dreamer101,

Hope you don't mind me asking you a question.

Assuming an investor has USD100k to spare (i.e. capital preservation is not a priority), should he not focus on buying index funds of mainly companies that are relatively small and have high book to market value and not buy bonds at all nor the wider equity market?

I say this because -

1) Historically speaking, the risk premium of shares (over risk free treasury bills) is circa 7% whilst the risk premium for bonds is only 1.4%.

If the said investor can stomach the volatility of investing 100% equities, why bother with bonds? Is the risk adjusted return for a 80/20 (80 being equity and 20 being bonds) portfolio better than a 100 equity only portfolio?

Assuming I don't panic sell my 100 equity portfolio in a stock market crash, would my long term risk adjusted return be lower than a 80/20 portfolio? If yes, have this been proven before?

2) Fama and French in their 1995 article - "Size and Book to Market Factors in Earnings and return" have found that shares of smaller companies and those with high book to value ratio have provided above average return compared to the wider market.

Applying their findings (if still true today, which one can doubt since they is no free lunch in the financial markets), would one again not be better off by investing in index funds focusing on these companies and not the wider equity market?
Knowing a little could be dangerous when investing (talking about myself here haha), hence I would like to have your learned opinion on the above.

As you can probably guess, I have not invested in an index fund yet but rather in certain individual UK small caps.   
I suspect in the long term index investing would probably turn out to be a wiser choice!

Thanks

I understand your 'theory' of using ratios to govern your decision. But here is a scenario I propose to you:

Sooner or later, you are at a losing point..
You see what i'm getting at.. same situation can happen if both rise at unequal rates, placing your ratios out of balance as you attempt to correct it..

Using ratios to govern your investment strategy is missing a crucial point of stock markets.. The market is emotionally fueled and driven.

Asset location does not make sense. At what point do you adjust your ratios? One day? a week? a month? Everytime you decide to adjust, that cost money as you move your funds around. Probably will wipe your gains..

A better way of doing this is to time your ETF investment at a good entry point and leave it 100% as Stock.. When markets begin to shift, then switch some to Bonds or buy up cheaper ETFS.. Alternatively, diversify your portfolio to include investments in share dividends and property.  Allocation based on ratios may look good in theory, but it doesn't work applied..