The modern prudent investor rule endorses diversification as a tool for managing risk and return. In this context, investing only in government bonds and cash deposits would likely be viewed as what?

• A. Wise diversification.
• B. Required under the trust instrument.
• C. Failure to diversify leading to imprudent investment.
• D. The only acceptable strategy for a trust with a sole income objective.

Answer: (C)

Diversification across asset classes is central to the modern prudent investor approach. The idea is to spread risk and tailor the portfolio to the trust’s objectives and needs, rather than tying everything to a very narrow set of investments. If a portfolio consists only of government bonds and cash deposits, it is extremely narrow and lacks meaningful diversification. While those assets are very safe, they expose the portfolio to inflation risk and interest-rate risk and miss the potential for higher returns from other asset classes. In the context of prudent investing, this overly narrow approach is viewed as failing to diversify and therefore imprudent. The other options don’t fit because diversification in practice means more than just sticking to a few safe assets, it often requires a broader mix aligned with the trust’s goals, distributions, and time horizon.