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Simple English definitions for legal terms
Modern Portfolio Theory
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A quick definition of Modern Portfolio Theory:
Modern Portfolio Theory: A way of managing money that looks at the whole collection of investments instead of just one at a time. It helps people decide how much risk to take based on what they want to achieve. This is important for people who are in charge of other people's money, like trustees. Before, they only had to make sure each investment was safe, but now they have to make sure the whole group of investments is safe together.
A more thorough explanation:
The Modern Portfolio Theory is a way of managing investments that looks at the entire portfolio as a whole, rather than individual investments. This theory is used by trustees to guide their investment decisions when managing trusts.
Under the old Prudent Man Rule, trustees were not required to diversify their investments. Instead, judges would look at each investment decision individually and decide if it was a good or bad decision based on that one investment. However, under the Modern Portfolio Theory, judges look at the entire portfolio and determine if it is diversified enough to manage risk.
For example, let's say a trustee is managing a trust with $100,000. Instead of investing all of the money in one stock, the trustee would invest in a variety of stocks, bonds, and other assets to create a diversified portfolio. This way, if one investment performs poorly, the overall portfolio is not as affected.
The goal of the Modern Portfolio Theory is to manage risk and determine the appropriate level of risk for the particular trust based on its objectives.