Prudent Investment

What Is a Prudent Investment?

A prudent investment refers to the recognized use of financial assets that are suitable for an investor’s goals and objectives. A prudent investment considers the risk/return profile and the time horizon of an investor.

Fiduciaries (such as financial advisors, attorneys, CPAs and retirement plan sponsors), whom an investor entrusts to make prudent investments, should make certain that a chosen investment makes sense within their client's overall portfolio and that fees will not detract significantly from the investment's returns.

How Prudent Investment Works

Good fiduciaries monitor the performance of the investments they have selected for their clients to make sure they are achieving their stated goals. The Prudent Investor Rule specifies that fiduciaries must make sound money-management decisions for their clients based on the information available. The outcome of their investment decision, whether good or bad, is not a factor in whether the investment is considered prudent.

The prudent-person rule (formerly known as the "prudent man rule") is a legal maxim restricting the discretion allowed in managing a client's account to the types of investments that a prudent person seeking reasonable income and preservation of capital might buy for their own portfolio.

Investors can increase the likelihood of making a prudent investment by following these three recommendations:

Prudent Investor Rule Example

If a financial planner advised a 70-year-old client to invest all of their money in a single stock, it would not be considered a prudent investment, even if the stock skyrocketed in value and the investor sold at just the right time to make a substantial profit. It is an imprudent investment because putting all of the investor's money into a single stock is a risky strategy, especially as the investor approaches retirement age.