Prudent Investor Rule
In 1992, The American Law Institute (ALI) published its
Restatement of the Law, Trusts: Prudent Investor
Rule. Based on the tenets of Modern Portfolio
Theory (for which three financial economists were awarded
a Nobel Prize), the Prudent Investor Rule provides some
300 pages of detailed description on how to adopt a “general
standard of prudent investment.”
Most
states followed ALI’s lead and passed legislation
incorporating its recommendations into their standards
for trust management.
Following are some key concepts described in ALI’s
publication:
• Diversification is fundamental to risk management.
• Risk and expected return are directly related.
• Trustees have a duty to avoid unjustified
expenses.
• Trustees must balance protection of principal
with need for current income.
• "Uncompensated risk" is undesirable,
but it is appropriate to select a degree of compensated,
or "market" risk.
• Because managing risk requires "deliberate
assessment and judgment," trustees have "a
duty as well as the authority to delegate as prudent
investors would."
While the Prudent Investor Rule was designed to guide
trust managers, a retirement plan sponsor’s responsibilities
can be comparable.
As a plan sponsor, how do you minimize the liability
to which you are exposed? First, when you work with
Focus Asset’s Retirement Plan Services, we can
sign on as your co-fiduciary. Second, by offering your
plan participants a passive investment approach based
on the same tenets of Modern Portfolio Theory, you can
help them adhere to what is widely considered to be
a prudent investment approach.
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