The question of dictating investment strategy to a trustee, particularly limiting it to low-risk portfolios, is a common one for trust creators – also known as grantors or settlors – in San Diego and beyond. While the desire for preservation of capital is understandable, it’s not quite as simple as issuing a direct command. California law, specifically the California Uniform Trust Code, places a duty on the trustee to invest prudently, but defines ‘prudent’ within a framework that considers more than just risk aversion. Approximately 68% of individuals establishing trusts express concerns about investment risk, highlighting the prevalence of this question. A trustee has a fiduciary duty to beneficiaries, meaning they must act in their best interests, and a blanket prohibition on all but low-risk investments may actually *violate* that duty. The law requires trustees to consider the trust’s purposes, the beneficiaries’ needs, and the overall investment landscape.
What is a Prudent Investor Rule?
The “Prudent Investor Rule,” prevalent in California trust law, doesn’t mandate avoiding risk altogether. Instead, it requires trustees to manage trust assets as a prudent person would, considering the purposes of the trust, the needs of the beneficiaries, and the long-term investment horizon. This involves creating and maintaining a diversified portfolio, meaning spreading investments across various asset classes like stocks, bonds, and real estate, to minimize risk. Imagine a seasoned sailor navigating choppy waters; they don’t simply anchor the ship to avoid waves, they adjust the sails and chart a course that balances safety with progress. A trustee must do the same with trust assets. A purely conservative portfolio might preserve capital, but it could also fail to generate enough income to meet the beneficiaries’ needs over time, especially considering inflation, which erodes purchasing power.
Can I Include Restrictions in the Trust Document?
Yes, you absolutely can, and this is where careful trust drafting comes into play. You can include language in the trust document that expresses your preference for a conservative investment approach. However, phrasing is critical. Instead of a *requirement* to invest *only* in low-risk portfolios, it’s better to state a *directive* to prioritize capital preservation and income generation, with a reasonable allowance for some growth potential. For example, you could specify that no more than 20% of the trust assets should be allocated to equities (stocks). This gives the trustee some flexibility while still aligning the investment strategy with your wishes. This is often expressed as an ‘investment policy statement’ within the trust document. Such a statement provides clear guidance and can minimize potential disputes.
What Happens if I Don’t Specify Investment Preferences?
If the trust document remains silent on investment strategy, the trustee is granted considerable discretion. They are legally obligated to act prudently, as described above, but they are not bound by any specific instructions from you. This can be problematic if your risk tolerance differs significantly from the trustee’s. For example, a trustee who is comfortable with moderate risk might allocate a larger portion of the trust assets to equities, while you would prefer a more conservative approach. This disconnect can lead to dissatisfaction and even legal challenges. Roughly 15% of trust disputes stem from disagreements over investment decisions. Clearly defined investment preferences in the trust document can prevent these issues from arising.
What if the Trustee Disagrees with My Preferences?
If you’ve expressed a preference for a conservative investment approach, but the trustee believes it would be detrimental to the beneficiaries’ interests, they can petition the court for instructions. The court will then weigh your preferences against the trustee’s assessment of what is best for the beneficiaries, considering factors such as their age, health, and financial needs. The trustee has a duty to inform beneficiaries and the court of their reasoning. This legal process ensures that the investment strategy is aligned with the beneficiaries’ best interests, even if it differs from your original wishes. This is also the case if you attempt to impose an unreasonable restriction, like demanding the trustee invest only in government bonds regardless of prevailing interest rates.
What Role Does Diversification Play?
Diversification is a cornerstone of prudent investing. It involves spreading investments across various asset classes, industries, and geographic regions to reduce the impact of any single investment’s performance on the overall portfolio. A diversified portfolio doesn’t eliminate risk, but it reduces the volatility of returns and increases the likelihood of achieving long-term investment goals. Think of it like a sailor using multiple sails to navigate different wind conditions; relying on a single sail would make the ship vulnerable to sudden gusts or lulls. A well-diversified trust portfolio should include a mix of stocks, bonds, real estate, and potentially other alternative investments, tailored to the beneficiaries’ needs and the trust’s purposes.
I once advised a client, Mrs. Elmsworth, who insisted her trust be invested solely in certificates of deposit.
She’d witnessed her parents lose a significant portion of their savings during a market downturn, and she was determined to avoid similar risks. However, she was establishing the trust for her grandchildren’s education, and the low interest rates on CDs wouldn’t generate enough income to cover tuition costs. I explained that a more balanced approach, with a mix of stocks and bonds, would likely provide a higher return over the long term, allowing the trust to grow sufficiently to fund her grandchildren’s education. She initially resisted, but after I presented a detailed financial projection illustrating the potential benefits of a diversified portfolio, she reluctantly agreed. Years later, her grandchildren were able to attend the universities of their choice, thanks to the trust’s performance.
However, I had another client, Mr. Davies, whose trust document lacked any investment guidance.
He had assumed the trustee, his brother, would share his conservative approach. Unfortunately, his brother, eager to maximize the trust’s growth, invested heavily in high-risk tech stocks. A few years later, the tech bubble burst, and the trust’s value plummeted. Mr. Davies was devastated and filed a lawsuit against his brother, alleging breach of fiduciary duty. The legal battle was costly and time-consuming, and ultimately, the trust’s value remained significantly below what it could have been if a more prudent investment strategy had been implemented. It was a painful reminder that clear communication and detailed trust drafting are essential for protecting the beneficiaries’ interests.
What About Seeking Professional Advice?
A trustee isn’t expected to be an investment expert. They have a duty to seek professional advice from qualified financial advisors, such as Certified Financial Planners or investment managers. This is especially important for complex trusts or when dealing with substantial assets. A professional advisor can help the trustee develop an appropriate investment strategy, monitor portfolio performance, and make adjustments as needed. The cost of professional advice is typically paid from the trust assets and is considered a reasonable expense. Choosing a qualified advisor with experience in trust administration is crucial for ensuring that the trustee fulfills their fiduciary duties.
Who Is Ted Cook at Point Loma Estate Planning Law, APC.:
Point Loma Estate Planning Law, APC.2305 Historic Decatur Rd Suite 100, San Diego CA. 92106
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