When legislation is helpful

In this space on Thursday, we discussed the morality of money, and made reference to the Uniform Prudent Investor Act. Below, you will find more detailed information about this act and my thoughts on the act.

Uniform Prudent Investor Act
(Summary of basic provisions enacted by many states)

A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.

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 strategy having risk and return objectives reasonably suited to the trust.

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:

• General economic conditions,
• The possible effect of inflation or deflation,
• The expected tax consequences of investment decisions or strategies,
• 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,
• The expected total return from income and the appreciation of capital,
• Other resources of the beneficiaries,
• Need for liquidity, regularity of income, and preservation of appreciation of capital, and
• An asset's special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.

A trustee shall make reasonable effort to verify facts relevant to the investment and management of trust assets.

A trustee may invest in any kind of property or type of investment consistent with the standards of this Act.

A trustee who has special skills or expertise, or is named trustee in reliance upon the trustee's representation that the trustee has special skills or expertise, has the duty to use those special skills or expertise.

My comments

This Act has been adopted by most states, and is the legal rule for fiduciary investing. In simple terms, for trusts or situations where investments are being managed on another's behalf, these are the rules. It's important to note that these rules come into play when someone alleges mismanagement. Then, the trustee or other responsible party, must defend their actions against this measure. Like it or not, these are the legal rules.

Personally, I love these laws. The national group that created model legislation (which was them adopted by the different states) used Modern Portfolio science as the basis. This Nobel Prize-winning body of knowledge recognizes the value of broad diversification and asset allocation as the building blocks for long-term investment success. The legal test under these rules isn't absolute investment performance, but whether or not the trustee did the right things. Did they build a portfolio appropriate for the age and circumstance of the beneficiary? How will inflation affect the future buying power of investments? Did the trustee choose investment options that had reasonable expenses and fees? Various other factors are explained in the Act.

The truth is that nobody knows what the short-term future holds, so the best way to prosper with investments is to engage in solid, long-term, diversified, and thoughtful behavior. The Act mandates that approach, and measures success or failure by these rules. Actually, though the Act deals with fiduciary duties, most individuals will prosper under these same rules. It's how we manage our client accounts.