If you haven’t figured it out by now, I’m a bit obsessed with financial rules – and I really enjoy testing the theory behind them using my own personal investments. I like to see whether they still hold up in today’s world, especially since many of these rules were developed over 50 years ago.

One rule I came across several years ago is the so-called 7 per cent rule. Not everyone has heard of it, but it’s a fascinating investing guideline that I decided to put to the test. I wasn’t entirely sure whether it still held any real value in 2025.

First, the 7 per cent rule is a guideline used by many investors to help manage risk when investing in stocks. The idea is simple: limit losses on individual stocks to no more than 7 per cent of the original investment. This rule is designed to protect investors from major downturns and to help keep their overall portfolio more secure over time.

For example, say you buy a stock at $100. The 7 per cent rule suggests that if the stock drops to $93 – a 7 per cent decline from your purchase price – you should consider selling it. The idea is to prevent small losses from turning into bigger ones. A drop beyond that 7 per cent threshold often signals that the investment isn’t performing well, or that market sentiment around the stock or even the broader industry has shifted. By selling at this point, investors can avoid deeper losses if the decline continues.

The 7 per cent rule comes from a risk-management perspective. Rather than holding onto a declining stock in the hope that it will recover, investors who follow the 7 per cent rule take a more disciplined approach to limit their downside. This helps protect their capital and prevents emotional decision-making – something that often leads to holding onto losing stocks for too long or selling winners too early.

One of the key benefits of the 7 per cent rule is that it encourages consistency and discipline. Investing can be emotional, especially when watching a stock’s price fall. The temptation to hold on in hopes of a rebound – or to sell out of fear – can lead to larger losses or missed opportunities.

Having a clear rule in place helps take some of the emotion out of the decision-making process. It becomes mechanical: if the stock drops 7 per cent, sell. This removes the guesswork and supports a steady, disciplined investment strategy.

The 7 per cent rule also encourages investors to use stop-loss orders – predefined points at which a stock is sold if it drops to a certain price. For example, if an investor buys a stock at $50, they might set a stop-loss order at $46.50 (which is 7 per cent below the purchase price). If the stock falls to that level, the order automatically triggers a sale, helping to limit losses without the need for constant monitoring.

On the other hand, the 7 per cent rule challenges one of the core investing principles – the “buy-and-hold” strategy – that we’ve all been taught time and again. This suggests that the 7 per cent rule doesn’t apply to every situation.

For example, in highly volatile markets or with certain types of stocks, prices can swing more than 7 per cent in a short period (I currently have a crypto ETF that’s up and down like a yo-yo).

In such cases, sticking rigidly to the 7 per cent rule might lead to selling too soon and missing out on potential rebounds. Conversely, some investors may prefer a larger or smaller threshold, depending on their risk tolerance and investment goals.

Another angle to consider is that the 7 per cent rule is most effective when used as part of a broader investment strategy. For instance, it pairs well with diversification – spreading investments across different stocks or asset classes to reduce overall risk. Diversification helps cushion the impact of a decline in any single stock, making the 7 per cent rule more manageable and less likely to trigger unnecessary sales.

It’s also important for investors to understand that the 7 per cent rule isn’t a guarantee against losses. Market conditions can shift quickly, and sometimes a stock may fall more than 7 per cent in a single day due to unforeseen events. In such cases, the rule might not prevent larger losses – but it still offers a framework for managing risk and reducing emotional reactions.

Furthermore, some investors combine the 7 per cent rule with other risk-management techniques. For example, they might use it alongside regular portfolio reviews to ensure their investments remain aligned with their long-term goals and risk appetite. They may also incorporate position sizing – limiting how much they invest in each stock – to further control potential losses.

At the end of the day, the 7 per cent rule in stock investing serves as a sensible guideline rooted in risk management principles. It emphasises the importance of limiting individual investment exposure to help safeguard capital. By capping each stock position at around 7 per cent of the total portfolio, investors can diversify effectively and reduce the impact of any single underperforming asset on their overall portfolio.

It's clear that the purpose of this rule is to promote disciplined investing, encouraging individuals to avoid over-concentration and the risks associated with significant losses. It removes emotional decision-making and encourages a more controlled approach, helping to prevent panic selling during market downturns.

Implementing the 7 per cent rule aligns with a core principle of risk management: balancing potential returns with acceptable levels of risk. From my perspective, the 7 per cent rule is better suited to those who are fairly risk adverse, as it encourages regular portfolio review and rebalancing to ensure risk exposure stays within manageable bounds as market conditions evolve.

Ultimately, following this rule supports long-term financial stability by minimising the impact of volatility and unexpected market events.

While no rule can guarantee success, the 7 per cent guideline offers a practical framework for disciplined, risk-aware investing. It helps investors focus on sustainable growth rather than chasing high-risk, high-reward strategies.

• Carla Seely has 25 years of experience in the international financial services, wealth management and insurance industries. During her career, she has obtained several investment licences through the Canadian Securities Institute. She holds the ACSI certification through the Chartered Institute for Securities and Investments (UK), the QAFP designation through FP Canada, and the AINS designation through The Institutes. She also holds a master’s degree in business and management