In a S Trust where X is to receive income for X's lifetime, and Y is remainder; if T's conservative strategy causes lack of diversification, does Y have a case under the prudent investor rule?

• A. Yes, the investments are appropriate.
• B. The investments may violate prudent investor rule due to lack of diversification.
• C. The investments are required.
• D. The investments are prohibited by law.

Answer: (B)

The key idea here is diversification under the prudent investor rule. A trustee must manage trust assets as a coordinated portfolio, spreading risk across different asset classes and investments while considering the trust’s objectives and the needs of all beneficiaries.

In a trust where X is entitled to income for life and Y is the remainder beneficiary, the trustee’s job is to provide a steady income to X while also preserving enough value to pass to Y. If the trustee adopts a very conservative approach that results in little diversification, the portfolio becomes more vulnerable to market swings or a few failed investments. That elevated risk can jeopardize both funding X’s income over X’s lifetime and preserving assets for Y’s remainder.

Because diversification is a fundamental component of prudent investing, a lack of diversification can be viewed as imprudent. Therefore, Y may have a case under the prudent investor rule, since the conservative, undiversified strategy risks not meeting the trust’s aims and duty to both beneficiaries.

This isn’t saying the strategy is automatically illegal; it signals a potential breach of fiduciary duty due to failure to diversify.