A legal investment is an investment which a fiduciary is legally permitted to purchase. Fiduciaries are people who act on behalf of others, and are therefore held to high standards of ethical and professional behavior because they are making investments with other people's money on their behalf. Investments by fiduciaries are limited by law in the interests of protecting the people they act for, ensuring that some basic standards are met by fiduciaries. Setting a standard such as requiring that each investment be a legal investment is designed to create a stopgap to prevent gross financial misconduct among organizations which are trusted to act as agents for other people and institutions.
Institutional investors are a classical example of a fiduciary. These include insurance companies, retirement funds, savings banks, and so forth. People trust these institutions to invest their funds wisely and to generate basic returns, and thus, these organizations are only allowed to buy legal investments. This is designed to limit their investment activities to investments which are reasonably safe.
Organizations with fiduciary responsibilities can still make mistakes. Even when limited to legal investments, they may not distribute their portfolios wisely, or they may make investments which later turn out to be unwise. Financial institutions have lost substantial sums in investments, and there are risks involved, even when working with an extremely conservative organization. However, excluding clearly risky investments by law can make these organizations much safer.
Typically, management of the portfolio is handled by several people who apply their experience, skills, and knowledge to make sound investment choices while monitoring the market to enable rapid responses to changing market events. These organizations are also held accountable for their actions through a variety of means, and one of the things they may need to demonstrate is proof that each investment is a legal investment.
A legal investment will be clearly designated as such to alert institutional investors to the fact that they can legally purchase it. A wide variety of investment instruments can be considered legal investments, allowing great diversity and flexibility in purchasing decisions which is designed to promote the development of well balanced, healthy portfolios of investments which will perform well through changing market conditions. If it is believed that a potential purchase is not a legal investment, research can be performed to determine whether or not it can be bought according to the laws which govern financial activities by fiduciaries.