Islamic Finance Blog & Articles
Investing is the main way to increase your finances in the modern market. Our day-to-day jobs only go so far, and as such when it comes to any sort of financial advice you can expect to see investment tutorials and guides at the top of the list.
However, what most investors don't take into account are the key differences between Islamic and Western cultures when it comes to investing and finances as a whole. Not all traditional forms of investments are halal, and this can be a setback when you are trying to get your finances in shape.
So today we'll discuss halal investing. So you can know what you can invest in safely, what alternatives are there, and how to best handle your finances moving on forward.
What are bonds?
Bonds are defined as a "fixed income instrument" but the easiest way to look at them is to call them loans. In this case, the investor who is usually an individual pays a fixed amount to the borrower (which more often than not is the government). In exchange for this payment, the investor receives a "Bond" which is ultimately proof of a debt. The bond itself details how much needs to be paid back, at what intervals, and at what interest.
As far as investments come the interest is the main way to benefit from bonds. Traditionally a bond sets a fixed interest rate over the original value, which the borrower must pay out in specified intervals until the debt is completely repaid. As an investment alternative bonds are popular for their simplicity and reliability. Bonds allow the government or corporations to easily obtain funds for upcoming projects and provide investors with a stable source of income. After all payments from the government are functionally guaranteed so investing in a bond is a simple matter of waiting.
Why bonds are haram?
The reason why bonds are considered haram is rather simple, it's because they rely on interest or Riba. The term "Riba" stands for usury and it's one of the most discussed prohibitions in our faith. The concept of Riba is explicitly discussed in Quran 2:275 when it's mentioned and reiterated that Allah allows trade but forbids usury, so the stance is completely clear and not open to arguments.
While usury is a broad term, interest is explicitly referred to as a type of Riba under the term Riba al-Quran. This type of Riba is described as an excess amount that is paid over a loan to a borrower due to a contractual obligation. Or in simpler terms, interest. As such bonds which completely rely on interest to make a profit are simply haram, and there's no way to go around the fact.
Interest is an issue because it goes against the real purpose of money. Money is just a medium to facilitate trade, in trade, everybody plays a part, and profit is generated due to a real effort in the creation of goods and services. But interest is a way to earn money without trade or a real effort, which ultimately distorts the economy.
What are the alternatives to bonds for Muslims?
While interest plays a major role in any investment that relies on loans, this doesn't mean that it's impossible to invest without relying on interests. There are countless ways to make a profit in this world, and there are various investment options that are completely halal. Today we'll focus on the three most relevant ones, explaining their pros, cons, and what makes them unique and separate from traditional bonds.
Property is one of the most rewarding investment opportunities in the market, and if handled properly it is completely halal as well. The main issue most people have with it is the pre-conception that it takes a lot of money to get involved in the property market, but nowadays that doesn't have the case.
Logically buying a property on your own and having full control of it will cost a large amount of money, but that's not the only way to invest in property. Property Investment Companies for example pool the resources of multiple investors to obtain a property and then manage it. Investors will receive a portion of the profits, allowing them to make money without having to worry about managing a project. Property Funds work similarly, and while you won't have direct ownership they also provide a stable income over time.
Higher-risk fixed yield options
A lot of projects rely on capital growth to pay back investors instead of interest, and these projects are a solid alternative to traditional bonds as well. Of course, this also means that there's a higher risk attached overall, so you need to have a critical eye for projects and business. Nonetheless, since these yield projects circumvent interest altogether they are a great option for Muslim investors. Ensure that the projects and companies engage in halal and ethical businesses.
A Sukuk is one of the most interesting investment options for Muslims because they are a Shariah compliant investment.
While people usually refer to Sukuk as an "Islamic Bond" it's more accurate to call it a financial certificate. Sukuk avoid interest altogether and as such are halal, instead they rely on actual revenue to make returns
. A Sukuk is an ideal investment option for any Muslim, but to this day they remain less plentiful than bonds, so you will need to stay alert to seize these opportunities.
Sukuk vs bond
The main difference between a Sukuk and a Bond comes down to how the investor makes money. In a Sukuk, there's no debt. as such while they fulfill similar roles they aren't equivalent certifications.
In a Bond, there's a debt and that has to be paid on specified dates, it's Riba and there's no way around it. Sukuk however represents ownership. A Sukuk makes it clear that you supported a project or company and as such you will be paid back the amount. However, instead of relying on interest, you are paid back through the revenue the project generates. This key difference ensures that Sukuk is halal. Do keep in mind however that since interest doesn't play a role in a Sukuk, if there's no revenue your income might get delayed.
How much of your portfolio fixed income assets could be
An investment portfolio is generally a personal matter, and how much you should focus on fixed income assets comes down to your appetite for risk. For most individuals, fixed-income assets will make up between 20% to 50% of their portfolio. This percentage provides a safety net while giving you room to invest in more profitable projects.
However fixed income doesn't mean that something is completely free of risk. Sukuk are traditionally a very safe investment, but if you go for high-risk projects as we mentioned above you should exercise moderation. In these cases we recommend you don't go above 30% with fixed income assets, so you can rebuild your portfolio in the case something unexpected does happen.