How much Zakat should I pay on the stocks I own?

Like many Muslims, I've made a habit of paying my Zakat every Ramadan — with the goal of multiplying the benefit of the charity I donate.

As today's the first day of Ramadan, I thought I'd take a bit of time to walk through the opinion of various scholars on the required rate for Zakat on stocks, and how they compare.

My initial thought was that Zakat would be paid on stocks just like it is on cash — namely, 2.5% of the portion of the portfolio that's been held for over a year. It's how I've been paying Zakat for the past few years.

Turns out, it's actually a bit more nuanced.

Zakat On Cash

Zakat on any cash balance that you hold, regardless of whether you keep that balance at a broker, in a bank account or under your pillow is 2.5%. This rate only applies to money you've had for over a year.¹

This bit is pretty straight forward, and it's what most scholars agree on.

Zakat on Stocks

Zakat on stocks is a different matter; there are several opinions on how stocks get treated, the rate that applies, as well as the portion of the portfolio you're required to pay Zakat on.

Some scholars find that you should pay 2.5% irrespective of your intention (e.g. to trade or invest). Examples include Monzer Kahf, Zakat.org and others.

Others, including the International Islamic Fiqh Council², posit that the Zakat you pay on stocks depends on the intention you had when buying them.

Short-term trader

If your intention was to trade in the stocks (for a short-term profit), then they're basically treated like cash, and you pay 2.5% on the stocks you own.

Long-term investor

If your intention was to hold the stocks (and benefit from the dividends, or the long-term price appreciation), then there are several opinions on the matter.

These are:

2.5% of profits

According to the International Islamic Fiqh Council, you're only required to pay 2.5% on the profits made over the course of the year.³

It's worth noting that this statement was made specifically in reference to zakat on "rented real estates and non-agricultural leased lands" — so it's unclear if they even intended for this to apply to other industries.

I'm almost certain it won't given that the dividends on a typical portfolio are very, very small compared to the overall portfolio — to the tune of 1% on average.[^fn-growth_divs]

That means the "real" zakat rate, according to the Fiqh council, would work out to be just 2.5% of 1%, or 0.025% (!)

2.5% of zakatable assets

There are a few outlets that apply the 2.5% rate on the "zakatable assets" of a business. The math can be difficult to grapple with, but the theory is simple:

You own shares in companies. These companies own assets. They should pay the 2.5% zakat rate on these assets. But since the companies don't, you should.

How?

Find out the ratio between assets and market cap for your portfolio, and pay the 2.5% zakat on that portion of your stock portfolio. (For the UK, this works out to roughly 25% of the average FTSE stock).

10% of gains

Finally, Saturna (the company that runs the famous Amana Mutual funds), has laid out their rationale for calculating Zakat:

Muslim scholars believe stocks and investments are most appropriately categorized as "the produce of plowed land," as both are "productive capital" assets which yield gains. Accordingly, zakat is due on the gains of such "productive capital," not the "productive capital" itself.

The Prophet (Salla Allahu Alayhi wa Sallam) said: "On a land irrigated by rain water or by natural water channels or if the land is wet due to a nearby water channel, ushr (i.e. one-tenth, 10%) is compulsory (as zakat); and on the land irrigated by the well, half of ushr (i.e. one twentieth, 5%) is compulsory (as zakat on the yield of the land)."

This is the basis for their calculation: 10% of the gains in stocks over the course of a given year. More specifically, they calculate it like so:

$$\text{Zakat} = 10% \times (\text{End of Year balance} - \text{New Investments} - \text{Beginning of Year balance})$$

Also, it's worth clarifying that if you don't make any money on a given year, you don't pay Zakat — since the 10% rate applies only to the gain in your portfolio.

What I'm doing

The first approach (2.5% of profits) seemed way too low, especially since I don't own much in terms of dividend paying stocks to justify using this approach. The second approach (10% of "zakatable assets") seems overly complex, and it's unclear to me why you'd pay more Zakat on asset-heavy companies (e.g. industrial stocks) vs. asset light companies (e.g. software).

The approach that made the most sense to me is the one used by the Amana funds: 10% of gains.

Example

Say you have a portfolio of $10,000, with an average yearly return of 8%/year. That means, in that year, you have earned $800 in profit.

Cash treatment: 2.5% * ($10,000 + $800 profit) = $270 zakat

Amana treatment: 10% * $800 gain = $80 zakat

Turns out, it does make a pretty big difference, numbers-wise vs. just treating it like cash and paying 2.5% outright.

Summary

To sum up, the amount of zakat you pay on stocks depends on your intention behind purchasing these stocks.

Traders are required to pay 2.5% on the entire portfolio. The amount of zakat long term investors pay varies depending on the scholar. I'm most comfortable with the approach of paying out 10% of gains over the course of the year.

Lastly, I should mention that I don't tend to be too precise about the calculation — and I certainly don't recommend "optimizing" zakat exposure by picking the option that throws out the lowest number. I remind myself that it's all going to charity at the end of the day. Any "extra" you may end up paying will be considered Sadaqah, and to quote the Hadith from the Prophet PBUH:

مَا نَقَصَ مَالُ عَبدٍ مِن صَدَقَةٍ — "The wealth of a man will not diminish by charity"