If you are a follower of the religious tenets of Islam, you have probably heard the term Halal Investing and wondered how you can comply with the religious norms of Islam and continue to invest your money.
This article is a beginner’s guide to Halal Investing.
What is Halal Investing?
Halal Investing is a term used to describe investing under the Shariah law, which essentially translates to socially responsible investing. Under Shariah law, an individual can pursue investments, but they must invest in a manner where they build a balanced ecosystem between society and themselves.
Shariah law or Halal Investing is based on the following principles:
- Sharing of profit
- Prohibition on Gambling
- Prohibition on unjust, exploitative gains
- Upholding ethical and moral values
- Investing in lawful activities only
- Successful and functional with the real economy
Are your investments Shariah-compliant?
Many Muslims make investments unknowingly and unintentionally that are not Shariah-compliant as they often violate the principles of Halal Investing.
Investments that pay interest are not considered to be Shariah-compliant, including:
- Corporate bonds,
- Municipal bonds,
- Certificate of Deposit,
- U.S. Treasuries,
- Money market instruments
- Forward contracts
- Swaps and foreign exchange
To gain a complete understanding of permissible investments under Shariah law, consult a professional.
Halal Investment Options
Your investment options may be limited, but Shariah law permits investing under four asset classes.
The most common form of investment under Halal Investing is investing in stocks. While stocks offer the flexibility to invest in a wide array of listed companies on the stock market, there are some caveats under Shariah law that must be noted to ensure your investments are Shariah-compliant.
Determine the Type of Stock
Only common stocks are permitted under Halal investing. Preferred stocks or shares are a combination of debt and stock and are not permissible under Shariah law due to their debt component.
Determine the Company’s Business Activities
The company you invest in, must not be earning more than 5% of their total income through non-compliant activities. These include – selling alcohol, gambling, adult entertainment, selling of tobacco, pork products, defense, interest income, conventional insurance, and financial services.
Any company debts, receivables, and cash are subject to Shariah restrictions and must be monitored.
Stock market investments are considered a high-risk and volatile investment. The Shariah board of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has determined the above three areas to determine compliance.
Another option for investment under Halal Investing is direct business ownership. While this option can be extremely risky, it can also prove to be a highly profitable investment.
As an investor, you may risk losing your entire investment in the business if the business fails to deliver on its promises. In comparison to stocks, business ownership also requires a high investment capital along with thorough research and due diligence before investing.
Additionally, you cannot own a business that earns its income from activities that are not Shariah-compliant. This is similar to the activities listed above.
Real estate investing is the most desirable option for Muslims due to its ability to make large gains in the long-term.
While real estate investing can act as a hedge against inflation and results in significant value appreciation over time, certain pitfalls must be kept in mind before investing. Investing in real estate requires a large sum to invest along with substantial knowledge about the real estate market and its regulations.
You could save potential tax dollars due to real estate investments, but you will also be required to consistently maintain and manage the property you own.
Under Shariah law, you must not utilize an interest-based mortgage to invest in real estate. If you invest in commercial properties, you must not lease to a tenant who engages in any non-Shariah compliant activity.
While holding cash is certainly not an investment, but Muslims who have limited knowledge about investing or are fearful to invest in real estate, stocks, or land tend to hold on to cash.
The option to have significant liquidity is attractive to many Muslims, regardless of losing any potential gains through systematic investing.
The biggest con associated with keeping all your cash is your ability to make your money work for you. Investors often choose their investments to ensure their money can beat their country’s average inflation and holding cash can result in negative returns due to inflation.
For example, if you hold $1,000 in cash and the average inflation is 2.5%, what you can purchase today for $1,000 is going to cost you $1025 the following year. If you do not invest your money, you are potentially losing $25 every year on $1,000 cash.
Under Shariah law, your cash must be held in a checking account or one that does not pay any interest. A savings account or trading account is not permissible.
Are 401(k) or IRA Contributions considered Halal Investments?
No. 401(k) and IRA contributions result in accounts that invest in several asset classes that are not considered Shariah-compliant. Many Muslims unknowingly contribute to these accounts, not realizing that their contributions are often invested in interest-earning bonds, or, money market instruments that violate the one or more foundations of Halal investing.
Building a Shariah-Compliant Portfolio
With the limited number of options permissible under Shariah law, it can be hard to build a portfolio that can provide substantial returns and also protect you against inflation.
With interest-earning accounts or investments out of the picture, one of the best ways to generate a stable income is to invest in real estate. Real estate investments can offer a regular income similar to bonds and also offer several tax benefits. In the long-term, real estate offers the potential for long-term capital appreciation that can match no other investments.
In addition, investing in the right mix of stocks can result in periodic dividend payments that can serve as a great way of generating an income stream. Keep in mind that an all-equity portfolio can be risky and it is important to do your due diligence for the companies you choose to invest in.
Building a diversified portfolio under Shariah-law can be tricky and requires a substantial amount of research on your part. Understand your investment appetite and risk-appetite to outline your investment goals and continue to learn the nuances of Halal investing to make your best investments.