Do You Invest Your Money as Prudently as You Would Invest Somebody Else’s?

The Uniform Prudent Investor Act is a model law that outlines the principles a trustee has to follow when investing the trust’s money. The Act, or something similar, has been adopted in all 50 states. So, roughly speaking, the rules set forth in the Act are the rules you have to follow if you’re managing money on somebody else’s behalf.

And as it turns out, it’s actually a great set of guidelines for managing one’s own money.

The Act begins with various wording about its applicability. And then we get into the nitty gritty with the following opening instruction: “A trustee’s investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.”

The key takeaways here?

• Decisions should not be made looking at one piece of the portfolio in isolation. Instead you must take an overall portfolio approach.
• You must consider the purpose of the money and the circumstances of the investor — and craft the portfolio to suit those.
• The relationship between risk and return is the fundamental point of interest when making investment decisions.

And then the Act provides us with the following list of things to consider when making decisions:

“Among circumstances that a trustee shall consider in investing and managing trust assets are such of the following as are relevant to the trust or its beneficiaries:

1. general economic conditions;
2. the possible effect of inflation or deflation;
3. the expected tax consequences of investment decisions or strategies;
4. the role that each investment or course of action plays within the overall trust portfolio, which may include financial assets, interests in closely held enterprises, tangible and intangible personal property, and real property;
5. the expected total return from income and the appreciation of capital;
6. other resources of the beneficiaries;
7. needs for liquidity, regularity of income, and preservation or appreciation of capital; and
8. an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.”

Key takeaways:

• We’re concerned with real returns (i.e., after inflation).
• We’re concerned with after-tax returns (i.e., tax-efficiency is important).
• We’re concerned with total return. (In other words, even if the beneficiary is spending from the portfolio, the focus must be on total return, rather than income/yield.)
• And again, one individual asset should not be considered in isolation. It’s about the portfolio as a whole. And you have to consider the investor’s individual needs and circumstances.

The concept of diversification is sufficiently important that it gets its own (brief) section: “A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.”

Investment costs get their own section as well: “In investing and managing trust assets, a trustee may only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee.” And the following comment is provided: “Wasting beneficiaries’ money is imprudent. In devising and implementing strategies for the investment and management of trust assets, trustees are obliged to minimize costs.”

Diversifying and minimizing costs are not just suggested; they’re required.

The Act then concludes by making various important points about conflicts of interest and the trustee’s duty to put the beneficiaries’ interests before the trustee’s own interests, but those are not really relevant to our purpose here.

So, if you were a trustee for somebody else, you would be legally obligated to manage their money pursuant to the above principles. Are you treating your own money as well as you would treat somebody else’s?