Authorized Investment

What Is an Authorized Investment?

An authorized investment is one that is made by a trustee–or fiduciary–that follows the written instructions in a trust. Many trust documents specifically exclude certain speculative investments, in order to ensure that trust funds are managed conservatively. In the past, some states limited the types of investments that a trust could make, although most have eliminated these restrictions.

Key Takeaways

  • Authorized investments may be dictated by state laws or by trust instruments designed to restrict the kinds and amounts of investments allowed within a trust. 
  • An authorized investment list prevents aggressive or speculative investments and ensures that the trust is conservatively managed.
  • A trustee must act as a fiduciary, meaning they must invest the trust's assets as carefully as their own.
  • Public funds, such as municipal treasuries, may also be limited to certain authorized investments.
  • Authorized investments can include rules for SRI and ESG investing.

How Authorized Investments Work

Authorized investments may be dictated by state laws or by trust instruments designed to restrict the kinds and amounts of investments allowed within a trust. In the past, some states created legal lists of investments that could be made in trusts, though many states have now abolished these rules. In most cases, an authorized investment list prevents aggressive or speculative investments and ensures that the trust is conservatively managed.

When an individual sets up a trust, there are three key roles: the grantor, the trustee, and the beneficiaries. The individual who sets up the trust is usually the grantor. The grantor funds the trust and the beneficiaries eventually receive money or other assets from that trust.

When the trust is set up, it includes an authorized investment list. That list provides guidance on the types of investments that can be made with the trust's funds and is set up to help ensure that investment outcomes align with the grantor’s wishes. For example, the trust may permit investing in stocks to provide growth and bonds to provide some stability to the trust portfolio. However, riskier investments such as private equity may not be allowed.

It is the responsibility of the trustee to comply with the list of authorized investments for the trust account involved. Grantors can be trustees themselves, or a third party such as a trusted family member, a lawyer, an accountant, a bank, or a third-party trust company.

Special Considerations

Special care should be taken when choosing trustees because of the critical role they play in managing trust assets. The grantor and beneficiaries cannot influence the trustee to make investments that are not on the authorized list.

The trustee must act as a fiduciary with regard to trust beneficiaries and assets. While trustees have legal ownership over the assets held in trust, they are also legally and ethically bound to act in the best interest of the beneficiaries who have equitable title to the property, according to the general rules that govern a fiduciary's investment choices and the management of trust assets. 

These rules are governed both by states and by the Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC). Fiduciary cases are usually arbitrated in the surrogate or probate courts.

Regardless of the assets a trust authorizes, trustees must abide by the prudent investor rule. This means that they must invest trust assets as carefully as their own.

Potential Investments

Trust funds can be invested in the same types of assets as any other investment account, provided that they are not prohibited by local laws or the trust documents. For small trusts, the most obvious investments are mutual funds, index funds, and other pooled structures that provide exposure to a large basket of assets without excessive risk exposure.

Larger trusts have access to a wider range of potential investments because they are not bound by the restrictions on retail investors. Hedge funds and private equity funds are typical examples of investments that can outperform retail assets. These large trusts may have the additional benefit of being professionally managed, allowing higher returns.

Real-World Example

In 2014, the Office of the State Comptroller of New York published a Local Government Management Guide titled Investing and Protecting Public Funds. Under the heading "Investment of Public Funds" the guide lists several types of authorized investments for both short- and long-term.

In the short-term, local governments are told that they are allowed to invest in:

  • Time deposit accounts in a bank or trust company located and authorized to do business in New York State.
  • Certificates of deposit issued by a bank or trust company located and authorized to do business in New York State
  • “Obligations” such as bonds, notes, or other such forms of indebtedness issued by certain specific entities.

The document also lists unauthorized investments. Local governments may not invest in mutual funds, unit investments trusts, or the stocks or bonds of any private company. Savings banks, savings and loans, and credit unions are also off-limits except in certain circumstances.

Can a Trustee Invest in Stocks?

Generally speaking, a trustee can choose to invest trust assets in stock, as long as this type of investment is authorized by the trust document and local laws. However, there is a danger that such investments could create a conflict of interests. For example, if a trustee invested a trust's money into a company where the trustee is a CEO, that could create a legal liability for the trustee.

What Are Some Investments You Should Avoid in a Trust?

The prudent investor rule requires the trust managers to invest a trust's assets as carefully as if the funds were their own. Therefore, trust managers should avoid excessively risky or speculative assets that might see a sharp drop in value.

Does Money Grow in a Trust Fund?

A well-managed trust fund should see its assets grow over time, but there is no guarantee that they will do so. On average, a trust fund's assets should approximate the overall growth of the stock market, usually estimated at around 7% per year. However, depending on how a trust is invested, even a well-managed trust may face occasional declines.

Do Trust Funds Get Taxed?

Trust funds are taxed more favorably than direct inheritance, making them a favorite way for the ultra-rich to pass on their wealth. The beneficiary pays income tax on any distributions they take from the fund's income, but they do not pay tax on distributions from the trust's principal. Trusts allow the beneficiaries to reduce their inheritance and estate taxes, effectively allowing one's heirs to keep more of their inheritance.

Article Sources
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  1. Office of the New York State Comptroller. "Investing and Protecting Public Funds," Page 5.

  2. Office of the New York State Comptroller. "Investing and Protecting Public Funds." Page 9.

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