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

BREAKING DOWN Prudent Investor Rule

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, 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 amount 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.