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Financial crisis: Lessons learned by advisors

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Just like death and taxes, financial advisors know that markets going up and down are inevitable. Yet in the midst of the 2008 financial crisis, it took every ounce of resolve to remember that good times would return.

That experience five years ago was so jarring for some advisors that they completely had to rethink the way they conducted business.

Take for example, Lea Ann Knight, founder of Waltham, Mass.-based Garrison/Knight Financial Planning. During those dark, ugly months when the Standard & Poor 500 plummeted 45 percent from the day of the Lehman Brother's bankruptcy announcement on Sept. 15, 2008, to its lowest point on March 9, 2009, Knight was spending 10 hours a day on the phone with clients trying to convince them not to sell.

"I was telling them (not to sell), but I was really worried too," she said. Much to her disappointment two clients—one in her early 50s and the other already in retirement—did sell, locking in their respective losses.

A broker with Edward Jones at the time, Knight wasn't getting paid when clients took her advice to stand pat, since brokers are paid by commissions on the purchase and sale of securities.

"The way you make lots of money is constantly selling clients investments or selling them out of investments," she said. "But I stand by the advice I gave them and I wouldn't do it any other way."

That's when it hit her, she said. Knight decided the business model she was working in no longer made any sense for her.

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She formed her own fee-only financial planning firm a few months later in June 2009 and is now affiliated with the Garrett Financial Network and charges an hourly rate.

To be sure, the financial crisis tested advisors and clients alike because not many people were prepared to withstand such a severe and sudden drop in their net worth.

"I had never seen anything like it before," said Ted Sarenski, principal with Blue Ocean Strategic Capital in Syracuse, N.Y. "I was frightened myself, but I couldn't let (my clients) know that."

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Sarenski was far from alone when it came to the fear of the uncertainty advisors were experiencing from the market gyrations five years ago.

Many financial advisors were basically shell shocked in the months after the 2008 financial crisis. In fact, many were so worried about their clients that they suffered bouts of anxiety and depression and self-doubt.

To that end, a recent study in the Journal of Financial Therapy found that 93 percent of financial advisors suffered some form of post-traumatic stress disorder as a result of the financial crisis.

Such a dramatic event forced many advisors to rethink their investment strategies.

The diversification that many advisors had worked so painstakingly hard to craft didn't help protect portfolios since many different asset classes fell in tandem. During that almost six-month period, bonds increased just 0.61 percent and international equities dropped 44.9 percent according to Morningstar, an independent research firm.

Jim Heitman, founder of Compass Financial Planning in Alta Loma, Calif., now thinks about risk in a different way.

"Everybody is risk tolerant in a bull market," he said.

Since the financial crisis, he no longer relies on the standard risk tolerance questionnaires that clients fill out and are assessed by advisors.

He now uses a risk tolerance assessment tool from FinaMetrica.

"The system is based on science and statistics, and has significant research to support its findings," Heitman explained. "It uses language clients can understand so I do not have to explain what terms mean."

He added: "The most significant contribution for my practice is when the results of the testing differ from my impressions. It sends me back to ask more questions and get a clearer understanding of what is going on with a client."

Heitman also asks about a client's past experience with investing. A client who has already weathered a financial storm and didn't panic is probably less likely to do so in the next decline than one who is new to investing.

And just as importantly, he relies on his gut instinct of a client's appetite for risk having spent time with that person.

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Within portfolios, Heitman is now utilizing hedging instruments.

"It's something I would talk to clients about in the past, but it's not something I was serious about," he said.

Now any client with more than a 60 percent allocation to stocks is getting an education about hedging from Heitman.

Communication seems like a basic advisor skill, but for many, it took some time to figure out the right method.

Many advisors say they ramped up their communication with clients during the financial crisis.

"Every client got a call," Sarenski said.

Jesse Abercrombie, an advisor with Edward Jones in Dallas, started a monthly coffee club during the crisis, which drew about a dozen clients around a conference room table. He used the opportunity to discuss market developments and his own investing ideas.

"But really it was therapy," he said.

Basically, clients wanted to be heard and they needed some handholding.

(Read more: Year-end financial planning)

When attendance dwindled to just a few clients in mid-2009, Abercrombie stopped hosting the meetings.

To keep his clients connected, Heitman began writing frequent market email updates during the financial crisis and he continues doing so. He's not sure how many clients read them, but he believes it's important for them to see that he's engaged and closely following the markets.

"Clients are not looking for perfection," Abercrombie said. "They know that this is an unpredictable world. What they're looking for is someone who is concerned enough about their portfolios that they are paying attention."

—By Ilana Polyak, Special to CNBC.com.

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