Index funds have long been known as one of the best and easiest ways to invest your money. The increase in the availability of halal index funds, that is funds that comply with Islamic Sharia rules, means that there is an even greater opportunity to maximize your investments without breaching Islamic finance principles.
Halal index funds enable investors to invest in a wider selection of stocks all within one fund.
WHAT ARE INDEX FUNDS?
An index fund is essentially a fund that follows what is known as a benchmark index, for example, Nasdaq 100, FTSE 100, and the S&P 500. Index funds are a portfolio of stocks and bonds.
Index funds are generally regarded as a passive form of investing. What this means is that investors who invest in index funds do not have to actively manage their investments.
The index fund will aim to mirror the index they track, they do not need to be actively and constantly managed.
Exchanged traded funds (ETFs) are those funds that are traded on exchanges and usually ETFs will track a specific index. EFTs offer investors a basket or bundle of assets that can be traded. The result is that the portfolio is diversified and the risk is deemed to be low, especially in times of economic growth.
Index funds are popular with all kinds of investors from angel investors, stock investors, new investors, and those looking for responsible investment options.
DIFFERENCE BETWEEN MUTUAL FUNDS AND INDEX FUNDS
The main difference between mutual funds and index funds is that mutual funds need a great deal more active management by fund managers. These fund managers actively choose the investments and manage the mutual fund and this leads to increased management fees and costs.
Before making any kind of investment in index funds you should make some inquiries about the fund, read online information from the relevant website and try and look into the methodology the fund uses (this includes yield, capitalisation, and price).
HOW DO INDEX FUNDS WORK
Index funds work by investors investing their money in to an index fund that has been created. The money is then used to invest into the companies that comprise the particular index fund chosen. This means investors are able to diversify their portfolios and invest in companies they want to.
For example, if an investor invests money in the S&P 500. This index fund essentially tracks the performance of 500 of the largest companies in the USA. The S&P 500 is one of the largest and most popular index funds on the market.
Investing in companies via index funds means that investors' money is linked to, and tied up with, the performance of the companies within the fund. Many of these index funds have a very wide range of companies within the fund.
INDEX FUNDS - WHAT ARE THE RISKS?
As many of the most popular index funds are diverse, this means they are less risky for investors. The reason the risk is lowered with index funds is that there are usually many companies within the fund, so all the investment is not tied up with the performance of one company.
Index funds are known for offering what is considered to be a broad market exposure for investors, with very low operating costs and risk. Index funds are popular with people who want to use the fund as a pension and plan for retirement.
Index funds are normally managed by a fund manager whose employment is based on ensuring that the fund is managed and tracked properly.
SHARIA PRINCIPLES RELATING TO INDEX FUNDS
The Sharia rules that relate to investment funds are the same rules that apply across all financial transactions.
The main principles of Islamic finance that should always be considered when looking for halal index funds to invest in include the following:
- There should be no element of interest (riba)
- The investments should be ethical and should enhance communities and society in keeping with the social justice element of Islamic finance
- There should be no element of speculation or gambling (maisir)
- Both parties in the transaction should share the risks and profits
- There should be no transactions involving uncertainty (gharar)
- There must be asset backing - this means that every financial investment and transaction must relate to a tangible asset
- The industries, business, and companies within the fund should not be deemed to be impermissible in Islam
The aim of halal index funds is to create long term appreciation of the investment funds via a diversified portfolio. Revenue is generated if the portfolio increases in value.
This portfolio is securities and investments are compliant with Islamic finance investment principles as laid down by Sharia laws.
Two of the largest index funds are the HSBC Islamic Global Equity Index Fund (halal) and the Vanguard FTSE 100 Index Fund. In the Unites States, the Dow Jones Industrial Average is one of the most popular funds to invest in. However, there are other index funds that meet the Sharia principles of halal investment. The numbers in the name often refer to the number of companies included within the index. For example, the FTSE 100 includes the largest 250 companies that are currently listed on the London Stock Exchange.
Before investing, always make sure you have done your due diligence and that the index fund you are investing in has been certified as compliant with Sharia rules.
For Muslims, the main incentive for investing in halal index funds is that they comply with Islamic finance rules and regulations. Any stock or bond within a halal index fund needs to be compliant with Sharia rules relating to investing.
ADVANTAGES OF INVESTING IN HALAL INDEX FUNDS
One of the main advantages for any individual investing in a halal index fund or product is knowing that you will be investing your money in funds that comply with Sharia principles. Halal index funds also take care to ensure that the money is not invested in industries prohibited by Islamic finance principles (such as the gambling, alcohol, and porn industries).
For investors who want to invest in an ethical way that does not adversely impact society, then halal index funds offer the opportunity to do that. The relevance of halal index funds has grown significantly in recent years with the increase in demand for Sharia compliant and ethical investment options.
There is a great deal of global movement towards more responsible investing and halal index funds meet the criteria for ethical investing.
In the United Kingdom, index funds are regulated by the Financial Conduct Authority.
CONSIDERATIONS FOR INVESTORS WANTING TO INVEST IN HALAL INDEX FUNDS
Investment in any kind of fund comes with its own risks. You should always seek to do as much research as possible before you invest.
Some of the key risks relating to halal index funds include:
- Risk of the investment value going down
- Exchange rate risks - if the economy and the markets are volatile then the exchange rates could fluctuate and affect your investment gains
- Tracking risks - whilst index funds will track the index, you should expect to see occasional differences in the gains
- Operational risks - as with any fund, halal index funds could be subject to operational and compliance risks which could affect any profit or return generated
LOOKING FOR THE RIGHT HALAL INDEX FUND
In addition to the points raised above, if you want to invest in a halal index fund then you should look specifically for:
- Confirmation/documentation that the index fund has been certified as being compliant with Sharia rules
- The scope for diversification - the greater the diversification the lower your overall risk
- Fund fees - check what fees your investment will incur
- Foreign companies - looking at companies abroad is a great way of diversifying your portfolio and finding halal investment funds
- Minimum investment levels - check to see if there is a minimum investment level required for the fund you are interested in. Many halal index funds are accessible and have reasonable charges for every level of investor
- Information - check what information is available on the index funds you are interested in. If you have any questions find an expert who can help you with your queries
SAVING VERSUS INVESTING IN FUNDS
Whilst is it always a good idea to have savings, if you are comfortable with taking small risks and want to diversify your investment portfolio, then halal index funds are the way forward.
If you are risk averse and do not want to deal with any market fluctuations, then it is probably best for you to maximise your savings. However, in the current economy savings are not the best way to use your money. Also, for Muslims who are not permitted to make use of high interest savings accounts, looking into index funds is a good way of earning revenue from the money they have.
Halal index funds are a great way for beginners to invest in the stock market. Index funds enable investors to own a share in a company for relatively low cost.
The company that manages the fund will do all the running around and hard work so you do not have to.