A Trustee’s duty to manage Trust assets is very different from how you are allowed to manage your own individual assets. This is America, you can manage your own finances any way you please. You can be risky and invest big, you can be conservative and invest small, or you can hide your money in your mattress if you like.
But Trustee’s don’t have this freedom of investing. In California, Trustees are required by law to follow the Prudent Investor Rule, which puts a whole host of rules on investing Trust assets. For example, Probate Code Section 16047(a) specifically requires a Trustee to invest and manage Trust assets “as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust.” The Trustee must use reasonable skill, care, and caution in making these decisions. Skill, care and caution (especially caution) are attributes rarely exhibited by individual Trustees.
Furthermore, the investment decisions must have risk and return objectives reasonably suited to the trust—not the Trustee individually, but the Trust as a whole. Some of the circumstances that the Trustee must consider include (See Probate Code Section 16047(c)):
- General economic conditions,
- The possible effect of inflation and 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
- The expected total return from income and the appreciation of capital
- Other resources of the beneficiaries known to the Trustee as determined from information provided by the beneficiaries
- Needs for liquidity, regularity of income, and preservation or appreciation of capital
If you really think about this list of circumstances you will find that most of the criteria is geared towards the needs of the beneficiaries. Trying to make money is fine, but it cannot outweigh other important factors, such as the need to preserve capital, generate income, and provide liquidity for upcoming Trust requirements—like distributions. Notice the difference between this list of Trustee investing versus your own personal investments? As an individual you can focus on just one goal if you like—such as capital appreciation—and you can ignore the other factors. If you don’t want to focus on income, or capital preservation, you don’t have to. But Trustee’s don’t have that luxury, they MUST consider all of the factors all of the time.
There are times when I hear people compare Trusts to businesses. That is a dangerous (and very misapplied) analogy. Businesses are allowed to risk capital for profit. If a business risks capital and looses it, then we say “that’s business.” Businesses operate under the “business judgment rule,” which is a very liberal standard that allows a business to take all sorts of risk without being held liable for those decisions.
Trusts on the other hand have no such luxury. Trustees are not allowed to risk capital for profit—in fact that is specifically precluded. Instead, a Trustee’s investments must be much more calculated and planned out. Trustee’s must look at the needs of the beneficiaries, the overall purposes of the Trust, and weigh any investment risk against the need to produce income and preserve capital. In fact, capital preservation is the single biggest differences between Trusts and businesses—businesses can risk capital, Trusts must preserve capital whenever possible.
If you are an individual Trustee and you think you can invest however you like, or you think you can invest as your parents did when they were alive, you are flat wrong. This is the biggest single mistake individual Trustees make, and it can be a very costly mistake. As a Trustee, you have many duties when it comes to investing. You would be well advised to (1) learn those duties, and (2) follow them as much as possible.
If you are a beneficiary dealing with an individual Trustee who does not know the Prudent Investor Rule, watch out! Your Trust fund may be at serious risk of loss. The Prudent Investor Rule is there to protect you, but it does no good if the Trustee does not know and follow the mandates of the Rule.