Prudent Investor Rule

What Is the Prudent Investor Rule?

The prudent investment rule requires a fiduciary to invest trust assets as if they were her or his own. This managing investor should consider the needs of the trust's beneficiaries—such as a family or employees that do not have a background in investing, the provision of regular income, and the preservation of trust assets—and should avoid investments that are excessively risky. Today the rule is codified in the Uniform Prudent Investor Act (UPIA) of 1992.

The prudent investor rule states that the decision-making process must follow certain guidelines.

Key Takeaways

  • The prudent investor rule stipulates fiduciaries to invest in trust assets as if they were his or her own and avoid excessively risky assets that may result in a steep drop in values.
  • Judge Samuel Putnam was responsible for formulating the first known instance of this rule.
  • A declaration of trust is used to provide explicit instructions for its management in order to support beneficiaries.
  • The standards of the Rule are spelled out in the 1992 Uniform Prudent Investor Act (UPIA).

Understanding the Prudent Investor Rule

In 1830, Judge Samuel Putnam formulated the Prudent Man Rule. He wrote as a judgment in the Harvard v. Amory case:

"Do what you will, the capital is at hazard...All that can be required of a trustee to invest is that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion, and intelligence manage their own affairs...considering the probable income, as well as the probable safety of the capital to be invested."

This case pitted Harvard College against the trustees of John McLean's estate. In its case, the college alleged that the trustees had purposely made risky bets in order to benefit the deceased man's widow rather than establish a standard source of income. This is the earliest record of an attempt to establish prudent standards for investments.

A prudent investment will not always turn out to be a highly profitable investment; in addition, no one can predict with certainty what will happen with any investment decision. Thus, the prudent investor rule only applies to the decision-making process of investing the assets of a trust. This relies on the knowledge the fiduciary has at the time to determine if an investment is a good idea. Investing exclusively in penny stocks, for example, could violate the prudent investor rule, because they are known to be risky at the outset.

Prudent Investor Rule and Trust Management

Managing a trust is a delicate and potentially very difficult task given the number of stakeholders involved (often multiple generations of a family or employees in an employee trust with separate desires and objectives). For this reason, many trusts are originally set up with strict policies.

A declaration of trust outlines who the trust will benefit, who can amend or revoke the trust (if it can be amended at all), who will serve as trustee, and what powers the trustee holds. The statement also includes information regarding what is to happen if a beneficiary wants to receive distributions or who will replace the trustee in the event of illness, incapacitation, death, or any other reason, such as legal action taken against the trustee.

The core of the declaration of trust is the trust's purpose or objectives and explicit instructions for how the trustee may invest and manage assets to support beneficiaries. While the declaration of trust is not required to be made in writing, it often is. In addition, some states require the declaration to be written.

Finally, this document can highlight details about the types of assets within a trust, depending on its objectives. For example, if the trust’s main goal is to provide a relatively liquid pool of assets for beneficiaries in a family for generations to come, the trust may hold safer securities, such as Treasury securities of medium duration.

Example of Prudent Investor Rule

Olga is a 27-year-old employed female who had in the past entrusted her collected savings to a fiduciary. Being young, she has a long time horizon and high-risk tolerance and would like to build an investment portfolio that includes well-diversified holdings of stocks and bonds, as well as a small allocation to speculative holdings like cryptocurrencies. She has stated that she likes the idea of high-risk, high-reward opportunities and understands she may lose some or all of that small allocation.

Her financial advisor provides her with the necessary advice regarding cryptocurrencies (because they are not allowed to recommend them) and suggests that Olga may want to invest a portion of her savings in other risky assets, such as penny stocks. This would be consistent with the prudent investor rule as this advice is in accordance with her high-risk philosophy and ability to bear such risk.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Federal Deposit Insurance Corporation. "Trust Examination Manual." Accessed March 28, 2021.

  2. Octavius Pickering. "Reports of Cases Argued and Determined in the Supreme Judicial Court of the Commonwealth of Massachusetts," Page 461. Hilliard, Gray, Little and Wilkins, 1831.

  3. Octavius Pickering. "Reports of Cases Argued and Determined in the Supreme Judicial Court of the Commonwealth of Massachusetts," Pages 461-462. Hilliard, Gray, Little and Wilkins, 1831.

Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.