By Mark Higgins

A powerful insight that emerges from the study of financial history is that solutions to past problems often sow the seeds of future ones . But this principle is often hidden by the glacial pace of the transformation process . This is why financial historians often feel like time-lapse photographers who reveal the motion of financial transformation by separating the snapshots of events with years rather than milliseconds .

The evolution of the Prudent Investor Rule fits neatly in this framework . This article reveals how the rule evolved over nearly 200 years to intermittently solve and cause problems . The history begins in the 1820s with the establishment of the Prudent Man Rule . It then recounts its slow evolution over the next 160 years , culminating in its conversion into the Prudent Investor Rule at the end of the 20th century . The narrative then returns to the present and explains how trustees now use the Prudent Investor Rule to rationalize progressively higher levels of portfolio diversification , despite

Illustration of Harvard University with an alumni procession , dated 1830s . This was the same decade that Harvard College v . Amory reached the Supreme Court of the State of Massachusetts .

mounting evidence that such efforts are more likely to increase fees , impair performance and distract trustees from more important financial tasks . In 2024 , it once again appears that the current interpretation of the Prudent Investor Rule has outlived its utility , making it necessary for another revision .

Origin of the Prudent Investor Rule

On October 23 , 1823 , a wealthy merchant named John McLean passed away in Boston , Massachusetts . In his will , he bequeathed $ 50,000 to two sets of beneficiaries using a structure commonly referred to as a remainder trust . The first beneficiary was his wife , Ann McLean , who was entitled to the income produced by the trust for the remainder of her life . A second set ( Harvard College and Massachusetts General Hospital ) was entitled to receive what remained after Ann McLean ’ s death . The will listed Jonathan and Francis Amory as the executors , and it provided them with a flexible set of investment guidelines .

The problem with McLean ’ s trust was that the trustees representing Ann McLean and the remaindermen held different beliefs regarding the flexibility of the investment guidelines . The disagreement surfaced when the trustees offered to

—— Robert Sobel , author of The Great Bull Market : Wall Street in the 1920s

turn over the trust assets to the remaindermen in exchange for a guaranteed annual payment of 6 % per year for the remainder of Ann McLean ’ s life . The trustees based this requirement on the expected return of securities in which much of the estate was already invested . These included two manufacturing company stocks , an insurance company stock and a bank stock . The manufacturing company stock was most concerning to the remaindermen , as they believed it was too risky and , thus , inconsistent with John McLean ’ s instructions .

On February 9 , 1824 , the trustees sought approval of their estate plan by presenting the portfolio to the Supreme Court of Probate in the State of Massachusetts . The remaindermen voiced no formal objection in court , even though they had expressed disapproval on several occasions during the preceding year . The court approved the plan , and it seemed that the case would quickly disappear in the annals of history .

16 FINANCIAL HISTORY | Winter 2024 | www . MoAF . org