Serving as a trustee involves more than managing money. A trustee is a fiduciary responsible for administering trust assets in accordance with the trust’s terms, applicable law, and fiduciary obligations to the beneficiaries.
When it comes to investing trust assets, trustees generally must follow standards designed to ensure investment decisions are made prudently and in the interests of the beneficiaries. One important framework is the Prudent Investor Rule.
Understanding how this rule works can help trustees better understand their responsibilities and the factors that may need to be considered when managing a trust portfolio.
What Is the Prudent Investor Rule?
The Prudent Investor Rule generally requires trustees to invest and manage trust assets with the care, skill, and caution that a prudent investor would use under similar circumstances. Modern applications focus on the portfolio as a whole rather than judging every investment independently.
Depending on applicable law and the terms of the trust, prudent investment management may involve considering:
- The trust’s purpose and terms.
- Risk and expected return.
- The beneficiaries’ needs and circumstances.
- Diversification.
- Liquidity and income needs.
- Preservation or growth of capital.
- Inflation or deflation.
- General economic conditions.
- Potential tax consequences.
The Uniform Law Commission identifies these considerations as part of the framework governing prudent investment of trust property.
Importantly, prudence doesn’t mean avoiding all investment risk or producing positive returns every year. Investment decisions are generally evaluated based on the circumstances and information available when they were made, rather than solely on their eventual outcome.
Being a prudent investor isn’t about predicting what markets will do. It’s about following a thoughtful process appropriate for the trust.
Understanding the Uniform Prudent Investor Act
The Uniform Prudent Investor Act (UPIA) provides a model legal framework for trustee investment responsibilities. It was developed by the Uniform Law Commission and has been enacted wholly or substantially in nearly all U.S. jurisdictions. Individual state laws can differ, however, so trustees need to consider the rules that apply to the particular trust.
A central concept of the UPIA is that investment decisions generally shouldn’t be evaluated in isolation. Instead, individual investments are considered in the context of the trust portfolio as a whole and its overall investment strategy.
That distinction is important. An investment that appears risky when viewed independently may serve a reasonable role within a diversified portfolio. Conversely, individually reasonable investments don’t necessarily create an appropriate overall portfolio.
Diversification Is an Important Consideration
Diversification is one of the central principles associated with modern prudent-investor standards.
Spreading investments across different asset classes, sectors, or other exposures can help manage concentration risk. Diversification does not guarantee gains or prevent investment losses, but it can help reduce the portfolio’s dependence on the performance of a single investment or area of the market.
For trustees, diversification decisions should be evaluated in light of the trust’s particular circumstances rather than according to a universal portfolio formula.
For example, the appropriate investment approach for a trust expected to make significant near-term distributions may differ from one designed to support beneficiaries for several decades.
Consider the Needs of the Beneficiaries
Managing a trust isn’t simply about maximizing investment returns.
A trustee may need to balance multiple objectives, including current income needs, future distributions, liquidity, preservation of capital, long-term growth, taxes, and the interests of different beneficiaries.
The UPIA specifically recognizes beneficiary needs for liquidity, regular income, and preservation or appreciation of capital as relevant considerations.
This is one reason the appropriate investment strategy can vary significantly from one trust to another.
Monitor the Portfolio Over Time
A trustee’s investment responsibilities don’t necessarily end once investments have been selected.
Trustees generally have an ongoing responsibility to monitor and review trust investments. Changes in markets, beneficiary circumstances, distribution needs, tax considerations, or the trust itself may affect whether an existing investment strategy remains appropriate. The continuing duty to monitor trust investments is well established in trust law.
Portfolio reviews may consider factors such as:
- Asset allocation.
- Investment performance.
- Risk and concentration.
- Fees and expenses.
- Liquidity requirements.
- Upcoming distributions.
- Changes in beneficiary needs.
- Tax considerations.
The purpose isn’t to react to every market movement. Rather, monitoring helps determine whether the portfolio continues to serve the trust’s objectives.
Understand the Role of Costs
Investment costs are another consideration trustees shouldn’t overlook.
Management fees, fund expenses, transaction costs, and other investment expenses can affect the trust’s net returns over time.
Prudence doesn’t necessarily mean selecting the least expensive investment available. Instead, costs should be evaluated alongside factors such as investment objectives, risk, diversification, services provided, and the overall role of an investment within the trust portfolio.
Can Trustees Work With an Investment Advisor?
Trustees aren’t necessarily expected to personally possess expertise in every aspect of investing.
Depending on applicable law and the trust’s terms, a trustee may be able to delegate certain investment and management responsibilities to qualified professionals. However, engaging an advisor doesn’t necessarily eliminate the trustee’s fiduciary responsibilities.
A trustee may still have responsibilities related to selecting the professional, defining the scope of the engagement, and periodically reviewing the relationship.
Because delegation requirements can vary by jurisdiction and trust document, trustees should consult qualified legal counsel about their specific responsibilities.
Document the Decision-Making Process
Good recordkeeping can be an important part of trust administration.
Maintaining records of investment decisions, portfolio reviews, professional recommendations, distributions, and relevant beneficiary circumstances can help demonstrate the process used to manage the trust.
For example, documentation may include an investment policy statement, meeting notes, portfolio reports, and records explaining significant investment or allocation decisions.
The goal isn’t simply to document performance. It’s to create a record of the reasoning and process behind important decisions.
The Bottom Line
The Prudent Investor Rule isn’t about finding the highest-returning investments or avoiding every possible loss. It establishes a framework for making thoughtful investment decisions based on the trust’s purpose, beneficiaries, risk and return objectives, and other relevant circumstances.
For trustees, prudent investment management generally involves looking at the portfolio as a whole, considering diversification, monitoring investments over time, evaluating costs and liquidity needs, and maintaining a thoughtful decision-making process.
Because fiduciary requirements vary based on state law and the terms of individual trusts, trustees should work with qualified legal, tax, and financial professionals when appropriate to understand how their responsibilities apply to their particular circumstances.