I have a confession to make. Even though prior to March 2000, the market was our biggest client, and even though since then we have lost revenues due to lower portfolio valuations, and even though clients have been nervous and somewhat anxious, I was secretly pleased when investments, especially technology and large-cap growth, headed south. I reveled in self-satisfaction when all those market hotshots called us, panicked because their recent fortunes were being whacked away month by month. I resisted saying "I told you so," when clients who had been giving us hassles because of our low market return expectations, finally began to feel the effects.

Listen, I know this thinking is somewhat like shooting myself in the foot. Nobody really wants this kind of market volatility, and certainly nobody in his right mind would want this bear market. In these times, advisers work harder, trying to keep jittery clients from bailing out when they should not. We make less money, particularly if we charge based on percentage of assets. Nobody's fat and happy anymore; just fat, overeating from depression.

Thinking over the changes in client behavior in the past two years, it would appear that a monstrous trend of hurricane proportions is gathering force. Advisors are going to need to change their attitudes and approach about what to expect from client relationships, and we are going to need to re-educate our clients about what to expect from us-and from their investments.

Five years ago, consumers were in the conspicuous consumption mode. Everybody on our street owned a BMW or a Lexus. Most working, upper-income clients that I'd see lived well beyond their means, primarily on their whopping salaries, supplemented by credit cards and home equity loans. We stocked our reception room with Sotheby's catalogs and back issues of the Robb Report. Markets were high; everybody felt rich.

A few months ago, while standing in line at the grocery store, I came upon a new magazine called, Real Simple. It was chock full of ideas about living a simpler lifestyle with less frenzy, fewer possessions and more quality experiences. It talked about finding bargains, using coupons and the status of getting more for less. What a fascinating, foreign concept! Baby boomers, notoriously conspicuous consumers who have historically worn all of their assets on their backs, or at least parked them in the driveways of their trendy neighborhood condos, are now priding themselves in wearing Target t-shirts, getting discounts at Walgreen Drug Stores and driving fuel-efficient electric cars.

A 1999 Gallup poll found that most investors expected 20% returns on their investments for the next 20 years. This, they felt, was a "reasonable expectation." Last week, I sat on a plane with a pilot who was deadheading home from five particularly grueling days of flying. We started talking about his forced retirement when he turns 60 next year. He asked me what my expectations for returns were for the next five years. Before I could answer, he shared his thoughts on the subject. "Ten percent sounds really good," he began, "but I figure we are all going to have to be happy with about six."

My buddy the pilot has come to grips with his investment future, although I believe most investors have not yet made that leap. My pilot friend told me he lost a lot of money in tech stocks, but he knew that just meant that he was going to have to work longer to realize his idea of a comfortable retirement. "I'm going to fly those executive jets when I retire," he said. "You can be over 60 and still work."

This brings me to the second trend I see in investor behavior. In the 1990s, investors felt their biggest risk was not getting rich. Today, their biggest risk is not surviving financially. In the '90s, they focused on upside potential; today, downside risk. In the '90s they felt in control. Risks were predictable. Investing on your own is fun in a bull market. Today, investors are cautious. They don't know what the risks may be, and worst of all, they know that investing to avoid losses is no fun at all.

Part of these fundamental changes in investors may have been exacerbated by the events of September 11. Before 9/11, we equated security with money. We knew what would make us feel safe and happy. If we just had enough, we would be okay. Now, we equate security with trust, relationships and family, because no amount of money will really make us feel secure on our own shores again.

Our solutions to the needs created by these cross-currents lie in behavioral finance. In the past 50 years, classical finance principles taught us that investors are rational. Those of us who have been working in the financial advice field for any length of time know that clients do not make rational decisions. Behavioral finance teaches us that investors are normal. They will fall prey to some faulty thinking in reaching their decisions, but fortunately for us, their thinking is predictable. Professor Meir Statman, finance professor at Santa Clara University, puts it succinctly: "Behavioral finance is about the management of investors, not about the management of investments."

There's an "ah-ha" for you. All this time, we have been telling clients that we are in the financial planning or investment planning or investment advice business. But we really are in the business of managing client behavior and expectations. We are in the business of keeping our clients from making (or not making) decisions now that will seriously affect their future lives. Fortunately for us, investors have become empowered delegators.

They want to hire the general contractor, not simply to relieve them of the current responsibilities but also to provide tangible benefits that will save them money in the long run. A good contractor knows how the windows should be hung, saving big dollars in later years. Homeowners may not know the difference when the windows are installed incorrectly, but they wise up fast when years later the plaster disintegrates around them, allowing rainwater to damage the interior and exterior walls, requiring total replacement. Investors no longer want to make mistakes today that will cost them dearly in later years.

So, with a nod to Professor Statman, here are a few ways you can use behavioral finance solutions to meet the investor trends of today.

Deal With Losses

My first car was a 1962 Plymouth, about eight years old at the time. It was owned by a little old lady who sold it to me because she felt sorry for a poor young student who needed to drive to work while attending college. It was in beautiful condition, except for the crack in the engine block big enough to drive a monster truck through, fat wheels and all. The car cost me $300-a real bargain-until I discovered the bald tires, another $300, the defective solenoid starter, another $500, and of course, the engine block that the mechanic quoted me $3,200 to replace. That car taught me how to cut my losses. I sold it for $50 for parts and saved $3,950 in real dollars-and Lord knows how much in aggravation.

Your client's reluctance to realize losses is a behavioral heuristic (mental shortcut) referred to as mental accounting. The loss of a dollar is twice as painful as the gain of a dollar is pleasurable. "That Cisco stock is a dog," one of my clients told me. "I want to sell it, but I will wait until it goes up some." A good investor repurchases his investments every day. So I asked my client, "Would you buy that stock today?" If he says "No," he should sell it. Why doesn't he? Because investors think a real loss occurs when a paper loss is realized. If he doesn't sell, he still has hope. As soon as he sells, his hope is gone.

Having this kind of loss discussion with your client is a great way to help him see his faulty thinking, but to have real impact you need to redefine loss for him. Tell him loss realization promotes tax efficiency. In effect, we are not losing the asset; we are simply transferring that asset to another, similar one. And, we get tax benefits too. "Transfer" and "tax benefits" are good words to know.

Recognize Cognitive Biases

A couple of years ago, just before the end of the raging bull market days, my partner, Harold Evensky, had a prospect meeting with a physician who was nearing retirement and wanted some projections on future income during his retirement years. Harold walked him through our philosophy, explaining that our long-term return expectations were lower than he had anticipated. "Just how low are we talking?" the doctor asked. "About 6%," replied Harold. "Six percent!!!!" the doctor yelled, "My barber can do better than that!"

Most people are overconfident and unrealistically optimistic about the situations in their lives. Garrison Keillor, of Public Radio's program A Prairie Home Companion, invented an entire town, Lake Wobegon, "where all the women are strong, all the men are good-looking, and all the children are above average." My sister knows, with certainty, that every one of her grandchildren is gifted. Accidents happen to someone else, not you.

So it's not surprising that your clients are overconfident about your abilities as an advisor to perform well in poor markets. In their eyes, you are a professional, so you must have something they do not. They will pay you for something they believe they cannot do themselves. However, when you do not meet their performance expectations, they will transfer their regret biases to you. ("I am not stupid; my adviser is stupid.")

Furthermore, investors often do not know how to differentiate between foresight and hindsight. Look at Warren Buffett. What client has not mentioned Warren Buffett as the investment icon of the past two decades? I actually have a client who owns one share of Berkshire Hathaway (only one, because she felt it was too expensive to own more,) because Buffett is her hero. She likes to go to the annual meetings because he personally shakes the hand of everyone there. The truth is, if you invested a dollar in Berkshire Hathaway in 1976, that dollar would have been worth $1,044 at the end of 2000, whereas a dollar in the S&P would have grown to $30. That's surely impressive, until you realize that Home Depot would have grown to $1,347 during that same period. Mylan Labs would have grown to $1,545.

It's important to ask your clients plenty of questions about how they see the future. Ask them to make predictions. Ask them their expectations. Then perform the reality check: Did they know it when it mattered?

Frame Decisions To

Affect The Outcome

We have a client who asked us for help in making a decision on whether to buy a vacation condo in St. Maartin, French West Indies.

"It's a bargain at $650,000," he told me. "They were asking "$900,000."

"How often will you go there?" I asked.

"About five to seven weeks a year," he replied.

"Let's see, just for the purchase price, that's about 49 days a year. That's about $13,000 a night. Now, what's the very best resort on the island?"

"That's easy, it's the Samanna, with beautiful suites and villas, spas, tennis courts and excellent service."

"And, how much," I ask, "does the best villa cost per night?"

"About $3,000," he speculates.

"Ah," I reply, "$10,000 difference, and no ongoing assessments. Not to mention the opportunity cost of spending such a large amount outright or not adding in the interest you would pay if you financed it. Then, of course, there is the responsibility of selling it should you decide that someplace else has more appeal. More important, how have real estate values held there?"

He looked discouraged, then brightened. "But, I would own this," he said.

"Or, it would own you," I replied.

Framing is possibly one of the most powerful techniques we can use to help clients make decisions and to manage their expectations in our relationships going forward. The way you frame a decision alters the outcome. In behavioral finance, people often are confused (yet often helped) by framing; in classical finance, people never are.

Professor Amos Tversky and Professor Daniel Kahneman experimented with the effects of framing by interviewing 400 physicians. They presented these doctors with a hypothetical outbreak of an unusual "Asian disease expected to kill 600 persons." Each doctor had a choice of two programs of treatment. One was presented in terms of a gain: That is the number of potential lives saved. The other was presented in terms of a loss: the number of potential deaths. The first 200 physicians had the following choice:

Program A: Certainly save 200 lives.

Program B: One-third probability that 600 lives will be saved but two-thirds probability that none will be saved. Presented in this way, the majority of the physicians, chose A.

Then the problem was presented to the remaining 200 physicians. But their program choices were as follows:

Program A: Certain death for 400.

Program B: Two-thirds probability that all 600 would die, but a one-third probability that no one would die.

When presented this way, the physicians chose the uncertain or risky program B. In the face of gains, they were risk averse; in the face of loss, they became risk seekers. It's important to remember that the perception of gain and loss was entirely induced by the framing. This framing exercise is particularly useful for a client who wishes to make an ill-advised investment. You can frame the consequence of choice like this: "If you are right, you will make a handsome profit; if you are wrong, you will need to work three more years."

Yankelovich, the marketing consulting firm, recently conducted a survey that discovered that 73% of people these days are in "lifestyle triage." They are attempting to reconnect with what is important in their lives. They are exploring their spiritual side and are more focused on ideas and values than making money for status. More important, they are making hard choices, not lowering their standards. That means that while people want advice, they want it in the context of the entire lives, not just their financial ones. While they see the need for professional support, they are overwhelmed with the uncertainty of decisions and unwilling to pay for something that they perceive has no tangible value. Today, and in the foreseeable future, trusting relationships are more important than ever. We'll be there. It's our job to manage the person; not the portfolio.

Deena Katz, CFP, is chairman of Evensky, Brown & Katz in Coral Gables, Fla.