Legal Definitions - prudent man rule

The Prudent Man Rule is a requirement that applies to trustees, investment managers of pension funds, treasurers of cities or counties, or any fiduciary who manages funds on behalf of others. It mandates that they must invest the funds entrusted to them with discretion, care, and intelligence, just as a prudent person would do.

Under this rule, investments in solid "blue chip" securities, secured loans, federally guaranteed mortgages, treasury certificates, and other conservative investments that provide a reasonable return are considered acceptable. Some states have statutes that specify the types of investments that are allowable under the rule.

However, the rule is subjective, and some financial managers have put funds into speculative investments to achieve higher rates of return, which has resulted in bankruptcy and disaster, as in the case of Orange County, California (1994).

For example, a trustee of a pension fund may invest the fund's assets in a diversified portfolio of stocks, bonds, and other securities that are expected to provide a reasonable return while minimizing risk. The trustee must exercise due diligence in selecting the investments and monitoring their performance to ensure that they are consistent with the prudent man rule.