Is Investing in Index Funds and S&P 500 permissible?

Answered by Ustadh Sufyan Qufi

Question

I’d like to inquire about investing in the stock market, specifically in Index Funds and the S&P 500. Is this permissible? If not, what are the reasons?

Are high-value savings accounts also permissible? My assumption is no since there is interest involved, but I’d like to clarify how to invest in a Halal way.

Answer

In the name of Allah, Most Compassionate, Most Merciful,

I pray this finds you in the best of states.

It is not permissible to invest in the stock market blindly because many companies whose stocks are publicly traded are involved in impermissible activities. For example, Bank of America, which is part of the S&P 500, deals mainly in interest. If you check its income statement, interest is by far the largest source of its income.

Despite this, the activity of several companies listed in the S&P 500 is permissible, and investing in them will be permissible if all the conditions are met.

As stated in the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) standards:

It is permissible to buy and sell shares of corporations if the activity of the corporation is permissible irrespective of its being an investment (that is, the share is acquired to profit from it by adopting a buy-and-hold strategy) or deal in it (that is, to sell it and benefit from the difference in prices).

Basis for the Permissibility of the Sale and Purchase of Shares of Corporations

In short, a stock is a claim on a part of a company’s assets (ie its cash, plant, equipment, inventory, and so on). Thus a stock, when the activity of the corporation is permissible, is deemed to be wealth from which one is allowed to benefit from religiously. The shares are owned by the shareholder, and he has the right to undertake transactions in them as he desires, whether this is by way of sale, gift, or another way. [Majalla; AAOIFI]

Allah, Most High, says: “Allah has permitted trading and forbidden interest.” [Quran, 2:275]

The basis for the permissibility of the issuance of shares, when the objectives for which the corporation has been established are permissible, is the basis for the permissibility of commercial partnership. [AAOIFI]

The Messenger of Allah (Blessings and Peace be upon him) has said: “Allah is the third of two partners as long as they don’t cheat” [Abu Dawud]

Shares of Corporations Whose Primary Activity Is Permissible but Are Involved in Usury (Interest)

The fundamental rule is that of prohibition of acquiring shares of corporations that sometimes undertake transactions in usury and other prohibited things (such as selling pork or alcohol) even when their primary activity is permissible.

Dispensation

If all of the four following conditions are met:

(1) The corporation does not state in its memorandum of association that one of its objectives is to deal in interest or in prohibited goods or materials like pork and the like.

(A memorandum of association is a legal statement signed by shareholders or guarantors when they agree to form a limited company.)

(2) The collective amount raised as a loan on interest – whether long-term or short-term debt – does not exceed 30% of the market capitalization of the corporation.

(Market capitalization refers to the total market value of a company’s outstanding shares of stock. The term “outstanding shares” refers to the company’s stocks currently held by all its shareholders. In other words, Market capitalization is the number of shares of the company multiplied by the current price of these shares in the stock market.)

(3) The total amount of interest-taking deposits made by the corporation does not exceed 30% of the corporation’s market capitalization.

(4) The amount of income generated from prohibited components does not exceed 5% of the corporation’s total income.

Then it will still be permissible to buy and sell the stocks of this corporation, despite the impermissible elements mentioned above. [AAOIFI]

Where to Find These Numbers

These numbers are easily checked online for any publicly traded corporation by looking at its annual 10-K report. These reports are available on the SEC website and the corporation website. You will need to look at the section of this report gathering all the financial statements of this corporation, especially the balance sheet, to check the long-term and short-term debt (liabilities) and the number of shares outstanding. For the current price of these shares, you will have to look at the stock market. For the details regarding the origin of the income of the company, you will have to look at its income statement (often called consolidated statement of operations).

Basis for This Dispensation

The basis for exempting trading in the shares of corporations whose primary activity is permissible but nonetheless deposit amounts and borrow on the basis of interest, is the application of the rule of removal of hardship and acknowledging the general need. [AAOIFI]

This is based on the following legal principle:

“General public need is akin to distress.” [Majalla]

Allah, Most High, says: “[Allah] has not laid upon you any hardship in the religion.” [Quran, 22:78]

Eliminating Prohibited Income

It is obligatory to eliminate prohibited income specific to the share that is mixed up with the earnings of the corporations.

The elimination of prohibited income is obligatory on the person who is the owner of the share, whether an investor or a trader, at the end of the financial period. Accordingly, elimination is not obligatory for someone who sells the shares before the end of the financial period.

(The financial period is the period over which a company measures its performance. It can but does not have to correspond to a calendar year. At the end of the financial year, the company will prepare its annual report for the shareholders.)

The figure, whose elimination is obligatory on the person owning the shares, is arrived at by dividing the total prohibited income of the corporation whose shares are traded by the number of shares of the corporation. Thereafter the result is multiplied by the number of shares owned, and the result is what is to be eliminated as an obligation.

For the determination of these percentages, recourse is to be had to the last budget or verified financial position.

How Do I Get Rid Of Haram Money?

Please see: How Do I Get Rid Of Haram Money? to learn how to eliminate prohibited incomes.

Final Remarks

It is necessary to observe these rules throughout the period of participation or trading. If the rules cannot be applied, it is obligatory to give up such investment.

It is not permissible to sell shares that the seller does not own (short sale), and the promise of a broker to lend these at the time of delivery is of no consequence.

Practical Advice

The strictness of the rules above should not discourage you from investing in the stock market. One of the easiest ways to do so is to use the services of a specialized broker who conducts stockbroking business in accordance with Islamic law. They can be found online or through an Islamic bank, for example.

Islamic Investment Funds are also available all over the world.

High-Value Savings Account

Traditional high-value saving accounts are impermissible because of the interest involved.

Please see: Is It Permissible to Open a Savings Account Which Will Receive Interest?

However, some Islamic financial institutions have developed high-value savings accounts that are compliant with Islamic rulings.

Before turning yourself towards Islamic financial institutions, please watch this important answer by Shaykh Faraz Rabbani (may Allah preserve him), as not every “Islamic” bank is really in line with the Islamic rulings.

Is there Islamic banking in the West? Islam FAQ with Shaykh Faraz Rabbani?

And Allah knows best.
Wassalam
[Ustadh] Sufyan Qufi
Checked and Approved by Shaykh Faraz Rabbani

Ustadh Sufyan Qufi is an advanced seeker of knowledge, originally from Algeria, who grew up in France. He began searching far and wide for answers to the fundamental questions of life and was disappointed at the answers he found. Then he connected with various traditional teachers and gradually connected with SeekersGuidance. He embarked on his journey of learning through the various teachers at SeekersGuidance, including his mentor Shaykh Faraz Rabbani. He studied numerous texts in Islamic Law, Theology, Hadith, and other areas with Shaykh Faraz Rabbani and other teachers, including Shaykh Abdurrahman al-Sha‘ar, Shaykh Ali Hani, and others. He is an active instructor at SeekersGuidance and answers questions through the SeekersGuidance Answers Service.