Introduction to Islamic Investments

Islamic investments are investments that fall in line with the principles of Islamic banking. Islamic banking, in turn, is banking that follows the rules of Shariah--the sacred law of Islam. The rules of Islamic banking prohibited most of the financial practices that led to the collapse of the housing bubble and the subsequent financial crisis. As the result, Islamic investments fared better than other investments. Investors throughout the world are looking at this form of investing with new interest. Making Islamic investments has its own, unique challenges, but so long as investors understand what they are, they should be able to manage just fine.

Shariah Boards

One of the most notable differences between Islamic investments and other forms of investment is the existence of the Shariah Board. This is comprised of a group of independent Islamic scholars that must check whether potential investments comply with Islamic law. They also make periodic reviews to make sure that the investments remain Shariah-compliant every step of the way. No Islamic investment can be made without their approval.

Areas of Investment and Shariah Boards

Under Islamic law, investors can't invest in any businesses that deal with alcohol, tobacco, pork, gambling, entertainment media, financial services (such as banks) or pornography or in anything else that is deemed Haraam (unlawful). The Shariah boards evaluate whether an investment is Haraam according to the following criteria:

  • Gharar (uncertainty)--This includes any investment whose outcome is uncertain and in which risk is significant. It also includes any investments with uncertain or unclear characteristics. To put it another way, if the investment does not involve any tangible objects, odds are pretty good that it will be considered Haraam.
  • Maysir (gambling)--Somewhat overlapping with the above, this includes "games of chance involving money." Aside from the kind of gambling one would find in casinos, the term includes things like insurance products and any investments that generate derivatives.
  • Riba (interest)--Simply put, this covers any investments that generate any and all forms of interest.

How Islamic Investments Work

Once the Shariah Board rules an investment Shariah-compliant, investors are free to proceed with making investments. While, in many respects, the processes are similar to what would be found in other forms of banking, they do incorporate several concepts that are unique to Islamic investing. They include:

  • Musharakah--This is an investment partnership in which profits are shared between the partners involved according to an agreed-upon ratio, while the losses are distributed based on how much capital each partner invested. This is meant to ensure that no partner suffers excessive loss.
  • Mudarabah--This is an investment partnership in which the investor provides funds to the investment manager so that the business manager can undertake an investment activity on the investor's behalf. The investor and the investment manager split the profits based on an agreed-upon ratio, but the investor bears all the losses.
  • Ijarah funds--These are the funds that are used to purchase assets such as real estate, motor vehicles and equipment. Usually, the investor would expect to earn profit through interest. Yet, since Shariah doesn't allow investment in anything that involves interest, the investors earn profit by charging rent to whomever uses it. The rent must have a fixed value. The profits from rents are split between investors. Each investor gets a sukuk--a certificate that signifies the investor's stake in the assets. Sukuks can be traded in secondary markets, and their prices are based on market conditions.

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