Salaam, is it permissible to invest in a total stock market index fund where its only invested into stocks/shares and not bonds???
In the name of Allah, Most Compassionate, Most Merciful,
As-salāmu ‘alaykum wa-rahmatullāhi wa-barakātuh.
A Total Stock Market Index Fund is a mutual fund that invests in a variety of stocks of different companies. The same laws that apply to trading in the stock market will apply to investing in a Total Stock Market Index Fund.
The DarulIftaa has written a detailed answer regarding investing in shares. If the companies in the Total Stock Market Index Fund fulfil the conditions laid out in the answer below, then it will be permissible to invest in the company.
There are various types of companies in terms of how Shariah compliant they are. We can broadly group the companies into three:
1) Shariah compliant business & Shariah compliant financials
This refers to companies which have a Shariah compliant business activity such as the trading of halal food and beverages, textiles, halal pharmaceuticals. They further have no borrowings with interest and they do not receive any unlawful earnings from interest-bearing deposits, unlawful investments or trade of unlawful products.
Such listed companies are very difficult to find as they require an entire Islamic economic system with all Islamic financial institutions in terms of capital markets, Shariah compliant money markets, Takaful institutions, Islamic banks and more.
2) Non-Shariah compliant business
This refers to those companies which have a non-Shariah compliant business activity such as the production of pork, production of alcohol and conventional financial institutions trading in non-Shariah compliant products and instruments. Investing in such equities is never Shariah compliant and should be avoided at all cost.
3) Shariah compliant business & mixed financials
Many companies fall into this area where their business is Shariah compliant but they may have a small proportion of borrowings with interest or may have deposits in a business account in a conventional bank and thus receive interest.
With the interconnectedness of the financial system and most companies operating in conventional systems, it becomes almost impossible to evade some exposure to non-Shariah compliant financial services. Thus, the majority of contemporary jurists permit investing in such companies as long as one does not benefit from the impure income and secondly, as long as the company proves to have minimal exposure to interest. This is established by successfully passing financial screening criteria. The two screenings a company must go through are as follows:
1) Business screening
A company shall not be involved in any of the following businesses:
a) Companies in the Financial services industry that are involved in interest-based lending and/or distribution of interest-based products. This includes financial intermediaries such as conventional banks, conventional insurance, interest-based lending (excluding windows operating in compliance with Shariah principles).
b) Manufacturing or distribution of alcohol and tobacco;
c) Companies operating in betting and gambling operations like casinos or manufactures and providers of slot/gambling machines;
d) The production, packaging, processing, or any other activity related to pork and non-halal food and beverages;
e) Bio-technological companies involved in human genetic manipulation, alteration, mutation and cloning; excluding those that are involved in medical research.
f) Shariah non-compliant entertainment, that deals with the operation of cinema theatres, composing, production and distribution or sale of music or pornography, the operation of Shariah non-compliant TV or radio stations; and
g) Any other activities not permissible under Shariah, as determined by the Shariah Advisor.
2) Financial Ratios Screening
Once a company passes the initial screening, a detailed analysis of its financials will be conducted using the last available audited financial statements. It will be permissible to invest in a company subject to the following conditions:
1) That the collective amount raised as loans on interest does not exceed 30% of the total assets of the company.
2) That the total amount of interest-bearing securities, whether short, medium or long term does not exceed 30% of the total assets.
3) That the amount of income generated from prohibited sources does not exceed 5% of the total revenue of the company.
If all of the above conditions are duly satisfied, then the shares will be deemed to be Shariah compliant. However, the proportion of income generated from prohibited sources is to be given in charity and must not be retained under any circumstance.