Andrew Hallam
10.01.2020

Muslims Can Use Stocks and Gold To Build Shariah-compliant Portfolios
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In this article, Andrew Hallam describes how Muslims can build a winning portfolio that aligns with Shariah law. This story, however, isn’t just for Muslims. It reveals the universal benefits of low-cost investing and diversification. It also answers a question that would fool most investors: "What’s more volatile, gold or stocks? The answer might surprise you.

Shakespeare’s character, Polonius, continues to delight audiences that watch Hamlet. In the play’s first act, he gives his son some good advice. The younger man is getting ready to continue his education in Paris. At one point, Polonius says: "Neither a borrower nor a lender be." Muslims can relate. After all, Polonius’ words echo Shariah law.

When Muslims invest, they aren’t supposed to loan money that pays interest. That rules out bonds. The Koran says such interest would be usery, which is against Shariah law.

Muslims also have other faith-based investment principles. They aren’t supposed to invest in financial institutions or companies that produce or sell alcohol. They shouldn’t invest in companies associated with gambling, weapons of mass destruction, pornography or cloning.

That crosses plenty of investments off the list. But Muslims can still build stock market wealth. If they buy low-cost, Shariah-compliant stock market funds, they can reap big rewards, while complying with faith-based principles.

Plenty of financial companies have created Shariah-compliant funds. But their fees are high. As with regular mutual funds or unit trusts, the less you pay in fees, the more money you will make.

That’s why Muslims should consider Shariah-compliant ETFs. They only include stocks in industries that comply with their religion. What’s more, they charge lower fees than actively managed funds. As a result, they have much higher odds of earning strong returns.

Three examples trade on the London Stock Exchange. They include the iShares MSCI World Islamic ETF (ISWD). It includes 525 stocks from dozens of developed market countries. The United States is the world’s biggest market, so almost half of the fund comprises U.S. stocks. The rest is split between European, Asian, Canadian and Australian shares.

The iShares MSCI USA Islamic ETF (ISUS) is another Shariah-compliant fund on the London Stock Exchange. New investors might compare the returns of this fund to the World Islamic ETF…and then choose the U.S. fund. They might be impressed that the American Shariah-compliant fund gained a total of 99.84 percent during the ten-year period ending June 30, 2018.

That compares to a ten-year total return of 58.11 percent for the Shariah- compliant world stock index. But focusing on the U.S. fund might be a mistake.

After all, it doesn’t include European, Asian, Australian or Canadian stocks. As a result, it’s far less diversified.

What’s more, U.S. stocks are currently expensive. Based on the most respected predictor of long-term returns (something called the CAPE ratio) U.S. stocks are expected to lag global markets in the decade ahead. A world stock index provides U.S. stock exposure, without going overboard.

Muslims should also include the iShares MSCI Emerging Markets Islamic ETF (ISDE). It contains 260 stocks from several emerging market countries. Emerging market shares have high growth potential. But they can be volatile, and they can sometimes fall hard. That’s why investors shouldn’t put more than 10 percent of their portfolio’s value in emerging market stocks.

Shariah-compliant ETFs Trading On The London Stock Exchange

Source: iShares UK

By now you might be asking, "How do we manage risk?" Diversification helps. Non-Muslims should build portfolios with stocks and bonds. Muslims could use stocks and gold instead. The Accounting and Auditing Organization for Islamic Financial Institutions recently approved a new Shariah Standard on gold. That means Muslims can buy gold ETFs.

Rebalancing a stock market portfolio with bonds or gold reduces risk. For example, when stocks fall hard, plenty of people stuff their money into bonds, gold, savings accounts or mattresses. Needless to say, I don’t recommend the bed.

But when an asset class has more buyers than sellers, it increases demand for that investment. This can boost the price. As a result, when stocks crash, gold and bond prices often rise as people jump out of stocks and into bonds or gold.

Here are some examples. Since 1986, global stocks dropped more than 10 percent on five occasions: 1990, 2000, 2001, 2002 and 2008. As you can see below, bonds and gold either gained in price, or they didn’t fall as far.

When Stocks Crash, Bonds and Gold Buffer The Fall
Years When Global Stocks Fell More Than 10%

Source: portfoliovisualizer.com

However, here’s a word of warning. By itself, gold is a horrible investment. It jumps up and down like a crazed jack rabbit. But it doesn’t gain much ground.

For example, over the 46.5 years between 1972 and July 2018, gold prices fell 19 times (if we include 2018). By comparison, global stocks fell during just 11 calendar years.

Gold’s long-term returns are just as bad. If one of your forefathers invested $1 in gold in 1801, it would have been worth about $52 by 2017. But if somebody invested $1 in the U.S. stock market, it would have grown to about $17 million.

That said, gold’s price volatility could help Muslims. After all, gold often rises when stocks fall. Nobody can predict where stocks or gold are headed, so Muslims should own them both and rebalance once a year. For example, assume an investor has 70 percent in stocks and 30 percent in gold. If stocks dropped the following year, the portfolio might then have 60 percent in stocks and 40 percent in gold.

To rebalance, an investor would skim proceeds off the winner (in this case, gold) adding the proceeds to their loser (in this case, stocks). Over time, annual rebalancing increases stability. It also ensures that investors are always buying a little bit low, and selling a little bit high.

Below, I’ve created five Shariah-compliant portfolios using stocks and gold. They represent different levels of risk. Investors with the nerve to embrace more risk should select a portfolio with a higher stock allocation. But such portfolios also fall harder when stocks plunge.

For example, an aggressive portfolio with 100 percent devoted to global stocks (and no gold) would have earned a compound annual return of 9.03 percent between 1986 and 2018. It would have turned a $10,000 investment into $165,888. But, over the 32-year period, it would have fallen more than 10 percent during five calendar years.

In contrast, a conservative portfolio with 30 percent in global stocks and 70 percent in gold wouldn’t have made as much money. It would have turned $10,000 into just $67,599 between 1986 and 2018. But it would have been easier on the nerves. It dropped more than 10 percent during just two calendar years.

Of course, past returns aren’t a prologue to the future. But, based on Nobel-prize winning research, diversified portfolios of low-cost ETFs should beat most professional traders over an investment lifetime. If Muslims select Shariah-compliant ETFs, they should be able to do the same thing.

Shariah-compliant Portfolio Samples

Source; iShares UK; portfoliovisualizer.com

*Such historical performances tracked broad stock market indexes. Although Shariah-compliant equivalents didn’t exist in 1986, their long term performance (15 years or longer) are likely to be similar to the returns of broad index funds.

Writer’s note: Portfolio’s were rebalanced once a year, back to their original allocation. This reduces risk. Sometimes, such rebalancing also boosts returns.

Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas

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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.