desire to be in a part-
nership with a trusted financial advisor. Moreover, they
need such counsel' to navigate the complex economic
uncertainty ahead. However, clients are badly bruised
and skittish of thé industry, leaving them stuck at a
crossroads of ambivalence and angst: Who to hire? Who
to fire? Is anyone trustworthy and competent?
Now that the damage has been done, the top prior-
ity for financial professionals is mending client relation-
ships and restoring trust, even if the advisor did not
directly cause any damage to the client. When couples
choose to remain together following indiscretions, it can
be an arduous road, with repeated tests to the integrity of
the relationship. Even for those who move on to form
new relationships, a sense of mistrust follows them, ofi:en
revealed as worry, skepticism, and emotional neediness
until they feel secure again. Financial professionals might
experience analogous relationship dynamics when man-
aging clients' perspectives and future expectations about
performance, invesrment decisions, and perhaps even
culpability in the economic downturn.
Although the picture could appear bleak, financial
advisors can use the crisis to redefine and to strengthen
their professional practice. In a Utopian world, people
forgive, kiss, and rriake up. In reality, it takes humility,
earnestness, patience, and hard work to earn back trust
and commitment from jaded partners. Equally as critical,
advisors must provide innovative yet tangible solutions
that mitigate financial damage with swift impact. As
fallout from the crisis, clients have unapologetically raised
the bar on standards for competent, transparent, and
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS/JULY 2009
76
ethical practice in financial services. Specifically, advisors
should expect to provide evidence of high caliber expert-
ise in risk management, diversified asset allocation, and
application of behavioral finance in portfolio manage-
ment and financial counsel.
Restoring Trust through Behavioral :
Finance: An interdependent Approach
By now, most financial professionals are acquainted
with research about financial decision making from the
field of behavioral finance. Behavioral finance illuminates
the psychological and emotional dynamics at play between
investors and the market.'^ Relevant to the times, its research
provides insight about human decision making under
duress and uncertainty—the current state for many Amer-
icans. The recent financial turmoil and its negative global
cascade provide evidence to further support its tenets.'
While the media often fuel fear about the crisis, they
have also elevated the public's understanding of psycho-
logical factors that influence the economy and consumer
behavior. Through the disciplined study of such factors,
behavioral finance offers advisors critical insights about
the economic collapse that should result in less biased,
more rational decisions in the future.•* Moreover, this
environment offers an ideal "teachable moment" to add
a behavioral finance component to the planning process
in both dialogue and tangible solutions for clients.'
The economic crisis will be extensively analyzed and
debated for years to come. Behavioral economisrs are sure
to play an instrumental role in such discussions. However,
a major gap frequently exists in its body of literature: rhe
intellectual appreciation of investor psychology verslis the
real life, real time, /»enow^/application of these insights to
individuals, i.e., when advisors look across the table into a
client's eyes, trying to interpret the thoughts and emotions
staring back. Therefore, it is the combination of the con-
ceptual and relational approach to behavioral finance that
defines a new way of practice and improves the probabil-
ity of avoiding the serious mistakes of the past. ;
The most fundamental notion of behavioral
finance—and most of psychology—is that people's behav-
ior does not necessarily make sense! The good news? Peo-
ple are predictably irrational. Whether in relationships or
with money, people do not fit into neat, pretty packages of
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
rational, self-interesred, linear behavior as tradirional eco-
nomics would predict and business schools still frequently
teach. Through meaningful conversation, the underlying
logic (subjective to the individual) reveals itself to the lis-
tener. Consequently, seemingly "irrational" feelings or
behavior are more intelligible and understandable.'^
For many people caught in a cycle of panic and fear,
the ability to think clearly is greatly impeded. Emotions
cloud perception, like driving through a dense fog. It is
this cycle that creates catastrophic thinking, some of
which may be valid, but some of which could be irra-
tional. However, clients rarely make an explicit state-
ment such as "I am feeling scared." Instead, they mani-
fest their feelings in a range of behaviors on the outside,
such as anger and hostility, angst or depression, indeci-
sion, and self-destructive behaviors (e.g., drinking, over-
spending.). As emotions intensify with no outlet, irra-
tional behavior or decisions become more problematic'
While difficult to do, fmancial advisors cannot be
defensive or stubbornly cling to "the facts" when clients
offer these negative feelings or irrational thoughts about
the impact of the crisis. Paradoxically, in such extraordi-
nary times, a clear defmition of "irrational" is nonexist-
ent. While objectivity is paramount to sound fmancial
guidance, in restoring clients' trust, it is equally impor-
tant to validate their viewpoint first and foremost. To
truly be "client centered" as a fmancial professional, one
must regularly put aside personal beliefs and assumptions
to understand the person across the table. Advisors
should invest time actively listening, paraphrasing, and
clarifying the client's perspective to mend the relationship
and heal injuries sustained from market revelations.
A few key tenets of behavioral finance provide
insight into best practice tools that can restore trust with
clients and also cultivate more competence in dealing
with the complexities of the market.
Following the Herd and Confirmation Bias
A curious behavior repeats every generation across
America: teenagers all dress alike. Similarly, any new trend
worn by a pop star spreads like wildfire, a fact well known
by market researchers. This phenomenon illuminates an
important tenet of behavioral finance: humans tend to
follow the herd.. .even when we grow up!
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS /JULY 2009
77
Americans place great value on their uniqueness as
individuals, yet this belief often runs counter to evolu-
tionary hard wiring. Humans are deeply social beings,
dependent on each other for survival. When people
make decisions—especially if they feel unsure or threat-
ened—they watch what other people do and then copy
them. Across situations and cultures, psychologists have
found that humans employ such "social comparison" to
inform their beliefs and decisions even when it contradicts
facts or their better judgment."
''How did this happen?" is the most common, per-
plexing, unanswered question of the economic crisis. It
echoes in the halls of Congress, in board rooms, and in
kitchens across the nation. Research would suggest that
a herd mentality played an instrumental role on both
sides of the equation, impacting institutional decision
making and investor behavior alike. Unfortunately, such
massive momentum created an economic tsunami. How-
ever, any one cow is incapable of stopping the herd. In
fact, the herd makes it quite difficult to follow another
path. Outliers or naysayers are cast aside when the herd
is blissfully on its path off a cliff
Additionally, research demonstrates that when people
come to a decision, they pay most attention to people or
facts that further confirm their conclusions. This behav-
ioral phenomenon is a convenient circle. More omi-
nously, people also tend to ignore people or facts that con-
tradict those beliefs. These tendencies are respectively
referred to as "confirmation bias" and "disconfirmation
disinclination."' They underlie herd behavior throughout
many periods of history (e.g.. The Inquisition, Dutch
tulip mania, Nazi Cermany, Jim Jones mass suicide).
Confirmation bias ran rampant during the two salient
financial bubbles of recent years: the dot-com boom of
the late 1990s and the fresh housing and mortgage crisis
that largely accounts for present economic turmoil.
Instincts for human herding exist for good reason
though. Conforming is often healthy and necessary for
human society and survival. For example, following the
laws or the moral code is critical to a stable, civilized soci-
ety. Social comparison enables humans to filter vast
amounts of information quickly and efficiently, often
resulting in generally sound conclusions (these rules of
thumb referred to as "heuristics").'" In financial planning.
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
there are situations in which a "herd" investment (e.g.
index funds) is completely appropriate. Common wis-
dom now encourages people to take advantage of 401 (k)
accounts for retirement planning, which most people
choose to do. Despite the dismay that many employees
have had about the declines in their 401 (k) value, it is
still a prudent option to exercise for retirement savings.
While it would be unwise to make investment decisions
in a vacuum, it is equally important that fmancial profes-
sionals employ a h;ealthy dose of skepticism when the
herd is clearly moving en masse in a certain direction.
The best practice for an advisor, then, is to regularly
consider the direction and timing of the herd, specifically
toward and away from salient trends. By elevating aware-
ness of this humari bias, one becomes more skilled at
noticing moments yvhen the herd veers in a potentially
worrisome direction.
Cultivation of this skill requires due diligence, fore-
sight, objectivity, and confidence. Although it would be
unrealistic to have perfect accuracy in predicting herd
behavior, advisors could benefit from incremental success
on this learning continuum. For example, an advisor
may have exited real estate investments at an earlier point
in the housing bubble. Through their advisor, clients
can also benefit frorh learning about the energy and pull
of the herd, especially to guard against their inner dis-
comfort for investment decisions that go against the
grain. The following example illustrates underlying emo-
tional responses to recent herding in the housing market.
Example: Jack and Rita have always dreamed of a
retirement home in Florida, yet they usually rent to min-
imize costs on a fixed income. Several years ago, it
appeared that many friends were buying homes in Naples
that rapidly increased in value each year. Rita wanted to
invest money in an appreciating asset that they could also
enjoy, but Jack felt nervous. He came from a working
class background and liked to have his hard-earned
money in the bank! While he wanted to ride the wave
too, something did not feel right; but he thought he
lacked the education of those around him who "knew"
more about real estáte investments. Jack and Rita's advi-
sor Tim knew they could objectively afford the mortgage
in Naples. However, after working with them for many
years, he also knew their personalities, marriage dynam-
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS / JULY 2009
78
ics, and stress points. While the Naples house was an
attractive investment and location—which Rita clearly
desired—Tim also respected Jack's intuition and his low
tolerance for stress. He advised them to purchase aihome
in a more affordable but less glamorous community.
Despite the crisis, they are able to afford their monthly
bills for a second home they enjoy. Jack listened to his
instincts (and to Tim) and followed a more conservative
path compared to the herd. i
The popular term "irrational exuberance" is | more
than an allusion to stock market bubbles. It accourits for
the utter blindness and vulnerability of the herd when
times are good. It is herd behavior that creates a forum
in which excess and greed flourish, as demonstrated by
the housing bust. :
Loss Aversion
In the financial wodd, the term "loss" is tossed around
daily and often unemotionally. In an objective sense, loss
is simplified to one side of the balance sheet. In this linear
world of facts and figures, loss is external. However, for
people (even those employed in finance), loss is actually
internal. It is a sensation experienced on a subjective level,
whether through investments, through relationships,
through jobs, or through death." Humans do not like to
experience loss, on any level, as it causes distress and pain.
This aspect of human nature may seem simple and obvi-
ous. However, it is critical to understand its power over
investing behavior and in relationships, as people avoid
any subjective sense of loss at all costs.
Research shows that most people feel twice thé pain
from a financial loss as they do pleasure in an equivalent
gain.'^ As explained by Kahnemann and Tversky's
"Prospect Theory," loss aversion and regret aversion are
often the underlying motivations for what appears to
be irrational investment behavior." As financial profes-
sionals rebuild client trust in the face of uncertainty and
skepticism, loss aversion is likely to play a prominent role
in the dialogue and subsequent decisions. Consequently,
advisors face two challenges: 1) the ^tír of further loss is
more powerful than any objective, logical data thatl min-
imizes the likelihood of loss, and 2) people are largely
unaware of the dynamic operating between their feelings
about loss and their emotional state or financial deci-
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
sions. "While the intensity of loss aversion varies hased on
individual factors (e.g., life experience, current financial
stability, life stage), the human tendency to avoid loss
predictably interacts v^^ith tolerance toward risk.''*
Conversations that shed light on clients' attitudes
toward recent and future loss can grease the wheels of
"stuck" points in the planning process. However, many
Americans are obviously faced with very realistic losses:
incomes, jobs, health insurance, savings, even houses.
Advisors must navigate a complex situation: stopping
the financial bleeding, shifting clients to new budget
constraints, and simultaneously absorbing clients' reac-
tions to stressful life events.
Managing the External:
Adaptation of Budget and Lifestyle
External aspects of financial planning have histori-
cally defined its focus: income and expense budgets, sav-
ings and retirement, investment vehicles, etc. This side of
the equation is tangible, pragmatic, immediate, and log-
ical. In prosperous, stable times, the role of fmancial advi-
sor is fairly well defined. In a more daunting environment
filled with added emotional strife, advisors may need to
attend to the internal world of clients when managing
external financial decisions. On the outside, many house-
holds must make significant changes in their spending
and saving behaviors to weather the downturn. Intellec-
tually, people usually understand this new reality. How-
ever, changing their daily behavior is much harder in
practice, as they must change habits as well as their mind-
set. The following example provides an illustration.
Example: Camille is worried about downsizing at her
company. She only has two months of living expenses
saved, some credit card debt, and student loans. Camille
agrees with the suggestions of her financial advisor that
she minimize discretionary spending each day to quickly
bolster savings. She struggles most with the litde "pick me
ups" that she "deserves" while working hard to keep her
job. For example, every day she and a colleague enjoy cof-
fee and treats from Starbuck's at 3 p.m., which gives her
energy to return to her work. Camille felt embarrassed by
this lack of willpower until her advisor suggested a solu-
tion that worked for another client. Instead of Starbucks,
she and colleagues could take turns baking treats for their
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS / JULY 2009
79
team, and limit gourmet coffee purchases to two after-
noons. By showing Camille the dollar amount saved per
year, she was able to mentally make the change in her
weekly habits and commit to her savings plan.
Managing the Internal:
Mental Accounting and Expectations
One dollar equals one dollar...right? Officially, yes.
Objectively, yes. In practice, not really. People physi-
cally separate their money into different accounts: short-
term savings, long-term savings or retirement, and imme-
diate cash. These accounts represent different purposes,
and individuals add to or withdraw from them according
to "rules" about their use. There is another accounting
system that most people rely heavily on in juggling
finances—the one in their heads.'^
The human mental accounting system, while infor-
mal, is very powerful, often holding equal weight to the
dictates of physical ledgers. In essence, money is "stored"
in different mental compartments. Even if dollar
amounts are objectively the same for two different
accounts (e.g., tax refund versus weekly salary), spending
or saving behavior can vary dramatically as a function of
the account's meaning to the individual. Some money is
considered untouchable (e.g., earmarked for college),
whereas some money is lavishly spent as though it is
one's final dinner (e.g., gifts, inheritance).
If mental accounts exert a strong pull on financial
behavior and decision making, what is the source of this
power? It is the deep-rooted beliefs and expectations that
people have about money. When people react to some-
thing, the observable behavior ofi:en reveals expectations
they hold about the event. Therefore, the external range of
emotions and attitudes displayed by clients reflects the
variability of their internal expectations and attitudes."^
Expectations, of course, are future oriented, and the
financial future for most people—and for the country—
is uncertain and rather gloomy. In rebuilding client trust
within these murky waters, it is critical that an advisor
understand the impact that the crisis has on the client's
expectations. At a deeper level, the economic losses rep-
resent a complete shattering of people's plans and dreams
for the future. Justifiably, people seek someone or some-
thing to blame, especially those who are most drastically
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
impacted. Ironically, many professionals in the fmancial
industry seek the sarhe vindication for their outrage about
the devastating impact from the economic collapse.
Therefore, restoring trust in the client relationship
becomes even more; complex due to a revolving subtext
of blame, guilt, and anger. Returning to the analogy of an
affair, the past relationship no longer exists, as breaches
of trust (including those of distant parties) irrevocably
change what "couldthave been" or "should have been" in
the future. Therefore, fmancial professionals should not
assume the relationship is intact simply because a client
shows up for meetings. Even for advisors who prudendy
prepared clients forjdownturns, the new economic real-
ity suggests that in restoring clients' fmancial health, it
would be wise for advisors to reestablish the psycholog-
ical contract too.
Lessons of the. Crisis:
CuHtivating Best Practices for the Future
Wisdom is cultivated by studying the past and
applying its lessons to the present. As hindsight bias
would propose, the economic collapse seemed obvious,
inevitable, and perhaps even predictable. If only tradi-
tional economics, or behavioral economics, or psychol-
ogy could provide ai single, coherent explanation for the
complexity of this tsunami. Standing alone, each has its
limitations. Weaved together, their knowledge and
insights become powerful, meaningful, and highly appli-
cable to the investment profession.
The following recommendations offer guidelines to
advisors to begin a process of systematic integration of
behavioral fmance irito their practice. An interdependent,
two-pronged approach is outlined. One side of the equa-
tion focuses on the| client relationship. The other side
focuses on the development of a more balanced, multi-
disciplinary model of fmancial planning.
Rebuilding the Client Relationship
through Communication
Advisors Should First Seek to Understand
Financial professionals must suspend the impulse
to dive in and "fix" the situation until clients have been
able to openly describe their viewpoint and feelings.
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS/JULY 2009
SO
Advisors Must Avoid Defensiveness
Clients are feeling nervous, fearful, resentful and
indignant—about the larger crisis, their personal losses,
and about change. If an advisor is defensive, it polarizes
the discussion. It is wise to frequently paraphrase and
clarify a client's statements and feelings.
Advisors Are the Voice of Optimism
and Calm within This Storm
While no one has a crystal ball, clients must sense—
on an intellectual and an emotional level—that ¡their
advisor is the best partner to weather this fmancial storm.
Tough messages and truthfulness must be balanced; with
the ability to instill genuine hope in clients. :
Advisors Can Assist Clients in Restoring a '•
Sense of Control to Their Life
The economic crisis can feel overwhelming due to a
lack of control over most aspects of it. Overexposure to
the media exacerbates this sense of anxiety and helpless-
ness. Clients and advisors can make a list of factors
within and outside of their control, focusing their energy
on the former. Clients should set a daily limit for watch-
ing news reports or checking fmancial statements, or
clients could implement a "positive" activity, such as a
comedy show or pleasure reading before bed.
Advisors Can Have Conversations That
Redefine "Wealth"for Clients
What is wealth? As an affluent society, Americans
have grown accustomed to overconsumption of material
goods during prosperity. Some people have considered
the economic crisis as an opportunity to reassess priori-
ties and values. Advisors and clients can redefme Wealth
and its meaning to their families, e.g,. health, achieve-
ment, quality of relationships, time. This shift in perspec-
tive can buffer people psychologically against the nega-
tive feelings from loss and enable them to make lifestyle
changes due to the economy. '
Advisors Must Communicate Frequently,
Thoroughly, and Candidly
Clients feel anxious and fearful. The quality and
frequency of communication with their fmancial advisor
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
can have an enormous impact on their feelings about the
future, about the advising relationship, and about invest-
ment decisions. They are analyzing words, actions, and
statements with this lens and will do so repeatedly for
quite some time. Managing this level of scrutiny will
require patience, time, and professional clarity on the
advisor's part.
Advisors Must Customize and Vary
Their Communications to Clients
Frequent communication is optimal when integrated
with a targeted, relevant, and personal touch from advi-
sors. For instance, a monthly statement might feel more
meaningful with an attached handwritten note and
recent news article addressing an area of concern for the
client. Through creativity and thoughtfulness, advisors
can ensure multiple avenues of dialogue to review invest-
ment decisions while also reminding clients of their per-
sonal importance.
Advisors Must See the Person, Not the Person's
Portfolio, across the Table
While the definitive marker of success in financial
services is financial health and growth, the bottom line
is meaningless without the human element. Money holds
deep personal meaning for each client, representing his
or her hopes, expectations, and emotional life. Financial
models, data analysis, and conceptual paradigms (even
behavioral finance) are critical, but only represent one
side of the planning equation. People define the other.
Restoring Financial Health:
Behavioral Economics in Financial Portfolios
Advisors Should Systematically Incorporate
Behavioral Finance Principles into Their Practice—
Beginning Today
The economic crisis demonstrates that the "soft"
side of investing—human psychology—has enormous
implications for outcomes and the bottom line. It should
not be considered as an afterthought in practice. Dom-
inant economic models rely on the "facts" and few
account for perceptions. Financial professionals should
become well versed (in understanding its principles and
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS /JULY 2009
81
implications for competence in today's practice. As out-
lined above, conversations with clients can immediately
incorporate its fundamental tenets.
These roadmaps are ideally used in the quantitative
analysis as well as systematic qualitative analysis of com-
panies and their management. As a practice shifts toward
a more multidisciplinary approach, advisors should use
the opportunity to educate and update clients about
changes in store. Clients will expect and appreciate that
their advisor learns from mistakes (his or her own or
the market's) and seeks new insights for practice.
Advisors Must Consider the Crisis as an Event
in History, Despite the Acute Turmoil
Yes, the economic collapse feels unprecedented.. .but
it is not. At the time of writing, this view is considered
politically incorrect and possibly uninformed. However,
when people live through any emotionally intense event,
the past and the future are elusive. It is difficult to keep
a long-term perspective. The stock market will eventually
rise (and fall) again. The economy and industries such as
housing will rise (and fall) again. As history teaches,
more bubbles and busts will follow, but no one can pre-
dict exactly when. Advisors must force themselves to
look beyond the fires to the clearing ahead in order to
make wise investment choices right now with their
clients, whose lives feel chaotic and in turmoil.
Advisors Must Summon Their Courage to
Step Away from the Herd
Advocating, and acting upon, a contrarian point of
view is no easy task. Paradoxically, those who rang warn-
ing bells about an impending catastrophe in the housing
and financial markets are now being lauded as visionar-
ies and geniuses—perhaps rightly so in this perfect storm
of economic circumstances. However, the newfound
popularity of these critics' views on the direction of the
economy could be an equal mistake, as the herd will
just trend toward the genius out of fear of the unknown.
How, then, to balance prevailing beliefs against
healthy skepticism? To remain independent of the herd's
confirmation bias, a disciplined process must be insti-
tuted that forces a consideration of divergent informa-
tion. It is wise to seek out diverse perspectives by listen-
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
ing to contrarians and finding the validity in their point
of view, even if you generally do not agree (for example,
reading "The Black Swan" by Nassim Nicholos Taleh,
who warned of the dire consequences to risk-manage-
ment practices in 2005).'^ Therefore, financial profes-
sionals should incorporate a herd scenario analysis into
their practice, ultirnately weighing the herd's wisdom
(benefits) against it's blind spots (risks).
Financial professionals should also routinely gather
with people who hold different views or backgrounds on
the economy to serve as devil's advocate to their overcon-
fidence. For example, host quarterly roundtables about
the economy with people from different industries, aca-
demic disciplines, and even political views. Otherwise,
financial professiorials gravitate toward those who think
and act like them, creating a house of mirrors.
Ironically, the rharket is ripe with opportunity due to
the massive market josses. The individuals with the most
personal courage add fortitude, and perhaps chutzpah as
well, will capitalize on the times. The rest of the herd will
wait until everyone else invests again.
Advisors and Their Clients Can't Have It All;
Risk Tolerance Must Be Redefined in the Future
Prior to the economic crash, greed and hubris were
not the exclusive domain of a group of professionals on
Wall Street. Material exuberance also ran rampant in
shopping malls, in tony housing developments, and in the
mental fantasies of American consumers. Broadly speak-
ing, many people vvanted all upside, with little consider-
ation or tolerance for the downside. Such expectations
drove the frenzy, and now there is a high collective cost.
The exuberance of recent years has important impli-
cations for a true understanding of risk. The most accu-
rate profile of risk tolerance is generated during crisis
and duress, «oí during times of ease and prosperity. Client
portfolios should be reassessed from this perspective. In
addition, now is the time to recalibrate expectations about
performance. Specifically, there may now be a stronger
case for investments that earn more modest gains, while
protecting assets that "help one sleep at night." Going for-
ward, the latter may; comprise a larger percentage of assets
than previous standards of practice specifically reserved as
insurance against economic catastrophes.
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS /JULY 2009
82
Investment Professionals Need to Demonstrate
Leadership, Learning from the Crisis with Humility
while Also Moving Forward with Hope
It is perhaps one of most difficult times to be a
financial advisor in the history of the modern profession.
Until the crisis, financial professionals could use pre-
vailing notions for competent practice to earn relatively
good returns and satisfy clients: diversifying assets, i hold-
ing equities for the long term, capitalizing on dips, advis-
ing contributions toward 401(k)s, etc. Not surprisingly
or uncommonly, advisors who followed "the rules" feel
angry at themselves and also dumbfounded at how the
system basically failed to see the catastrophe coming.
Just as clients need an outlet for their thoughts and
emotions related to the crisis, financial professionals are
likely to benefit from carving out a time and place to do
the same. To move forward productively with sufficient
energy and clarity, advisors first need to digest the events
of the past few months. Informally, financial colleagues,
other business associates, and close family and friends can
remind professionals of their identity and worth out-
side of work. Formally, many resources exist to support
financial professionals in navigating the crisis, such as
financial psychologists and executive coaches.'*
Five Steps for Advisors to Restore Clients'
Trust in Their Practice and Relationship
Advisors Can Explicitly Demonstrate
Updated Risk Management Practices
Clients will need reassurance that advisors have new
ideas that proactively and aggressively protect them| from
future calamities. Current clients will appreciate this clear
sense of purpose, and such clarity about safety mecha-
nisms enhances an advisor's brand to prospects. Commu-
nication about initiatives should be frequent and clear.
Advisors Can Conduct an Audit of Their Own Practice
To achieve standards for best practice, blind ¡spots
must be discovered. In the context of the financial crisis,
advisors should engage in a disciplined self-appraisal
(e.g.. Were diversification strategies broad enough?
Where was the greatest mental bias in the planning
process? What information is typically discounted?
 Repairing Relationships and Restoring Trust:
Behavioral Finance and the Economic Crisis
Where is herding evident in planning, creating a vulner-
ability?). Advisors can enlist a respected colleague to
evaluate his or her practice with a critical eye and offer
tangible modifications.
Advisors Can Solicit Specific Feedback
from Clients about Changes They Desire
following the Financial Crisis
To uncover clients' expectations about the future, it
is critical to create a forum that actively promotes this
type of candid dialogue. If clients feel any loss of trust in
the advisor or the industry, it provides an opportunity to
convey their desires for the practice or the relationship
going forward. While this suggestion may feel expos-
ing, such humility can generate considerable trust with
clients and can build credibility in learning from mistakes
to improve practice.
Advisors Can Revisit and Redefine Risk Tolerance
vMthough sound financial advice includes an accurate
assessment of risk, it would be beneficial to reassess client
risk profiles in the midst of economic crisis, when risk
feels quite close and real. A familiarity with loss aversion
in advisors and clients would enhance this dialogue.
Advisors Can Institute More Discipline for
Including Divergent Information in Their Practice,
Reducing Bias and Herding
As confirmation bias refiects, people gravitate toward
information that supports their conclusions and generally
discard disconfirming information. Advisors could com-
mit to reviewing two additional sources of information on
a regular basis, with the goal being a credible but very dif-
ferent viewpoint than their own. Similarly, advisors could
commit to a scheduled dialogue with a colleague who
thinks and acts dissimilarly, enhancing both practices by
pushing the boundaries of each others' thinking.
Conclusion:
The Outlook in an Uncertain Future
The field of psychology is eternally balancing the art
and science of good practice. In the clinical field, when
individuals routinely swing between extremes in behav-
ior, it is very likely that this pattern will repeat through-
JOURNAL OF FINANCIAL SERVICE PROFESSIONALS / JULY 2009
83
out life. However, a psychologist cannot predict exactly
when and how extreme the swings will be. Instead, there
is an appropriate diagnosis based on symptoms and past
behavior, with subsequent treatment that prevents wild
extremes and minimizes the adverse impact of the
patient's behavior.
Similarly, the pendulum of market behavior swings
regularly and systematically. One can be 100% certain
that the pattern will repeat, yet no crystal ball can spec-
ify the time or intensity. Like a psychologist mixing sci-
ence with art, financial advisors can learn to understand
the cluster of signs associated with an upswing or down-
draft. Consequently, they will be better prepared to antic-
ipate and act on various potential scenarios in the future
with credibility and confidence.
From the view of behavioral economics, human
behavior is the powerful, uncertain, irrational wild card
in the equation for analyzing, understanding, and pre-
dicting market behavior. Insights from human history
across time, however, suggest the inverse: the human
element is the only real constant in the formula. As his-
tory generously teaches us, patterns repeat across peri-
ods, cultures, wars, and industries because while the cir-
cumstances change, basically the people do not.
Therefore, advisors who can apply these lessons of
behavioral finance and also engage clients around the
personal meaning and impact of the crisis are more
likely to survive this moment of history and thrive in
long-term business, n
Kathleen M. Gounaris, PsyD, MBA, earned a joint degree in
clinical psychology and business administration from Widener
University in Chester, Pennsylvania. She manages the Philadel-
phia office of YSC Ltd., specializing in wealth and business
psychology. Dr. Gounaris consults to senior executives about
business strategy and leadership. She may be reached at kath-
leen.gounaris@ysc.com.
Maurice Prout, PhD, is a full professor at the Institute of Grad-
uate Clinical Psychology at Widener University, Chester, Penn-
sylvania. He is a Founding Fellow of the Academy of Cognitive
Therapy and a Diplomate in Clinical Psychology. He maintains
a private practice in Wayne, Pennsylvania. He may be reached
at mfprout@widener.edu.
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