Thursday, July 2, 2020

Halal Investing: A Beginner’s Guide

As a muslim investor, you might often wonder, “Are my income sources Halal?” A lot of people, including many Muslims only associate the term Halal with food. However, that’s not necessarily the case, various other aspects of life also need the consideration of being Halal or not. Consider the following hadith: Invest, trade, and save […]

As a muslim investor, you might often wonder, “Are my income sources Halal?” A lot of people, including many Muslims only associate the term Halal with food. However, that’s not necessarily the case, various other aspects of life also need the consideration of being Halal or not. Consider the following hadith:

Invest, trade, and save for a better future.

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“On the authority of Abu Huraira (RA) the Messenger of Allah (SAW) said:

If anyone amasses wealth through haram means and then gives charity from it,

there is no regard for him and the burden of sin remains.”

(Sahih Ibn Khuzaymah (4/110) No. 2471)

For Muslim investors, ensuring that their earnings are Halal is very crucial. The earnings don’t just include salary and business revenue, they also include income earned through investments as well. Let’s find out more about Halal investing.

Halal Investing: Things you need to know

What is Halal Investing?

Halal Investing is a term used to describe investing that is Shariah compliant. In modern parlance, Halal investing can also be considered as a type of socially responsible investing. As per the religious tenets of Islam, the objective of the Shariah is to protect and preserve five areas: religion, life, intellect, family, and property. With the doctrines and guidelines of Shariah, a balanced ecosystem of social responsibility between the society and the individual is created. While individuals aren’t prohibited to pursue self interest, they are supposed to not ignore the interests of other people in the process. The Shariah by design is meant to govern a balanced relationship between the individual and the society. 

The following points form the six foundations of Shariah-compliant or Halal investing:

  • Sharing of profit
  • Prohibition of riba (unjust, exploitative gains)
  • Gambling prohibition
  • Investing in lawful activities only
  • Upholding of ethical and moral values at all times
  • A successful and functional with the real economy

Which Investments are not considered Halal/Shariah-Compliant?

A significant percentage of the muslim population unknowingly and unintentionally invests money in its 401(k)s, IRAs, and bank accounts. A lot of times, these investments violate one or more foundations of Halal/Shariah Compliant investing. These types of investments are not considered Halal/Shariah Compliant since they pay interests: Money Market, Certificates of Deposit, Municipal Bonds, US Treasuries, and Corporate Bonds. So if you are starting off with Halal investing, ensure that you avoid these types of investments.

In addition to the investment tools mentioned earlier, a lot of commonly used methods of investments such as options, swaps, foreign exchange, forwards, and futures have features that tend to render them non-Shariah-compliant quite often. So if you are planning to invest in one or more of those tools, get in touch with a person who has a good idea of Halal/Shariah compliant investing, so that you can know enough about their permissibility.

What are some Halal Investment options?

There are four common Halal investment options: Stocks, Businesses, Real Estate, and Cash.

Stocks

Stocks – publicly traded shares of companies – are the most common investment type that Muslims use.

Pros: Stocks provide investors access to a wide array of company sizes and types. They are liquid, allowing investors to contribute and withdraw money in short time periods.

Cons: Stocks are considered a higher risk investment because prices can fluctuate significantly – such as when the NASDAQ fell 78% in 2000-02 and the DJIA fell 50% in 2007-09. Few stocks pay dividends, and the ones that do generally do so at a rate which is well below the rate of inflation.

Shariah-compliance: Many Muslims buy stocks without knowing that the shares they are buying may not be Shariah-compliant. Significant time must be invested into screening each company’s stock for Shariah compliance and continually monitoring to ensure that the company and its practices remain Shariah compliant. To illustrate that aspect, the Shariah board of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has identified three areas required to ensure compliance of stocks.

Type of Share

Only common stocks are Shariah-compliant. Preferred shares, which are a combination of debt and stock, are non-compliant.

Business Activities

Non-compliant activities must constitute less than 5% of total income. These include: Alcohol, gambling, tobacco, adult entertainment, pork products, defense, interest income, conventional insurance, conventional financial services

Financial Screens

Company debts, cash and receivables generally have some restrictions.

Business Ownership

Direct business ownership may be a less common investment option for Muslims. An individual either runs the whole business themselves, or as partners with a gaggle of investors to run the business.

Pros: The potential returns are very high and you can exercise direct control over your business.

Cons: Requires significant investment of your time and knowledge to be competitive within the market. Business Ownership is definitely one of the most risky types of investment available for investors. Any business carries the dreaded possibility of a complete loss of the invested capital along with a further strain on your resources because of expensive lawsuits.

Shariah-compliance: Muslims must make sure that their business activities don’t fall under the non-compliant business activities list as illustrated above.

Real Estate

Real estate investing is one of the most highly desired types of investments for Muslims, but many find it difficult to take a position thanks to a lack of data or resources, making it an option that few are ready to pursue by themselves.

Pros: Land may be a tangible asset that is a hedge to inflation. It can produce stable income at higher levels than other investment types while also taking advantage of appreciation over time. On top of that, you can also enjoy a lot of income tax advantages by investing in real estate.

Cons: Requires larger investment amounts with limited liquidity. A strong knowledge of land and market trends is required. Consistent attention, maintenance and management is required to take care of tenants.

Shariah-compliance: Must not utilize an interest-based mortgage. For commercial properties, investors must not lease to any tenant that engages in any kind of non-Shariah-compliant commercial activity.

Cash

Cash isn’t an investment – but many Muslims hold cash because they’re not well versed with the knowledge required to invest in stocks, businesses, or land. As a result, not only are they missing out on growing their money for the long term, but suffering from an annual loss of savings of up to 2.5% as a result of inflation.

Pros: Liquidity, available immediately.

Cons: Effectively produces a negative return of -2.5% per annum after inflation. What does this mean?

Consider the following two scenarios:

Muhammed saves $1,000/month for 5 years. But, after adjusting his $60,000 savings for inflation, his money is only worth $55,600.

Noorie invests $1,000/month for 5 years and earns a 6% annual return. Her savings will total $66,600 – even after inflation.

Shariah-compliance: Cash must be held in an account that does not pay interest, such as a checking account. Cash held in savings accounts, stock trading accounts, and 401(k)s tends to generate interest and falls outside the Shariah-compliant/Halal category.

How to manage the portfolio diversification problems which come with Shariah-Compliant/Halal Investing?

Portfolio diversification can often be an arduous task, even for the strict adherents of Shariah-compliant investing. In most instances of Shariah-compliant/Halal investing, the portfolios start featuring a disproportionate amount of cash and stocks.

According to most financial advisors, investors should try to hold anywhere between 25-75% of their investment portfolio in bonds as bonds are a great source of stable income. However, there’s a catch in this situation for investors looking for Shariah-compliant/halal methods of investing. As it is well known, bonds generate interest for the investor. If you are looking to have at least 75% of your investment as a source of income, not having bonds as an option makes the situation very difficult. A good alternative in that situation is a nice and stable real estate investment which generates reliable dividends. Real estate investments will provide an income stream which is similar to that of bonds while safeguarding you from inflation and giving you additional tax benefits. Another bonus of investing in real estate is the possibility of long term capital appreciation.

In order to become a successful Shariah-compliant/Halal investor, you need to dedicate some time for understanding its terms and nuances. Outline your investment goals, risk appetite and the time frame for your investment and commit towards learning all you need to know about Shariah-compliant/halal investing. Get in touch with a financial advisor from Wealthface for more help on the subject.

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