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ISLAMIC
FINANCIAL PLANNING
Mahyuddin Khalid
Personal Investment Instruments

2.
Chapter Outlines
Content
Investment
Categories of Investment
Return and Risk in Investment
Type of Investment
• Investment in Savings Account
• Investment in Fixed Deposits
• Investment in Shares
• Investment in Bonds
• Investment in Properties
• Investment in Funds
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Introduction
Financial planning involved a decision on how individual
create and accumulate more wealth.
Muslims are encouraged to create more wealth to meet
their darurriyat, hajiyyat and tahsiniyyat needs.
Investment are activities involved by a person to increase
it’s a assets value.
Ultimate aim of investing is to achieve a positive income
and/or preserve or increase its value.
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Investment
The Process of Investment Management
Financial Status, needs, and personal characteristics
What is investment?
Risk taking financial activities perform by an individual or companies with the expectation for a
positive changes in the value of their principal amount.
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Categories of Investment
Financial assets
or real assets
High or low
risk
Short or long
term
Direct or
indirect
Debt or
ownership
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Your financial plan?
Asset allocation
Decide your
own financial
objectives
Diversification
Risk tolerance
Investment
return
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Risk and Return
What is risk?
• Uncertainty - the possibility that the actual return may differ
from the expected return
• Probability - the chance of something occurring
• Expected Returns - the sum of possible returns times the
probability of each return
Risk, from a finance
viewpoint, refers to
the uncertainties
associated with
returns from an
investment
• These uncertainties would translate into volatility or
fluctuation of returns from an investment.
• Measured by standard deviation.
• Gains & losses, “upside” potential & “downside”
possibility
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Risk Profile in Investment
•Affects income returnInterest Rate Risk
•Overall market effects (politic, economic and social)Market Risk
•Purchasing power variabilityInflation Risk
•Ability to liquidate investment convenientlyLiquidity Risk
•Investment earning and ability to pay the return (interest, principle, dividend)Business Risk (non-systematic)
•Payment attributable to the mix of debt and equity to finance business (Default, Liquidity, Marketability, Leverage)Financial Risk
•Changes in code, treatment, fluctuationExchange Rate/Currency/Tax Risk
•Failure to comply with the Shariah rules and principles in investmentShariah Non-Compliance Risk
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Risk-Return Trade-off
Risk-Return Trade-off
•The risk-return trade-off is the principle
that potential return rises with an increase in
risk.
•Low levels of uncertainty or risk are
associated with low potential returns,
whereas high levels of uncertainty or risk are
associated with high potential returns.
•According to the risk-return trade-off,
invested money can render higher profits
only if the investor is willing to accept the
possibility of losses.
•For investors, the risk-return trade-off is
one of the essential components of each
investment decision as well as in the
assessment of portfolios as a whole.
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Investment Instrument
Equities
• (i.e. common
shares)
Fixed income
securities
• (i.e. bonds and
sukuk)
Investment
funds
• (i.e. unit trust, ETF,
REITs)
Tangibles
• (i.e. properties)
Derivatives
• (i.e. forward,
futures)
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Types of Investment
Investment in Savings Account
Investment in Fixed Deposits
Investment in Shares
Investment in Bonds
Investment in Properties
Investment in Funds
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Saving Account
 Accounts maintained by retail financial institutions that pay
interest but can not be used directly as money (for example, by
writing a cheque).
 This saving account under Al-Wadiah Yad Dhamanah.
 Bank accept deposits from customers looking for safe custody
of their funds and at the same time the customers are able to
withdraw their money at any amount at any time.
 These accounts let customers set aside a portion of their liquid
assets while earning a monetary return.
 Types of saving account:
 Individual saving account
 Joint saving account
 Saving account for associations, societies and clubs
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Why Is Saving Account Necessary?
These are the reasons why you should open a savings
account if you do not yet have one.
Provide you with a safe place where you can store your
money.
Savings accounts provide you with PIDM insurance.
Savings accounts allow you to earn profit.
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Interest on Saving Account
Profit rate on saving account is calculated on the account’s
outstanding balance at end of each day.
The profit is credited to the account every 6 months, that
is on June 30 and December 31 each year.
Formula used to calculate interest using simple interest
 Interest amount = Principal x Time x Rate
 Principal: balance at the end of each day of the month
 Time : 1/365
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How do saving account works?
When you put your money into a savings account, it earns
interest, so bank can use your money to fund loans for
other people. Actually it works like this:
 Open a savings account at the bank.
 The bank pays interest on the money that you deposit and leave
in that account.
 Bank loans that money out to other people, charge a slightly
higher interest rate on the loan than what they pay you for your
account.
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Advantages of Saving Account
Advantages:
 Most basic account
 Simple Procedures - Photostat IC front and back and be present
at the bank.
 Low initial deposit to open an account
Disdvantages:
 Low returns - Negligible
 Troublesome to withdraw money
 For ATM card service there is a charge of RM 8 annual fees for all
banks in Malaysia.
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Investing in Fixed Deposit
 Using Mudharabah contract
 No interestPayment of profit is under discretion of Islamic
banks
 No interest paid on 1, 2, or 3 month
 No interest paid on FD of 4 month and above
 Rate payable for FD withdrawn before maturity is half the contracted
rate
 Fixed Deposit can be opened by:
 Individual aged 18 years and above
 Joint individual
 Societies
 Associations and clubs
 Companies
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Investment in Shares
Characteristics of Common
stock
• Right to residual value of the firm
• Right to the portions of dividends if announced
• Right to vote in the AGM.
Common Stock Dividend
• Cash: Treated as investment income and taxable
• Stock: Dividend in form of additional stock issued in proportion of stock owned
• Property: Dividend in form of product and services
Equity instruments represent ownership in the company.Common stock is
• A public listed company is jointly owned by its shareholders.
• Since the corporation is a separate legal entity the shareholder is responsible for any losses up to his total investment.
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Advantages of Investing in Common
Stock
Advantages of investing in
Common stock
• High current income
• Higher rate of return
• Low unit cost
• Less risky due to its position
during liquidation
Disadvantages of investing
in Common stock
• Return is limited and fixed in
amount
• Capital gain potential is small
• Yield give-up relative to bond
• Yield not kept up with inflation
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Why invest in stocks?
Wide range of choices.
Immediate buy/sell at any time.
Low transaction cost.
Easy to monitor.
Ability to maximize return whilst spreading risk.
Freedom to work at your own place.
Managed by professional managers.
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Investment in Bonds/ Sukuk
Definition
 Long term debt instrument issued by a corporation either public
or private to finance the company’s long term assets.
The issuer has to make periodic interest payments to the
bondholder who is also known as the buyer at the
maturity.
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Bonds from Shariah Perspective
Securities representing a loan or debt (such as bonds) cannot be sold or purchased.
If they are sold at a price higher or lower than their face value, it is considered as “Riba”
If they are purchased at their face value (Bai al-Dayn), this involves “Gharar” and hence prohibited.
However, securities may be assigned to a third party at par value.
The difference between sale and assignment (al-hawalah) is that transfer in al-hawalah is with
recourse while transfer in sales in without recourse.
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Characteristic of bonds
Par value
• Par value in
malaysia is RM
1000
• Selling at discount
if it is sold below
RM 1000
• Selling at premium
if it is sold above
RM 1000
Coupon rate
• The percentage of
the par value of the
bond that will be
paid out
periodically in the
form of interest
Maturity period
• The maturity period
is between 10 to 30
years
Claims on asset
• Bondholders will be
the first to receive
the firm’s asset
before the
preferred
stockholder if the
firm is declared
bankrupt
Voting right and
fixed income
• Receives fixed
income in terms of
coupon rate, which
is predictable and
regular income
• Has no voting right
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Sukuk vs. Bonds
Bond Item Sukuk
Short, Medium and Long Term Tenor Short and Med-Term (≤5 yrs)
Debt Financing Category No debt but ownership of specific
asset and its cash flows
Not necessary, unless
collateralized
Underlying Necessary underlying asset,
usually tangible asset
Fixed in time, and amount Claim Ownership claim on specific asset
and its cash- flows
Depends on rating, yield
environment and demand (book-
building)
Pricing Use of indicative yields-
benchmarked on reference rates
Fixed income
(known/predetermined cash flows)
Total Returns No guarantee in returns
Unrestricted Funding Purpose Restricted for use in Shariah
compliant assets, in a
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Property Investment
Property investment is where investor make a small
investment into a property, then go on to rent it out to
cover mortgage repayments,
Once raised in price, sell it, or remortgage to acquire the
finance tax free, thus gaining a profit or to purchase more
property.
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Types of Property
Residential House Shop Houses
Standard Lots In
Shopping or Office
Complex
Condominium Flats
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Important Part in Property Investment
It less volatiles compared to equity
Asians like physical assets due to less development
investment market
Government bonds are not readily available to small
investor
Opportunities for growth due to stage development in
economic and society
Still perceive the intrinsic values of properties
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Factor to consider when investing
• How much
• %
Funds
• Determine the value
• Strategic place
Location
• Track of record
• Good decision
Developer
• Structure of properties
• Example: cracks or leaks in the wall
Physical condition
• Example:
• public transport, markets, shopping mall, car park,
Infrastructure
• Loans
• Banks
Sources of findings
To evaluate the real estate cycle or the timing of entry and also exit
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Factors that Influence Return
Population
Growth
Scarcity of
land
Income
Growth
Economic
Activities
Supply and
Demand
Speculation
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Investment Fund
AAOIFI define Investment fund as
Funds are investment vehicles
•Which are financially independent of the institutions that establish them.
Funds take the form of equal participating shares/units
•Which represent the shareholders’/unitholders’ share of the assets,
•Entitled to profits or losses.
The funds are managed on the basis of either mudharabah or wakalah (agency )contract
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Investment in Unit Trust
One important feature of unit trust is that
professional fund managers are employed to
manage the funds.
• They are highly qualified and
experienced in investments.
• It is done at minimal cost,
minimizing, liquidity, and
capital appreciation
Investors money will be
pooled together to be
invested in a single diversified
investment portfolio which
comprise stocks, bonds and
others in accordance with the
investment objective.
Unit Trust investment
offers a reasonable
amount of return with
minimal risk.
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Key Differences between Islamic and
Conventional Funds
Investible
Universe
Purification
Role of
Shariah
Advisor
Fee
structure
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Types of Funds by Investment Portfolio
Equity Funds Fixed Income Funds Money Market Funds Balanced Funds
Islamic/ Shariah Funds Sukuk Funds
Real Estate Investment Trust
Funds
Exchange Traded Funds
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Types of Funds
TYPES OBJECTIVES STRUCTURE/UNDERLIER
Money Market Funds To invest in money market.
Short term debt instrument,
mostly treasury bills
Income Funds
To provide current income
on a steady basis.
Government and corporate
debt, stocks and bonds
Balance Funds
To provide a balance
mixture of safety, income
and capital appreciation.
Mixture of fixed incomes and
equity
Index Funds
To replicate the
performance of a broad
market index.
Market Index
Investment-Linked
Funds
To provide balanced
income for specific life
insurance or family takaful
plans.
Stock and bonds
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Advantages of Unit Trust
Many investors lack sufficient resources to establish an adequate diversification on their
own.
Diversification
Different types of funds are created for different investment objectives. So investors
should have no problem finding funds that meet their objectives in terms of return and risk
Funds with variety of
objectives
The management company maintains and administers the records of shareholder’s activity
for a given year. This is a great convenience for the investors.
Record keeping services.
Fund managers who are knowledgeable about investment and they have good track
records of performance, high integrity, etc.
Professional management
Unit trust can be bought and sold easily. Thus they do not suffer from liquidity risk.
High liquidity
Only a small amount of money is needed to participate in a portfolio of investment which
enjoys the same benefits as in direct investment which requires large amount capital.
Affordability
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Mahyuddin Khalid 36
End of Chapter
Personal Investment Instruments