Initially, there is denial. Shocked by their loss, individuals refuse to accept facts. This is a perfectly natural defense mechanism. Everything is fine.

Anger, the second stage, presents itself in different ways. Frustrated and exasperated people seek to blame someone, anyone. It's not fair—it's wrong. Maybe it's a crime.

The bargaining stage is the term for individuals' attempts to make deals with reality. Perhaps the bad news is reversible if the right things happen. Depression is the reluctant dress rehearsal for acceptance. Despondency, regret and uncertainty set in. Finally, there is acceptance. Individuals find their emotional footing and consider strategies to move forward.

Stages of Grief

We could be talking about the five stages of grief laid out in Elisabeth K bler-Ross' seminal 1969 book, On Death and Dying—or we could be addressing the emotional rollercoaster many investors are riding now, as the market meltdown and the recession shred their portfolios and plans. The emotional journeys are analogous. It may help to understand and process the various interactions you have with clients if you view their experiences of the downturn as similar to a personal loss—in this case, of their financial achievements and, in many cases, their faith in their ability to provide for their families and themselves in the future.

Planners, too, are grieving. "I think the entire financial community is in the fourth stage of grief—depression—and at this point, most investors are in a state of despair," says Richard Peterson, M.D., a neurologist and managing director at Los Angeles-based MarketPsy, a psychology-based hedge fund. "They have essentially become resigned to further losses, which is not healthy for the markets."

But people don't necessarily progress smoothly to acceptance. Certainly, most advisors have been on the receiving end of anger from a shocked client base. "Anger against advisors tends to be increasing, with many investors feeling betrayed," Peterson says. "They are asking themselves if their advisor is trained in sales, as opposed to having a deep understanding of markets. They may be thinking 'Here we are at 1997 levels, so clearly he doesn't know what he's talking about.'"

Not every advisor is under fire, says Gary Schatsky, founder of Objective Advisor. "The majority of those I work with have been thankful that they only came out 10% to 15% down, not 40%."

Risk Averse

People tend to buy when the market dips, which is no surprise. But now the average investor is less willing to take even a favorable risk. "So we find a self-fulfilling prophecy, or what we would call a psychological feedback loop," Peterson explains.

The issue is confidence in general, or confidence with a capital C, observes Richard Stein, a Denver-based financial planner. "Try telling a client that this economic climate is like running in the fog. We simply don't know if a wall is six inches before us or a mile."

Investor confidence continues to wane as the market shifts from uncertainty to ambiguity, according to Brian Knutson, associate professor of psychology and neuroscience at Stanford University. "To hold a risky stock, we would call that uncertainty," he says. "But when you invest in something that is very hard to define or place a value on, that falls out of uncertainty and into ambiguity—where the brain really can't evaluate the risk involved."

Balancing Fears

Since 1926, the country has experienced 16 corrections or bear markets, defined as periods of six months or more during which the S&P 500 Index drops 10% or greater. Following each dip, the stock market bounced back—often in short, powerful and extreme bursts. In the first six months of 1975, for example, the S&P 500 rose 41%; at the end of the Great Depression, it delivered monthly gains of more than 38% in three of the subsequent 12 months (beginning July 1932).

So how does a financial advisor address client confidence and handle the anger and hurt coming from investors? Experts say it is crucial to be constantly available and to play armchair psychologist as investors try to counterbalance two fears: losing their savings by staying in the market and missing out on a recovery by pulling out now.

Some advisors are referencing best sellers to put the economic downturn into context. Shannon Eusey of Beacon Pointe Advisors in Newport Beach, Calif., has been pointing clients to Nassim Nicholas Taleb's book, The Black Swan: The Impact of the Highly Improbable, which argues that humans, while quick to devise explanations for events after the fact, are woefully unprepared for randomness as it unfolds.