One question we must ask ourselves as Muslims is “Are my sources of income Halal?” Many Muslims think of Halal in terms of food, but take into consideration the following hadith:
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)
Ensuring that our earnings are Halal is critical, and not just earnings from employment or business, but earnings from investments as well.
WHAT IS HALAL INVESTING?
Halal investing is also known as Shariah-compliant investing. The objective of the Shariah is to protect five areas: religion, life, intellect, family, and property. In this way, the Shariah creates a balanced ecosystem of social responsibility between the individual and society. Individuals may pursue self-interest, but must also be conscious of the interests of others. The Shariah is designed with an encompassing view of society that governs a balanced relationship between the two.
The following are the six foundations of Shariah-compliant investing:
Prohibition of riba (unjust, exploitative gains)
Prohibition of gambling
Ethical and moral values
Linkage with the real economy
WHICH INVESTMENTS ARE NOT SHARIAH-COMPLIANT?
Many Muslims unknowingly and unintentionally carry investments in their 401(k)s, IRAs, and bank accounts that violate one or more of the six foundations above. The following investments are not Shariah-compliant because they pay interest: Money Market, Certificates of Deposit, Municipal Bonds, US Treasuries, and Corporate Bonds. Be sure to avoid these investments.
Additionally, many common investments such as options, swaps, foreign exchange, forwards, and futures have features that nearly always render them non-Shariah-compliant – if you invest in these, obtain advice as to their permissibility.
HALAL INVESTMENT OPTIONS
There are four common Halal investment options: Stocks, Businesses, Real Estate, and Cash.
Stocks – publicly traded shares of companies – are the most common investment type 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 below the rate of inflation.
Shariah-compliance: Many Muslims buy stocks without knowledge 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 remains compliant. To illustrate, 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 stock is Shariah-compliant. Preferred shares, which are a combination of debt and stock, are non-compliant.
Non-compliant activities must be <5% of total income. These include: Alcohol, gambling, tobacco, adult entertainment, pork products, defense, interest income, conventional insurance, conventional financial services
Restrictions on levels of company debt, cash, and receivables.
Direct business ownership is a less common investment option for Muslims. An individual either runs the entire business themselves, or partners with a group to run the business.
Pros: Direct control over the business and high potential returns.
Cons: Requires significant investment of time and knowledge to be competitive in the market. Business ownership is the riskiest investment type, with the potential to lose all invested capital and possibly more given exposure to lawsuits.
Shariah-compliance: Muslims must ensure that their business activities do not fall into the non-compliant business activities list as shown above.
Real estate investing is one of the most desired investment types for Muslims, but many find it difficult to invest due to lack of knowledge or resources, making it an option that few are able to pursue by themselves.
Pros: Real estate is a tangible asset that serves as a hedge to inflation. It can produce stable income at higher levels than other investments while also benefiting from appreciation over time. In addition, significant tax advantages shield much income from taxation.
Cons: Requires larger investment amounts with limited liquidity. A strong knowledge of real estate and market trends is needed. Ongoing attention and management is required to maintain tenants.
Shariah-compliance: Must not utilize an interest-based mortgage. For commercial properties, may not lease to any tenant that engages in a non-compliant business activity.
Cash is not an investment – but many Muslims hold cash because they are unsure how to invest in stocks, businesses, or real estate. As a result, not only are they missing out on growing their money for the future, but each year their savings are reduced by approximately 2.5% due to inflation.
Pros: Liquid, available immediately.
Cons: Effectively produces a negative return of -2.5% per year after inflation. What does this mean? Consider the following two scenarios:
Ahmed saves $1,000/month for 5 years. But, after adjusting his $60,000 savings for inflation, his money is only worth $55,600.
Fatima 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 is usually paid interest and therefore, not Shariah-compliant
PORTFOLIO DIVERSIFICATION PROBLEM
Even for Muslims that already adhere to Shariah-compliant investing, proper portfolio diversification is difficult. Portfolios tend to become heavily weighted towards cash and stocks.
Most financial advisors guide investors to hold between 25-75% of their portfolio in bonds because bonds provide stable income. The problem? Bonds pay interest. If up to 75% of a portfolio should be in an income-producing investment, but bonds are off the table, what is the alternative?
One answer is stable real estate investments that pay reliable dividends. They provide the income of bonds, with the added advantages of inflation protection and tax benefits. As a bonus, they can deliver long-term capital appreciation potential.
WHAT TO DO
Identify your: 1) Investment goals, 2) Time horizon, and 3) Risk tolerance level. Commit to improving your knowledge of Halal investing and start building a diversified Shariah compliant portfolio that’s right for you.