Portfolio allocation (no bonds allowed), please suggest

[Houston101]

[Note - this is a thread from 2010 that has been restarted. Please check posting dates before responding - admin alex]

This is probably going to sound weird but I need help.

Due to religious reasons I cannot invest in bonds (interest is not allowed), but I still want a diversified portfolio. I do know that any diversified portfolio already has some interest income already included in it but lets just say that is ignorable.

Here is my suggestion:

35% Stocks
35% Real Estate
15% Gold
15% Cash

I am just interested in an auto pilot portfolio where I don't have to watch the stock market every day. I am 30, married, $50K annual income and have about $45K saved.

Please help.

[Adrian Nenu]

http://en.wikipedia.org/wiki/Islamic_banking

http://en.wikipedia.org/wiki/Sukuk

My guess is that you are attempting to stay in compliance with Islamic Sharia laws which prohibit interest. The only financial debt instruments I can think of which might be acceptable are zero coupon bonds.

http://www.sec.gov/answers/zero.htm

Here's how I'd set it up:

25% - stocks

25% - real estate

35% - zero coupon bonds (in tax advantaged accounts if in the US)

15% - cash


Adrian
anenu@tampabay.rr.com

[MBMiner]

Are you saying that zeroes don't pay interest? What would you call the accretion to maturity then - capital gain, dividends? I think you're stretching the prohibition a bit.
Bruce

[bearcub]

Amana funds family has a couple of funds that follow Islamic law.
JETS ETF is the Dow Jones Islamic Market International Index. It has large energy sector holdings.Im thinking off the top of my head but their may be a few more. Good luck with your search.

[EO 11110]

This is probably going to sound weird but I need help.

Due to religious reasons I cannot invest in bonds (interest is not allowed), but I still want a diversified portfolio. I do know that any diversified portfolio already has some interest income already included in it but lets just say that is ignorable.

Here is my suggestion:

35% Stocks
35% Real Estate
15% Gold
15% Cash

I am just interested in an auto pilot portfolio where I don't have to watch the stock market every day. I am 30, married, $50K annual income and have about $45K saved.

Please help.

i like it. two questions though:

is that real real esate or paper real estate? same question for gold -

if it's paper real estate i would dial it back a little. that's a heavy sector bet on those types of stocks. risk/reward doesnt work -

and the gold - physical possession, gold mining stocks/mutual funds, etf, or closed end fund?

[xerty24]

Treasury futures don't pay or accrue interest. However, they do become more valuable as time goes on.

[Houston101]

Yes this is related to Islamic Shariah restrictions.

Zero coupon bonds are still bonds, doesn't matter how the interest is paid.

I think there are two possible solutions
1) Invest in traditional bond alternative that offer a similar risk profile, return and liquidity. Sukuk's exist but they are not traded as liquidly and since they are not guaranteed by any state/country they are very risky too.

2) Model my portfolio in a way with the remaining asset classes so that the returns and risk are similar to someone who holds bonds. That is why I was including a higher percentage of Real estate to provide higher safey and regular income.

EO 11110, that is brick & mortar real estate (house owned by my parents which I will be inheriting) & the gold is also solid metal gold.

[jej]

This is probably going to sound weird but I need help.

Due to religious reasons I cannot invest in bonds (interest is not allowed), but I still want a diversified portfolio. I do know that any diversified portfolio already has some interest income already included in it but lets just say that is ignorable.

Here is my suggestion:

35% Stocks
35% Real Estate
15% Gold
15% Cash
.......

.

Your stocks will generate interest and dividends. Even a stock that does not dividend at all [Berkshire Hathaway, for example] profits from interest and dividends. They hold a lot of cash and a lot of bonds and a lot of stock that issue all sorts of interest and dividends. They just do not pass it on to you in the form of a dividend. Instead, they hold it and invest as they see fit and pass the interest on to you in the form of capital gains. Again using Berkshire as an example, holding large amounts of cash is a strategy that generates a substantial portion of the return.

Same for real estate held as paper/investments in real estate trusts or companies.

Cash, unless held as physical cash, generates interest. Held as physical cash, it presents risk of physical loss and risk of inflationary loss.

So - I think it cannot be done honestly with other than physical assets.

jej

[EO 11110]

Yes this is related to Islamic Shariah restrictions.

Zero coupon bonds are still bonds, doesn't matter how the interest is paid.

I think there are two possible solutions
1) Invest in traditional bond alternative that offer a similar risk profile, return and liquidity. Sukuk's exist but they are not traded as liquidly and since they are not guaranteed by any state/country they are very risky too.

2) Model my portfolio in a way with the remaining asset classes so that the returns and risk are similar to someone who holds bonds. That is why I was including a higher percentage of Real estate to provide higher safey and regular income.

EO 11110, that is brick & mortar real estate (house owned by my parents which I will be inheriting) & the gold is also solid metal gold.

then i have no argument. nice AA. 8)

the cash - is that all in one currency? if so, might look at spreading it out some

[Houston101]

So - I think it cannot be done honestly with other than physical assets.

jej

I understand that almost every company has some interest income, but I am compromising on that as long as I don't have any direct stake in interest bearing assets like bonds etc.

[Houston101]

the cash - is that all in one currency? if so, might look at spreading it out some

Yes, it is & thanks for the suggestion, I will do just that.

[jej]

So - I think it cannot be done honestly with other than physical assets.

jej

I understand that almost every company has some interest income, but I am compromising on that as long as I don't have any direct stake in interest bearing assets like bonds etc.

So its OK to earn interest as long as you hire someone else to earn it and pass it on to you?

That is a curious standard.

I am out of this thread.

jej

[ResNullius]

Sorry, but I think it's a huge mistake to mix religion with investing. One requires common sense, while the other requires.... Sorry, but that's how I feel about this.

[Houston101]

So its OK to earn interest as long as you hire someone else to earn it and pass it on to you?

That is a curious standard.

I am out of this thread.

jej

jej, I don't know why are you getting so upset. I am against a lot of things (revenue from tobacco, firearms, casinos, strip clubs and so on). They are all included when I purchase a VTI share. But I compromise on that on the grounds that they will all be less than a significant share of the S&P 500 earnings. I am pretty sure many of other people on this forum are on the same boat.

[Houston101]

Sorry, but I think it's a huge mistake to mix religion with investing. One requires common sense, while the other requires.... Sorry, but that's how I feel about this.

I understand what you mean ResNullius.

If I could do it otherwise and it was plain easy I wouldn't even post my question to the experts on this forum.

[KyleAAA]

This is probably going to sound weird but I need help.

Due to religious reasons I cannot invest in bonds (interest is not allowed), but I still want a diversified portfolio. I do know that any diversified portfolio already has some interest income already included in it but lets just say that is ignorable.

Here is my suggestion:

35% Stocks
35% Real Estate
15% Gold
15% Cash

I am just interested in an auto pilot portfolio where I don't have to watch the stock market every day. I am 30, married, $50K annual income and have about $45K saved.

Please help.

For the record, cash does pay interest. I don't know if that's technically allowable or not since I don't know what religious rules you're following.

[xerty24]

Treasury futures don't pay or accrue interest. However, they do become more valuable as time goes on.

Oh, and they get better tax treatment too (partial long term capital gain treatment).

[Houston101]

Treasury futures don't pay or accrue interest. However, they do become more valuable as time goes on.

Oh, and they get better tax treatment too (partial long term capital gain treatment).

Yeah, but that still would be considered investing in bonds.

[SpecialK22]

It seems strict adherence to Sharia would make it difficult to invest along Boglehead ideas. Under strict adherence not only are you prohibited from earning interest, but you are also prohibited from investing in businesses which provide goods or services contrary to Islamic principles. It seems that buying and holding a Western market like the US would be near impossible. There are plenty of industries which are legal under US law but which would be forbidden by Sharia. Correct me if I am wrong on any of this.

It does appear Islamic banking essentially bends the rules so as to make a profit without specifically charging interest. Take for example someone wishing to purchase a house. An Islamic bank will purchase the house from the current owner and then sell it at a higher price to the buyer. The buyer than owes the bank in installments, but the bank still maintains rights to the property until the full amount is paid. Effectively this allows the bank to profit from the housing industry without making loans.

A quick search reveals that Islamic banking does have a financial equivelant to bonds. These are called Sukuk. While not technically the same as a bond, they seem to have similar risk aspects and could be useful in your portfolio.

edit: On further thought, you would probably technically be banned from investing in any US stocks since every US company will in some form use debt and loans. These companies would then be operating contrary to Islamic principles and thus be forbidden to invest in. It seems other posters have alluded to this as well. I'm not a Muslim, so if any of what I say is wrong please correct me.

[winelvr]

Here is my suggestion:

35% Stocks
35% Real Estate
15% Gold
15% Cash

Disclaimer: I am new here.

Given your restrictions, and given that the real estate and gold are actual physical assets, your essentially 70/30 stocks/cash split sounds reasonable to me. Good luck!

[Valuethinker]

This is probably going to sound weird but I need help.

Due to religious reasons I cannot invest in bonds (interest is not allowed), but I still want a diversified portfolio. I do know that any diversified portfolio already has some interest income already included in it but lets just say that is ignorable.

Here is my suggestion:

35% Stocks
35% Real Estate
15% Gold
15% Cash

I am just interested in an auto pilot portfolio where I don't have to watch the stock market every day. I am 30, married, $50K annual income and have about $45K saved.

Please help.

Cash pays interest, no?

Don't keep large amounts of cash around the house.

In your shoes, I would probably:

- only have the cash equivalent to the emergency fund needs (is there such a thing as a no interest account in the USA?)

- keep the gold down to 5% (I am assuming holding gold bullion in a bank deposit account)

- up the equity proportion with the difference

[xerty24]

Treasury futures

Yeah, but that still would be considered investing in bonds.

Perhaps it would be helpful if you could give the exact specification of your religious rule is as to what is and isn't allowed. Otherwise, everyone here is just guessing and probably not able to offer much constructive advice. Consider the following and why they are or aren't allowed:

zero coupon bond
bond future
bank stock, with profits coming from mortgage lending
dividend paying stock
company stock in liquidation, trading at a discount to the future distribution amount
options-based synthetic cash (long stock, short call, long put)
etc

[market timer]

Selling deep-in-the-money LEAP call options against your equity or gold holdings could serve as a 2-3 year bond surrogate. Ditto for selling futures against equity or gold holdings. I think the Medicis did something similar with currency forwards to get around usury laws back in the Middle Ages.

Obviously, paying down a mortgage if you have one also works. Are there laws against paying interest?

[Indices]

Aren't there global sukuk bonds listed as shares on NYSE or Euronext? They're probably as reliable as corporate bonds.

I worked in the Middle East in financial services, specifically public relations. Stocks you should have no problem with. When you say real estate do you mean your home or do you mean REITs? REITs and Stocks seem pretty closely coordinated, why not just go with all stocks?

The problem with not holding government bonds is that you won't get the flight to quality defense that a Bogleheads portfolio has. Gold might work, but I doubt it would work too well. It would lack the inverse relationship with stocks that government backed bonds have.

There are also government bonds (sukuks) issued by the Gulf states or banks that are backed by the Gulf states that might be seen as pretty reliable and won't default. Pick some from Abu Dhabi or Kuwait or Qatar as they have a huge amount of oil wealth and will always pay their debts.

[Tramper Al]

Hey, can we respect the OP's stipulation, and simply do our best to help? Please?

Houston, please forgive my ignorance. Is an interest-bearing investment acceptable if the interest is given away, passed on to a charitable organization?

[Houston101]

- only have the cash equivalent to the emergency fund needs (is there such a thing as a no interest account in the USA?)

Thanks Valuethinker, I can always use a checking account (pays no interest) and occasionally I have put money in savings accounts also where I donated the interest income at the end of the year.

[Houston101]

Are there laws against paying interest?

Yes, the specific restriction is that you cannot pay or receive interest. Other than that it doesn't matter what kind of investment vehicle you choose (stocks, derivatives, options etc.) There is no mortgage so I am not paying any interest.

Like I said I know I will be in slight violation of this law when I buy any index fund since almost all companies pay and/or receive interest but I will have to compromise on that otherwise I will be completely out of the equities.

[Houston101]

Sukuk bonds are a solution to the problem but I haven't found any etf or mutual fund that invests in these and is traded on the U.S. exchanges yet. If I could get that I would certainly be happy.

Aren't there global sukuk bonds listed as shares on NYSE or Euronext? They're probably as reliable as corporate bonds.

I worked in the Middle East in financial services, specifically public relations. Stocks you should have no problem with. When you say real estate do you mean your home or do you mean REITs? REITs and Stocks seem pretty closely coordinated, why not just go with all stocks?

The problem with not holding government bonds is that you won't get the flight to quality defense that a Bogleheads portfolio has. Gold might work, but I doubt it would work too well. It would lack the inverse relationship with stocks that government backed bonds have.

There are also government bonds (sukuks) issued by the Gulf states or banks that are backed by the Gulf states that might be seen as pretty reliable and won't default. Pick some from Abu Dhabi or Kuwait or Qatar as they have a huge amount of oil wealth and will always pay their debts.

[Houston101]

Is an interest-bearing investment acceptable if the interest is given away, passed on to a charitable organization?

Yes, I can certainly do that and like mentioned earlier I have done this with my savings account.

[Opponent Process]

Shariah-compliant assets reached about $400 billion throughout the world in 2009, according to Standard & Poor’s Ratings Services, and the potential market is $4 trillion...

as East meets West, I'm sure the trend will be towards more financial services for Muslims. If these emirates can manage to finance islands and skyscrapers, there should be something for the little guy. alternatively, the interpretation of usury laws could simply be loosened as has occurred in Western beliefs.

[joe8d]

Bond Funds / Money Market Funds payouts are considered to be dividends not interest according to the IRS.Would that be a loophole to consider?

[DSInvestor]

Here's a page from muslim investor called "Purification by Charity":
http://muslim-investor.com/mi/purification.phtml

Since most bank accounts, Mutual Funds, and other financial instruments operate under non-Islamic Financial systems, they have some income from interest despite the investor (or the fund managers) being keen on not to get any interest.

The reason for interest creeping all over the place is that financial institutions will give interest on cash balances, often mandated by local law. A Mutual Fund will keep up to 15% of holdings in the form of cash, so as to respond to people requesting liquidation of their share in the fund.

So, the question is: "What should a Muslim do about this interestbased income?". The answer is simple and logical: Get rid of thisincome to charity (Sadaqah).

This process has been approved by scholars, in view of the practicallyimpossible goal of investing in a totally interest free area. The processis called "Purification".

Some fund managers have kindly shown the willingness to donate theirinterest to qualified Islamic charities. Only registered non-profitcharities are eligible.

If donation of the interest is an approved method of purifying one's investments, can you extend this argument to hold say 15% of your portfolio in say cash or short term securities and donate all of the interest to muslim charities your choosing. If 15% is OK, then why not 20% or 25% or whatever your asset allocation calls for?

[Opponent Process]

Bond Funds / Money Market Funds payouts are considered to be dividends not interest according to the IRS.Would that be a loophole to consider?

but the dividends are based on interest payments. I guess stock dividends are OK because they are based on earnings. anyway, it would be hard to discern how much of those earnings came from borrowed money.

maybe some Jewish Bogleheads could chime in? I know they are required to loan money/services but can't charge interest.

[Houston101]

Bond Funds / Money Market Funds payouts are considered to be dividends not interest according to the IRS.Would that be a loophole to consider?

It doesn't matter what the IRS says. The bond fund dividends are coming 100% from interest income so I can't take it.

[Houston101]

If 15% is OK, then why not 20% or 25% or whatever your asset allocation calls for?

I can use that approach for the S&P500 index but not for a bond fund. If I am going to give all the bond interest to the charity then why would I invest in it in the first place.

[Houston101]

I guess stock dividends are OK because they are based on earnings. anyway, it would be hard to discern how much of those earnings came from borrowed money..

You can estimate how much of your S&P500 earnings and/or dividends are from financial institutions and just donate that much away. It is not going to be exact but it will be close.

[infecto]

You could also buy sector ETFs and eliminate the financial sector.

[mda42]

I don't see how one can own the S&P if he or she is opposed to interest. Probably a large percentage of S&P companies have debt as a significant part of the financing of their operations. It would be like saying "I can't sell tobacco, but I'm going to give my money to this smoke shop that sells tobacco and they will give me some of that they make."

[infecto]

I don't see how one can own the S&P if he or she is opposed to interest. Probably a large percentage of S&P companies have debt as a significant part of the financing of their operations. It would be like saying "I can't sell tobacco, but I'm going to give my money to this smoke shop that sells tobacco and they will give me some of that they make."

This was already addressed above.

[Houston101]

You could also buy sector ETFs and eliminate the financial sector.

Can you give me any suggestion on what would be the best way of doing this?

There are 10 sector etfs offered by vanguard excluding financials. If I was to by 10 etf every month it would cost me $77.00 every month just to buy those ( 10 x $7 per trade at scottrade).

[DSInvestor]

If you're considering Vanguard ETFs, you can trade them commission free in a Vanguard brokerage account.

[Tramper Al]

If I am going to give all the bond interest to the charity then why would I invest in it in the first place.

Right, so maybe this is the tricky part to understand. What portfolio benefits are you looking for here, with interest removed from the equation?

One nice thing about bonds like US Treasuries is how you might expect them to behave in an otherwise equity-dominated portfolio. By that I mean the possibility of negative correlations, with magnitudes of effect fairly large at the long duration end. I can't really think of an interest-free vehicle that will do that, and still provide a reasonable and positive expected real return.

I guess that would leave no-interest cash. Cash will smooth the returns, but you can't expect and zig while zag benefit. On the bright side, it's not all that hard to find cash-equivalents with effective yields of about zero. The MMFs in Vanguard 529 and Vanguard VA are zero and negative, respectfully.

Now, there are LEAP call options available on TLT that would likely go a long way in providing the same sort of diversification as holding the long term Treasuries themselves. Strictly speaking, they pay no interest. Not sure if this would be acceptable, though.

[JasonP]

If you want simple, auto-pilot investing that also meets these stipulations, I would just put it all into Amana funds and they will make sure you're doing right.

As a side question, I noticed he said 'Real Estate' and was thinking about REITs. I haven't seen it mentioned in my quick scan of the thread yet, but I would think the dividends would not be like interest in his case and he could have his real estate allocation be REITs? Probably obvious, but is that everybody's take too?

[Harold]

Right, so maybe this is the tricky part to understand. What portfolio benefits are you looking for here, with interest removed from the equation?

Jewish guys get hungry, even though they can't eat pork. I suspect Houston wants everything the rest of us do -- he just can't get interest.

[masteraleph]

maybe some Jewish Bogleheads could chime in? I know they are required to loan money/services but can't charge interest.

The Jewish situation is somewhat easier to deal with, for the following reasons:

Interest to non-Jews is not a problem. Interest to Jews is a problem, and is typically dealt with by something called "Heter Iska," which is a combination loan/partnership.

I haven't specifically looked into it (it's not really relevant in the US, since very few companies are directly Jewish owned and a bond fund probably would trigger the issues anyways). With that said, a heter iska's function is to combine the loan into a partnership, where the creditor takes on some of the risk of the debtor. That is, to a large extent, the goal of a bond as well (i.e. you take on the risk that the company will collapse and you won't get repaid). The real issues in Jewish law revolve more around an interest bearing loan where there is collateral at stake. Reading between the lines, the Jewish situation presumes no such thing as bankruptcy protection, because the primary question is the creditor demanding repayment of the debt when the debtor simply cannot actually repay it and when removing the collateral would be dangerous to the debtor's health or life (heter iska, mentioned above, actually does create a bankruptcy protection, requiring the debtor to swear in front of the community that the inability to pay was not due to fraud or negligence). If you actually owned a lien on someone's house, there would be much more of an issue.

Judaism also treats judicial and corporate bodies distinctly from individuals, and I'm not sure how that plays in here, either.

Regardless, there seems to be significantly less legal finagling in Islam regarding loans at interest and investments in Islam than there has been in Judaism, making it significantly harder for Muslims to invest.[/url]

[Ping Pong]

Investors provide capital to companies for an interest in the company. Bondholders get paid first while stockholder agree to get paid last. Both groups of investors have an interest in the company. I don't know why the OP thinks that if he can't take an interest as a bondholder that he can somehow take an interest as a stockholder. Both kinds of holders demand their slice of profits for their interest in the venture, or else.

[jh]

...

[masteraleph]

Investors provide capital to companies for an interest in the company. Bondholders get paid first while stockholder agree to get paid last. Both groups of investors have an interest in the company. I don't know why the OP thinks that if he can't take an interest as a bondholder that he can somehow take an interest as a stockholder. Both kinds of holders demand their slice of profits for their interest in the venture, or else.

In theory, a bondholder is a creditor (i.e. the bond is essentially a loan), while a shareholder is a partner in the business. Shareholders get more money (in theory) if the company does better; bondholders only get what their agreement provides.

[Ziggy75]

Could buy bricks of gold.

[Ping Pong]

In theory, a bondholder is a creditor (i.e. the bond is essentially a loan), while a shareholder is a partner in the business. Shareholders get more money (in theory) if the company does better; bondholders only get what their agreement provides.

Right, but both bondholders and shareholders only get what their agreements provide. The shareholder's agreement is more variable in nature than the bondholder's, but the principles are the same.