Index funds have become one of the most popular ways to invest: low fees, broad diversification and no need to pick individual shares. For a Muslim investor the question is whether owning one is permissible.
What an index fund does
An index fund buys every company in a market index, in proportion. A fund that tracks the S&P 500 owns shares in roughly five hundred large US companies; one that tracks the Nifty 50 owns fifty large Indian companies. You own a small slice of all of them.
Why a conventional index fund is a problem
Because it owns everything in the index, a conventional index fund includes companies whose core business is impermissible, such as conventional banks, insurers, alcohol producers and gambling businesses. It also includes companies whose debt or interest income is far above the limits scholars set. Most scholars therefore do not consider a conventional index fund Shariah-compliant.
Shariah index funds
Index providers publish Shariah versions of their indices, which apply business and financial screens to the parent index. Examples include the S&P 500 Shariah, the Dow Jones Islamic Market indices, the MSCI Islamic indices, the FTSE Shariah indices and, in India, the Nifty50 Shariah index. Funds that track these indices invest only in the companies that pass.
When you look at such a fund, check:
- The index it follows, and that index's published screening rules.
- Its Shariah supervision: who reviews it, and how often.
- Purification: whether the fund purifies impermissible income itself or tells you how much to give.
- How it holds cash, which should not be in interest-bearing deposits.
Common questions
Are fund fees a problem? A management fee is payment for a service, and is generally considered permissible.
Are index funds risk-free? No. An index fund spreads your risk across many companies, but its value still rises and falls with the market.
Do I pay Zakaat on an index fund? Yes, on your share of its zakatable holdings or on its market value, depending on the approach you follow. Many Shariah funds publish a Zakaat figure each year.