A Changed World for Financial Advisers

Investment plans developed by professional financial advisers failed miserably in 2008. What have they learned from the meltdown?

By Ben Steverman

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Financial advisers are looking themselves in the mirror these days, and they don't always like what they see. A year like 2008 was enough to shake the confidence of anyone who helps investors manage their money.

For advisers and their clients, "the world has been turned upside-down," says Frank Boucher, a financial planner in Reston, Va. "We've been disappointed and even betrayed by a system that I thought was being adequately regulated."

Advisers might not be to blame for the recession and financial crisis, but their advice is responsible for investment portfolios that, combined, lost trillions of dollars. In 2008 tried-and-true investing maxims suddenly stopped working. Tools such as diversification that were used to manage risk failed as the value of almost every asset class, from real estate and stocks to bonds and commodities, plummeted at once.

BusinessWeek asked dozens of financial advisers what lessons their industry should learn from the financial crisis. Most financial planners sounded as stunned and befuddled as their clients or their colleagues in other parts of the devastated financial sector. But most are also full of ideas for how better to protect and plan for their clients in the future.

Asleep at the Wheel?

For some, the lesson of 2008 is clear: With the financial crisis approaching like an out-of-control bus, advisers should have pushed their clients out of the way. Client portfolios could have been moved into cash or Treasuries, the year's only safe havens. "Unfortunately, I think the industry fell asleep," says Chip Addis, of Addis & Hill Financial Advisors, based in Wayne, Pa. But this perspective isn't quite new. It's another wrinkle in an old debate between those, such as Addis, who would actively manage their clients' money and "buy-and-hold" advisers who believe it's foolish to try to adjust portfolios in light of market conditions.

"The buy-and-hold guys are going to tell you: 'Go 55 [miles per hour] on the highway all the time,'" says Fred Amrein of Amrein Financial in Wynnewood, Pa. "Common sense says when it's icy, rainy, or snowy, maybe you have to go slower." But buy-and-hold advisers point out that active management is more expensive, and it's impossible to tell in advance which strategies or investment managers will work. While a few active managers can brag they saved their clients from deeper losses, the past year also showed how unpredictable markets can be.

"There's always going to be one person who timed it right," says Barry Korb of Lighthouse Financial Planning in Potomac, Md. But, there is no "magic bullet."

The crazy volatility of 2008 markets—and particularly the stock market—may be the year's most lasting impression. And that is sparking a broad recognition that, until last year, many advisers and investors forgot how risky the markets really are.

Too Much Risk

With only a few interruptions, stocks have provided steady profits for investors since the 1980s. In that time, "people began to feel a little more casual about the inherent risks in being a stock investor," says Paula Hogan of Hogan Financial Management in Milwaukee, Wis. "There is a notion that if you just hold stocks for a long time, somehow they get less risky."

However, when one year—such as 2008—is enough to cut the value of your stock portfolio almost in half, any exposure to stocks may be just too risky for most investors, says Zvi Bodie, a professor at Boston University's School of Management. Equities usually do well over the long term, but not reliably enough to bet your hard-earned retirement funds on, he says.

"You ought to be very careful about taking equity exposure if your standard of living is really going to be affected by the outcome," says Bodie, who favors a very conservative strategy centered on inflation-protected Treasuries.