Being a "Prudent Investor": A Trustee's Duty
As a trustee handling other people's money, you need an investment plan that complies with both the trust document and state law.
If you’re the trustee of an ongoing trust, then a big part of your responsibilities will be investing trust assets. Don’t worry—you have to be a careful investor, not a stock market genius.
There’s no one investment strategy that works for every trust. To settle on a good strategy for the trust you’re in charge of, you must look to the document that created the trust, your state’s statutes on trusts, and other legal rules for trustees. They set out your legal responsibilities and authority when it comes to investing.
What Does the Trust Document Say?
Most trust documents don’t set out explicit investment instructions for a trustee. After all, it’s impossible for the settlor (the person who set up the trust) to know what market conditions will be when you take over as trustee. Most settlors don’t want to tie the hands of the trustee—instead, they pick people they trust and leave matters to their good judgment.
The trust document likely does, however, state at least in general terms what the trust is supposed to accomplish. Because your job is to carry out the settlor’s purpose in creating the trust, it follows that your investments should reflect that purpose. For example, if the declared goal of the trust is to pay for your nephew’s college education, and he is in his last year of high school, you wouldn’t put all the trust money in a long-term investment or lock it up in a five-year CD.
The Prudent Investor Rule
Almost every state has adopted a version of the "prudent investor" rule. Under prudent investor standards, you are judged by how you manage the trust assets as a whole—in other words, the only results that matter are the results of the whole "portfolio" of assets. If one asset does poorly, but the success of others makes the portfolio as a whole grow, then you have fulfilled your legal duty.
Being a prudent investor means following what’s called modern portfolio theory when it comes to investment. Instead of approving certain safe investments and forbidding others (as old law did), this theory lets you choose whatever investments you want, and judges you on the results.
To be a prudent investor, you must:
Keep up with inflation, at least.
You cannot simply maintain the value of the trust assets. That’s an executor’s job, but a trustee has different responsibilities.
You can’t just put everything in a savings account—or stocks, or gold—and sit back. Instead, you must diversify with an eye toward successful investing in different kinds of market conditions.
Although no investments are forbidden, you are supposed to be prudent, which means avoiding very risky investments that might jeopardize the overall performance of the trust assets. If something sounds too good to be true, it almost certainly is.
Keep expenses low.
Costs eat into your investment return, so keep them down when possible. If you’re looking for a checking account, find one without a monthly fee; if you’re buying an investment, try not to pay a commission.
Look at the big picture.
Look not only at the features of a particular investment, but at external factors: inflation, prospects for economic growth or contraction, changes in tax law, and so on.
Always keep the beneficiaries' needs in mind.
This, of course, goes along with keeping the trust purpose first and foremost in your considerations. Especially when you’re managing a child’s trust, the beneficiaries’ needs change constantly as they grow older.
Don’t just sit back and wait.
Once you’ve made an investment plan, monitor it. As we all know from the last few years, conditions can change quickly, and you’ll need to respond.
When To Hire an Expert
Many trustees - or their attorneys - hire some kind of professional adviser to help them come up with an investment strategy. Working with the adviser, they develop a plan that takes into account the trust’s goals and prudent investor rules. Most trust documents allow the trustee to use a reasonable amount of trust funds to pay for expert advice on investing and other matters. The adviser may want to write up your strategy in a document called an "investment policy statement." This may help you really think through your plans—your goals, as well as your assumptions about risk and return. It can be especially useful if beneficiaries (or their legal guardians) have questions about how trust assets are being managed. Remember, as trustee, you are required to keep them in the loop.