Bear markets are the greatest cause of angst for advisors and their clients. In a bear market, what clients previously thought of as a remote risk becomes reality and may trigger a complete crisis of confidence in the advisor's competence.

Whether it does depends on risk tolerance and expectations. Specifically, was the client's investment strategy consistent with his or her risk tolerance, and did the client understand the risks he or she was taking?

The better we understand these relationships and how clients reacted to this bear market, the better able we should be to minimize the likelihood of angst in the next bear market. After all, advisors and clients share a common interest: Neither wants the relationship to end unhappily.

LATEST RESEARCH

To this end, my research firm FinaMetrica has been conducting three streams of research:

* The FinaMetrica database of 360,000 completed risk profiles collected over the past 12 years provides data on both averages across time and changes in individuals who have completed multiple risk tolerance tests. In particular, we have test/retest data for 2,586 individuals, where the first test was completed in the 2003-2007 bull market and the second in the 2007-2009 bear market.

* From December 2008 to June 2009 we surveyed our subscribers and their clients about their bear market experiences in the Global Financial Crisis (GFC) survey.

* Since October 2009, in conjunction with Nightly Business Report (NBR) and Kiplinger's Personal Finance, we have been conducting an ongoing survey of their viewers and readers that has included looking back to the impact of the 2007-2009 bear market.

While the research is ongoing, four key findings are already evident:

* The actual impact of the bear market on investors has been exaggerated by the press.

* Clients had been expecting that their advisors could protect them from the vagaries of the market.

* Contrary to popular belief, behavioral changes in a bear market are not due to a collapse in risk tolerance but rather to changes in risk perception.

* The bear market experience has decreased investors' overall sensitivity to market falls.

Each of these has implications for how advisors manage client relationships. They are discussed in more detail below.

EXAGGERATED IMPACT

According to media reports, the bear market was a devastating event for all investors; however the evidence does not support this view. Looking at the NBR/Kiplinger data, only 14% of investors reported a big loss, and 24% made at least some profit. In addition, 61% say their long-term goals are unaffected, and 34% believe their long-term goals are only going to be somewhat more difficult to achieve. The vast majority did not make radical changes to their investment portfolios.

While the NBR/Kiplinger respondents may be savvier than investors as a whole, they are not from a different planet. Although most investors were unhappy during the recent bear market, there is no evidence that they were devastated, nor that they panicked.

The anecdotal evidence from advisors suggests a gloomier picture for their clients. But upon further questioning, this seems to have come from their interactions with a handful of clients rather than their client base as a whole. Thus, the negative outlook may be due to the fact that human beings overweight dramatic events and feel more pain from a negative event than the pleasure of an equivalent positive event.

We have completed two surveys for NBR/Kiplinger respondents and have just started a third. In total, there will be more than 70 questions across the three surveys, with thousands of respondents for each survey. The data is currently being analyzed by researchers at Texas Tech University and elsewhere.

CLIENT EXPECTATIONS

In the GFC Survey, we asked clients how the effect of the market decline on their investments compared with their expectations. For almost half, the effect was considerably outside their expectations and for another 13%, the effect was completely outside their expectations. So it is fair to say that 59% were at least considerably surprised by what happened to their investments.

We also asked how the market decline affected their view of stock market risk. Here, one-third said that the market was at least considerably more risky than they had thought.

While the two questions are worded differently, it seems reasonable to conclude that clients were more surprised by what happened to their investments than by what happened in the market, suggesting that clients expected their advisors somehow to be able to insulate their investments from the vagaries of the market. This should be a warning to advisors: Even though their value propositions to clients do not claim they can beat the market, their clients may not want to hear this and in fact may not hear it.