<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 2-31333) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. [X]
POST-EFFECTIVE AMENDMENT NO. 45 [X]
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 45 [X]
VANGUARD/WELLESLEY INCOME FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
P.O. BOX 2600, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
on April 25, 1997, pursuant to paragraph (a) of Rule 485.
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after this Registration Statement becomes effective.
WE HAVE ELECTED TO REGISTER AN INDEFINITE NUMBER OF SHARES PURSUANT TO
REGULATION 24f-2 UNDER THE INVESTMENT COMPANY ACT OF 1940. WE FILED OUR RULE
24f-2 NOTICE FOR THE YEAR ENDED DECEMBER 31, 1996 ON FEBRUARY 26, 1997.
================================================================================
<PAGE> 2
VANGUARD/WELLESLEY INCOME FUND, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <S> <C>
Item 1. Cover Page.................................... Cover Page
Item 2. Synopsis...................................... Not Applicable
Item 3. Condensed Financial Information............... Financial Highlights; Fund Expenses
Item 4. General Description of Registrant............. The Fund's Objective; Who Should
Invest; Investment Strategies;
Investment Limitations; Investment
Policies; Investment Performance;
General Information
Item 5. Management of the Fund........................ The Fund and Vanguard; Investment
Adviser
Item 6. Capital Stock and Other Securities............ Buying Shares; Redeeming Shares; The
Fund's Share Price; Dividends,
Capital Gains, and Taxes;
Distribution Options; General
Information
Item 7. Purchase of Securities Being Offered.......... Buying Shares
Item 8. Redemption or Repurchase...................... Redeeming Shares
Item 9. Pending Legal Proceedings..................... Not Applicable
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
<C> <S> <C>
Item 10. Cover Page.................................... Cover Page
Item 11. Table of Contents............................. Cover Page
Item 12. General Information and History............... Investment Objective; Investment
Policies; General Information
Item 13. Investment Objective and Policies............. Investment Objective; Investment
Policies; Investment Limitations
Item 14. Management of the Fund........................ Management of the Fund; Investment
Advisory Services
Item 15. Control Persons and Principal Holders of
Securities.................................... Management of the Fund; General
Information
Item 16. Investment Advisory and Other Services........ Management of the Fund; Investment
Advisory Services
Item 17. Brokerage Allocation.......................... Not Applicable
Item 18. Capital Stock and Other Securities............ General Information; Financial
Statements
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered................................. Purchase of Shares; Redemption of
Shares
Item 20. Tax Status.................................... Appendix
Item 21. Underwriters.................................. Not Applicable
Item 22. Calculations of Yield Quotations of Money
Market Fund................................... Not Applicable
Item 23. Financial Statements.......................... Financial Statements
</TABLE>
<PAGE> 3
VANGUARD/
WELLESLEY INCOME
FUND
Prospectus
April 25, 1997
- ----------
This prospectus
contains financial data
for the Fund through
the fiscal year ended
December 31, 1996.
[VANGUARD LOGO]
<PAGE> 4
VANGUARD/WELLESLEY INCOME FUND An Income Mutual Fund
CONTENTS
Fund Expenses 2
Financial Highlights 3
A Word About Risk 4
The Fund's Objectives 4
Who Should Invest 4
Investment Strategy 5
Investment Policies 9
Investment
Limitations 10
Investment
Performance 10
Share Price 11
Dividends, Capital
Gains, and Taxes 11
The Fund and
Vanguard 12
Investment Adviser 12
General Information 13
Investing
with Vanguard 15
Services and
Account Features 15
Types of Accounts 16
Distribution Options 17
Buying Shares 17
Redeeming Shares 19
Fund and Account
Updates 21
Prospectus Postscript 23
Risk Quiz 24
Glossary Inside Back Cover
INVESTMENT OBJECTIVES AND POLICIES
Vanguard/Wellesley Income Fund, Inc. (the "Fund") is an open-end diversified
investment company, or mutual fund.
The Fund seeks to provide a high and sustainable level of income along with
moderate long-term capital growth by investing approximately 60% to 70% of its
assets in high-quality, longer-term corporate, U.S. Treasury, government agency,
and mortgage-backed bonds. The remaining 30% to 40% of Fund assets are invested
in stocks of companies that have a history of above-average dividends or
expectations of increasing dividends.
IT IS IMPORTANT TO NOTE THAT THE FUND'S SHARES ARE NOT GUARANTEED OR INSURED
BY THE FDIC OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT. AS WITH ANY INVESTMENT
IN BONDS (WHICH ARE SENSITIVE TO CHANGES IN INTEREST RATES) AND STOCKS (WHICH
ARE SUBJECT TO WIDE FLUCTUATIONS IN MARKET VALUE), YOU COULD LOSE MONEY BY
INVESTING IN THE FUND.
FEES AND EXPENSES
The Fund is offered on a no-load basis, which means that you pay no sales
commissions or 12b-1 marketing fees. You will, however, incur expenses for
investment advisory, management, administrative, and distribution services,
which are included in the expense ratio.
ADDITIONAL INFORMATION ABOUT THE FUND
A Statement of Additional Information (dated April 25, 1997) containing more
information about the Fund is, by reference, part of this prospectus and may be
obtained without charge by writing to Vanguard or by calling our Investor
Information Department at 1-800-662-7447.
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objectives, risks, and strategies of
Vanguard/Wellesley Income Fund. To highlight terms and concepts important to
mutual fund investors, we have provided "Plain Talk" explanations along the way.
Reading the prospectus will help you to decide whether the Fund is the right
investment for you. We suggest that you keep it for future reference.
These securities have not been approved or disapproved by the Securities and
Exchange Commission or any state securities commission, nor has the Securities
and Exchange Commission or any state commission passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
<PAGE> 5
PORTFOLIO PROFILE Vanguard/Wellesley Income Fund
WHO SHOULD INVEST (page 4)
- - Investors seeking a balanced mutual fund as part of a diversified investment
program.
- - Investors seeking current income along with moderate capital growth and
willing to invest for the long term--at least five years.
WHO SHOULD NOT INVEST
- - Investors seeking a fund that invests exclusively in either stocks or in
bonds.
- - Investors unwilling to accept significant fluctuations in share price.
RISKS OF THE FUND (pages 4-9)
The Fund's total return will fluctuate within a wide range, so an investor could
lose money over short or even extended periods. The Fund is subject to--among
other risks--interest rate risk (the chance that bond prices will decline
because of rising interest rates) and stock market risk (the chance that stock
prices in general will decline, sometimes suddenly and sharply).
DIVIDENDS AND CAPITAL GAINS (page 11)
Dividends are paid in March, June, September, and December. Capital gains, if
any, are paid in December.
INVESTMENT ADVISER (page 12)
Wellington Management Company, LLP,
Boston, MA.
INCEPTION DATE: July 1, 1970
NET ASSETS AS OF 12/31/96: $7.01 billion
FUND'S EXPENSE RATIO FOR THE
YEAR ENDED 12/31/96: 0.31%
LOADS, 12B-1 MARKETING FEES: None
SUITABLE FOR IRAs: Yes
MINIMUM INITIAL INVESTMENT: $3,000; $1,000 for IRAs and custodial accounts for
minors
NEWSPAPER ABBREVIATION: Wellsl
VANGUARD FUND NUMBER: 027
ACCOUNT FEATURES (page 15)
- - Telephone Redemption
- - Vanguard Direct Deposit Service(sm)
- - Vanguard Automatic Exchange Service(sm)
- - Vanguard Fund Express(R)
- - Vanguard Dividend Express(sm)
AVERAGE ANNUAL TOTAL RETURNS--
PERIODS ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS
---------------------------------
<S> <C> <C> <C>
Wellesley Income Fund 9.4% 10.9% 11.1%
Composite Index* 6.8 10.8 11.2
</TABLE>
QUARTERLY RETURNS (%) 1987-1996 (intended to show volatility of returns)
[GRAPH]
* The Composite Index is made up of 65% bonds and 35% stocks. See page 10 for
details.
In evaluating past performance, remember that it is not indicative of future
performance. Performance figures include the reinvestment of any dividends and
capital gains distributions. The returns shown are net of expenses for the Fund,
but they do not reflect income taxes an investor would have incurred. The
Composite Index is a theoretical portfolio, incurring none of the advisory fees,
operating expenses, and portfolio transaction costs that are borne by an
operating mutual fund. Note, too, that both the return and principal value of an
investment will fluctuate so that investors' shares, when redeemed, may be worth
more or less than their original cost.
1
<PAGE> 6
PLAIN TALK ABOUT
THE COSTS OF INVESTING
Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with buying, selling, or exchanging shares. These costs can
erode a substantial portion of the gross income or capital appreciation a fund
achieves. Even seemingly small differences in fund expenses can, over time, have
a dramatic impact on a fund's performance.
PLAIN TALK ABOUT
FUND EXPENSES
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. Vanguard/Wellesley Income Fund's expense ratio in fiscal year 1996 was
0.31%, or $3.10 per $1,000 of average net assets. The average balanced mutual
fund had expenses in 1996 of 1.32%, or $13.20 per $1,000 of average net assets,
according to Lipper Analytical Services, Inc., which reports on the mutual fund
industry.
FUND EXPENSES
The examples below are designed to help you understand the various costs you
would bear, directly or indirectly, as an investor in the Fund.
As noted in this table, you do not pay fees of any kind when you buy, sell,
or exchange shares of the Fund:
SHAREHOLDER TRANSACTION EXPENSES
<TABLE>
<S> <C>
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
</TABLE>
The next table illustrates the operating expenses that you would incur as a
shareholder of the Fund. These expenses are deducted from the Fund's income
before it is paid to you. Expenses include investment advisory fees as well as
the costs of maintaining accounts, administering the Fund, providing shareholder
services, and other activities. The expenses shown in the table are for the
fiscal year ended December 31, 1996.
ANNUAL FUND OPERATING EXPENSES
<TABLE>
<S> <C> <C>
Management and Administrative Expenses: 0.23%
Investment Advisory Expenses: 0.05%
12b-1 Marketing Fees: None
Other Expenses
Marketing and Distribution Costs: 0.02%
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.01%
----
Total Other Expenses: 0.03%
----
Total Operating Expenses (Expense Ratio): 0.31%
====
</TABLE>
The following example illustrates the hypothetical expenses that you would
incur on a $1,000 investment over various periods. The example assumes (1) that
the Fund provides a return of 5% a year and (2) that you redeem your investment
at the end of each period.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------------------------------------------------------
<S> <C> <C> <C>
$3 $10 $17 $39
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE, WHICH MAY BE HIGHER OR LOWER THAN
THOSE SHOWN.
2
<PAGE> 7
FINANCIAL HIGHLIGHTS
The following financial highlights table shows the results for a share
outstanding for each of the last ten years ended December 31, 1996. The
financial highlights were audited by Price Waterhouse LLP, independent
accountants. You should read this information in conjunction with the Fund's
financial statements and accompanying notes, which appear, along with the audit
report from Price Waterhouse, in the Fund's most recent Annual Report to
shareholders. The Annual Report is incorporated by reference in the Statement of
Additional Information and in this prospectus, and contains a more complete
discussion of the Fund's performance. You may have the Report sent to you
without charge by writing to Vanguard or by calling our Investor Information
Department.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
1996 1995 1994 1993 1992 1991
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD $20.44 $17.05 $19.24 $18.16 $18.08 $16.02
--------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 1.17 1.13 1.11 1.14 1.21 1.27
Net Realized and
Unrealized Gain (Loss)
on Investments .66 3.68 (1.95) 1.48 .29 2.06
--------------------------------------------------------------
TOTAL FROM INVESTMENT
OPERATIONS 1.83 4.81 (.84) 2.62 1.50 3.33
- -----------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (1.16) (1.14) (1.11) (1.14) (1.21) (1.27)
Distributions from
Realized Capital Gains (.60) (.28) (.24) (.40) (.21) --
--------------------------------------------------------------
TOTAL DISTRIBUTIONS (1.76) (1.42) (1.35) (1.54) (1.42) (1.27)
- -----------------------------------------------------------------------------------------
NET ASSET VALUE,
END OF PERIOD $20.51 $20.44 $17.05 $19.24 $18.16 $18.08
=========================================================================================
TOTAL RETURN 9.42% 28.91% -4.44% 14.65% 8.67% 21.57%
=========================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions) $7,013 $7,181 $5,681 $6,011 $3,178 $1,934
Ratio of Expenses to
Average Net Assets 0.31% 0.35% 0.34% 0.33% 0.35% 0.40%
Ratio of Net Investment
Income to Average
Net Assets 5.74% 5.96% 6.16% 5.79% 6.50% 7.08%
Portfolio Turnover Rate
Bonds 29% 33% 31% 18% 24% 34%
Stocks 18% 26% 32% 26% 16% 19%
Average Commission
Rate Paid .0334 N/A N/A N/A N/A N/A
- -----------------------------------------------------------------------------------------
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1990 1989 1988 1987
----------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD $16.82 $15.26 $14.57 $16.27
----------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 1.30 1.32 1.23 1.24
Net Realized and
Unrealized Gain (Loss)
on Investments (.72) 1.79 .69 (1.52)
----------------------------------------
TOTAL FROM INVESTMENT
OPERATIONS .58 3.11 1.92 (.28)
- ------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (1.30) (1.31) (1.23) (1.04)
Distributions from
Realized Capital Gains (.08) (.24) -- (.38)
----------------------------------------
TOTAL DISTRIBUTIONS (1.38) (1.55) (1.23) (1.42)
- ------------------------------------------------------------------
NET ASSET VALUE,
END OF PERIOD $16.02 $16.82 $15.26 $14.57
==================================================================
TOTAL RETURN 3.76% 20.93% 13.61% -1.92%
==================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions) $1,022 $ 788 $ 567 $ 495
Ratio of Expenses to
Average Net Assets 0.45% 0.45% 0.51% 0.49%
Ratio of Net Investment
Income to Average
Net Assets 7.77% 7.68% 8.14% 7.83%
Portfolio Turnover Rate
Bonds 13% 11% 19% 48%
Stocks 12% 10% 19% 27%
Average Commission
Rate Paid N/A N/A N/A N/A
- ------------------------------------------------------------------
</TABLE>
From time to time, the Vanguard funds may advertise yield and total return
figures. Yield is an historical measure of dividend income, and total return is
a measure of past dividend income (assuming that it has been reinvested) plus
capital appreciation. Neither yield nor total return should be used to predict
the future performance of a fund.
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 1996 with a net asset value (price) of $20.44 per share.
During the year, the Fund earned $1.17 per share from investment income
(interest and dividends) and $0.66 per share from investments that had
appreciated in value or that were sold for higher prices than the Fund paid for
them. Of those total earnings of $1.83 per share, $1.76 per share was returned
to shareholders in the form of distributions ($1.76 in dividends, $0.60 in
capital gains). The earnings ($1.83 per share) less distributions ($1.76 per
share) resulted in a share price of $20.51 at the end of the year, an increase
of $0.07 per share (from $20.44 at the beginning of the period to $20.51 at the
end of the period). Assuming that the shareholder had reinvested the
distributions in the purchase of more shares, total return from the Fund was
9.42% for the year.
As of December 31, 1996, the Fund had $7.01 billion in net assets; an expense
ratio of 0.31% ($3.10 per $1,000 of net assets); and net investment income
amounting to 5.74% of average net assets. It sold and replaced bonds valued at
29% of its bond holdings and stocks valued at 18% of its stock holdings.
3
<PAGE> 8
PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are "middle-of-the-road" investments that seek to provide some
combination of income, growth, and conservation of principal by investing in a
mix of stocks, bonds, and/or money market instruments. Because stocks and bonds
tend to move in different directions, balanced funds are able to use the rewards
from one type of investment to help offset the risks from another.
PLAIN TALK ABOUT
COSTS AND MARKET TIMING
Some investors try to profit from "market timing"--switching money into
investments when they expect prices to rise, and taking money out when they
expect the market to fall. As money is shifted in and out, a fund incurs
expenses for buying and selling securities. These costs are borne by all fund
shareholders, including long-term investors who do not generate the costs.
Therefore, the Fund discourages short-term trading by, among other things,
limiting the number of exchanges it permits.
A WORD ABOUT RISK
This prospectus describes the risks you will face as an investor in
Vanguard/Wellesley Income Fund. It is important to keep in mind one of the main
axioms of investing: the higher the risk of losing money, the higher the
potential reward. The reverse, also, is generally true: the lower the risk, the
lower the potential reward. However, as you consider an investment in Wellesley
Income Fund, you should also take into account your personal tolerance for the
daily fluctuations of both the bond and stock markets, as well as your need for
current income.
Look for this "warning flag" symbol [FLAG] throughout the prospectus. It is
used to mark detailed information about each type of risk that you, as a
shareholder of the Fund, will confront.
THE FUND'S OBJECTIVES
The Fund seeks to provide a high and sustainable level of income along with
moderate capital growth. These objectives are not fundamental, which means that
they can be changed by the Fund's board of directors without shareholder
approval. However, before making any important change in its objectives, the
Fund will give shareholders 30-days notice, in writing.
[FLAG] BECAUSE OF THE SEVERAL TYPES OF RISK DESCRIBED ON THE FOLLOWING PAGES,
YOUR INVESTMENT IN THE FUND, AS WITH ANY INVESTMENT IN BONDS AND
STOCKS, COULD LOSE MONEY.
WHO SHOULD INVEST
The Fund may be a suitable investment for you if:
- - Your primary investment goal is income.
- - You wish to add an income fund to your existing holdings, which could include
other stock and bond--as well as money market and tax-exempt--investments.
- - You want a simple way to invest in a relatively fixed percentage of bonds and
stocks.
- - You are looking for moderate growth of capital over the long term--at least
five years.
This Fund is not an appropriate investment if you are a market-timer.
Investors who engage in excessive in-and-out trading activity generate
additional costs that are borne by all of the Fund shareholders. To minimize
such costs, which reduce the ultimate returns achieved by you and other
shareholders, the Fund has adopted the following policies:
- - The Fund reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it
4
<PAGE> 9
regards as disruptive to the efficient management of the Fund. This could be
because of the timing of the investment or because of a history of excessive
trading by the investor.
- - There is a limit on the number of times you can exchange into or out of the
Fund (see "Redeeming Shares" in the INVESTING WITH VANGUARD section).
- - The Fund reserves the right to stop offering shares at any time.
INVESTMENT STRATEGY
This section explains how Wellesley Income Fund's investment adviser pursues the
objectives of income and moderate capital growth. It also explains important
risks--interest rate risk, stock market risk, manager risk, credit risk, call
risk, and prepayment risk--faced by investors in the Fund. Like the Fund's
objectives, the adviser's investment strategies are not fundamental and can be
changed by the Fund's board of directors without shareholder approval. However,
before making any important change in its strategy, the Fund will give
shareholders 30-days notice, in writing.
MARKET EXPOSURE
BONDS
The Fund invests approximately two-thirds of its assets in bonds.
[FLAG] THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE POSSIBILITY
THAT BOND PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED
PERIODS DUE TO RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE
MODEST FOR SHORTER-TERM BONDS AND HIGH FOR LONGER-TERM BONDS.
In the past, bond investors have seen the value of their investment rise and
fall--sometimes significantly--with changes in interest rates. Between December
1976 and September 1981, for instance, rising interest rates caused the price of
long-term bonds to fall by almost 48%.
Because of the Fund's emphasis on bonds, changes in interest rates will have
a significant impact on the Fund's assets. To illustrate how much of an impact,
the following table shows the effect of a 2% change (both up and down) in
interest rates on three $1,000 bonds, each with a different maturity.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
HOW INTEREST RATE CHANGES AFFECT BONDS*
- -----------------------------------------------------------------
VALUE OF A $1,000 BOND
----------------------------
AFTER A AFTER A
MATURITY 2% INCREASE 2% DECREASE
- -----------------------------------------------------------------
<S> <C> <C>
Short-Term (2.5 years) $956 $1,046
Intermediate-Term (10 years) $870 $1,156
Long-Term (20 years) $816 $1,251
- -----------------------------------------------------------------
</TABLE>
*Assumes a 7% yield.
PLAIN TALK ABOUT
BONDS AND INTEREST RATES
When interest rates rise, bond prices fall. The opposite is also true: Bond
prices go up when interest rates fall. Why do bond prices and interest rates
move in opposite directions? Let's assume that you hold a bond offering a 5%
yield. A year later, interest rates are on the rise and bonds are offered with a
6% yield. With higher-yielding bonds available, you would have trouble selling
your 5% bond for the price you paid--causing you to lower your asking price. On
the other hand, if interest rates were falling and 4% bonds were being offered,
you would be able to sell your 5% bond for more than you paid.
PLAIN TALK ABOUT
BOND MATURITIES
A bond is issued with a specific maturity date--the date when the bond's issuer,
or seller, must pay back the bond's initial value (known as its "face value").
Bond maturities generally range from less than one year (short term) to 30 years
(long term). The longer a bond's maturity, the more risk you, as a bond
investor, face as interest rates rise--but also the more interest you could
receive. Long-term bonds are more suitable for investors willing to take greater
risks in hope of higher yields; short-term bond investors should be willing to
accept lower yields in return for less fluctuation in the value of their
investment.
5
<PAGE> 10
These figures are for illustration only and should not be regarded as an
indication of future returns from the bond market as a whole, or the Fund in
particular.
STOCKS
Roughly one-third of Wellesley Income Fund's assets are invested in common
stocks.
[FLAG] THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE POSSIBILITY THAT
STOCK PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING STOCK
PRICES AND PERIODS OF FALLING STOCK PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns (dividend income plus change in market
value) for the U.S. stock market over various time periods as measured by the
Standard & Poor's 500 Composite Stock Price Index, a widely used barometer of
stock market activity. Note that the returns shown do not include the costs of
buying and selling stocks or other expenses that a real-world investment
portfolio would incur. Note, also, how the gap between best and worst tends to
narrow over the long term.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-1996)
- ------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- ------------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 53.9% 23.9% 20.1% 16.9%
Worst -43.3 -12.5 -0.9 3.1
Average 12.7 10.4 10.8 10.8
- ------------------------------------------------------------------
</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1996. For example, while the average return on stocks for all of the
5-year periods was 10.4%, returns for these 5-year periods ranged from a -12.5%
average (from 1928 through 1932), to 23.9% (from 1951 through 1955). These
average returns reflect past performance on common stocks and should not be
regarded as an indication of future returns from either the stock market as a
whole or this Fund in particular.
The stocks held by Wellesley Income Fund are chosen primarily for their
income potential. As a result, the Fund does not hold the same securities held
in the S&P 500 Index or any other market index, and the performance of the
Fund--or the Fund's stock holdings--will not mirror the returns of any
particular index.
Because bond prices and stock prices often move in different directions, the
Fund's stock holdings help to dampen--but not eliminate--some of the bond-price
fluctuations caused by changes in interest rates. Likewise, stock market
volatility may not be as dramatic for Wellesley Income Fund as it would be for a
fund made up entirely of stocks.
6
<PAGE> 11
SECURITY SELECTION
Wellington Management Company, LLP (WMC), adviser to the Fund, invests
approximately 60% to 70% of the Fund's assets in high-quality bonds and
approximately 30% to 40% of the Fund's assets in dividend-paying common stocks.
While the mix of bonds and stocks will vary from time to time depending on the
adviser's view of economic and market conditions, bonds can be expected to
represent at least 60% of the Fund's holdings.
The Fund is run by WMC according to traditional methods of active investment
management. Securities are bought and sold according to WMC's judgments about
bond issuers and the general level of interest rates, and about companies and
their financial prospects. To achieve the Fund's objectives of income and
moderate capital growth, the adviser follows specific strategies when selecting
bonds and stocks.
[FLAG] THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE POSSIBILITY THAT WMC
MAY DO A POOR JOB OF SELECTING BONDS AND STOCKS.
PLAIN TALK ABOUT
TYPES OF BONDS
Bonds are issued (sold) by many sources: corporations issue corporate bonds; the
federal government issues U.S. Treasury bonds; agencies of the federal
government issue agency bonds; mortgage holders issue "mortgage-backed" bonds
such as Government National Mortgage Association (GNMA). Each issuer is
responsible for paying back the bond's initial value as well as periodic
interest payments.
PLAIN TALK ABOUT
CREDIT QUALITY
A bond's credit quality depends on the issuer's ability to pay interest on the
bond and, ultimately, to repay the debt. The lower the rating by one of the
independent bond-rating agencies (such as Moody's or Standard & Poor's), the
greater the chance (in the rating agency's opinion) that the bond issuer will
default, or fail to meet its payment obligations. Most bond-rating agencies use
a descending alphabet scale to rate bonds (for example, Aaa is the highest
rating, C among the poorest quality ratings). All things being equal, the lower
a bonds's credit rating, the higher the yield the bond seeks to pay (as
compensation for the risks an investor must take).
BONDS
WMC selects high-quality bonds that, it believes, will generate a high and
sustainable amount of current income. These include intermediate- and long-term
corporate, U.S. Treasury, government agency, mortgage-backed, and asset-backed
bonds. The average maturity of these bonds as of December 31, 1996, was 17.2
years.
A breakdown of the Fund's bond holdings (which amounted to 60% of the Fund's
total net assets) as of December 31, 1996, follows.
<TABLE>
<CAPTION>
- -------------------------------------------------------
PERCENTAGE OF FUND'S
TYPE OF BOND BOND COMPONENT
- -------------------------------------------------------
<S> <C>
Utilities 26%
Industrial 26
Banks/Finance 16
Treasury/Agency 13
Mortgage 14
Foreign Issuers 5
- --------------------------------------------------------
</TABLE>
Keep in mind that, because the bond makeup of the Fund changes daily, this
listing is only a "snapshot" at one point in time.
[FLAG] THE FUND IS SUBJECT TO CREDIT RISK, WHICH IS THE POSSIBILITY THAT A
BOND ISSUER WILL FAIL TO REPAY INTEREST AND PRINCIPAL IN A TIMELY
MANNER.
The bonds WMC purchases for the Fund are primarily investment-grade
quality--that is, the bonds are rated at least Baa by Moody's Investors Service
Inc., or BBB by Standard & Poor's
7
<PAGE> 12
Corporation. The average quality of the bonds held by the Fund as of December
31, 1996, was Aa3 by Moody's.
The U.S. government guarantees the timely payment of interest and principal
for its Treasury bonds, but does not guarantee the bonds' prices. In other
words, while the Treasury bonds enjoy the highest credit ratings, their
prices--like the prices of the other bonds held by the Fund--will fluctuate with
changes in interest rates.
Falling interest rates will affect two other types of bonds held by the
Fund--although for different reasons.
[FLAG] THE FUND IS SUBJECT TO CALL RISK, WHICH IS THE POSSIBILITY THAT DURING
PERIODS OF FALLING INTEREST RATES, A CORPORATE BOND ISSUER WILL
"CALL"--OR REPAY--ITS HIGH-YIELDING BOND BEFORE THE BOND'S MATURITY
DATE. FORCED TO INVEST THE UNANTICIPATED PROCEEDS AT LOWER INTEREST
RATES, THE FUND WOULD EXPERIENCE A DECLINE IN INCOME.
To protect the Fund's corporate bond holdings against call risk, WMC
purchases bonds that have reasonable protection from being called.
Bond issuers take advantage of falling interest rates by calling corporate
bonds. With mortgage-backed securities, it is the mortgage holder--such as the
American homeowner--who benefits from lower rates.
[FLAG] THE FUND IS SUBJECT TO PREPAYMENT RISK, WHICH IS THE POSSIBILITY THAT
FALLING INTEREST RATES WILL PROMPT HOMEOWNERS TO REPAY THEIR MORTGAGES
EARLIER THAN EXPECTED OR TO REFINANCE AT LOWER RATES. AS WITH CALL
RISK, THE FUND IS FORCED TO REPLACE THE PAID-UP BONDS WITH
LOWER-YIELDING ISSUES--EXPERIENCING A DECLINE IN INCOME AND SHARE
PRICE.
PLAIN TALK ABOUT
CALLABLE BONDS
Although bonds are issued with clearly defined maturities, a corporate issuer
may be able to redeem, or call, a bond earlier than its maturity date. The bond
holder must now replace the called bond with a bond that may have a lower yield
than the original. One way for bond investors to protect themselves against call
risk is to purchase a bond early in its lifetime, when it is less likely to be
called. Another way is to buy bonds with call protections--that is, assurances
that a bond will not be called for a specific time period, such as ten years.
PLAIN TALK ABOUT
STOCKS AND DIVIDENDS
Many large and established companies share their profits, in the form of
dividends, with their shareholders. Other companies--particularly those that are
new or small--reinvest any profits back into the business to help the company
grow (and, hopefully, increase its stock's share price). In general, stocks that
offer above-average dividends appeal to investors who want some dividend income
and the potential for capital growth but are less tolerant of share-price
fluctuations, while growth stocks are appropriate for investors who will accept
more share-price volatility in hope of a greater increase in share price.
STOCKS
The Fund's stocks are chosen primarily for their dividend-producing
capabilities, along with their potential for moderate long-term capital growth.
WMC looks for stocks of companies that either offer significant dividends now or
expect to increase their dividends in the future.
The Fund's top ten stock holdings (which amounted to 13% of the Fund's net
assets) as of December 31, 1996, follow.
1. First Union Corp.
2. Bristol-Myers Squibb Co.
3. Keycorp
4. Amoco Corp.
5. Ford Motor Co.
6. J.C. Penney Co., Inc.
7. Royal Dutch Petroleum Co. ADR
8. Kimberly-Clark Corp.
9. BankAmerica Corp.
10. NYNEX Corp.
8
<PAGE> 13
Keep in mind that, because the stock makeup of the Fund changes daily, this
listing is only a "snapshot" at one point in time.
PORTFOLIO TURNOVER
Although the Fund generally seeks to invest for the long term, it retains the
right to sell stocks and bonds regardless of how long they have been held. The
Fund's average turnover rate for the past ten years has been about 26% and it is
not expected that the Fund's turnover would exceed 40% in the future. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its total net assets within a one-year period.)
INVESTMENT POLICIES
Besides investing in bonds and stocks, the Fund may follow a number of
investment policies to achieve its objectives.
Up to 20% of the Fund's stock holdings may be invested in foreign common
stocks as well as securities that are convertible into foreign stocks. The Fund
may also invest in fixed-income securities issued by foreign governments and by
companies domiciled outside the United States; however, these securities must be
valued in U.S. dollars and meet the Fund's credit quality standards.
Over the years, the prices of foreign investments and the prices of U.S.
investments have often moved in different directions. In addition, international
markets operate differently from U.S. markets. For instance, foreign exchanges,
brokers, and companies generally have less government supervision and regulation
than in the U.S.
The Fund may also invest in derivatives and may invest up to 15% of its
assets in restricted securities with limited marketability or other illiquid
securities.
[FLAG] THE FUND RESERVES THE RIGHT TO INVEST, TO A LIMITED EXTENT, IN BOND AND
STOCK FUTURES AND OPTIONS CONTRACTS, WHICH ARE TRADITIONAL TYPES OF
DERIVATIVES. THE FUND MAY ALSO INVEST MODESTLY IN LESS RISKY CLASSES OF
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS).
Losses (or gains) involving futures can sometimes be substantial--in part
because a relatively small price movement in a futures contract may result in an
immediate and substantial loss (or gain) for a fund. This Fund will not use
futures and options for speculative purposes or as leveraged investments that
magnify the gains or losses of an investment. If it holds futures and options,
the Fund will keep separate cash reserves or other liquid portfolio securities
in the amount of the obligation underlying the contract. Only a limited
percentage of the Fund's assets--up to 5% if required for deposit and no more
than 20% of total assets--may be committed to such contracts.
PLAIN TALK ABOUT
PORTFOLIO TURNOVER
Before investing in a mutual fund, you should review its portfolio turnover rate
for an indication of the potential effect of transaction costs on the fund's
future returns. In general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and other transaction
costs will have on its return. Also, funds with high portfolio turnover rates
may be more likely than low-turnover funds to generate capital gains that must
be distributed to shareholders as taxable income. The average turnover rate for
actively managed balanced funds is 92%.
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new, exotic types of derivatives--some of which can
carry considerable risks.
9
<PAGE> 14
PLAIN TALK ABOUT
CASH RESERVES
With mutual funds, holding cash reserves--or "cash"--does not mean literally
that the fund holds a stack of currency. Rather, cash reserves refer to
short-term, interest-bearing securities that can easily and quickly be converted
to cash, such as those described in the Glossary of this prospectus. (Most
mutual funds hold at least a small percentage of assets in cash to accommodate
shareholder redemptions.) While some funds strive to keep cash levels at a
minimum and to always remain fully invested in stocks and/or bonds, other funds
allow investment advisers to hold up to 20% of a fund's assets in cash reserves.
PLAIN TALK ABOUT
PAST PERFORMANCE
Whenever you see information on a fund's performance, do not consider the
figures to be an indication of the performance you could expect by making an
investment in the fund today. The past is an imperfect guide to the future;
history does not repeat itself in neat, predictable patterns.
The reasons for which the Fund may use futures and options are:
- - To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in bonds and stocks.
- - To make it easier to trade.
- - To reduce costs by buying futures instead of actual bonds and stocks when
futures are cheaper.
The Fund will usually hold only a small percentage of its assets in cash
reserves, although if the investment adviser believes that market conditions
warrant a temporary defensive measure, the Fund may hold cash reserves without
limit.
INVESTMENT LIMITATIONS
To reduce risk and maintain diversification, the Fund has adopted limits on some
of its investment policies. Specifically, the Fund will not:
- - Invest more than 25% of its total assets in any one industry.
- - Borrow money, except for the purpose of meeting shareholder requests to
redeem shares--and not more than 10% of the Fund's net assets. With respect
to 75% of its assets, the Fund will not:
- - Invest more than 5% of its assets in the securities of any single issuer
except the U.S. government.
- - Buy more than 10% of the outstanding voting securities of any issuer.
The limitations listed in this prospectus and in the Statement of Additional
Information are fundamental and may be changed only by approval of a majority of
the Fund's shareholders.
INVESTMENT PERFORMANCE
Although Vanguard/Wellesley Income Fund invests primarily in bonds, it holds a
sizable percentage of common stocks, so the Fund's performance is closely tied
to both the bond and stock markets. Changes in interest rates are the strongest
influence on bond market performance. Stock market performance, on the other
hand, has historically been characterized by sharp up-and-down swings in the
short term, but by more stable growth over the long term.
The results shown represent the Fund's "average annual total return"
performance, which assumes that any distributions of capital gains and dividends
were reinvested for the indicated periods. Also included is comparative
information on an unmanaged "composite" index of 65% bonds and 35% stocks. The
Lehman Long-Term Corporate AA or Better Bond Index (an index of high-quality
intermediate- and long-term corporate bonds) represents the bond portion of the
composite index. The S&P/BARRA Value Index (an index of dividend-oriented
large-company stocks) makes up 75% of the composite index's stock portion; the
S&P's
10
<PAGE> 15
AVERAGE ANNUAL TOTAL RETURNS
FOR PERIODS ENDED 12/31/96
[BAR GRAPH]
*The Composite Index is made up of 65% bonds and 35% stocks.
Utilities Index (a measure of large gas and electric utility companies) makes up
12.5%; and the S&P's Telephone Index (a measure of large telephone utility
companies) makes up the remaining 12.5%. The chart does not make any allowance
for federal, state, or local income taxes that shareholders must pay on a
current basis.
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your share of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or capital gains distribution. Income
dividends come from interest the fund earns from its money market and bond
investments as well as dividends it receives from its stock investments. Capital
gains are realized whenever the fund sells securities for higher prices than it
paid for them. These capital gains are either short-term or long-term depending
on whether the fund held the securities for less than or more than one year.
SHARE PRICE
The Fund's share price, called its net asset value, is calculated each business
day after the close of regular trading (generally 4 p.m. Eastern time) on the
New York Stock Exchange. Net asset value per share is calculated by adding up
the total assets of the Fund, subtracting all of its liabilities, or debts, and
then dividing by the number of Fund shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = -----------------------------------------
NUMBER OF SHARES OUTSTANDING
The daily net asset value, or NAV, is useful to you as a shareholder because
the NAV, multiplied by the number of Fund shares you own, gives you the dollar
amount you would have received had you sold all of your shares back to the Fund
that day.
The Fund's share price can be found daily in the mutual fund listings of most
major newspapers under the heading Vanguard Group. Different newspapers use
different abbreviations of the Fund's name, but the most common is Wellsl.
DIVIDENDS, CAPITAL GAINS, AND TAXES
Each March, June, September, and December, the Fund distributes to shareholders
virtually all of its income from interest and dividends. Any capital gains
realized from the sale of securities are distributed in December. In addition,
the Fund may occasionally be required to make supplemental dividend or capital
gains distributions at some time during the year (usually in March). Your
distributions of income and capital gains will be automatically invested in more
shares of the Fund, unless you elect to receive these distributions in cash. In
either case, distributions that are declared in December--even if paid to you in
January--are taxed as if they
11
<PAGE> 16
had been paid to you in December. Vanguard will process your dividend
distribution and send you a statement each year showing the tax status of all
your distributions.
- - The dividends and short-term capital gains that you receive are taxable to
you as ordinary dividend income. Any distributions of net long-term capital
gains by the Fund are taxable to you as long-term capital gains, no matter
how long you've owned shares in the Fund. Both dividends and capital gains
distributions are taxable to you whether received in cash or reinvested in
additional shares. Although the Fund does not seek to realize any particular
amount of capital gains during a year, such gains are realized from time to
time as byproducts of the ordinary investment activities of the Fund.
Consequently, distributions may vary considerably from year to year.
- - If you sell or exchange shares of the Fund, any gain or loss you have is a
taxable event, which means you may have a capital gain to report as income,
or a capital loss to report as a deduction, when you complete your federal
income tax return.
- - Distributions of dividends or capital gains, and capital gains or losses
from your sale or exchange of Fund shares, may be subject to state and local
income taxes as well.
The tax information in this prospectus is provided as general information and
will not apply to you if you are investing in a tax-deferred account such as an
IRA. You should consult your own tax adviser about the tax consequences of an
investment in the Fund.
THE FUND AND VANGUARD
The Fund is a member of The Vanguard Group, a family of more than 30 investment
companies with more than 90 distinct investment portfolios and total net assets
of more than $250 billion. All of the Vanguard funds share in the expenses
associated with business operations, such as personnel, office space, equipment,
and advertising.
Vanguard also provides marketing services to the funds. Although shareholders
do not pay sales commissions or 12b-1 marketing fees, each fund pays its
allocated share of The Vanguard Group's costs.
A list of the Fund's directors and officers, and their present positions and
principal occupations during the past five years, can be found in the Statement
of Additional Information.
INVESTMENT ADVISER
The Fund employs Wellington Management Company, LLP (WMC), 75 State Street,
Boston, MA 02109, as its investment adviser. WMC manages the Fund subject to the
control of the officers and directors of the Fund.
PLAIN TALK ABOUT
"BUYING A DIVIDEND"
Unless you are investing in a tax-deferred retirement account (such as an IRA),
it is not to your advantage to buy shares of a fund shortly before it makes a
distribution, because part of your investment will come back to you as a taxable
distribution. This is known as "buying a dividend." For example: on December 15,
you invest $5,000, buying 250 shares for $20 each. If the fund pays a
distribution of $1 per share on December 16, its share price would drop to $19
(not counting market change). You would still have only $5,000 (250 shares x $19
= $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you
would owe tax on the $250 distribution you received, even if you had reinvested
it in more shares. To avoid "buying a dividend," check a fund's distribution
schedule before you invest.
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group, Inc. is the only mutual mutual fund company. It is owned
jointly by the funds it oversees and by the shareholders in those funds. Other
mutual funds are operated by for-profit management companies that may be owned
by one person, by a group of individuals, or by investors who bought the
management company's publicly traded stock. Because of its structure, Vanguard
operates its funds at cost. Instead of distributing profits from operations to a
separate management company, Vanguard returns profits to fund shareholders in
the form of lower operating expenses.
12
<PAGE> 17
Each quarter, WMC is paid an advisory fee based on the Fund's average
month-end net assets during that quarter:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
ASSETS MANAGED FEE
- -------------------------------------------------------------------------------
<S> <C>
First $1 billion 0.10%
Next $2 billion 0.05
Next $7 billion 0.04
Assets over $10 billion 0.03
- -------------------------------------------------------------------------------
</TABLE>
The advisory fee can be increased or decreased based on the difference
between the Fund's total return performance and that of an unmanaged "composite
index," which is made up of Lehman Long-Term Corporate AA or Better Bond Index
(65% of the composite index), the S&P's/BARRA Value Index (approximately 26% of
the composite index) and the S&P's Utilities Index (approximately 9% of the
composite index). Under the fee schedule, the basic fee may be increased or
decreased by as much as 20%. The incentive/penalty fee will not be in full
operation until the quarter ending March 31, 1999. Until that date, the
incentive/penalty fee will be calculated using certain transition rules that are
explained in the Statement of Additional Information.
For the fiscal year ended December 31, 1996, the investment advisory fee paid
to WMC was $3.61 million.
The agreement authorizes WMC to choose brokers or dealers to handle the
purchase and sale of the Fund's securities, and directs WMC to get the best
available price and most favorable execution from these brokers with respect to
all transactions. At times, WMC may choose brokers who charge higher commissions
in the interest of obtaining better execution of a transaction. If more than one
broker can obtain the best available price and favorable execution of a
transaction, then WMC is authorized to choose a broker who, in addition to
executing the transaction, will provide research services to WMC or the Fund.
However, WMC will not pay higher commissions specifically for the purpose of
obtaining research services. The Fund may direct WMC to use a particular broker
for certain transactions in exchange for commission rebates or research services
provided to the Fund.
The board of directors may, without prior approval from shareholders, change
the terms of the advisory agreement or hire a new investment adviser, either as
a replacement for WMC or as an additional adviser. However, no such change would
be made before giving shareholders 30-days notice, in writing.
GENERAL INFORMATION
Vanguard/Wellesley Income Fund is a corporation organized under the laws of the
state of Maryland. Shareholders of the Fund have rights and privileges similar
to those enjoyed by other corporate shareholders. For example, shareholders will
not be
PLAIN TALK ABOUT
THE FUND'S ADVISER
Wellington Management Company, LLP, an investment advisory firm founded in 1933,
currently manages more than $140 billion in stock and bond portfolios, including
14 Vanguard Funds. The managers responsible for overseeing Vanguard/Wellesley
Income Fund are:
EARL E. MCEVOY, Senior Vice President of WMC; 25 years investment experience,
19 years with WMC (including 13 years with Wellesley Income Fund); B.A. from
Dartmouth College, M.B.A. from Columbia Business School.
JOHN R. RYAN, CFA, Senior Vice President and Managing Partner of WMC; 16
years with WMC (including 11 years with Wellesley Income Fund); B.S. from Lehigh
University, M.B.A. from the University of Virginia.
13
<PAGE> 18
responsible for any liabilities of the corporation. If any matters are to be
voted on by shareholders (such as the election of directors), each share
outstanding at that point would be entitled to one vote. Annual meetings will
not be held by the Portfolio except as required by the Investment Company Act of
1940. A meeting will be scheduled (for example, to vote on the removal of a
director) if the holders of at least 10% of the Fund's shares request a meeting
in writing.
14
<PAGE> 19
INVESTING WITH VANGUARD
Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information? Establish an account for a
minor child or for your retirement savings?
Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.
The following sections of the prospectus briefly explain the many services we
offer you as a Vanguard/Wellesley Income Fund shareholder. Booklets providing
detailed information are available on the services marked with a [BOOK GRAPHIC].
Please call us to request copies.
SERVICES AND ACCOUNT FEATURES
Vanguard offers many services that make it convenient to buy, sell, or exchange
shares.
<TABLE>
<S> <C>
TELEPHONE REDEMPTIONS Automatically set up for this Fund unless you notify us
(SALES AND EXCHANGES) otherwise.
VANGUARD DIRECT DEPOSIT Automatic method for depositing your paycheck or U.S. gov-
SERVICE ernment payment (including Social Security and government
[BOOK GRAPHIC] pension checks) into your account.
VANGUARD AUTOMATIC EXCHANGE Automatic method for moving a fixed amount of money from
SERVICE one Vanguard fund account to another.*
[BOOK GRAPHIC]
VANGUARD FUND EXPRESS Electronic method for buying or selling shares. You can trans-
[BOOK GRAPHIC] fer money between your Vanguard fund account and an ac-
count at your bank, savings and loan, or credit union on a
systematic schedule or whenever you wish.*
VANGUARD DIVIDEND EXPRESS Electronic method for transferring dividends and/or capital
[BOOK GRAPHIC] gains distributions directly from your Vanguard fund account
to your bank, savings and loan, or credit union account or to
another Vanguard fund account.
VANGUARD BROKERAGE SERVICES A cost-effective way to trade stocks, bonds, and options on
(VBS) major exchanges, the Nasdaq Stock Market, and other
[BOOK GRAPHIC] domestic over-the-counter markets at reduced rates, and to
buy and sell shares of non-Vanguard mutual funds. Call VBS
(1-800-992-8327) for additional information and the
appropriate forms.
</TABLE>
*Can be used to "dollar-cost average" [BOOK GRAPHIC] or to contribute to an IRA
or other retirement plan.
15
<PAGE> 20
INVESTOR INFORMATION 1-800-662-7447 [] CLIENT SERVICES 1-800-662-2739
[] TELE-ACCOUNT 1-800-662-6273
TYPES OF ACCOUNTS
INDIVIDUAL OR OTHER ENTITY
Vanguard's account registration form can be used to establish a variety of
non-retirement accounts.
<TABLE>
<S> <C>
FOR ONE OR MORE PEOPLE To open an account in the name of one (individual) or more
(joint tenants) people. $3,000 minimum initial investment.
FOR A MINOR CHILD To open an account as an UGMA/UTMA (Uniform Gifts/
[BOOK GRAPHIC] Transfers to Minors Act). Age of majority and other require-
ments are set by state law. $1,000 minimum initial investment.
FOR HOLDING TRUST ASSETS To invest assets held in an existing trust. $3,000
[BOOK GRAPHIC] minimum initial investment.
FOR THIRD-PARTY TRUSTEE To open an account as a retirement trust or plan based on an
RETIREMENT INVESTMENTS existing corporate or institutional plan. These accounts are
(Vanguard is not the custodian established by the custodian or trustee of the existing plan.
or trustee.)
FOR AN ORGANIZATION To open an account as a corporation, partnership, or other
entity. These accounts may require a corporate resolution or
other documents to name the individuals authorized to act.
$3,000 minimum initial investment.
</TABLE>
RETIREMENT
You establish these accounts with a Vanguard adoption agreement -- not a
Vanguard account registration form. To request the appropriate adoption
agreement and forms, or to ask questions about investing for retirement, call
Investor Information.
<TABLE>
<S> <C>
FOR AN INDIVIDUAL RETIREMENT To open a retirement account in the name of an individual.
ACCOUNT (IRA) IRAs can be established with a contribution, a direct roll-
(Vanguard Fiduciary Trust over from an employer's plan, such as a 401(k), or an asset
Company is the custodian.) transfer or rollover from another financial institution, such
as a bank or mutual fund company. $1,000 minimum initial investment.
FOR A SIMPLIFIED EMPLOYEE To open a retirement account in the name of an employee.
PENSION PLAN ACCOUNT (SEP-IRA) SEPs allow employers to make deductible contributions
(Vanguard Fiduciary Trust directly to IRAs established by their employees. A SEP can
Company is the custodian.) be established by people who are self-employed, small-busi-
ness owners, partnerships, or corporations.
</TABLE>
16
<PAGE> 21
TYPES OF ACCOUNTS (continued)
<TABLE>
<CAPTION>
<S> <C>
FOR A SAVINGS INCENTIVE MATCH To open a retirement account in the name of an employee.
PLAN FOR EMPLOYEES ACCOUNT Created as part of the Small Business Job Protection Act of
(SIMPLE-IRA) 1996, SIMPLEs replace SAR-SEPs. SIMPLEs are exclu-
(Vanguard Fiduciary Trust sively for employers that had 100 or fewer employees in the
Company is the custodian.) most recent calendar year and that do not maintain another
employer-sponsored retirement plan. A SIMPLE can be es-
tablished by people who are self-employed, small business
owners, partnerships, or corporations. Salary reduction con-
tributions may be made by the employee, with matching or
non-matching contributions from the employer.
FOR A QUALIFIED RETIREMENT To open a retirement account that allows small-business owners
PROGRAM ACCOUNT or people who are self-employed to make tax-deductible
(Vanguard Fiduciary Trust retirement contributions for themselves and their
Company can be the custodian.) employees into Profit-Sharing and Money Purchase Pension
(Keogh) plans.
FOR A 403(b)(7) CUSTODIAL ACCOUNT To open a retirement account that allows employees of tax-
(Vanguard Fiduciary Trust exempt institutions (for example, schools or hospitals) to make
Company is the custodian.) pre-tax retirement contributions.
</TABLE>
DISTRIBUTION OPTIONS
You can receive distributions of dividends and/or capital gains in a number of
ways:
<TABLE>
<CAPTION>
<S> <C>
REINVESTMENT Dividends and capital gains are automatically reinvested in
additional shares of the Fund, unless you request a different
distribution method.
DIVIDENDS IN CASH Dividends are paid by check and mailed to your account's
address of record, and capital gains are reinvested in ad-
ditional shares of the Fund.
DIVIDENDS AND CAPITAL GAINS Both dividends and capital gains are paid by check and mailed
IN CASH to your account's address of record.
</TABLE>
To electronically transfer cash dividends and/or capital gains to your bank,
savings and loan, or credit union account, or to another Vanguard fund account,
see Vanguard Dividend Express under "Services and Account Features."
BUYING SHARES
You buy your shares at the Fund's next-determined net asset value after Vanguard
receives your request, provided we receive your request before 4 p.m. Eastern
time (the close of trading on the New York Stock Exchange). The Fund is offered
on a no-load basis, meaning that you do not pay sales commissions or 12b-1
marketing fees.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739
- - TELE-ACCOUNT 1-800-662-6273
17
<PAGE> 22
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739
- - TELE-ACCOUNT 1-800-662-6273
BUYING SHARES (continued)
<TABLE>
<CAPTION>
<S> <C> <C>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
MINIMUM INVESTMENT $3,000 (regular account); $1,000 $100 by mail or exchange; $1,000 by wire.
(IRAs and custodial accounts for minors).
BY MAIL
[ENVELOPE] Complete and sign the application form. Mail your check with an Invest-By-Mail
FIRST-CLASS mail to: form detached from your confirmation
The Vanguard Group statement to the address listed on the form.
P.O. Box 2600
Valley Forge, PA 19482 Make your check payable to: Make your check payable to:
The Vanguard Group - 27 The Vanguard Group - 27
EXPRESS or REGISTERED mail to:
The Vanguard Group All purchases must be made in All purchases must be made in U.S. dollars,
455 Devon Park Drive U.S. dollars, and checks must be and checks must be drawn on U.S. banks.
Wayne, PA 19087 drawn on U.S. banks.
</TABLE>
IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.
<TABLE>
<CAPTION>
<S> <C> <C>
BY TELEPHONE Call Vanguard Tele-Account* 24 hours Call Vanguard Tele-Account* 24 hours a
[TELEPHONE RECEIVER] a day -- or Client Services during day -- or Client Services during business
1-800-662-6273 business hours -- to exchange from hours -- to exchange from another
Vanguard Tele-Account(R) another Vanguard fund account with the Vanguard fund account with the same
1-800-662-2739 same registration (name, address, registration (name, address, taxpayer
Client Services taxpayer I.D., and account type). I.D., and account type).
Use Vanguard Fund Express (see "Services
and Account Features") to transfer
assets from your bank account. Call Client
Services before your first use to
verify that this option is in place.
</TABLE>
*You must obtain a Personal
Identification Number through
Tele-Account at least seven days before
you request your first exchange.
IMPORTANT NOTE: Once a telephone transaction has been approved by you and a
confirmation number assigned, it cannot be revoked. We reserve the right to
refuse any purchase.
<TABLE>
<CAPTION>
<S> <C> <C>
BY WIRE Call Client Services to arrange Call Client Services to arrange
[WIRE] your wire transaction. your wire transaction.
Wire to:
CoreStates Bank, N.A. Wire transactions are not Wire transactions are not available
ABA 031000011 available for retirement accounts. for retirement accounts.
CoreStates No 01019897
[Temporary Account Number]
Vanguard/Wellesley Income Fund
[Account Registration]
Attention: Vanguard
</TABLE>
18
<PAGE> 23
BUYING SHARES (continued)
<TABLE>
<CAPTION>
<S> <C> <C>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
AUTOMATICALLY Vanguard offers a variety of ways
[GRAPHIC OF ARROWS IN A CIRCLE] that you can add to your account
automatically. See "Services and
Account Features."
</TABLE>
You can redeem (that is, sell or exchange) shares purchased by check or Vanguard
Fund Express at any time. However, while your redemption request will be
processed at the next-determined net asset value after it is received, your
redemption proceeds will not be available until payment for your purchase is
collected, which may take up to ten calendar days.
NOTE: If you buy Fund shares through a registered broker-dealer or investment
adviser, the broker-dealer or adviser may charge you a service fee.
It is important that you call Vanguard before you invest a large dollar amount
by wire or check. We must consider the interests of all Fund shareholders and so
reserve the right to delay or refuse any purchase that will disrupt the Fund's
operation or performance.
REDEEMING SHARES
IMPORTANT TAX NOTE: Any sale or exchange of shares in a non-retirement account
could result in a taxable gain or a loss.
The ability to redeem (that is, sell or exchange) Fund shares by telephone is
automatically established for your account unless you tell us in writing that
you do not want this option.
To protect your account from unauthorized or fraudulent telephone
instructions, Vanguard follows specific security procedures. When we receive a
call requesting an account transaction, we require the caller to provide:
- - Fund name.
- - 10-digit account number.
- - Name and address exactly as registered on that account.
- - Social Security or employer identification number as registered on that
account.
If you call to sell shares, the sale proceeds will be made payable to you, as
the registered shareholder, and mailed to your account's address of record.
If we follow reasonable security procedures, neither the Fund nor Vanguard
will be responsible for the authenticity of transaction instructions received by
telephone. We believe that these procedures are reasonable and that, if we
follow them, you bear the risk of any losses resulting from unauthorized or
fraudulent telephone transactions on your account.
HOW TO SELL SHARES
You may withdraw any part of your account, at any time, by selling shares. Sale
proceeds are normally mailed within two business days after Vanguard receives
your request. The sale price of your shares will be the Fund's next-determined
net asset value after Vanguard receives all required documents in good order.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739
- - TELE-ACCOUNT 1-800-662-6273
19
<PAGE> 24
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739
- TELE-ACCOUNT 1-800-662-6273
REDEEMING SHARES (continued)
Good order means that the request includes:
- Fund name and account number.
- Amount of the transaction (in dollars or shares).
- Signatures of all owners exactly as registered on the account.
- Signature guarantees (if required).
- Any supporting legal documentation that may be required.
- Any certificates you are holding for the account.
Sales or exchange requests received after the close of trading on the New York
Stock Exchange (generally 4 p.m. Eastern time) are processed at the next
business day's net asset value.
The Fund reserves the right to close any non-retirement or UGMA/UTMA account
whose balance falls below the minimum initial investment. The Fund will deduct a
$10 annual fee if your non-retirement account balance falls below $2,500 or if
your UGMA/UTMA account balance falls below $500. The fee is waived if your total
Vanguard account assets are $50,000 or more.
Some written requests require a signature guarantee from a bank, broker, or
other acceptable financial institution. A notary public cannot provide a
signature guarantee.
HOW TO EXCHANGE SHARES
An exchange is the selling of shares of one Vanguard fund to purchase shares of
another.
Although we make every effort to maintain the exchange privilege, Vanguard
reserves the right to revise or terminate the exchange privilege, limit the
amount of an exchange, or reject any exchange, at any time, without notice.
Because excessive exchanges can potentially disrupt the management of the Fund
and increase transaction costs, Vanguard limits exchange activity to two
substantive exchange REDEMPTIONS (at least 30 days apart) from the Fund during
any 12-month period. "Substantive" means either a dollar amount large enough to
have a negative impact on the Fund or a series of movements between Vanguard
funds.
Before you exchange into a new Vanguard fund, be sure to read its prospectus.
For a copy and for answers to questions you might have, call Investor
Information.
<TABLE>
<CAPTION>
SELLING OR EXCHANGING SHARES ACCOUNT TYPE
<S> <C>
BY TELEPHONE ALL TYPES EXCEPT RETIREMENT:
[TELEPHONE]
Call Vanguard Tele-Account* 24 hours a day -- or Client
1-800-662-6273 Services during business hours -- to sell or exchange
Vanguard Tele-Account shares. You can exchange shares from this Fund to open an
account in another Vanguard fund or to add to an existing
1-800-662-2739 Vanguard fund account with an identical registration.
Client Services
RETIREMENT:
You can exchange -- but not sell -- shares by calling
Tele-Account or Client Services.
*You must obtain a Personal Identification Number through
Tele-Account at least seven days before you request your
first redemption.
</TABLE>
20
<PAGE> 25
REDEEMING SHARES (continued)
<TABLE>
<CAPTION>
SELLING OR EXCHANGING SHARES ACCOUNT TYPE
<S> <C>
BY MAIL ALL TYPES EXCEPT RETIREMENT:
[ENVELOPE] Send a letter of instruction signed by all
FIRST-CLASS mail to: registered account holders. Include
The Vanguard Group the fund name and account number and (if
Vanguard/Wellesley Income Fund you are selling) a dollar amount or number
P.O. Box 1120 of shares OR (if you are exchanging) the name
Valley Forge, PA 19482 of the fund you want to exchange into and a
dollar amount or number of shares.
EXPRESS or REGISTERED mail to: RETIREMENT:
The Vanguard Group
Vanguard/Wellesley Income Fund For information on how to request distributions from . . .
455 Devon Park Drive - IRAs, call Client Services.
Wayne, PA 19087 - SEP-IRAs, SIMPLE-IRAs, 403(b)(7) custodial accounts, and
Profit-Sharing and Money Purchase Pension (Keogh) Plans,
call Individual Retirement Services at 1-800-662-2003.
Depending on your account registration type, additional
documentation may be required.
AUTOMATICALLY ALL TYPES EXCEPT RETIREMENT:
[GRAPHIC OF ARROWS IN A CIRCLE] Vanguard offers several ways to sell or exchange shares
automatically (see "Services and Account Features"). Call
Investor Information for the appropriate booklet and
application if you did not elect this feature when you
opened your account.
</TABLE>
It is important that you call Vanguard before you redeem a large dollar
amount. We must consider the interests of all Fund shareholders and so reserve
the right to delay your redemption proceeds -- up to seven days -- if the amount
will disrupt the Fund's operation or performance.
A NOTE ON UNUSUAL CIRCUMSTANCES
Vanguard reserves the right to revise or terminate the telephone redemption
privilege at any time, without notice. In addition, Vanguard can stop selling
shares or postpone payment at times when the New York Stock Exchange is closed
or under any emergency circumstances as determined by the United States
Securities and Exchange Commission. If you experience difficulty making a
telephone redemption during periods of drastic economic or market change, you
can send us your request by regular or express mail. Follow the instructions on
selling or exchanging shares by mail in the "Redeeming Shares" section.
FUND AND ACCOUNT UPDATES
STATEMENTS AND REPORTS
We will send you clear, concise account and tax statements to help you keep
track of your Vanguard/Wellesley Income Fund account throughout the year as well
as when you are preparing your income tax returns.
In addition, you will receive financial reports about the Fund twice a year.
These comprehensive reports include an assessment of the Fund's performance (and
a comparison to its industry benchmark), an overview of the markets, a report
from the adviser, as well as a listing of its holdings and other financial
statements.
21
<PAGE> 26
FUND AND ACCOUNT UPDATES (continued)
<TABLE>
<S> <C>
CONFIRMATION STATEMENT Sent each time you buy, sell, or
exchange shares; confirms the trade date
and the amount of your transaction.
PORTFOLIO SUMMARY Mailed quarterly; shows the market value
of your account at the close of the
statement period, as well as
distributions, purchases, sales, and
exchanges for the current calendar year.
FUND FINANCIAL REPORTS Mailed in February and August for this
Fund.
TAX STATEMENTS Generally mailed in January; report
previous year's dividend distributions,
proceeds from the sale of Fund shares,
and distributions from IRAs or other
retirement accounts.
AVERAGE COST STATEMENT Issued quarterly for taxable accounts
[BOOK GRAPHIC] (accompanies your Portfolio Summary);
shows the average cost of shares that
you redeemed during the calendar year
using the average cost single category
method.
AUTOMATED TELEPHONE ACCESS
VANGUARD TELE-ACCOUNT Toll-free access to Vanguard fund and
1-800-662-6273 Any time, account information -- as well as some
seven days a week, from transactions -- through any
anywhere in the continental Touch-Tone(TM) telephone. Tele-Account
United States and Canada. provides total return, share price,
[BOOK GRAPHIC] price change, and yield quotations for
all Vanguard funds; gives your account
balances and history (e.g., last
transaction, latest dividend
distribution); and allows you to sell or
exchange fund shares.
COMPUTER ACCESS
VANGUARD ON THE Use your personal computer to visit
WORLD WIDE WEB Vanguard's education-oriented website,
http://www.vanguard.com which provides timely news and
information about Vanguard funds and
services; an on-line "university" that
offers a variety of mutual fund classes;
and easy-to-use, interactive tools to
help you create your own investment and
retirement strategies.
VANGUARD ONLINE- Use your personal computer to learn more
KEYWORD: VANGUARD about Vanguard funds and services; keep
in touch with your Vanguard accounts;
map out a long-term investment strategy;
and ask questions, make suggestions, and
send messages to Vanguard. Vanguard
Online is offered through America
Online(R) (AOL). To establish an AOL
account, call 1-800-238-6336.
</TABLE>
22
<PAGE> 27
PROSPECTUS POSTSCRIPT
This prospectus is designed to provide you with pertinent information about
Vanguard/Wellesley Income Fund, including its investment objective, risks,
strategies, and expenses, as well as services available to you as a shareholder.
It is important that you understand these facts so that you can decide whether
an investment in this Fund is right for you. The following questions offer a
quick review of some of the subjects covered by this prospectus.
IN READING THE PROSPECTUS, DID YOU LEARN . . .
[ ] The Fund's objectives? (page 4)
[ ] The Fund's investment strategy? (page 5)
[ ] Who should invest in the Fund? (page 4)
[ ] The risks associated with the Fund? (pages 4 - 9)
[ ] Whether the Fund is federally insured?
(inside front cover)
[ ] The Fund's expenses? (page 2)
[ ] The background of the Fund's investment managers?
(page 13)
[ ] How to open an account? (page 16)
[ ] How to sell or exchange shares? (page 19)
[ ] How often you'll receive statements and financial reports?
(page 21)
PLAIN TALK ABOUT
KEEPING YOUR PROSPECTUS
Reading this prospectus will help you to decide whether Vanguard/ Wellesley Fund
is suitable for your investment goals. If you decide to invest, don't throw the
prospectus out; you will no doubt need it for future reference.
23
<PAGE> 28
ABOUT THE QUIZ
Knowing your risk tolerance is important when you are making an investment
decision. To give you a general idea of your comfort level with investing,
circle the response that most closely matches your personal situation. Keep in
mind, though, that there is no "foolproof" way to accurately gauge your risk
tolerance. Scoring for the quiz is below.
A SIMPLE RISK QUIZ
A. I HAVE BEEN INVESTING IN STOCK AND BOND MUTUAL FUNDS (OR IN INDIVIDUAL STOCKS
OR BONDS) FOR . . .
1. Less than a year
2. 1 - 2 years
3. 3 - 4 years
4. 5 - 9 years
5. 10 years or more
B. WHEN IT COMES TO INVESTING IN STOCK OR BOND MUTUAL FUNDS (OR INDIVIDUAL
STOCKS OR BONDS), I WOULD SAY I'M . . .
1. A very inexperienced investor
2. A somewhat inexperienced investor
3. A somewhat experienced investor
4. An experienced investor
5. A very experienced investor
C. I AM COMFORTABLE WITH INVESTMENTS THAT MAY LOSE MONEY FROM TIME TO TIME IF
THEY OFFER THE POTENTIAL FOR HIGHER RETURNS.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
D. I WILL KEEP AN INVESTMENT EVEN IF IT LOSES 10% OF ITS VALUE OVER THE COURSE
OF A YEAR.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
E. IN ADDITION TO MY LONG-TERM INVESTMENTS, I HAVE EMERGENCY SAVINGS EQUAL TO
____ MONTHS OF MY TAKE-HOME PAY.
1. Zero
2. One
3. Two
4. Three
5. Four or more
F. I FIND IT EASY TO PAY MY MONTHLY BILLS FROM MY CURRENT PAY.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
G. OVERALL, MY PERSONAL FINANCIAL SITUATION IS SECURE.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
HOW TO SCORE THE QUIZ
Use the number of your answer as the number of points scored. For instance, if
you chose answer #3 to a question, that's worth three points. Add up your points
and check below for the type of investor you are. (Note: If you chose answer #1
or #2 to Question C, subtract five points from your total score.)
- - If you scored between 0 and 25 points, you are considered a conservative
investor.
- - If you scored between 26 and 32 points, you are considered a moderate
investor.
- - If you scored between 33 and 35 points, you are considered an aggressive
investor.
24
<PAGE> 29
GLOSSARY OF INVESTMENT TERMS
BALANCED FUND
A mutual fund that seeks to provide some combination of income, capital growth,
and conservation of principal by investing in stocks, bonds, and/or money market
instruments.
BOND
A debt security (IOU) issued by a corporation, government, or government agency
in exchange for the money you lend it. The issuer usually agrees to pay back the
loan -- through regular interest payments -- by a specific date.
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized during the year on
securities that the fund has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits as well as short-term bank deposits, money market instruments,
bank CDs, repurchase agreements, and U.S. Treasury bills.
COMMON STOCK
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.
CREDIT QUALITY
A measure of a bond issuer's ability to repay interest and principal in a timely
manner.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by the
fund's investments.
DURATION
A measure of the sensitivity of bond prices -- and the share prices of bond
funds -- to interest rate changes. For example, if a bond has a duration of two
years, its price would fall about 2% when interest rates rose one percentage
point; conversely, the bond's price would rise about 2% if interest rates fell
one percentage point.
EXPENSE RATIO
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
marketing fees.
FIXED-INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a portfolio's
investments.
INVESTMENT GRADE
Bonds whose credit quality is considered to be among the highest by independent
bond-rating agencies.
MATURITY
The date that a bond issuer agrees to repay the bond's principal to the bond's
buyer.
MUTUAL FUND
An investment company that pools the money of many people and invests it in a
variety of securities in an effort to achieve a specific objective over time.
NET ASSET VALUE (NAV)
The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.
PRINCIPAL
The amount of your own money you put into an investment.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
VOLATILITY
The fluctuations in price of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Current income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's current price.
<PAGE> 30
[VANGUARD LOGO]
Post Office Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT
1-800-662-7447 (SHIP)
TEXT TELEPHONE:
1-800-952-3335
For information on our funds,
fund services, and retirement accounts; requests for
literature
CLIENT SERVICES DEPARTMENT
1-800-662-2739 (CREW)
TEXT TELEPHONE:
1-800-662-2738
For information on your
account, account transactions,
account statements
VANGUARD BROKERAGE
SERVICES
1-800-992-8327
For information on trading
stocks, bonds, and options
at reduced commissions
VANGUARD TELE-ACCOUNT(R)
1-800-662-6273 (ON-BOARD)
For 24-hour automated access
to price and yield, information
on your account, certain
transactions
ELECTRONIC ACCESS TO THE
VANGUARD MUTUAL FUND
EDUCATION AND INFORMATION
CENTER
World Wide Web
http://www.vanguard.com
E-mail
[email protected]
(C) 1997 Vanguard Marketing
Corporation, Distributor
<PAGE> 31
VANGUARD/WELLESLEY INCOME FUND
Institutional Prospectus
April 25, 1997
This prospectus contains financial data for the Fund through the fiscal year
ended December 31, 1996.
[GRAPHIC OF SHIP]
[VANGUARD LOGO]
<PAGE> 32
VANGUARD/WELLESLEY INCOME FUND
An Income Mutual Fund
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
Fund Expenses 2
Financial Highlights 3
A Word About Risk 4
The Fund's Objectives 4
Who Should Invest 4
Investment Strategy 5
Investment Policies 9
Investment
Limitations 10
Investment
Performance 10
Share Price 11
Dividends, Capital
Gains, and Taxes 11
The Fund and
Vanguard 12
Investment Adviser 12
General Information 13
Investing
with Vanguard
- - For Plan Participants 15
- - For Other
Institutional Investors 15
Accessing Fund
Information
by Computer 16
Glossary Inside Back Cover
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
Vanguard/Wellesley Income Fund, Inc. (the "Fund") is an open-end diversified
investment company, or mutual fund.
The Fund seeks to provide a high and sustainable level of income along with
moderate long-term capital growth by investing approximately 60% to 70% of its
assets in high-quality, longer-term corporate, U.S. Treasury, government agency,
and mortgage-backed bonds. The remaining 30% to 40% of Fund assets are invested
in stocks of companies that have a history of above-average dividends or
expectations of increasing dividends.
IT IS IMPORTANT TO NOTE THAT THE FUND'S SHARES ARE NOT GUARANTEED OR INSURED
BY THE FDIC OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT. AS WITH ANY INVESTMENT
IN BONDS (WHICH ARE SENSITIVE TO CHANGES IN INTEREST RATES) AND STOCKS (WHICH
ARE SUBJECT TO WIDE FLUCTUATIONS IN MARKET VALUE), YOU COULD LOSE MONEY BY
INVESTING IN THE FUND.
FEES AND EXPENSES
The Fund is offered on a no-load basis, which means that you pay no sales
commissions or 12b-1 marketing fees. You will, however, incur expenses for
investment advisory, management, administrative, and distribution services,
which are included in the expense ratio.
IMPORTANT NOTE
This prospectus is intended for institutional clients and for participants in
employer-sponsored retirement or savings plans. Another version--for investors
who would like to open a personal investment account--can be obtained by calling
Vanguard at 1-800-662-7447.
ADDITIONAL INFORMATION ABOUT THE FUND
A Statement of Additional Information (dated April 25, 1997) containing more
information about the Fund is, by reference, part of this prospectus and may be
obtained without charge by contacting Vanguard (see back cover).
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objectives, risks, and strategies of
Vanguard/Wellesley Income Fund. To highlight terms and concepts important to
mutual fund investors, we have provided "Plain Talk" explanations along the way.
Reading the prospectus will help you to decide whether the Fund is the right
investment for your needs. We suggest that you keep it for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
<PAGE> 33
PORTFOLIO PROFILE Vanguard/Wellesley Income Fund
WHO SHOULD INVEST (Page 4)
- - Investors seeking a balanced mutual fund as part of a diversified investment
program.
- - Investors seeking income along with moderate capital growth and willing to
invest for the long term--at least five years.
WHO SHOULD NOT INVEST
- - Investors seeking a fund that invests exclusively in either stocks or in
bonds.
- - Investors unwilling to accept significant fluctuations in share price.
RISKS OF THE FUND (Pages 4-9)
The Fund's total return will fluctuate within a wide range, so an investor could
lose money over short or even extended periods. The Fund is subject to--among
other risks--interest rate risk (the chance that bond prices will decline
because of rising interest rates) and stock market risk (the chance that stock
prices in general will decline, sometimes suddenly and sharply).
DIVIDENDS AND CAPITAL GAINS (Page 11)
Dividends are paid in March, June, September, and December. Capital gains, if
any, are paid in December. In participant accounts, all distributions are
automatically reinvested.
INVESTMENT ADVISER (Page 12)
Wellington Management Company, LLP,
Boston, MA.
INCEPTION DATE: July 1, 1970
NET ASSETS AS OF 12/31/96: $7.01 billion
FUND'S EXPENSE RATIO FOR THE
YEAR ENDED 12/31/96: 0.31%
NEWSPAPER ABBREVIATION: Wellsl
VANGUARD FUND NUMBER: 027
AVERAGE ANNUAL TOTAL RETURNS--
PERIODS ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS
---------------------------------
<S> <C> <C> <C>
Wellesley Income Fund 9.4% 10.9% 11.1%
Composite Index* 6.8 10.8 11.2
</TABLE>
QUARTERLY RETURNS (%) 1987-1996 (intended to show volatility of returns)
[GRAPH]
* The Composite Index is made up of 65% bonds and 35% stocks. See page 11 for
details.
In evaluating past performance, remember that it is not indicative of future
performance. Performance figures include the reinvestment of any dividends and
capital gains distributions. The returns shown are net of expenses for the Fund,
but they do not reflect income taxes an investor would have incurred. The
Composite Index is a theoretical portfolio, incurring none of the advisory fees,
operating expenses, and portfolio transaction costs that are borne by an
operating mutual fund. Note, too, that both the return and principal value of an
investment will fluctuate so that investors' shares, when redeemed, may be worth
more or less than their original cost.
1
<PAGE> 34
PLAIN TALK ABOUT
THE COSTS OF INVESTING
Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with buying, selling, or exchanging shares. These costs can
erode a substantial portion of the gross income or capital appreciation a fund
achieves. Even seemingly small differences in fund expenses can, over time, have
a dramatic impact on a fund's performance.
PLAIN TALK ABOUT
FUND EXPENSES
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. Vanguard/Wellesley Income Fund's expense ratio in fiscal year 1996 was
0.31%, or $3.10 per $1,000 of average net assets. The average balanced mutual
fund had expenses in 1996 of 1.32%, or $13.20 per $1,000 of average net assets,
according to Lipper Analytical Services, Inc., which reports on the mutual fund
industry.
FUND EXPENSES
The examples below are designed to help you understand the various costs you
would bear, directly or indirectly, as an investor in the Fund.
As noted in this table, you do not pay fees of any kind when you buy, sell, or
exchange shares of the Fund:
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
</TABLE>
The next table illustrates the operating expenses that you would incur as a
shareholder of the Fund. These expenses are deducted from the Fund's income
before it is paid to you. Expenses include investment advisory fees as well as
the costs of maintaining accounts, administering the Fund, providing shareholder
services, and other activities. The expenses shown in the table are for the
fiscal year ended December 31, 1996.
ANNUAL FUND OPERATING EXPENSES
<TABLE>
<S> <C> <C>
Management and Administrative Expenses: 0.23%
Investment Advisory Expenses: 0.05%
12b-1 Marketing Fees: None
Other Expenses
Marketing and Distribution Costs: 0.02%
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.01%
----
Total Other Expenses: 0.03%
----
TOTAL OPERATING EXPENSES (EXPENSE RATIO): 0.31%
====
</TABLE>
The following example illustrates the hypothetical expenses that you would
incur on a $1,000 investment over various periods. The example assumes (1) that
the Fund provides a return of 5% a year and (2) that you redeem your investment
at the end of each period.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------------------------------------------------------
<S> <C> <C> <C>
$3 $10 $17 $39
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE, WHICH MAY BE HIGHER OR LOWER THAN
THOSE SHOWN.
2
<PAGE> 35
FINANCIAL HIGHLIGHTS
The following financial highlights table shows the results for a share
outstanding for each of the last ten years ended December 31, 1996. The
financial highlights were audited by Price Waterhouse LLP, independent
accountants. You should read this information in conjunction with the Fund's
financial statements and accompanying notes, which appear, along with the audit
report from Price Waterhouse, in the Fund's most recent Annual Report to
shareholders. The Annual Report is incorporated by reference in the Statement of
Additional Information and in this prospectus, and contains a more complete
discussion of the Fund's performance. You may have the Report sent to you
without charge by writing to Vanguard (see back cover).
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $20.44 $17.05 $19.24 $18.16 $18.08 $16.02 $16.82 $15.26 $14.57 $16.27
--------------------------------------------------------------------------------------------------------
Investment Operations
Net Investment Income 1.17 1.13 1.11 1.14 1.21 1.27 1.30 1.32 1.23 1.24
Net Realized and
Unrealized Gain (Loss)
on Investments .66 3.68 (1.95) 1.48 .29 2.06 (.72) 1.79 .69 (1.52)
--------------------------------------------------------------------------------------------------------
Total from Investment
Operations 1.83 4.81 (.84) 2.62 1.50 3.33 .58 3.11 1.92 (.28)
- ----------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net
Investment Income (1.16) (1.14) (1.11) (1.14) (1.21) (1.27) (1.30) (1.31) (1.23) (1.04)
Distributions from
Realized Capital Gains (.60) (.28) (.24) (.40) (.21) -- (.08) (.24) -- (.38)
--------------------------------------------------------------------------------------------------------
Total Distributions (1.76) (1.42) (1.35) (1.54) (1.42) (1.27) (1.38) (1.55) (1.23) (1.42)
- ----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
End of Period $20.51 $20.44 $17.05 $19.24 $18.16 $18.08 $16.02 $16.82 $15.26 $14.57
==================================================================================================================================
Total Return 9.42% 28.91% -4.44% 14.65% 8.67% 21.57% 3.76% 20.93% 13.61% -1.92%
==================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Period (Millions) $7,013 $7,181 $5,681 $6,011 $3,178 $1,934 $1,022 $788 $567 $495
Ratio of Expenses to
Average Net Assets 0.31% 0.35% 0.34% 0.33% 0.35% 0.40% 0.45% 0.45% 0.51% 0.49%
Ratio of Net Investment
Income to Average
Net Assets 5.74% 5.96% 6.16% 5.79% 6.50% 7.08% 7.77% 7.68% 8.14% 7.83%
Portfolio Turnover Rate
Bonds 29% 33% 31% 18% 24% 34% 13% 11% 19% 48%
Stocks 18% 26% 32% 26% 16% 19% 12% 10% 19% 27%
Average Commission
Rate Paid .0334 N/A N/A N/A N/A N/A N/A N/A N/A N/A
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
From time to time, the Vanguard funds may advertise yield and total return
figures. Yield is an historical measure of dividend income, and total return is
a measure of past dividend income (assuming that it has been reinvested) plus
capital appreciation. Neither yield nor total return should be used to predict
the future performance of a fund.
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 1996 with a net asset value (price) of $20.44 per share.
During the year, the Fund earned $1.17 per share from investment income
(interest and dividends) and $0.66 per share from investments that had
appreciated in value or that were sold for higher prices than the Fund paid for
them. Of those total earnings of $1.83 per share, $1.76 per share was returned
to shareholders in the form of distributions ($1.76 in dividends, $0.60 in
capital gains). The earnings ($1.83 per share) less distributions ($1.76 per
share) resulted in a share price of $20.51 at the end of the year, an increase
of $0.07 per share (from $20.44 at the beginning of the period to $20.51 at the
end of the period). Assuming that the shareholder had reinvested the
distributions in the purchase of more shares, total return from the Fund was
9.42% for the year.
As of December 31, 1996, the Fund had $7.01 billion in net assets; an expense
ratio of 0.31% ($3.10 per $1,000 of net assets); and net investment income
amounting to 5.74% of average net assets. It sold and replaced bonds valued at
29% of its bond holdings and stocks valued at 18% of its stock holdings.
3
<PAGE> 36
PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are "middle-of-the-road" investments that seek to provide some
combination of income, growth, and conservation of principal by investing in a
mix of stocks, bonds, and/or money market instruments. Because stocks and bonds
tend to move in different directions, balanced funds are able to use the rewards
from one type of investment to help offset the risks from another.
PLAIN TALK ABOUT
COSTS AND MARKET TIMING
Some investors try to profit from "market timing"--switching money into
investments when they expect prices to rise, and taking money out when they
expect the market to fall. As money is shifted in and out, a fund incurs
expenses for buying and selling securities. These costs are borne by all fund
shareholders, including long-term investors who do not generate the costs.
Therefore, the Fund discourages short-term trading by, among other things,
closely monitoring daily transactions.
A WORD ABOUT RISK
This prospectus describes the risks you will face as an investor in
Vanguard/Wellesley Income Fund. It is important to keep in mind one of the main
axioms of investing: the higher the risk of losing money, the higher the
potential reward. The reverse, also, is generally true: the lower the risk, the
lower the potential reward. However, as you consider an investment in Wellesley
Income Fund, you should also take into account your personal tolerance for the
daily fluctuations of both the bond and stock markets, as well as your need for
current income.
Look for this "warning flag" symbol [FLAG] throughout the prospectus. It is
used to mark detailed information about each type of risk that you, as a
shareholder of the Fund, will confront.
THE FUND'S OBJECTIVES
The Fund seeks to provide a high and sustainable level of income along with
moderate capital growth. These objectives are not fundamental, which means that
they can be changed by the Fund's board of directors without shareholder
approval. However, before making any important change in its objectives, the
Fund will give shareholders 30-days notice, in writing.
[FLAG] BECAUSE OF THE SEVERAL TYPES OF RISK DESCRIBED ON THE FOLLOWING PAGES,
YOUR INVESTMENT IN THE FUND, AS WITH ANY INVESTMENT IN BONDS AND
STOCKS, COULD LOSE MONEY.
WHO SHOULD INVEST
The Fund may be a suitable investment for you if:
- - Your primary investment goal is income.
- - You wish to add an income fund to your existing holdings, which could include
other stock and bond--as well as money market and tax-exempt--investments. n
You want a simple way to invest in a relatively fixed percentage of bonds and
stocks.
- - You are looking for moderate growth of capital over the long term--at least
five years.
This Fund is not an appropriate investment if you are a market-timer.
Investors who engage in excessive in-and-out trading activity generate
additional costs that are borne by all of the Fund shareholders. To minimize
such costs, which reduce the ultimate returns achieved by you and other
shareholders, the Fund has adopted the following policies:
- - The Fund reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it
4
<PAGE> 37
regards as disruptive to the efficient management of the Fund. This could be
because of the timing of the investment or because of a history of excessive
trading by the investor.
- - There is a limit on the number of times you can exchange into or out of the
Fund. If you own shares of the Fund as an investment option in an
employer-sponsored retirement or savings plan, your plan dictates the rules
governing exchanges. Contact your plan administrator for details.
- - The Fund reserves the right to stop offering shares at any time.
INVESTMENT STRATEGY
This section explains how Wellesley Income Fund's investment adviser pursues the
objectives of income and moderate capital growth. It also explains important
risks--interest rate risk, stock market risk, manager risk, credit risk, call
risk, and prepayment risk--faced by investors in the Fund. Like the Fund's
objectives, the adviser's investment strategies are not fundamental and can be
changed by the Fund's board of directors without shareholder approval. However,
before making any important change in its strategy, the Fund will give
shareholders 30-days notice, in writing.
MARKET EXPOSURE
BONDS
The Fund invests approximately two-thirds of its assets in bonds.
[FLAG] THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE POSSIBILITY
THAT BOND PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED
PERIODS DUE TO RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE
MODEST FOR SHORTER-TERM BONDS AND HIGH FOR LONGER-TERM BONDS.
In the past, bond investors have seen the value of their investment rise and
fall--sometimes significantly--with changes in interest rates. Between December
1976 and September 1981, for instance, rising interest rates caused the price of
long-term bonds to fall by almost 48%.
Because of the Fund's emphasis on bonds, changes in interest rates will have
a significant impact on the Fund's assets. To illustrate how much of an impact,
the following table shows the effect of a 2% change (both up and down) in
interest rates on three $1,000 bonds, each with a different maturity.
PLAIN TALK ABOUT
BONDS AND INTEREST RATES
When interest rates rise, bond prices fall. The opposite is also true: Bond
prices go up when interest rates fall. Why do bond prices and interest rates
move in opposite directions? Let's assume that you hold a bond offering a 5%
yield. A year later, interest rates are on the rise and bonds are offered with a
6% yield. With higher-yielding bonds available, you would have trouble selling
your 5% bond for the price you paid--causing you to lower your asking price. On
the other hand, if interest rates were falling and 4% bonds were being offered,
you would be able to sell your 5% bond for more than you paid.
5
<PAGE> 38
PLAIN TALK ABOUT
BOND MATURITIES
A bond is issued with a specific maturity date--the date when the bond's issuer,
or seller, must pay back the bond's initial value (known as its "face value").
Bond maturities generally range from less than one year (short term) to 30 years
(long term). The longer a bond's maturity, the more risk you, as a bond
investor, face as interest rates rise--but also the more interest you could
receive. Long-term bonds are more suitable for investors willing to take greater
risks in hope of higher yields; short-term bond investors should be willing to
accept lower yields in return for less fluctuation in the value of their
investment.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
HOW INTEREST RATE CHANGES AFFECT BONDS*
- ---------------------------------------------------------------------------
VALUE OF A $1,000 BOND
----------------------------------
AFTER A AFTER A
MATURITY 2% INCREASE 2% DECREASE
- ---------------------------------------------------------------------------
<S> <C> <C>
Short-Term (2.5 years) $956 $1,046
Intermediate-Term (10 years) $870 $1,156
Long-Term (20 years) $816 $1,251
- ---------------------------------------------------------------------------
</TABLE>
*Assumes a 7% yield.
These figures are for illustration only and should not be regarded as an
indication of future returns from the bond market as a whole, or the Fund in
particular.
STOCKS
Roughly one-third of Wellesley Income Fund's assets are invested in common
stocks.
[FLAG] THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE POSSIBILITY THAT
STOCK PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING STOCK
PRICES AND PERIODS OF FALLING STOCK PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns (dividend income plus change in market
value) for the U.S. stock market over various time periods as measured by the
Standard & Poor's 500 Composite Stock Price Index, a widely used barometer of
stock market activity. Note that the returns shown do not include the costs of
buying and selling stocks or other expenses that a real-world investment
portfolio would incur. Note, also, how the gap between best and worst tends to
narrow over the long term.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-1996)
- ---------------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 53.9% 23.9% 20.1% 16.9%
Worst -43.3 -12.5 -0.9 3.1
Average 12.7 10.4 10.8 10.8
- ---------------------------------------------------------------------------------------
</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1996. For example, while the average return on stocks for all of the
5-year periods was 10.4%, returns for these 5-year periods ranged from a -12.5%
average (from 1928 through 1932), to 23.9% (from 1951 through 1955). These
average returns reflect past performance on common stocks and should not be
regarded as an indication of future returns from either the stock market as a
whole or this Fund in particular.
6
<PAGE> 39
The stocks held by Wellesley Income Fund are chosen primarily for their
income potential. As a result, the Fund does not hold the same securities held
in the S&P 500 Index or any other market index, and the performance of the
Fund--or the Fund's stock holdings--will not mirror the returns of any
particular index.
Because bond prices and stock prices often move in different directions, the
Fund's stock holdings help to dampen--but not eliminate--some of the bond-price
fluctuations caused by changes in interest rates. Likewise, stock market
volatility may not be as dramatic for Wellesley Income Fund as it would be for a
fund made up entirely of stocks.
SECURITY SELECTION
Wellington Management Company, LLP (WMC), adviser to the Fund, invests
approximately 60% to 70% of the Fund's assets in high-quality bonds and
approximately 30% to 40% of the Fund's assets in dividend-paying common stocks.
While the mix of bonds and stocks will vary from time to time depending on the
adviser's view of economic and market conditions, bonds can be expected to
represent at least 60% of the Fund's holdings.
The Fund is run by WMC according to traditional methods of active investment
management. Securities are bought and sold according to WMC's judgments about
bond issuers and the general level of interest rates, and about companies and
their financial prospects. To achieve the Fund's objectives of income and
moderate capital growth, the adviser follows specific strategies when selecting
bonds and stocks.
[FLAG] THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE POSSIBILITY THAT WMC
MAY DO A POOR JOB OF SELECTING BONDS AND STOCKS.
BONDS
WMC selects high-quality bonds that, it believes, will generate a high and
sustainable amount of current income. These include intermediate- and long-term
corporate, U.S. Treasury, government agency, mortgage-backed, and asset-backed
bonds. The average maturity of these bonds as of December 31, 1996, was 17.2
years.
A breakdown of the Fund's bond holdings (which amounted to 60% of the Fund's
total net assets) as of December 31, 1996, follows.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
PERCENTAGE OF FUND'S
TYPE OF BOND BOND COMPONENT
- ------------------------------------------------------------------------
<S> <C>
Utilities 26%
Industrial 26
Banks/Finance 16
Treasury/Agency 13
Mortgage 14
Foreign Issuers 5
- -------------------------------------------------------------------------
</TABLE>
PLAIN TALK ABOUT
TYPES OF BONDS
Bonds are issued (sold) by many sources: corporations issue corporate bonds; the
federal government issues U.S. Treasury bonds; agencies of the federal
government issue agency bonds; mortgage holders issue "mortgage-backed" bonds
such as Government National Mortgage Association (GNMA). Each issuer is
responsible for paying back the bond's initial value as well as periodic
interest payments.
PLAIN TALK ABOUT
CREDIT QUALITY
A bond's credit quality depends on the issuer's ability to pay interest on the
bond and, ultimately, to repay the debt. The lower the rating by one of the
independent bond-rating agencies (such as Moody's or Standard & Poor's), the
greater the chance (in the rating agency's opinion) that the bond issuer will
default, or fail to meet its payment obligations. Most bond-rating agencies use
a descending alphabet scale to rate bonds (for example, Aaa is the highest
rating, C among the poorest quality ratings). All things being equal, the lower
a bonds's credit rating, the higher the yield the bond seeks to pay (as
compensation for the risks an investor must take).
7
<PAGE> 40
PLAIN TALK ABOUT
CALLABLE BONDS
Although bonds are issued with clearly defined maturities, a corporate issuer
may be able to redeem, or call, a bond earlier than its maturity date. The bond
holder must now replace the called bond with a bond that may have a lower yield
than the original. One way for bond investors to protect themselves against call
risk is to purchase a bond early in its lifetime, when it is less likely to be
called. Another way is to buy bonds with call protections -- that is, assurances
that a bond will not be called for a specific time period, such as ten years.
PLAIN TALK ABOUT
STOCKS AND DIVIDENDS
Many large and established companies share their profits, in the form of
dividends, with their shareholders. Other companies -- particularly those that
are new or small -- reinvest any profits back into the business to help the
company grow (and, hopefully, increase its stock's share price). In general,
stocks that offer above-average dividends appeal to investors who want some
dividend income and the potential for capital growth but are less tolerant of
share-price fluctuations, while growth stocks are appropriate for investors who
will accept more share-price volatility in hope of a greater increase in share
price.
Keep in mind that, because the bond makeup of the Fund changes daily, this
listing is only a "snapshot" at one point in time.
[FLAG] THE FUND IS SUBJECT TO CREDIT RISK, WHICH IS THE POSSIBILITY THAT A BOND
ISSUER WILL FAIL TO REPAY INTEREST AND PRINCIPAL IN A TIMELY MANNER.
The bonds WMC purchases for the Fund are primarily investment-grade quality
- -- that is, the bonds are rated at least Baa by Moody's Investors Service Inc.,
or BBB by Standard & Poor's Corporation. The average quality of the bonds held
by the Fund as of December 31, 1996, was Aa3 by Moody's.
The U.S. government guarantees the timely payment of interest and principal
for its Treasury bonds, but does not guarantee the bonds' prices. In other
words, while the Treasury bonds enjoy the highest credit ratings, their prices
- -- like the prices of the other bonds held by the Fund -- will fluctuate with
changes in interest rates.
Falling interest rates will affect two other types of bonds held by the
Fund -- although for different reasons.
[FLAG] THE FUND IS SUBJECT TO CALL RISK, WHICH IS THE POSSIBILITY THAT DURING
PERIODS OF FALLING INTEREST RATES, A CORPORATE BOND ISSUER WILL "CALL" --
OR REPAY -- ITS HIGH-YIELDING BOND BEFORE THE BOND'S MATURITY DATE.
FORCED TO INVEST THE UNANTICIPATED PROCEEDS AT LOWER INTEREST RATES, THE
FUND WOULD EXPERIENCE A DECLINE IN INCOME.
To protect the Fund's corporate bond holdings against call risk, WMC
purchases bonds that have reasonable protection from being called.
Bond issuers take advantage of falling interest rates by calling corporate
bonds. With mortgage-backed securities, it is the mortgage holder -- such as the
American homeowner -- who benefits from lower rates.
[FLAG] THE FUND IS SUBJECT TO PREPAYMENT RISK, WHICH IS THE POSSIBILITY THAT
FALLING INTEREST RATES WILL PROMPT HOMEOWNERS TO REPAY THEIR MORTGAGES
EARLIER THAN EXPECTED OR TO REFINANCE AT LOWER RATES. AS WITH CALL RISK,
THE FUND IS FORCED TO REPLACE THE PAID-UP BONDS WITH LOWER-YIELDING
ISSUES -- EXPERIENCING A DECLINE IN INCOME AND SHARE PRICE.
STOCKS
The Fund's stocks are chosen primarily for their dividend-producing
capabilities, along with their potential for moderate long-term capital growth.
WMC looks for stocks of companies that either offer significant dividends now or
expect to increase their dividends in the future.
The Fund's top ten stock holdings (which amounted to 13% of the Fund's net
assets) as of December 31, 1996, follow.
8
<PAGE> 41
1. First Union Corp.
2. Bristol-Myers Squibb Co.
3. Keycorp
4. Amoco Corp.
5. Ford Motor Co.
6. J.C. Penney Co., Inc.
7. Royal Dutch Petroleum Co. ADR
8. Kimberly-Clark Corp.
9. BankAmerica Corp.
10. NYNEX Corp.
Keep in mind that, because the stock makeup of the Fund changes daily, this
listing is only a "snapshot" at one point in time.
PORTFOLIO TURNOVER
Although the Fund generally seeks to invest for the long term, it retains the
right to sell stocks and bonds regardless of how long they have been held. The
Fund's average turnover rate for the past ten years has been about 26% and it is
not expected that the Fund's turnover would exceed 40% in the future. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its total net assets within a one-year period.)
INVESTMENT POLICIES
Besides investing in bonds and stocks, the Fund may follow a number of
investment policies to achieve its objectives.
Up to 20% of the Fund's stock holdings may be invested in foreign common
stocks as well as securities that are convertible into foreign stocks. The Fund
may also invest in fixed-income securities issued by foreign governments and by
companies domiciled outside the United States; however, these securities must be
valued in U.S. dollars and meet the Fund's credit quality standards.
Over the years, the prices of foreign investments and the prices of U.S.
investments have often moved in different directions. In addition, international
markets operate differently from U.S. markets. For instance, foreign exchanges,
brokers, and companies generally have less government supervision and regulation
than in the U.S.
The Fund may also invest in derivatives and may invest up to 15% of its
assets in restricted securities with limited marketability or other illiquid
securities.
[FLAG] THE FUND RESERVES THE RIGHT TO INVEST, TO A LIMITED EXTENT, IN BOND AND
STOCK FUTURES AND OPTIONS CONTRACTS, WHICH ARE TRADITIONAL TYPES OF
DERIVATIVES. THE FUND MAY ALSO INVEST MODESTLY IN LESS RISKY CLASSES OF
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS).
Losses (or gains) involving futures can sometimes be substantial -- in part
because a relatively small price movement in a
PLAIN TALK ABOUT
PORTFOLIO TURNOVER
Before investing in a mutual fund, you should review its portfolio turnover rate
for an indication of the potential effect of transaction costs on the fund's
future returns. In general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and other transaction
costs will have on its return. The average turnover rate for actively managed
balanced funds is 92%.
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new, exotic types of derivatives -- some of which
can carry considerable risks.
9
<PAGE> 42
PLAIN TALK ABOUT
CASH RESERVES
With mutual funds, holding cash reserves -- or "cash" -- does not mean literally
that the fund holds a stack of currency. Rather, cash reserves refer to
short-term, interest-bearing securities that can easily and quickly be converted
to cash, such as those described in the Glossary of this prospectus. (Most
mutual funds hold at least a small percentage of assets in cash to accommodate
shareholder redemptions.) While some funds strive to keep cash levels at a
minimum and to always remain fully invested in stocks and/or bonds, other funds
allow investment advisers to hold up to 20% of a fund's assets in cash reserves.
PLAIN TALK ABOUT
PAST PERFORMANCE
Whenever you see information on a fund's performance, do not consider the
figures to be an indication of the performance you could expect by making an
investment in the fund today. The past is an imperfect guide to the future;
history does not repeat itself in neat, predictable patterns.
futures contract may result in an immediate and substantial loss (or gain) for a
fund. This Fund will not use futures and options for speculative purposes or as
leveraged investments that magnify the gains or losses of an investment. If it
holds futures and options, the Fund will keep separate cash reserves or other
liquid portfolio securities in the amount of the obligation underlying the
contract. Only a limited percentage of the Fund's assets -- up to 5% if required
for deposit and no more than 20% of total assets -- may be committed to such
contracts.
The reasons for which the Fund may use futures and options are:
- - To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in bonds and stocks.
- - To make it easier to trade.
- - To reduce costs by buying futures instead of actual bonds and stocks when
futures are cheaper.
The Fund will usually hold only a small percentage of its assets in cash
reserves, although if the investment adviser believes that market conditions
warrant a temporary defensive measure, the Fund may hold cash reserves without
limit.
INVESTMENT LIMITATIONS
To reduce risk and maintain diversification, the Fund has adopted limits on some
of its investment policies. Specifically, the Fund will not:
- - Invest more than 25% of its total assets in any one industry.
- - Borrow money, except for the purpose of meeting shareholder requests to
redeem shares -- and not more than 10% of the Fund's net assets.
With respect to 75% of its assets, the Fund will not:
- - Invest more than 5% of its assets in the securities of any single issuer
except the U.S. government.
- - Buy more than 10% of the outstanding voting securities of any issuer.
The limitations listed in this prospectus and in the Statement of
Additional Information are fundamental and may be changed only by approval of a
majority of the Fund's shareholders.
INVESTMENT PERFORMANCE
Although Vanguard/Wellesley Income Fund invests primarily in bonds, it holds a
sizable percentage of common stocks, so the Fund's performance is closely tied
to both the bond and stock markets. Changes in interest rates are the strongest
influence on bond market performance. Stock market performance, on the other
hand, has historically been characterized by sharp up-and-down swings in the
short term, but by more stable growth over the long term.
The results shown represent the Fund's "average annual total return"
performance, which assumes that any distributions of
10
<PAGE> 43
AVERAGE ANNUAL TOTAL RETURNS
FOR PERIODS ENDED 12/31/96
[GRAPH]
*The Composite Index is made up of 65% bonds and 35% stocks.
capital gains and dividends were reinvested for the indicated periods. Also
included is comparative information on an unmanaged "composite" index of 65%
bonds and 35% stocks. The Lehman Long-Term Corporate AA or Better Bond Index (an
index of high-quality intermediate- and long-term corporate bonds) represents
the bond portion of the composite index. The S&P/BARRA Value Index (an index of
dividend-oriented large-company stocks) makes up 75% of the composite index's
stock portion; the S&P's Utilities Index (a measure of large gas and electric
utility companies) makes up 12.5%; and the S&P's Telephone Index (a measure of
large telephone utility companies) makes up the remaining 12.5%. The chart does
not make any allowance for federal, state, or local income taxes that
shareholders must pay on a current basis.
SHARE PRICE
The Fund's share price, called its net asset value, is calculated each business
day after the close of regular trading (generally 4 p.m. Eastern time) on the
New York Stock Exchange. Net asset value per share is calculated by adding up
the total assets of the Fund, subtracting all of its liabilities, or debts, and
then dividing by the number of Fund shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = ------------------------------------------------
NUMBER OF SHARES OUTSTANDING
The daily net asset value, or NAV, is useful to you as a shareholder
because the NAV, multiplied by the number of Fund shares you own, gives you the
dollar amount you would have received had you sold all of your shares back to
the Fund that day.
The Fund's share price can be found daily in the mutual fund listings of
most major newspapers under the heading Vanguard Group. Different newspapers use
different abbreviations of the Fund's name, but the most common is Wellsl.
DIVIDENDS, CAPITAL GAINS, AND TAXES
Each March, June, September, and December, the Fund distributes to shareholders
virtually all of its income from interest and
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your share of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or capital gains distribution. Income
dividends come from interest the fund earns from its money market and bond
investments as well as dividends it receives from its stock investments. Capital
gains are realized whenever the fund sells securities for higher prices than it
paid for them. These capital gains are either short-term or long-term depending
on whether the fund held the securities for less than or more than one year.
11
<PAGE> 44
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group, Inc. is the only mutual mutual fund company. It is owned
jointly by the funds it oversees and by the shareholders in those funds. Other
mutual funds are operated by for-profit management companies that may be owned
by one person, by a group of individuals, or by investors who bought the
management company's publicly traded stock. Because of its structure, Vanguard
operates its funds at cost. Instead of distributing profits from operations to a
separate management company, Vanguard returns profits to fund shareholders in
the form of lower operating expenses.
dividends. Any capital gains realized from the sale of securities are
distributed in December. In addition, the Fund may occasionally be required to
make supplemental dividend or capital gains distributions at some time during
the year (usually in March).
If you own shares of the Fund as an investment option in an
employer-sponsored retirement or savings plan, these dividend and capital gains
distribution will be reinvested in additional Fund shares and accumulate on a
tax-deferred basis. You will not owe taxes on these distributions until you
begin withdrawals. You should consult your plan administrator, your plan's
Summary Plan Document, or your own tax adviser about the tax consequences of an
investment in the Fund and of any plan withdrawals.
If your Vanguard/Wellesley Fund investment is not part of an
employer-sponsored plan, you can receive distributions of income in cash or in
more shares of the Fund. Both dividend and capital gains distributions --
whether received in cash or reinvested in additional shares -- are subject to
federal (and possibly state and local) income taxes, no matter how long you
have held the shares in the Fund. You should consult your own tax adviser about
other tax consequences of an investment in the Fund.
THE FUND AND VANGUARD
The Fund is a member of The Vanguard Group, a family of more than 30 investment
companies with more than 90 distinct investment portfolios and total net assets
of more than $250 billion. All of the Vanguard funds share in the expenses
associated with business operations, such as personnel, office space, equipment,
and advertising.
Vanguard also provides marketing services to the funds. Although
shareholders do not pay sales commissions or 12b-1 marketing fees, each fund
pays its allocated share of The Vanguard Group's costs.
A list of the Fund's directors and officers, and their present positions
and principal occupations during the past five years, can be found in the
Statement of Additional Information.
INVESTMENT ADVISER
The Fund employs Wellington Management Company, LLP (WMC), 75 State Street,
Boston, MA 02109, as its investment adviser. WMC manages the Fund subject to the
control of the officers and directors of the Fund.
Each quarter, WMC is paid an advisory fee based on the Fund's average
month-end net assets during that quarter:
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<PAGE> 45
<TABLE>
<CAPTION>
ASSETS MANAGED FEE
---------------------------------------
<S> <C>
First $1 billion 0.10%
Next $2 billion 0.05
Next $7 billion 0.04
Assets over $10 billion 0.03
</TABLE>
The advisory fee can be increased or decreased based on the difference
between the Fund's total return performance and that of an unmanaged "composite
index," which is made up of Lehman Long-Term Corporate AA or Better Bond Index
(65% of the composite index), the S&P's/BARRA Value Index (approximately 26% of
the composite index) and the S&P's Utilities Index (approximately 9% of the
composite index). Under the fee schedule, the basic fee may be increased or
decreased by as much as 20%. The incentive/penalty fee will not be in full
operation until the quarter ending March 31, 1999. Until that date, the
incentive/penalty fee will be calculated using certain transition rules that are
explained in the Statement of Additional Information.
For the fiscal year ended December 31, 1996, the investment advisory fee
paid to WMC was $3.61 million.
The agreement authorizes WMC to choose brokers or dealers to handle the
purchase and sale of the Fund's securities, and directs WMC to get the best
available price and most favorable execution from these brokers with respect to
all transactions. At times, WMC may choose brokers who charge higher commissions
in the interest of obtaining better execution of a transaction. If more than one
broker can obtain the best available price and favorable execution of a
transaction, then WMC is authorized to choose a broker who, in addition to
executing the transaction, will provide research services to WMC or the Fund.
However, WMC will not pay higher commisions specifically for the purpose of
obtaining research services. The Fund may direct WMC to use a particular broker
for certain transactions in exchange for commission rebates or research services
provided to the Fund.
The board of directors may, without prior approval from shareholders,
change the terms of the advisory agreement or hire a new investment adviser,
either as a replacement for WMC or as an additional adviser. However, no such
change would be made before giving shareholders 30-days notice, in writing.
GENERAL INFORMATION
Vanguard/Wellesley Income Fund is a corporation organized under the laws of the
state of Maryland. Shareholders of the Fund have rights and privileges similar
to those enjoyed by other corporate shareholders. For example, shareholders will
not be responsible for any liabilities of the corporation. If any matters are to
be
PLAIN TALK ABOUT
THE FUND'S ADVISER
Wellington Management Company, LLP, an investment advisory firm founded in 1933,
currently manages more than $140 billion in stock and bond portfolios, including
14 Vanguard Funds. The managers responsible for overseeing Vanguard/Wellesley
Income Fund are:
EARL E. MCEVOY, Senior Vice President of WMC; 25 years investment
experience, 19 years with WMC (including 13 years with Wellesley Income Fund);
B.A. from Dartmouth College, M.B.A. from Columbia Business School.
JOHN R. RYAN, CFA, Senior Vice President and Managing Partner of WMC; 16
years with WMC (including 11 years with Wellesley Income Fund); B.S. from Lehigh
University, M.B.A. from the University of Virginia.
13
<PAGE> 46
voted on by shareholders (such as the election of directors), each share
outstanding at that point would be entitled to one vote. Annual meetings will
not be held by the Portfolio except as required by the Investment Company Act of
1940. A meeting will be scheduled (for example, to vote on the removal of a
director) if the holders of at least 10% of the Fund's shares request a meeting
in writing.
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<PAGE> 47
INVESTING WITH VANGUARD
FOR PLAN PARTICIPANTS
Vanguard/Wellesley Income Fund is an investment option in your retirement or
savings plan. Your plan administrator or your employee benefits office can
provide you with detailed information on how to participate in your plan and how
to elect the Fund as an investment option.
- - If you have any questions about the Fund or Vanguard, including the Fund's
investment objectives, strategies, or risks, contact Vanguard's Participant
Services Department, toll-free, at 1-800-523-1188.
- - If you have questions about your account, contact your plan administrator
or the organization that provides recordkeeping services for your plan.
INVESTMENT OPTIONS AND ALLOCATIONS
Your plan's specific provisions may allow you to change your investment
selections, the amount of your contributions, or how your contributions are
allocated among the investment choices available to you. Contact your plan
administrator or employee benefits office for more details.
TRANSACTIONS
Contributions, exchanges, or redemptions of the Fund's shares are processed as
soon as they have been received by Vanguard in good order. Good order means that
your request includes complete information on your contribution, exchange, or
redemption, and that Vanguard has received the appropriate assets.
EXCHANGES
The exchange privilege (your ability to redeem shares from one fund to purchase
shares of another fund) may be available to you through your plan. However,
because excessive exchanges can potentially disrupt the management of the Fund
and increase its transaction costs, Vanguard reserves the right to refuse any
exchange request. In addition, certain investment options, particularly funds
made up of company stock or investment contracts, may be subject to unique
restrictions. Contact your plan administrator for details on the exchange
policies that apply to your plan.
Before making an exchange, you should consider the following:
- - Before you exchange to another Vanguard fund available in your plan, you
should read that fund's prospectus. Contact Participant Services,
toll-free, at 1-800-523-1188 for a copy.
- - Vanguard can accept exchanges only as permitted by your plan. Your plan
administrator can explain how frequently exchanges are allowed.
FOR OTHER INSTITUTIONAL INVESTORS
If you have questions about Vanguard/Wellesley Income Fund, including how to
establish an account, call Vanguard, toll-free, at 1-800-523-1036.
If you have questions about an existing account, contact your Vanguard
account administrator.
TRANSACTIONS
Purchases, exchanges, or redemptions of the Fund's shares are processed as soon
as they have been received by Vanguard in good order. Good order means that your
request
15
<PAGE> 48
INVESTING WITH VANGUARD (continued)
includes complete information on your purchase, exchange, or redemption, and
that Vanguard has received the appropriate assets. The price of shares bought,
exchanged, or sold will be the Fund's next-determined net asset value after
Vanguard has processed your request, provided your request has been received
before 4 p.m. Eastern time.
Vanguard must consider the interests of all Fund shareholders and so
reserves the right to . . .
- - Delay or reject any purchase or exchange request that may disrupt the
Fund's operation or performance.
- - Revise or terminate the exchange privilege or limit the amount of an
exchange, at any time, without notice.
- - Take up to seven days to deliver your redemption proceeds.
- - Pay redemption proceeds -- in whole or in part -- through a distribution in
kind of readily marketable securities.
ACCESSING FUND INFORMATION BY COMPUTER
<TABLE>
<S> <C>
VANGUARD ON THE Use your personal computer to visit Vanguard's
WORLD WIDE WEB education-oriented website, which provides timely
http://www.vanguard.com news and information about Vanguard funds and
services; an on-line "university" that offers a
variety of mutual fund classes; and easy-to-use,
interactive tools to help you create your own
investment and retirement strategies.
VANGUARD ONLINE(SM) Use your personal computer to learn more about
KEYWORD: Vanguard Vanguard funds and services; map out a long-term
investment strategy; and ask questions, make
suggestions, and send messages to Vanguard.
Vanguard Online is offered through America
Online(R) (AOL). To establish an AOL account, call
1-800-238-6336.
</TABLE>
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<PAGE> 49
GLOSSARY OF INVESTMENT TERMS
BALANCED FUND
A mutual fund that seeks to provide some combination of income, capital growth,
and conservation of principal by investing in stocks, bonds, and/or money market
instruments.
BOND
A debt security (IOU) issued by a corporation, government, or government agency
in exchange for the money you lend it. The issuer usually agrees to pay back the
loan--through regular interest payments--by a specific date.
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized during the year on
securities that the fund has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits as well as short-term bank deposits, money market instruments,
bank CDs, repurchase agreements, and U.S. Treasury bills.
COMMON STOCK
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.
CREDIT QUALITY
A measure of a bond issuer's ability to repay interest and principal in a timely
manner.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by the
fund's investments.
DURATION
A measure of the sensitivity of bond prices--and the share prices of bond
funds--to interest rate changes. For example, if a bond has a duration of two
years, its price would fall about 2% when interest rates rose one percentage
point; conversely, the bond's price would rise about 2% if interest rates fell
one percentage point.
EXPENSE RATIO
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
marketing fees.
FIXED-INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a portfolio's
investments.
INVESTMENT GRADE
Bonds whose credit quality is considered to be among the highest by independent
bond-rating agencies.
MATURITY
The date that a bond issuer agrees to repay the bond's principal to the bond's
buyer.
MUTUAL FUND
An investment company that pools the money of many people and invests it in a
variety of securities in an effort to achieve a specific objective over time.
NET ASSET VALUE (NAV)
The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.
PRINCIPAL
The amount of your own money you put into an investment.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
VOLATILITY
The fluctuations in price of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Current income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's current price.
<PAGE> 50
[THE VANGUARD GROUP LOGO]
Institutional Division
Post Office Box 2900
Valley Forge, PA 19482
<TABLE>
<S> <C> <C>
For Participants in For Other Institutional Investors Electronic Access to the
Employer-Sponsored Plans 1-800-523-1036 Vanguard Mutual Fund
For information on Vanguard Education and Information
Participant Services Department funds and services Center
1-800-523-1188 World Wide Web
Text Telephone: http://www.vanguard.com
1-800-523-8004
For information on the E-mail
Vanguard funds in your plan, [email protected]
Monday through Friday
8:30 a.m. to 7 p.m.,
Eastern time
</TABLE>
<PAGE> 51
PART B
VANGUARD/WELLESLEY INCOME FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
APRIL 25, 1997
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated April 25, 1997). To obtain the Prospectus
please call:
INVESTOR INFORMATION DEPARTMENT
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................................... 1
Investment Limitations.................................................................... 5
Purchase of Shares........................................................................ 7
Redemption of Shares...................................................................... 7
Yield and Total Return.................................................................... 7
The Vanguard Group........................................................................ 8
Investment Advisory Services.............................................................. 12
Portfolio Transactions.................................................................... 14
Performance Measures...................................................................... 15
Appendix-Description and Ratings of Securities............................................ 17
Financial Statements...................................................................... 18
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
PORTFOLIO TURNOVER While the rate of portfolio turnover is not a limiting
factor when management deems changes appropriate, it is anticipated that the
Fund's annual common stock portfolio turnover rate will not normally exceed 40%.
The Fund's bond and common stock portfolio turnover rate for each of its last
ten fiscal years is set forth under "Financial Highlights," in the Fund's
Prospectus.
REPURCHASE AGREEMENTS The Fund may invest in repurchase agreements with
commercial banks, brokers or dealers either for defensive purposes due to market
conditions or to generate income from its excess cash balances. A repurchase
agreement is an agreement under which the Fund acquires a money market
instrument (generally a security issued by the U.S. Government or an agency
thereof, a banker's acceptance or a certificate of deposit) from a commercial
bank, broker or dealer, subject to resale to the seller at an agreed upon price
and date (normally, the next business day). A repurchase agreement may be
considered a loan collateralized by securities. The resale price reflects an
agreed upon interest rate effective for the period the instrument is held by the
Fund and is unrelated to the interest rate on the underlying instrument. In
these transactions, the securities acquired by the Fund (including accrued
interest earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by a custodian bank until repurchased. In
addition, the Fund's Board of Directors will monitor the Fund's repurchase
agreement transactions generally and will establish guidelines and standards for
review by the investment adviser of the creditworthiness of any bank, broker or
dealer party to a repurchase agreement with the Fund. No more than an aggregate
of 15% of the Fund's assets, at the time of investment, will be invested in
repurchase agreements having maturities longer than seven days and securities
subject to legal or contractual restrictions on resale for which there are no
readily available market quotations. From time to time, the Fund's Board of
Directors may determine that certain restricted securities known as Rule 144A
securities are liquid and not subject to the 15% limitation described above. See
"Illiquid Securities" on page 3.
The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has
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<PAGE> 52
declined, the Fund may incur a loss upon disposition of the security. If the
other party to the agreement becomes insolvent and subject to liquidation or
reorganization under the Bankruptcy Code or other laws, a court may determine
that the underlying security is collateral for a loan by the Fund not within the
control of the Fund and therefore the Fund may not be able to substantiate its
interest in the underlying security and may be deemed an unsecured creditor of
the other party to the agreement. While the Fund's management acknowledges these
risks, it is expected that they can be controlled through careful monitoring
procedures.
MORTGAGE-BACKED SECURITIES The Fund may invest in mortgage-backed
securities. Mortgage-backed securities are instruments that entitle the holder
to a share of all interest and principal payments from mortgages underlying the
security. The mortgages backing these securities include conventional
thirty-year fixed rate mortgages, graduated payment mortgages and adjustable
rate mortgages. During periods of declining interest rates, prepayment of
mortgages underlying mortgage-backed securities may be expected to accelerate.
Prepayment of mortgages which underlie securities purchased at a premium often
results in capital losses, while prepayment of mortgages purchased at a discount
often results in capital gains. Because of these unpredictable prepayment
characteristics, it is often not possible to predict accurately the average life
or realized yield of a particular issue.
Collateralized Mortgage Obligations ("CMOs") are debt obligations or
multi-class pass-through certificates issues by agencies or instrumentalities of
the U.S. Government, or by private originators or investors in mortgage loans.
In a CMO, series of bonds or certificates are usually issued in multiple
classes, with principal and interest allocated to each class in a variety of
ways. Each class of a CMO or "tranche" is issued with a specific fixed or
floating coupon rate and has a stated maturity or final distribution date. The
Fund will invest modestly in those CMO classes which feature a high degree of
cash flow predictability and moderate vulnerability to prepayment risk, and that
carry high-quality investment grade credit ratings.
LENDING OF SECURITIES The Fund may lend its securities to qualified
institutional investors who need to borrow securities in order to complete
certain transactions, such as covering short sales, avoiding failures to deliver
securities or completing arbitrage operations. By lending its portfolio
securities, the Fund attempts to increase its net investment income through the
receipt of interest on the loan. Any gain or loss in the market price of the
securities loaned that might occur during the term of the loan would be for the
account of the Fund. The Fund may lend its portfolio securities to qualified
brokers, dealers, banks or other financial institutions, so long as the terms,
the structure and the aggregate amount of such loans are not inconsistent with
the Investment Company Act of 1940, or the Rules and Regulations or
interpretations of the Securities and Exchange Commission (the "Commission")
thereunder, which currently require that (a) the borrower pledge and maintain
with the Fund collateral consisting of cash, an irrevocable letter of credit
issued by a domestic U.S. bank, or securities issued or guaranteed by the United
States Government having a value at all times not less than 100% of the value of
the securities loaned, (b) the borrower add to such collateral whenever the
price of the securities loaned rises (i.e. the borrower "marks to the market" on
a daily basis), (c) the loan be made subject to termination by the Fund at any
time, and (d) the Fund receive reasonable interest on the loan (which may
include the Fund's investing any cash collateral in interest bearing short-term
investments), any distribution on the loaned securities and any increase in
their market value. Loan arrangements made by the Fund will comply with all
other applicable regulatory requirements, including the rules of the New York
Stock Exchange, which rules presently require the borrower, after notice, to
redeliver the securities within the normal settlement time of three business
days. All relevant facts and circumstances, including the creditworthiness of
the broker, dealer or institution, will be considered in making decisions with
respect to the lending of securities, subject to review by the Fund's Board of
Directors.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's directors. In addition, voting rights pass
with the loaned securities, but if a material event will occur affecting an
investment on loan, the loan must be called and the securities voted.
FOREIGN INVESTMENTS As indicated in the Prospectus, the Fund may invest up
to 15% of its equity assets in foreign common stocks and securities convertible
into foreign stocks. The Fund may also invest in U.S.
2
<PAGE> 53
dollar denominated debt securities issued by foreign governments, their agencies
and instrumentalities, supranational entities and companies located outside the
U.S. without limit. Investors should recognize that investing in foreign
companies involves certain special considerations which are not typically
associated with investing in U.S. companies. Among these risks are the
following:
Country Risk As foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards and practices comparable
to those applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more volatile
than securities of comparable domestic companies. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
companies than in the U.S. In addition, with respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
U.S. investments in those countries.
Although the Fund will endeavor to achieve most favorable execution costs
in its portfolio transactions in foreign securities, fixed commissions on many
foreign stock exchanges are generally higher than negotiated commissions on U.S.
exchanges. In addition, it is expected that the expenses for custodial
arrangements of the Fund's foreign securities will be somewhat greater than the
expenses for the custodian arrangement for handling U.S. securities of equal
value.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income the Fund receives from its foreign investments.
Currency Risk Since the stocks of foreign companies are frequently
denominated in foreign currencies, and since the Fund may temporarily hold
uninvested reserves in bank deposits in foreign currencies, the Fund will be
affected favorably or unfavorably by changes in currency rates and in exchange
control regulations, and may incur costs in connection with conversions between
various currencies. The investment policies of the Fund permit it to enter into
forward foreign currency exchange contracts in order to hedge holdings and
commitments against changes in the level of future currency rates. Such
contracts involve an obligation to purchase or sell a specific currency at a
future date at a price set at the time of the contract.
ILLIQUID SECURITIES Illiquid securities are securities that may not be
sold or disposed of in the ordinary course of business within seven business
days at approximately the value at which they are being carried on a Fund's
books. An illiquid security includes repurchase agreements which have a maturity
of longer than seven days, securities which are illiquid by virtue of the
absence of a readily available market, and demand instruments with a demand
notice exceeding seven days. Illiquid securities may include securities that are
not registered under the Securities Act of 1933 (the "1933 Act"); however,
unregistered securities that can be sold to "qualified institutional buyers" in
accordance with Rule 144A under the 1933 Act will not be considered illiquid so
long as it is determined by the Fund's advisor that an adequate trading market
exists for the security.
FUTURES CONTRACTS AND OPTIONS The Fund may enter into futures contracts,
options, and options on futures contracts for the purpose of simulating full
investment and reducing transactions costs. Futures contracts provide for the
future sale by one party and purchase by another party of a specified amount of
a specific security at a specified future time and at a specified price. Futures
contracts which are standardized as to maturity date and underlying financial
instrument are traded on national futures exchanges. Futures exchanges and
trading are regulated under the Commodity Exchange Act by the Commodity Futures
Trading Commission ("CFTC"), a U.S. Government Agency. Assets committed to
futures contracts will be segregated at the Fund's custodian bank to the extent
required by law.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold," or "selling" a contract previously
purchased) in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
3
<PAGE> 54
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin which
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the prices of underlying securities. The Fund intends to use futures contracts
only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions. The Fund will
only sell futures contracts to protect securities it owns against price declines
or purchase contracts to protect against an increase in the price of securities
it intends to purchase. As evidence of this hedging interest, the Fund expects
that approximately 75% of its futures contract purchases will be "completed,"
that is, equivalent amounts of related securities will have been purchased or
are being purchased by the Fund upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Fund's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
the Fund will incur commission expenses in both opening and closing out futures
positions, these costs are lower than transaction costs incurred in the purchase
and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS The Fund will not enter into
futures contract transactions to the extent that, immediately thereafter, the
sum of its initial margin deposits on open contracts exceeds 5% of the market
value of the Fund's total assets. In addition, the Fund will not enter into
futures contracts to the extent that its outstanding obligations to purchase
securities under these contracts would exceed 20% of the Fund's total assets.
RISK FACTORS IN FUTURES TRANSACTIONS Positions in futures contracts may be
closed out only on an Exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, the Fund would continue to be required to make daily cash payments to
maintain its required margin. In such situations, if the Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, the Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on the ability to effectively hedge it.
The Fund will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a
4
<PAGE> 55
relatively small price movement in a futures contract may result in immediate
and substantial loss (as well as gain) to the investor. For example, if at the
time of purchase, 10% of the value of the futures contract is deposited as
margin, a subsequent 10% decrease in the value of the futures contract would
result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit if the contract
were closed out. Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the contract. The Fund also bears the
risk that the Adviser will incorrectly predict market trends. However, because
the futures strategies of the Fund are engaged in only for hedging purposes, the
Adviser does not believe that the Fund is subject to the risks of loss
frequently associated with futures transactions. The Fund would presumably have
sustained comparable losses if, instead of the futures contract, it had invested
in the underlying financial instrument and sold it after the decline.
Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that the Fund could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a futures contract or related
option. Additionally, investments in futures contracts and options involve the
risk that the investment adviser will incorrectly predict stock market and
interest rate trends.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of future positions and subjecting some futures
traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS The Fund is required for
Federal income tax purposes to recognize as income for each taxable year its net
unrealized gains and losses on certain futures contracts held as of the end of
the year as well as those actually realized during the year. In most cases, any
gain or loss recognized with respect to a futures contract is considered to be
60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the contract. Furthermore, sales of
futures contracts which are intended to hedge against a change in the value of
securities held by the Fund may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. A Fund may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Fund.
In order for the Fund to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of
securities or of foreign currencies or other income derived with respect to the
Fund's business of investing in securities. In addition, gains realized on the
sale or other disposition of securities held for less than three months must be
limited to less than 30% of the Fund's annual gross income. Any net gain
realized from the closing out of futures contracts will be considered gain from
the sale of securities and therefore be qualifying income for purposes of the
90% requirement. In order to avoid realizing excessive gains on securities held
less than three months, the Fund may be required to defer the closing out of
futures contracts beyond the time when it would otherwise be advantageous to do
so. It is anticipated that unrealized gains on futures contracts, which have
been open for less than three months as of the end of the Fund's fiscal year and
which are recognized for tax purposes, will not be considered gains on sales of
securities held less than three months for the purpose of the 30% test.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including unrealized
gains at the end of the Fund's fiscal year) on futures
5
<PAGE> 56
transactions. Such distributions will be combined with distributions of capital
gains realized on the Fund's other investments and shareholders will be advised
on the nature of the distributions.
INVESTMENT LIMITATIONS
The following restrictions and fundamental policies cannot be changed
without approval of the holders of a majority of the outstanding shares of the
Fund (as defined in the Investment Company Act of 1940). The Fund may not under
any circumstances:
1) Invest for the purpose of controlling management of any company;
2) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if as a result the Fund would
hold more than 10% of the outstanding voting securities of the issuer,
or more than 5% of the value of the Fund's total assets would be
invested in the securities of such issuer;
3) Invest in securities of other investment companies, except as may be
acquired as part of a merger, consolidation or acquisition of assets
approved by the Fund's shareholders or otherwise to the extent
permitted by Section 12 of the Investment Company Act of 1940. The Fund
will invest only in investment companies which have investment
objectives and investment policies consistent with those of the Fund;
4) Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed
to be an underwriter under the Securities Act of 1933, as amended, in
disposing of investment securities;
5) Purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are illiquid
(including the Fund's investment in The Vanguard Group, Inc.);
6) Borrow money, except that the Fund may borrow from banks (or through
reverse repurchase agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of redemption requests
which might otherwise require the untimely disposition of securities,
in an amount not exceeding 10% of the value of the Fund's net assets
(including the amount borrowed and the value of any outstanding reverse
repurchase agreements) at the time the borrowing is made. Whenever
borrowings exceed 5% of the value of the Fund's net assets, the Fund
will not make any additional investments;
7) Invest in commodities except that the Fund may invest in stock futures
contracts or stock options to the extent that not more than 5% of the
Fund's assets are required as deposit to secure obligations under
futures contracts and not more than 20% of the Fund's assets are
invested in futures contracts and options at any time or purchase or
sell real estate, although the Fund may purchase and sell securities of
companies which deal in real estate, or interests therein;
8) Purchase securities on margin or sell any securities short except as
specified above in investment limitation No. 7;
9) Pledge, mortgage or hypothecate any of its assets to an extent greater
than 5% of the value of its
total assets;
10) Purchase or retain securities of an issuer if an officer or director of
such issuer is an officer or Director of the Fund or its investment
adviser and one or more of such officers or directors of the Fund or
its investment adviser owns beneficially more than 1/2% of the shares
or securities of such issuer and all such directors and officers owning
more than 1/2% of such shares or securities together own more than 5%
of such shares or securities;
11) Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements) which are either publicly
distributed or customarily purchased by institutional investors, and
(ii) as provided under "Lending of Securities"; and
6
<PAGE> 57
12) Invest more than 25% of the value of its total assets in any one
industry. Utility companies will be divided according to their
services; for example, gas, gas transmission, electric and gas,
electric, and telephone will each be considered a separate industry.
Although not fundamental policies subject to shareholder vote, as long as
the Fund's shares are registered for sale in certain states, it may not invest
in put, calls, straddle or spread options (except as specified above in
investment limitation No. 7) or in interests in oil, gas or other mineral
exploration or development programs.
If a percentage restriction is adhered to at the time an investment is
made, a later increase in percentage resulting from a change in the value of
assets will not constitute a violation of such restriction.
The above-mentioned investment limitations are considered at the time
investment securities are purchased. Notwithstanding these limitations, the Fund
may own all or any portion of the securities of, or make loans to, or contribute
to the costs or other financial requirements of any company which will be wholly
owned by the Fund and one or more other investment companies and is primarily
engaged in the business of providing, at-cost, management, administrative,
distribution or related services to the Fund and other investment companies. See
"Management of the Fund."
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offerings of its shares, (ii) to reject purchase or exchange purchase orders
when in the judgment of management such rejection is in the best interest of the
Fund, and (iii) to reduce or waive the minimum for any other restrictions on
initial and subsequent investments for certain fiduciary accounts or under
circumstances where certain economies can be achieved in sales of the Fund's
shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods as
the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part, in investment securities or in cash, as the Directors
may deem advisable; however, payment will be made wholly in cash unless the
Directors believe that economic or market conditions exist which would make such
a practice detrimental to the best interests of the Fund. If redemptions are
paid in investment securities, such securities will be valued as set forth in
the Prospectus under "The Fund's Share Price" and a redeeming shareholder would
normally incur brokerage expenses if he converted these securities to cash.
No charge is made by the Fund for redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the
securities held by the Fund.
SIGNATURE GUARANTEES To protect your account, the Fund and Vanguard from
fraud, signature guarantees are required for certain redemptions. Signatures
guarantees enable the Fund to verify the identity of the person who has
authorized a redemption from your account. Signature guarantees are required in
connection with: (1) all redemptions, regardless of the amount involved, when
the proceeds are to be paid to someone other than the registered owner(s) and/or
to an address other than the address of record; and (2) share transfer requests.
7
<PAGE> 58
The signature guarantees must appear either: (1) on the written request for
redemption; (2) on a separate instrument for assignment ("stock power") which
should specify the total number of shares to be redeemed; or (3) on all stock
certificates tendered for redemption and, if shares held by the Fund are also
being redeemed, on the letter or stock power.
YIELD AND TOTAL RETURN
The yield of the Fund for the 30-day period ended December 31, 1996 was
+5.77%.
The average annual total return of the Fund for the one-, five- and
ten-year periods ended December 31, 1996 was +9.42%, +10.93% and +11.06%,
respectively. Total return is computed by finding the average compounded rates
of return over the one-, five- and ten-year periods set forth above that would
equate an initial amount invested at the beginning of the periods to the ending
redeemable value of the investment.
8
<PAGE> 59
THE VANGUARD GROUP
DIRECTORS AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Directors. The Directors set broad policies
for the Fund and choose its Officers. The following is a list of Directors and
Officers of the Fund and a statement of their present positions and principal
occupations during the past five years. The mailing address of the Fund's
Directors and Officers is Post Office Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman, and Director*
Chairman, and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group; Director of The Mead
Corporation, General Accident Insurance and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive Officer & Director*
President, Chief Executive Officer and Director of The Vanguard Group,
Inc., and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Director
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Director of
Sun Company, Inc.; Director of Westinghouse Electric Corporation.
BARBARA BARNES HAUPTFUHRER, Director
Director of The Great Atlantic and Pacific Tea Company, ALCO Standard
Corp., Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Company and Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY, Director
President Emeritus of The Brookings Institution; Director of American
Express Bank, Ltd., The St. Paul Companies, Inc. and National Steel
Corporation.
BURTON G. MALKIEL, Director
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co. and Southern New England Communications
Company.
ALFRED M. RANKIN, JR., Director
Chairman, President and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company, and The Standard Products Company.
JOHN C. SAWHILL, Director
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co., and President, New York
University; Director of Pacific Gas and Electric Company, Proctor & Gamble
Company and NACCO Industries.
JAMES O. WELCH, JR., Director
Retired Chairman of Nabisco Brands, Inc., retired Vice Chairman and
Director of RJR Nabisco; Director of TECO Energy, Inc., and Director of
Kmart Corporation.
J. LAWRENCE WILSON, Director
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company and Trustee of Vanderbilt University.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary
of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ---------------
* Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
9
<PAGE> 60
Vanguard/Wellesley Income Fund is a member of The Vanguard Group of
Investment Companies. Through their jointly-owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other Funds in the Group obtain at
cost virtually all of their corporate management, administrative and
distribution services. Vanguard also provides investment advisory services on an
at-cost basis to certain of the Vanguard Funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment. Each
Fund pays its share of Vanguard's net expenses which are allocated among the
Funds under methods approved by the Board of Directors (Trustees) of each Fund.
In addition, each Fund bears its own direct expenses such as legal, auditing and
custodian fees.
The Fund's officers are also officers and employees of Vanguard. No officer
or employee owns, or is permitted to own, any securities of any external adviser
for the Funds.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines substantially similar to
those recommended by the mutual fund industry and approved by the U.S.
Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts of which each of the Funds have invested are adjusted from time to time
in order to maintain the proportionate relationship between each Fund's relative
net assets and its contribution to Vanguard's capital. At December 31, 1996, the
Fund had contributed capital of $641,000 to Vanguard, representing 3.2% of
Vanguard's capitalization. The Fund's Service Agreement provides as follows: (a)
each Vanguard Fund may invest up to .40% of its current assets in Vanguard, and
(b) there is no other limitation on the amount that each Vanguard Fund may
contribute to Vanguard's capitalization.
MANAGEMENT Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During the
fiscal year ended December 31, 1996, the Fund's share of Vanguard's actual net
costs of operation relating to management and administrative services (including
transfer agency) totaled approximately $15,368,000.
DISTRIBUTION Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as Sales Agent for the shares of
the Funds in connection with any sales made directly to investors in the states
of Florida, Missouri, New York, Ohio, Texas and such other states as it may be
required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The directors and
officers of Vanguard determine the amount to be spent annually on distribution
activities, the manner and amount to be spent on each Fund, and whether to
organize new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon relative net assets. The remaining one
half of those expenses is allocated among the Funds based upon each Fund's sales
for the preceding 24 months relative to the total sales of the Funds as a Group,
provided, however, that no Fund's aggregate quarterly rate of contribution for
distribution expenses of a marketing and promotional nature shall exceed 125% of
average distribution expense rate for the Group, and that no Fund shall incur
annual distribution expenses in excess of 20/100 of 1% of its average month-end
net assets. During the fiscal year ended December 31, 1996, the Fund paid
approximately $1,383,000 of the Group's distribution and marketing expenses.
10
<PAGE> 61
INVESTMENT ADVISORY SERVICES Vanguard provides Vanguard Money Market
Reserves, Vanguard Treasury Fund, Vanguard Admiral Funds, Vanguard Municipal
Bond Fund, the several Portfolios of Vanguard Fixed Income Securities Fund,
several Portfolios of Vanguard Variable Insurance Fund, Vanguard Institutional
Index Fund, Vanguard Bond Index Fund, the Vanguard California Tax-Free Fund,
Vanguard Florida Insured Tax-Free Fund, Vanguard New Jersey Tax-Free Fund,
Vanguard New York Insured Tax-Free Fund, Vanguard Ohio Tax-Free Fund, Vanguard
Pennsylvania Tax-Free Fund, Vanguard Balanced Index Fund, Vanguard Index Trust,
Vanguard International Equity Index Fund, Vanguard Tax-Managed Fund, the
Aggressive Growth Portfolio of Vanguard Horizon Fund, the REIT Portfolio of
Vanguard Specialized Portfolios, a portion of Vanguard/Windsor II, a portion of
Vanguard/Morgan Growth Fund as well as several indexed separate accounts with
investment advisory services. These services are provided on an at-cost basis
from a money management staff employed directly by Vanguard. The compensation
and other expenses of this staff are paid by the Funds utilizing these services.
REMUNERATION OF DIRECTORS AND OFFICERS The Fund pays each Director, who is
not also an officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. The Fund's officers and employees are paid by Vanguard
which, in turn, is reimbursed by the Fund and each other Fund in the Group, for
its proportionate share of officers' and employees' salaries and retirement
benefits.
The following information is furnished with respect to the Directors and
officers of the Fund for whom the Fund's proportionate share of remuneration
exceeded $60,000 for the fiscal year ended December 31, 1996, and for all
Directors and officers as a group:
<TABLE>
<CAPTION>
NAMES AND CAPACITIES IN WHICH DIRECT
REMUNERATION WAS RECEIVED REMUNERATION(1)
- -------------------------------------------------------------------------------- ---------------
<S> <C>
John C. Bogle, Chairman......................................................... $ 109,699
John J. Brennan, President and Chief Executive Officer.......................... $ 67,395
All Directors and Officers as a Group........................................... $ 213,568
</TABLE>
(1) Includes, in the aggregate, $25,000 of fees and expenses paid by the Fund to
its "non-interested" Directors, and the Fund's proportionate share of
remuneration paid by Vanguard to all officers of the Fund, as a group.
Directors who are not Officers are paid an annual fee based on the number
of years of service on the Board upon retirement. The fee is equal to $1,000 for
each year of service (up to fifteen years) and each investment company member of
the Vanguard Group contributes a proportionate amount to this fee based on its
relative net assets. Under its retirement plan, Vanguard contributes annually an
amount equal to 10% of each eligible officer's annual compensation plus 5.7% of
that part of an eligible officer's compensation during the year, if any, that
exceeds the Social Security Taxable Wage Base then in effect. Under its thrift
plan, all eligible officers are permitted to make pre-tax contributions in an
amount up to 4% of total compensation, subject to federal tax limitations, which
are matched by Vanguard on a 100% basis. The Fund's proportionate share of
retirement contributions made by Vanguard under its Retirement and Thrift Plans
on behalf of all eligible officers of the Fund, as a group, during the 1996
fiscal year was approximately $4,800.
11
<PAGE> 62
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors and Officers of the Fund for the
fiscal year ended December 31, 1996.
VANGUARD/WELLESLEY INCOME FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE PENSION OR RETIREMENT ESTIMATED TOTAL COMPENSATION
COMPENSATION BENEFITS ACCRUED AS ANNUAL BENEFITS FROM ALL VANGUARD FUNDS
NAMES OF DIRECTORS FROM FUND PART OF FUND EXPENSES UPON RETIREMENT PAID TO DIRECTORS(2)
- --------------------------- ------------ --------------------- --------------- -----------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) -- -- -- --
John J. Brennan(1) -- -- -- --
Barbara Barnes Hauptfuhrer $ 2,458 $ 382 $15,000 $65,000
Robert E. Cawthorn $ 2,458 $ 318 $13,000 $65,000
Bruce K. MacLaury $ 2,660 $ 373 $12,000 $60,000
Burton G. Malkiel $ 2,458 $ 254 $15,000 $65,000
Alfred M. Rankin, Jr. $ 2,458 $ 201 $15,000 $65,000
John C. Sawhill $ 2,458 $ 238 $15,000 $65,000
James O. Welch, Jr. $ 2,458 $ 294 $15,000 $65,000
J. Lawrence Wilson $ 2,458 $ 212 $15,000 $65,000
</TABLE>
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no compensation
for their services as Director.
(2) The amounts reported in this column reflect the total compensation paid to
each Director for his or her service as Director or Trustee of 34 Vanguard
Funds (33 in the case of Mr. Malkiel; 27 in the case of Mr. MacLaury).
INVESTMENT ADVISORY SERVICES
The Fund employs Wellington Management Company, LLP (the "Adviser") under
an investment advisory agreement dated April 1, 1996 to manage the investment
and reinvestment of the assets of the Fund and to continuously review, supervise
and administer the Fund's investment program. The Adviser discharges its
responsibilities subject to the control of the officers and Directors of the
Fund. The Adviser is a Massachusetts limited liability partnership whose
managing partners are Robert W. Doran, Duncan M. McFarland and John R. Ryan.
The Fund pays the Adviser an advisory fee at the end of each fiscal
quarter, calculated by applying a quarterly rate, based on the following annual
percentage rates, to the Fund's average month-end net assets for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
---------------------------------------------------- ----
<S> <C>
First $1 billion.................................... .100%
Next $2 billion..................................... .050%
Next $7 billion..................................... .040%
Over $10 billion.................................... .030%
</TABLE>
Effective with the quarter ending March 31, 1997, the basic advisory fee
may be increased or decreased by applying an adjustment formula based on the
investment performance of the Fund relative to the investment performance of a
"composite index." This composite index is comprised of the Lehman Long-Term
Corporate AA or Better Bond Index (65%) and a 35% weighting in a blended equity
composite (75% Standard & Poor's/BARRA Value Index, 12.5% Standard & Poor's
Utilities Index and 12.5% Standard & Poor's Telephone Index).
12
<PAGE> 63
The following table sets forth the incentive/penalty adjustment to the
basic advisory fee payable by the Fund to WMC under the new advisory agreement:
<TABLE>
<CAPTION>
CUMULATIVE 36-MONTH PERFORMANCE PERFORMANCE FEE
VERSUS THE COMPOSITE INDEX ADJUSTMENT
-----------------------------------------------------------
<S> <C>
Less than -3% -0.20 X Basic Fee*
Between -1.5% and -3% -0.10 X Basic Fee
Between -1.5% and 1.5% 0 X Basic Fee
Between +1.5% and +3% +0.10 X Basic Fee
More than +3% +0.20 X Basic Fee
</TABLE>
* For purposes of this calculation, the Basic Fee is calculated by applying the
quarterly rate based on the Annual Basic Fee Rate using average assets over
the same time period which the performance is measured.
Until the quarter ending March 31, 1999, the performance adjustment for the
Adviser will be calculated according to the following transition rules:
(a) January 1, 1997 through March 31, 1999. Beginning with the
quarter ending March 31, 1997, and until the quarter ending March 31, 1999,
the Performance adjustment will be computed based upon a comparison of the
investment performance of the Fund and that of the Composite Index over the
number of months that have elapsed between April 1, 1996 and the end of the
quarter for which the fee is computed, and will be applied to the average
monthly assets over the same period. The number of percentage points by
which the investment performance of the Fund must exceed the investment
record of the Composite Index shall increase proportionately from .5 and 1,
respectively, for the twelve months ending March 31, 1997, to 1.5 and 3,
for the thirty-six months ending March 31, 1999.
(b) On and After March 31, 1999. For the quarter ending March 31,
1999 and thereafter, the period used to calculate the incentive/penalty
adjustment shall be the 36 months preceding the end of the quarter for
which the fee is being computed and the number of percentage points used
shall be 1.5 and 3. Upon request, the Fund will provide the Adviser access
to the documents substantiating the calculation of the performance
adjustment.
The investment performance of the Fund for such period, expressed as a
percentage of the net asset value per share of the Fund at the beginning of
such period, shall be the sum of: (i) the change in the net asset value per
share of the Fund during such period; (ii) the value of the cash
distributions per share of the Fund accumulated to the end of such period;
and (iii) the value of capital gains taxes per share paid or payable by the
Fund on undistributed realized long-term capital gains accumulated to the
end of such period. For this purpose, the value of distributions per share
of realized capital gains, of dividends per share paid from investment
income and of capital gains taxes per share paid or payable on
undistributed realized long-term capital gains shall be treated as
reinvested in shares of the Fund at the net asset value per share in effect
at the close of business on the record date for the payment of such
distributions and dividends and the date on which provision is made for
such taxes, after giving effect to such distributions, dividends and taxes.
The "investment record" of the Stock Index for the period, expressed
as a percentage of the Stock Index level at the beginning of the period,
shall be the sum of (i) the change in the level of the Stock Index during
the period and (ii) the value, computed consistently with the Stock Index,
of cash distributions having an ex-dividend date occurring within the
period made by companies whose securities comprise the Stock Index. The
"investment record" of the Bond Index for the period, expressed as a
percentage of the Bond Index level at the beginning of such period shall be
the sum of (i) the change in the level of the Bond Index during the period
and (ii) the value of the interest accrued or paid on the bonds included in
the Bond Index, assuming the reinvestment of such interest on a monthly
basis. Computation of these two components as the Combined Index shall be
made on the basis of 35% in the Stock Index and 65% in the Bond Index at
the beginning of each quarter.
During the fiscal years ended December 31, 1994, 1995 and 1996 the
investment advisory fees paid by the Fund totaled approximately $4,457,000,
$4,349,000 and $3,606,000 respectively. These fees were paid pursuant to the
terms of a previous investment advisory agreement, which called for a higher
rate of fees.
13
<PAGE> 64
The agreement continues in effect until March 31, 1998 and is renewable
thereafter, for successive one-year periods, only if such renewal is
specifically approved by a vote of the Fund's Board of Directors, including the
affirmative votes of a majority of the Directors who are not parties to the
contract or "interested persons" (as defined in the Investment Company Act of
1940) of any such party, cast in person at a meeting called for the purpose of
considering such approval. In addition, the question of continuance shall be
effected only if approved by the affirmative vote of a majority of the
outstanding voting securities of the Fund. The agreement is automatically
terminated if assigned, and may be terminated without penalty at any time (1)
either by vote of the Board of Directors of the Fund or by vote of its
outstanding voting securities on 60 days' written notice to the Adviser, or (2)
by the Adviser upon 90 days' written notice to the Fund.
The Fund's Board of Directors may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of a
new advisory agreement, either as a replacement for an existing adviser or as an
additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same advisory
contract terms where a contract has been assigned because of a change in control
of the adviser.
Any such change will only be made upon not less than 30 days' prior written
notice to shareholders, which shall include the information concerning the
adviser that would have normally been included in a
proxy statement.
The agreement is automatically terminated if assigned, and may be
terminated without penalty at any time (1) by vote of the Board of Directors of
the Fund on 60 days' written notice to WMC, or (2) by WMC upon 90 days' written
notice to the Fund.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the Adviser (with the approval
of the Fund's Board of Directors) to select the brokers or dealers that will
execute the purchases and sales of portfolio securities for the Fund and directs
the Adviser to use its best efforts to obtain the best available price and most
favorable execution as to all transactions for the Fund. The Adviser has
undertaken to execute each investment transaction at a price and commission
which provides the most favorable total cost or proceeds reasonably obtainable
under the circumstances.
In placing portfolio transactions, the Adviser will use its best judgment
to choose the broker most capable of providing the brokerage services necessary
to obtain best available price and most favorable execution. The full range and
quality of brokerage services available will be considered in making these
determinations. In those instances where it is reasonably determined that more
than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration may be given to
those brokers which supply investment research and statistical information and
provide other services in addition to execution services to the Fund and/or the
Adviser. The Adviser considers such information useful in the performance of its
obligations under the agreement but is unable to determine the amount by which
such services may reduce its expenses.
The investment advisory agreement also incorporates the concepts of Section
28(e) of the Securities Exchange Act of 1934 by providing that, subject to the
approval of the Fund's Board of Directors, the Adviser may cause the Fund to pay
a broker-dealer which furnishes brokerage and research services a higher
commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of the Adviser to the Fund and the other Funds in the Group.
Currently, it is the Fund's policy that the Adviser may at times pay higher
commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be in
14
<PAGE> 65
the best interest of the Fund. Some brokers or dealers who may receive such
higher commissions in recognition of brokerage services related to execution of
securities transactions are also providers of research information to the
Adviser and/or the Fund. However, the Adviser has informed the Fund that it will
not pay higher commission rates specifically for the purpose of obtaining
research services.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified broker-dealers who
recommend the Fund to other clients, or who act as agent in the purchase of the
Fund's shares for their clients, and may, when a number of brokers and dealers
can provide comparable best price and execution on a particular transaction,
consider the sale of Fund shares by a broker or dealer in selecting among
qualified broker-dealers.
During the fiscal years ended December 31, 1994, 1995 and 1996 the Fund
paid $2,062,311, $1,787,291 and $2,064,421 in brokerage commissions,
respectively.
Some securities considered for investment by the Fund may also be
appropriate for other Funds and/or clients served by the Adviser. If purchase or
sale of securities consistent with the investment policies of the Fund and one
or more of these other Funds or clients serviced by the Adviser are considered
at or about the same time, transactions in such securities will be allocated
among the several Funds and clients in a manner deemed equitable by the Adviser.
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of the Vanguard Group, including
Vanguard/Wellesley Income Fund, may, from time to time, use one or more of the
following unmanaged indices for comparative performance purposes.
STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX -- is a well diversified
list of 500 companies representing the U.S. Stock Market.
WILSHIRE 5000 EQUITY INDEX -- consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
WILSHIRE 4500 EQUITY INDEX -- consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard and Poor's 500 Index.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX -- is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX -- currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
SALOMON BROTHERS GNMA INDEX -- includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National Mortgage
Association.
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX -- consists of publicly issued,
non-convertible corporate bonds rated Aa or Aaa. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
LEHMAN LONG-TERM TREASURY BOND INDEX -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND INDEX -- consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
15
<PAGE> 66
LEHMAN CORPORATE (BAA) BOND INDEX -- all publicly offered fixed-rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
LEHMAN BROTHERS LONG-TERM CORPORATE BOND INDEX -- is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued fixed-rate,
nonconvertible US debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
BOND BUYER MUNICIPAL (20 YEAR) BOND INDEX -- is a yield index on current coupon
high-grade general obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX -- is a yield index based upon the average
yield of four high-grade, noncallable preferred stock issues.
NASDAQ INDUSTRIAL INDEX -- is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX -- 70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
COMPOSITE INDEX -- 65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
COMPOSITE INDEX -- 65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index and 12.5% Standard & Poor's Utilities Index and 12.5% Standard & Poor's
Telephone Index).
LEHMAN LONG-TERM CORPORATE AA OR BETTER BOND INDEX -- consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
RUSSELL 2000 STOCK INDEX -- consists of the smallest 2,000 stocks within the
Russell 3000; a widely-used benchmark for small capitalization common stocks.
LEHMAN BROTHERS AGGREGATE BOND INDEX -- is a market-weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass-through
securities corporate rated BBB- or better. The Index has a market value of over
$4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX -- is a
market-weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities
between 1 and 5 years. The index has a market value of over $1.6 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX -- is
a market-weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities between 5 and 10
years. The index has a market value of over $700 billion.
LEHMAN BROTHERS MUTUAL FUND LONG (10+) GOVERNMENT/CORPORATE INDEX -- is a
market-weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities greater than 10
years. The index has a market value of over $900 billion.
LIPPER BALANCED FUND AVERAGE -- an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of
average non-government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE -- the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company.
16
<PAGE> 67
From time to time, Vanguard may advertise using the average performance and/or
the average expense ratio of the small company growth funds. (This fund category
was first established in 1982. For years prior to 1982, the results of the
Lipper Small Company Growth category were estimated using the returns of the
Funds that constituted the Group at its inception.)
LIPPER GENERAL EQUITY FUND AVERAGE -- an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
LIPPER FIXED INCOME FUND AVERAGE -- an industry benchmark of average fixed
income funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
RUSSELL 3000 INDEX -- consists of approximately the 3,000 largest stocks of
U.S.-domiciled companies commonly traded on the New York and American Stock
Exchanges or the NASDAQ over-the-counter market, accounting for over 90% of the
market value of publicly traded Stocks in the U.S.
APPENDIX -- DESCRIPTION AND RATINGS OF SECURITIES
I. DESCRIPTION OF BOND RATINGS
The Fund will invest primarily in investment grade bonds (i.e. those rated
at least Baa by Moody's Investors Service, Inc. or those rated BBB by Standard &
Poor's Corporation). In the event that a bond held by the Fund is downgraded,
the adviser may continue to hold such bond. Excerpts from Moody's Investors
Service, Inc. description of its four highest preferred bond ratings:
AAA -- judged to be the best quality by all standards. Together with the
Aaa group they comprise what are generally known as high grade bonds;
A -- possess many favorable investment attributes and are to be considered as
"upper medium grade obligations"; BAA -- considered as medium grade obligations;
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Moody's also supplies numerical indicators 1, 2 and 3 to rating categories.
The modifier 1 indicates that the security is in the higher end of its rating
category; the modifier 2 indicates a mid-range ranking; and 3 indicates a
ranking toward the lower end of the category.
The following are excerpts from Standard & Poor's Corporation description
of its four highest stock ratings:
AAA -- highest grade obligations. Capacity to pay interest and repay
principal is extremely strong; AA -- also qualify as high grade obligations, a
very strong capacity to pay interest and repay principal and differs from
AAA -- issues only in small degree; A -- regarded as upper medium grade. They
have a strong capacity to pay interest and repay principal although it is
somewhat susceptible to the adverse effects of changes in circumstances and
economic conditions than debt in higher rated categories; BBB -- regarded as
having an adequate capacity to pay interest and repay principal. Whereas it
normally exhibits adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher rated
categories. This group is the lowest which qualifies for commercial bank
investment.
Standard & Poor's applies indicators "+", no character and "-" to its
rating categories. The indicators show relative standing within the major rating
categories.
II. FOREIGN INVESTMENTS
The Fund may invest in the securities (payable in U.S. dollars) of foreign
issues and in the securities of foreign branches of U.S. banks such as
negotiable certificates of deposit (Eurodollars). Because the Fund invests in
such securities, investment in the Fund involves investment risks that are
different in some respects from an investment in a fund which invests only in
debt obligations of U.S. issuers. Such risks may include future political and
economic developments, the possible imposition of withholding taxes on interest
income
17
<PAGE> 68
payable on the securities held, possible seizure or nationalization of foreign
deposits, the possible establishment of exchange controls or the adoption or
other restrictions by foreign governments which may adversely affect the payment
of principal and interest on securities held by the Fund, difficulty in
obtaining and enforcing court judgments abroad, the possibility of restrictions
on investments in other jurisdictions, reduced levels of government regulation
of securities markets in foreign countries, and difficulties in effecting the
repatriation of capital invested abroad. The Fund will not purchase any such
foreign security if, as a result, more than 20% of the value of the Fund's total
assets would be invested in such securities.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended December 31, 1996,
including the financial highlights for each of the five fiscal years in the
period ended December 31, 1996, appearing in the Vanguard/Wellesley Income Fund
1996 Annual Report to Shareholders, and the report thereon of Price Waterhouse
LLP, independent accountants, also appearing therein, are incorporated by
reference in this Statement of Additional Information. The Fund's 1996 Annual
Report to Shareholders is enclosed with this Statement of Additional
Information.
18
<PAGE> 69
PART C
VANGUARD/WELLESLEY INCOME FUND, INC.
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
(a) FINANCIAL STATEMENTS
The Registrant's financial statements for the year ended December 31, 1996,
including Price Waterhouse LLP's report thereon, are incorporated by reference,
in the Statement of Additional Information, from the Registrant's 1996 Annual
Report which has been filed with the Commission. The financial statements
included in the Annual Report are:
1. Statement of Net Assets as of December 31, 1996.
2. Statement of Operations for the year ended December 31, 1996.
3. Statement of Changes in Net Assets for the years ended December 31, 1995
and 1996.
4. Financial Highlights for each of the five years in the period ended
December 31, 1996 (also appearing in the Prospectus along with previous
years).
5. Notes to Financial Statements.
6. Report of Independent Accountants.
<TABLE>
<S> <C>
(b) EXHIBITS
Exhibit Number Description
1............... Articles of Incorporation**
2............... By-Laws of Registrant**
3............... Not Applicable
4............... Not Applicable
5............... Not Applicable
6............... Not Applicable
7............... Reference is made to the section entitled "Management of the Fund" in
the Registrant's Statement of Additional Information
8............... Form of Custody Agreement**
9............... Form of Vanguard Service Agreement**
10............... Opinion of Counsel**
11............... Consent of Independent Accountants*
12............... Financial Statements--reference is made to (a) above
13............... Not Applicable
14............... Not Applicable
15............... Not Applicable
16............... Schedule for Computation of Performance Quotations*
27............... Financial Data Schedule*
</TABLE>
- ------------
*Filed herewith
**Previously filed
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Registrant is not controlled by or under common control with any person.
The Officers of the Registrant, the investment companies in The Vanguard Group
of Investment Companies and The Vanguard Group, Inc. are identical. Reference is
made to the caption "The Fund and Vanguard" in the Prospectus constituting Part
A and "The Vanguard Group" in the Statement of Additional Information
constituting Part B of this Registration Statement.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES
As of December 31, 1996 there were 287,612 shareholders.
19
<PAGE> 70
ITEM 27. INDEMNIFICATION
Reference is made to Article XI of Registrant's Articles of Incorporation.
Insofar as indemnification for liability arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Reference is made to the caption "Investment Adviser" in the prospectus
constituting Part A of this Registration Statement and "Investment Advisory
Services" in Part B of this Registration Statement.
Wellington Management Company, LLP, 75 State Street, Boston, Massachusetts,
02109, is a Massachusetts limited liability partnership, of which the following
persons are managing partners: Robert W. Doran, Duncan M. McFarland and John B.
Neff. No partner has any other affiliation with the Registrant.
Wellington Management Company, LLP ("Wellington Management") is an
investment adviser registered under the Investment Advisers Act of 1940, as
amended (the "Advisers Act"). The list required by this Item 28 of officers and
partners of Wellington Management, together with any information as to any
business profession, vocation or employment of a substantial nature engaged in
by such officers and partners during the past two years, is incorporated herein
by reference to Schedules A and D of Form ADV filed by Wellington Management
pursuant to the Advisers Act (SEC File No. 801-159089).
ITEM 29. PRINCIPAL UNDERWRITERS
(a) None
(b) Not Applicable
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS
The books, accounts and other documents required by Section 31(a) under the
Investment Company Act and the rules promulgated thereunder will be maintained
in the physical possession of Registrant; Registrant's Transfer Agent, The
Vanguard Group, Inc. c/o The Vanguard Financial Center, Valley Forge,
Pennsylvania 19482; and the Registrant's Custodian, Chase Manhattan Bank.
ITEM 31. MANAGEMENT SERVICES
Other than the Amended and Restated Funds' Service Agreement with The
Vanguard Group, Inc. which was previously filed as Exhibit 9(c) and described in
Part B hereof under "Management of the Fund," the Registrant is not a party to
any management-related service contract.
ITEM 32. UNDERTAKINGS
Registrant hereby undertakes to comply with the provisions of section 16(c)
of the 1940 Act in regard to shareholders' rights to call a meeting of
shareholders for the purpose of voting on the removal of directors and to assist
in shareholder communications in such matters, to the extent required by law.
Registrant hereby undertakes to provide an Annual Report to Shareholders or
prospective investors, free of charge, upon request.
20
<PAGE> 71
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this
Post-Effective Amendment to this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the Town of Valley
Forge and the Commonwealth of Pennsylvania, on the 18th day of April, 1997.
VANGUARD/WELLESLEY INCOME FUND, INC.
BY: (Raymond J. Klapinsky) John C. Bogle*, Chairman
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to the Registration Statement has been signed below by
the following persons in the capacities and on the date indicated:
BY: (Raymond J. Klapinsky)
John C. Bogle*, Chairman of the Board and Director
April 18, 1997
BY: (Raymond J. Klapinsky)
John J. Brennan*, President, Director, and
Chief Executive Officer
April 18, 1997
BY: (Raymond J. Klapinsky)
Robert E. Cawthorn*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
Barbara B. Hauptfuhrer*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
Bruce K. MacLaury*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
Burton G. Malkiel*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
Alfred M. Rankin Jr.*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
John C. Sawhill*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
James O. Welch, Jr.*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
J. Lawrence Wilson*, Director
April 18, 1997
BY: (Raymond J. Klapinsky)
Richard F. Hyland*, Treasurer and Principal
Financial Officer and Accounting Officer
April 18, 1997
*By Power of Attorney. See File Number 2-14336, January 23, 1990. Incorporated
by Reference.
<PAGE> 72
INDEX TO EXHIBITS
<TABLE>
<S> <C>
Consent of Independent Accountants................................................... EX-99.B11
Schedule for Computation of Performance Quotations................................... EX-99.B16
Financial Data Schedule.............................................................. EX-27
</TABLE>
<PAGE> 1
EX-99.B11
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus and
Statement of Additional Information constituting parts of this Post-Effective
Amendment No. 45 to the registration statement on Form N-1A (the "Registration
Statement") of our report dated January 31, 1997 relating to the financial
statements and financial highlights appearing in the December 31, 1996 Annual
Report to Shareholders of Vanguard/Wellesley Income Fund, which are also
incorporated by reference into the Registration Statement. We also consent to
the references to us under the heading "Financial Highlights" in the
Prospectuses and under the heading "Financial Statements" in the Statement of
Additional Information.
PRICE WATERHOUSE LLP
Philadelphia, PA
April 17, 1997
<PAGE> 1
EX-99.B16
SCHEDULE FOR COMPUTATION OF PERFORMANCE QUOTATIONS
VANGUARD/WELLESLEY INCOME FUND, INC.
1. Average Annual Total Return (As of December 31, 1996)
P (1 + T)(n) = ERV
<TABLE>
<S> <C> <C>
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
N = number of years
ERV = ending redeemable value at the end of the period
EXAMPLE:
One Year
P = $1,000
T = +9.42%
N = 1 yr.
ERV = $1,094.19
Five Year
P = $1,000
T = +10.93%
N = 5 yrs.
ERV = $1,679.48
Ten Year
P = $1,000
T = +11.06%
N = 10 yrs.
ERV = $2,854.78
</TABLE>
2. YIELD (30 Days Ended December 31, 1996)
<TABLE>
<C> <S> <C>
a - b
Yield = 2[( ----- + 1)(6) - 1]
c X d
Where: a = dividends and interest paid during the period
b = expense dollars during the period (net of reimbursements)
c = the average daily number of shares outstanding during the period
d = the maximum offering price per share on the last day of the period
Example a = $35,318,125.36
b = $1,807,153.30
c = 340,176,294.250
d = $20.74
Yield = 5.77%
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000105544
<NAME> VANGUARD/WELLESLEY INCOME FUND, INC.
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<INVESTMENTS-AT-COST> 6274401
<INVESTMENTS-AT-VALUE> 7022097
<RECEIVABLES> 162144
<ASSETS-OTHER> 903
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 7185144
<PAYABLE-FOR-SECURITIES> 11600
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 160822
<TOTAL-LIABILITIES> 172422
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 6166680
<SHARES-COMMON-STOCK> 341976
<SHARES-COMMON-PRIOR> 351262
<ACCUMULATED-NII-CURRENT> 12026
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 86320
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 747696
<NET-ASSETS> 7012722
<DIVIDEND-INCOME> 116424
<INTEREST-INCOME> 307821
<OTHER-INCOME> 0
<EXPENSES-NET> 21154
<NET-INVESTMENT-INCOME> 403091
<REALIZED-GAINS-CURRENT> 258042
<APPREC-INCREASE-CURRENT> (41888)
<NET-CHANGE-FROM-OPS> 619245
<EQUALIZATION> (4740)
<DISTRIBUTIONS-OF-INCOME> 398277
<DISTRIBUTIONS-OF-GAINS> 202715
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 45503
<NUMBER-OF-SHARES-REDEEMED> 80687
<SHARES-REINVESTED> 25898
<NET-CHANGE-IN-ASSETS> (168014)
<ACCUMULATED-NII-PRIOR> 11952
<ACCUMULATED-GAINS-PRIOR> 30993
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 3606
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 21498
<AVERAGE-NET-ASSETS> 7016408
<PER-SHARE-NAV-BEGIN> 20.44
<PER-SHARE-NII> 1.17
<PER-SHARE-GAIN-APPREC> 0.66
<PER-SHARE-DIVIDEND> 1.16
<PER-SHARE-DISTRIBUTIONS> 0.60
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 20.51
<EXPENSE-RATIO> 0.31
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
