Prudent investor rule Definition

What is the prudent investor rule?

The prudent investor rule is a legal guideline for trustees of investment portfolios. It requires a fiduciary to act in the best interest of the trust’s beneficiaries and outlines standards for legally controlling investment portfolios. The prudent investor rule is very influential in the courts, the U.S. government and the banking industry.

Deeper definition

Under the prudent investor rule, the managing investor is required to consider the provision of regular income, the needs of the trust’s beneficiaries, and the preservation of the trust’s savings. Among the principles stated in the rule are diversification, minimizing of fees and the balancing of income production and capital appreciation.

No one can perfectly predict the outcome of every investment decision, but a trustee must apply the prudent investor rule when making investment decisions based on the information available at the time. Whether the outcome is good or bad is not a factor if the trustee followed the principles of the prudent investor rule.

Trustees are expected to analyze and make sound decisions that are compatible with portfolio distribution requirements, the level of risk tolerance and other factors pertaining to the trusts they manage. The nature and level of the investment risk should be compatible with the aims of the trust and its beneficiaries.

Prudent investor rule example

Richard is an elderly investor who has entrusted his capital to an investment manager who helps him identify the best investment opportunities. The trustee is obliged to follow the prudent investor rule and make sound decisions based on the goals, requirements and risk tolerance Richard, his client. For example, the trustee will not invest Richard’s money in the lottery or penny stocks, which are known to be risky. Instead, the trustee has to invest Richard’s money as if it were his own and follow the guidelines of the prudent investor rule, even if the results fall short of investment goals.