Financial advisors often talk of "staying the course," remaining faithful to modern portfolio theory, asset allocation and diversification through the best and worst of times. Through every peak and valley, adherents of this approach maintain, equities will get the job done and provide the best long-term returns for a retirement plan.

So says history.

But history books are full of unexpected turns and, as it turns out, 2008 dished out perhaps the most shocking financial upheaval ever witnessed by modern-day financial advisors.

Even investors who dutifully followed conservative asset allocation plans saw their retirement savings shattered, with some portfolios losing 20%, 30% or more in a matter of a few weeks. Diversification provided little shelter. Panicked selling by overleveraged hedge funds brought everything down and, as the year came to a close, economists were predicting things could get worse in 2009.

It amounted to the toughest test yet for those with a profound faith in long-term equity investing. For some, the crisis created doubts, a shift to a more conservative approach. Others, not thinking this situation was possible, became more reflective. Still others, confident the crisis would pass, stuck to their long-term approach under the assumption things would eventually get back to normal.

All advisors agreed fear and anxiety were at unprecedented levels, and much of their time was spent talking their clients through the turmoil.
"You have to remember you're the one thing standing between them and some really bad long-term decisions," says Chris Jordan, president and CEO of Lexco Wealth Management in Tarrytown, N.Y.

A Passing Storm?
To those who would say the crisis proves equities are too risky to form the basis of a retirement plan, Chris Cordaro, chief investment officer of RegentAtlantic Capital in Chatham, N.J., has a favorite analogy. Imagine, he says, that a big tornado storms through a farm and sucks up a cow, a pig and a tractor.

Those casting doubts on asset allocation, he says, are basically looking at the effects of the storm and saying the law of gravity has been repealed. "We're pretty confident that when the storm passes, everything will fall back to earth," he says. "We're in a huge financial storm right now, and I'm confident that when the storm is over, diversification will start to work again."

Daniel Moisand, principal of Moisand Fitzgerald Tamayo LLC in Melbourne, Fla., also feels long-term asset allocators will get through this crisis as they got through the bursting of the dot-com bubble and the post-September 11 market. "You don't go into a plan without expecting some pretty significant market events along the way of a normal person's life span," he says. "The new retiree should expect at least a couple of declines of this magnitude."

The current crisis does differ in terms of its complexity, he says. Most people knew why the market went down in the early part of the decade. The current crisis, with the involvement of terms such as credit default swaps and other exotic derivatives, leaves the average client confused, he says. "With this subject matter, people just don't know what everyone is talking about," says Moisand, some of whose clients include NASA rocket scientists.

The severity of the damage thus far has some advisors wondering if there will be lasting impacts. No one doubts the massive impact the ongoing economic and financial crisis is having on Americans' retirement plans, particularly those of people who recently retired or who are planning to do so within the next few years.

Even before the current crisis, when the economy and markets were perceived as faring well, study after study indicated that Americans were failing to put aside enough to last through retirement.

Recent data suggests that the problem has only deepened. As of early December, 2.2 million Americans between the ages of 56 and 65 lost, on average, between 23% and 24.5% on their 401(k) plans in 2008, according to the Employee Benefits Research Institute (EBRI).

Federal Reserve data suggests the nation's public and private pension funds have lost $1 trillion, or about 10% of their assets, from second quarter 2007 to second quarter 2008, according to Congressional hearings in October that looked into what impact the financial turmoil is having on retirement security. "I think people will definitely have to work longer, but to be honest, most of them should have been planning to work longer even before this happened," says Jack VanDerhei, EBRI research director.

Anecdotally, advisors say many of their clients are rethinking retirement dates, considering part-time work, postponing or canceling vacations and cutting spending in other ways to hunker down.

There are also those, in the small minority, who can't bear the losses and the wild market swings. They want to cash out of the market and, quite often, advisors will comply with the request. "When you say, 'Hey, just hang in there,' how many times is it before you are just long in the tooth?" says Jordan of Lexco Wealth Management.

He's had two clients pull all their money out of the market. One was a retiree he describes as a "Felix Unger type" whose request didn't surprise him. Jordan was more surprised, however, when one of his longtime clients, a "brilliant PhD" still several years away from retirement, decided to exit the market for six months.

"He's been investing for 30 years and is an astute guy," Jordan says. "He said he's been to this party when everything feels bad. He told me he didn't want to do it this time."

Jordan hasn't made significant changes in his investment approach, which emphasizes locking in short-term income through low-risk fixed-income vehicles. But the crisis and its impact on investors has caused him to have some doubts about modern portfolio theory.

"When the facts change and you use a universal assumption things will be the same as they were historically, people get crushed," he says. "I believe things have changed and it will be a different climate going forward."

Mark Cortazzo, senior partner at Macro Consulting Group in Parsippany, N.J., says his firm continues to invest for the long term but has decreased client exposure to equities as the crisis plays out. "A lot of that is driven by how much income they need and how much is discretionary spending versus need," he says.

He has seen some difficult cases. A new 67-year-old client walked in recently who lost 50% of his portfolio value. His investments weren't outlandish and were managed by a highly regarded advisor, he notes. "They were using modern portfolio theory with asset allocation models with some of the most respected fund families in the universe," Cortazzo adds.

Even with cases such as these, Cortazzo feels it was more difficult to be a financial advisor during the dot-com boom than it is now. "This year, people are saying they want to be more conservative," he says. "In 1999, I had people wanting to do things that were potentially devastating to their net worth because they wanted to take on so much excess risk."

A Matter Of  Timing
One of the chief complaints about modern portfolio theory as used in retirement planning is that it can't protect investors from bad timing.

A prime example would be retirement-age investors who saw their portfolios shredded in recent months. "The long term may not match with your time frame," says Paula Hogan of Hogan Financial Management LLC in Milwaukee. "Equities are risky even if you hold them for a long time. The day you need to take them out could be the day the value is down. Look at all the people out there who thought they were going to retire in '09."

She says advisors shouldn't be bashful about pulling client funds out of the current market. If a client wants to have a basic lifestyle in retirement and can't afford to lose any more, "you have to put a stop to the hemorrhage," she says.

She also believes 20% to 30% of a retirement portfolio should be in an inflation-indexed immediate annuity. The annuities, she adds, should be spread out among a diversified group of companies.

Cortazzo of Macro Consulting Group also uses income annuities as a way to transfer risk and create a guaranteed stream of income. It's the type of strategy that often goes missing in individual investor portfolios, which he sometimes feels are managed too much like those of institutions.

"Managing money for an individual is very different than managing money for an institution," he says. "Account cash flow and timing risk are much more critical to an individual than a large entity."

While annuities don't enjoy wide popularity among investment advisors, Hogan says, she feels the current crisis may change attitudes. Many advisors, she notes, developed and reinforced their skill during the 1990s bull market, when every correction was brief and equities quickly resumed their ascent, making risk management almost an afterthought.

"As an industry, we are taught that stocks are your friend, just hang on," she says. "I think when you have a recession of this severity, not only advisors' but consumers' notions of what is normal and prudent practice will change."

When it comes to their retirement outlook, consumers certainly are growing more pessimistic, according to recent poll data. Only 46% of Americans feel they will be able to live comfortably in retirement, according to an April Gallup poll. That's down from 53% a year ago and 59% in 2002. The poll also found 63% of Americans are worried they will not have enough money for their retirement.

Sheryl Garrett, founder of the Garrett Planning Network, says the clients worst off may be those who retired in the past year or two. Retirees typically spend at a higher rate during the first few years of their retirement, she notes.

"People have a lot of pent-up desires on what to do in the early years of retirement," she says. "Now, all of a sudden, there is no money."

The housing market collapse has added to the stress since many middle- and upper-middle-income clients depend on their home equity as a significant part of their retirement assets, she says. "Now, if they want to relocate, it may not make any sense to try," Garrett says.

The crisis has been just as much an eye-opener for advisors as it has been for clients, she says. For many advisors, it's the first time their carefully crafted plans have failed. "Our whole industry has been built on the analytics of, well, 98% of the time this is going to happen just fine," she says. "But if you are the client or individual that doesn't happen to be in the 98%, it is intolerable. It does not work."

Advisors in the Garrett Planning Network have tried to focus on identifying their clients' comfort level. This has led to many clients shifting from 20% to 50% of their assets from equities into fixed income, Garrett says. Some of the money has gone into CDs-which probably wasn't even on the list of options a year ago.

"If that makes someone more comfortable, that is where they ought to be," Garrett says.

'This Is Different'
John Napolitano, president of U.S. Wealth Management LLC in Braintree, Mass., says clients don't happily embrace the buy-and-hold approach as they have in the past. "This time it is different," he says.

This is partly because, for many younger investors, this represents their first crisis. Market losses this time around have also been very sudden, he notes.
"You go away for a month or two and you're down 40%," he says. This, plus the fact that the market drop could get worse, has caused clients to be "genuinely extremely nervous," he says.

Yet Napolitano hasn't made any significant changes in the firm's management style. He toyed with using technical analysis, but his clients and 50 advisors shot the idea down as a form of market timing. Even the possibility of making more use of income annuities makes Napolitano nervous because of solvency issues with the companies that back them.

For now, says Napolitano, it's a matter of waiting for the market to right itself. "Mutual fund managers are pretty smart guys that get paid a lot to try to be right," he says. "That's why I really haven't shattered my long-term buy-and-hold vision."

Advisors may have reason to further reassess their management style at the end of the year. Lou Stanasolovich, president and CEO of Legend Financial Advisors in Pittsburgh, says his firm's "lower volatility" strategy-a branded management style that seeks "equity-like returns with bond-like risk"-was able to keep losses to an average of about 14% for the firm's clients in 2008.

Advisors who weren't so fortunate following classic modern portfolio theory may find out how clients really feel about their approach in January or February, he says. "That's when clients look at their yearly returns," Stanasolovich says. "It's the day of reckoning."

As Stocks Sink, An 'I Told You So'
If you're a maverick who has spent years warning advisors and individual investors about the dangers of the stock market and mutual funds, now would be just the right time to gloat.

Zvi Bodie, however, isn't kidding himself.

Even with the stunning collapse of the stock market in late 2008, he realizes that equities will probably continue to be the mainstay of the nation's retirement planning industry.

"I would say that some people will never wake up," says Bodie, the Norman and Adele Barron Professor of Management at Boston University.

"It's like those folks who keep rebuilding on the shore every time the house is blown over and they say, 'Well, it's a once-in-100-years storm.' Then ten years later it happens again," he says. "The point is, it's unpredictable and that's what we mean by risk."

The argument Bodie makes in his speeches and in his book, Worry Free Investing, is that mutual funds, advisors and the rest of the retirement planning industry have created the false impression that long-term stock investments are a safe play for individual investors.

Bodie maintains stocks are in fact a big gamble for the typical investor, even over the long run.

The danger of stocks is borne out by mathematics, which shows that the chance of sustaining a severe loss on stocks increases the longer you hold them, Bodie says.

The stock market of 2008 is shaping up to be just such a "severe" event-one that has shattered the retirement plans of many investors.

"Planners comfort themselves by appealing to the long run," Bodie says. "But the long run becomes the short run when you're about to retire."

Bodie feels retirement planners should focus on managing risk with Treasury Inflation-Protected Securities (TIPS) and I-Bonds, which provide a guaranteed payoff on maturity. If he were an advisor, Bodie says that's where he would be telling his clients to put the remainder of their retirement money. If clients insist on stock exposure, he says, it should be through S&P 500 call options.

Critics say the return on TIPS and I-Bonds is too low to be a realistic option for most individual investors. TIPS, for example, were bringing negative yields for part of 2008.

Bodie, however, argues that the inflation protection guarantee is the key to these products. As for the low yields, he says that's the trade-off between risk and reward-and the reason he can sleep peacefully at night.

"When you shift into safe assets, as I have done, you give up the thrill of victory and the agony of defeat," says Bodie, who turned 65 in 2008. "Right now, I'm sitting at my computer looking up sailing vacations in the Caribbean. The fact that the market has gone down almost 50% from its high in 2007 doesn't bother me. I chose not to be part of that."