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The prudent man rule is based on common law stemming from the 1830
Massachusetts Massachusetts (Massachusett: ''Muhsachuweesut Massachusett_writing_systems.html" ;"title="nowiki/> məhswatʃəwiːsət.html" ;"title="Massachusett writing systems">məhswatʃəwiːsət">Massachusett writing systems">məhswatʃəwiːsət'' En ...
court formulation, '' Harvard College v. Amory'' The prudent man rule, written by Massachusetts Justice Samuel Putnam (1768-1853), directs trustees "to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested." Under the prudent man rule, when the governing trust instrument is silent concerning the types of investments permitted, the
fiduciary A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person. One party, for exa ...
is required to invest trust assets as a "
prudent man The prudent man rule is based on common law stemming from the 1830 Massachusetts court formulation, '' Harvard College v. Amory'' The prudent man rule, written by Massachusetts Justice Samuel Putnam (1768-1853), directs trustees "to observe how men ...
" would invest his own property with the following factors in mind: *the needs of beneficiaries; *the need to preserve the estate (or
corpus Corpus is Latin for "body". It may refer to: Linguistics * Text corpus, in linguistics, a large and structured set of texts * Speech corpus, in linguistics, a large set of speech audio files * Corpus linguistics, a branch of linguistics Music * ...
of the trust); and *the amount and regularity of income. The application of these general principles depends on the type of account administered. The prudent man rule continues to be the prevailing statute in a small number of states, in particular with regards to investments permitted by mutually-chartered institutions such as savings banks and insurance companies.


Investment choices

The prudent man rule requires that each investment be judged on its own merits and that speculative or risky investments must be avoided. Under the prudent man rule, certain types of investments, such as second
mortgages A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any ...
or new business ventures, are viewed as intrinsically speculative and therefore prohibited as fiduciary investments. As with any
fiduciary relationship A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person. One party, for examp ...
,
margin Margin may refer to: Physical or graphical edges * Margin (typography), the white space that surrounds the content of a page *Continental margin, the zone of the ocean floor that separates the thin oceanic crust from thick continental crust *Leaf ...
accounts and
short selling In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional "long" position, where the investor will profit if the value of the ...
of uncovered securities are also prohibited. In contrast with the modern Prudent Investor Rule, isolated investments in a portfolio may be imprudent on individual merits at the time of acquisition, however, as a part of a portfolio, the investment could be prudent. Thus, a
fiduciary A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person. One party, for exa ...
may not be held liable for a loss in one investment.


Trend

Since the prudent man rule was last revised in 1959, numerous investment products have been introduced or have come into the mainstream. For example, in 1959, there were 155
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICA ...
s with nearly $16 billion in assets. By year-end 2000, mutual funds had grown to 10,725, with $6.9 trillion in assets.as reported by CDA/Wiesenberger In addition, investors have become more sophisticated and are more attuned to investments since the last revision of the Rule. As these two concepts converged, the prudent man rule became less relevant. This discounting of the relevance of the prudent man rule is more the result of market forces than it is of the needs of individuals for "safety of capital". The 10,000+ mutual funds of 2000 have grown to over 15,000 mutual funds in 2006. The prudent man rule in its broader interpretations implies that the
fiduciary A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person. One party, for exa ...
should perform enough
due diligence Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care. It can be a ...
to ensure that the company meets the investment needs of the investors. Typical due diligence includes discussions with management, vendors and customers, as well as proper evaluation of any risk factors that might affect the performance of the company or its securities. The modern interpretation of the "prudent man rule" goes beyond the assessment of each asset individually to include the concept of due diligence and
diversification Diversification may refer to: Biology and agriculture * Genetic divergence, emergence of subpopulations that have accumulated independent genetic changes * Agricultural diversification involves the re-allocation of some of a farm's resources to n ...
. This is sometimes referred to as the "Prudent Investor Rule". The logic is this: an asset may be too risky to put all your money in (thus failing the prudent man rule) but may still be very diversifying and therefore beneficial in a small proportion of the total portfolio.


See also

*''
Bartlett v Barclays Bank Trust Co Ltd ''Bartlett v Barclays Bank Trust Co Ltd (No. 2)'' 9801 Ch 515 in an English trusts law case. In it Brightman J gave a comprehensive discussion of the duties of trustees in connection with companies whose shares are part of the trust property. A ...
'' * Man on the Clapham omnibus *''
Re Whiteley is an English trusts law case, concerning the duty of care owed by a trustee when exercising the power of investment. Facts Elizabeth Whiteley and her children sued the executors of Benjamin Whiteley's will (of 19 March 1874). The will containe ...
''


References


FDIC Trust Manual

Prudent Man Rule and Investment Portfolios

What is the prudent man rule
{{DEFAULTSORT:Prudent man rule Financial regulation in the United States Wills and trusts