<PAGE> 1
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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. [ ]
POST-EFFECTIVE AMENDMENT NO. 50 [ ]
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 50 [ ]
VANGUARD WELLESLEY INCOME FUND
(EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST)
P.O. BOX 2600
VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
R. GREGORY BARTON, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
on April 30, 1999, pursuant to paragraph (b) 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, 1998 ON MARCH 29, 1999.
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<PAGE> 2
VANGUARD WELLESLEY INCOME FUND
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
- ----------- ----------------------
<S> <C> <C>
Item 1. Front and Back Cover Pages............. Front and Back Cover Pages
Item 2. Risk/Return Summary: Investments,
Risks, and Performance................. Fund Profile
Item 3. Risk/Return Summary: Fee Table......... Fee Table
Item 4. Investment Objectives, Principal
Investment Strategies, and Related
Risks.................................. A Word About Risk; Who Should Invest;
Primary Investment Strategies
Item 5. Management's Discussion of Fund
Performance............................ Herein incorporated by reference to
Registrant's Annual Report to
Shareholders dated December 31, 1998
filed with the Securities and Exchange
Commission's EDGAR System on March 4,
1999
Item 6. Management, Organization, and Capital
Structure.............................. The Fund and Vanguard; Investment
Adviser
Item 7. Shareholder Information................ Share Price; Dividends, Capital Gains,
and Taxes; Investing with Vanguard
Item 8. Distribution Arrangements.............. Not Applicable
Item 9. Financial Highlights Information....... Financial Highlights
</TABLE>
<TABLE>
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
- ----------- -------------------------
<S> <C> <C>
Item 10. Cover Page and Table of Contents....... Cover Page; Table of Contents
Item 11. Fund History........................... Description of the Trust
Item 12. Description of the Fund and Its
Investments and Risks.................. Investment Policies; Fundamental
Investment Limitations; Description of
the Trust
Item 13. Management of the Fund................. Management of the Trust
Item 14. Control Persons and Principal Holders
of Securities.......................... Management of the Trust
Item 15. Investment Advisory and Other
Services............................... Investment Advisory Services
Item 16. Brokerage Allocation and Other
Practices.............................. Portfolio Transactions
Item 17. Capital Stock and Other Securities..... Description of the Trust
Item 18. Purchase, Redemption and Pricing of
Shares................................. Purchase of Shares; Redemption of
Shares; Share Price
Item 19. Taxation of the Fund................... Description of the Trust
Item 20. Underwriters........................... Not Applicable
Item 21. Calculation of Performance Data........ Yield and Total Return
Item 22. Financial Statements................... Financial Statements
</TABLE>
<PAGE> 3
VANGUARD WELLESLEY INCOME FUND
Prospectus
April 30, 1999
A Balanced Mutual Fund
CONTENTS
<TABLE>
<S> <C>
1 FUND PROFILE
3 ADDITIONAL INFORMATION
3 A WORD ABOUT RISK
3 WHO SHOULD INVEST
4 PRIMARY INVESTMENT STRATEGIES
9 THE FUND AND VANGUARD
9 INVESTMENT ADVISER
10 YEAR 2000 CHALLENGE
10 DIVIDENDS, CAPITAL GAINS, AND TAXES
11 SHARE PRICE
12 FINANCIAL HIGHLIGHTS
13 INVESTING WITH VANGUARD
13 SERVICES AND ACCOUNT FEATURES
14 TYPES OF ACCOUNTS
14 BUYING SHARES
16 REDEEMING SHARES
19 TRANSFERRING REGISTRATION
19 FUND AND ACCOUNT UPDATES
GLOSSARY (inside back cover)
</TABLE>
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WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objective, risks, and strategies of Vanguard
Wellesley Income Fund. To highlight terms and concepts important to mutual fund
investors, we have provided "Plain Talk(R)" 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.
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NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<PAGE> 4
1
FUND PROFILE -- VANGUARD WELLESLEY INCOME FUND
The following profile summarizes key features of Vanguard Wellesley Income Fund.
INVESTMENT OBJECTIVE
The Fund is a balanced fund that seeks to provide a high and sustainable level
of current income along with moderate long-term capital growth.
INVESTMENT STRATEGIES
The Fund invests approximately 60% to 65% of its assets in investment-grade,
longer-term corporate, U.S. Treasury, government agency, and mortgage-backed
bonds. The remaining 35% to 40% of Fund assets are invested in common stocks of
companies that have a history of above-average dividends or expectations of
increasing dividends.
PRIMARY RISKS
THE FUND'S TOTAL RETURN, LIKE STOCK AND BOND PRICES GENERALLY, WILL FLUCTUATE
WITHIN A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG
PERIODS. The Fund is also subject to:
- - Interest rate risk, which is the chance that bond prices overall will decline
over short or even long periods due to rising interest rates. Interest rate
risk is generally high for longer-term bonds.
- - Income risk, which is the chance that falling interest rates will cause the
Fund's income to decline. Income risk is generally low for longer-term bonds.
- - Credit risk, which is the chance that a bond issuer will fail to pay interest
and principal in a timely manner, reducing the Fund's return. Credit risk
should be low for the Fund.
- - Prepayment risk, which is the chance that during periods of falling interest
rates, a bond issuer will repay a high-yielding bond earlier than scheduled.
Forced to reinvest the unanticipated proceeds at lower interest rates, the
Fund would experience a decline in income.
- - Call risk, which is the chance that during periods of falling interest rates,
a bond issuer will "call" -- or repay -- a high-yielding bond before its
maturity date. Forced to reinvest the unanticipated proceeds at lower
interest rates, the Fund would experience a decline in income. Call risk is
generally high for longer-term bonds.
- - Investment style risk, which is the chance that returns from large-and
mid-capitalization value stocks will trail returns from other asset classes
or the overall stock market. Each type of stock tends to go through cycles of
doing better -- or worse -- than the stock market in general. These periods
have, in the past, lasted for as long as several years.
- - Manager risk, which is the chance that poor security selection will cause the
Fund to underperform other funds with similar investment objectives.
PERFORMANCE/RISK INFORMATION
The bar chart and table below provide an indication of the risk of investing in
the Fund. The bar chart shows the Fund's performance in each calendar year over
a ten-year period. The table shows how the Fund's average annual returns for
one, five, and ten calendar years compare with those of both the Lehman Long
Corporate AA or Better Bond Index, a broad-based securities market index and a
composite stock/bond index weighted to match the Fund's target allocation. Keep
in mind that the Fund's past performance does not necessarily indicate how it
will perform in the future.
<TABLE>
<CAPTION>
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ANNUAL TOTAL RETURNS
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12/31/1989 12/31/1990 12/31/1991 12/31/1992 12/31/1993 12/31/1994 12/31/1995 12/31/1996 12/31/1997 12/31/1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Wellesley
Income
Fund 20.93 3.76 21.57 8.67 14.65 -4.44 26.91 9.42 20.19 11.64
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
During the period shown in the bar chart, the highest return for a calendar
quarter was 8.77% (quarter ended June 30, 1989 ) and the lowest return for a
quarter was - 4.47% (quarter ended March 31, 1994).
<PAGE> 5
2
<TABLE>
<CAPTION>
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AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
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1 YEAR 5 YEARS 10 YEARS
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<S> <C> <C> <C>
Vanguard Wellesley Income Fund 11.84% 12.62% 13.16%
Wellesley Composite Index* 13.87 12.61 12.97
Lehman Long Corporate AA or Better Bond Index 10.52 8.73 10.72
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</TABLE>
* Weighted 65% in the Lehman Long Corporate AA or Better Bond Index, and 35% in
a blended stock composite (75% in the S&P/BARRA Value Index, 12.5% in the S&P
Utilities Index, and 12.5% in the S&P Telephone Index). Note: Prior to June 30,
1996, the S&P Telephone Index was a part of (and not separate from) the S&P
Utilities Index.
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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 the fund's buying and selling of securities. These costs
can erode a substantial portion of the gross income or capital appreciation a
fund achieves. Even seemingly small differences in expenses can, over time, have
a dramatic effect on a fund's performance.
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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 1998
was 0.31%, or $3.10 per $1,000 of average net assets. The average balanced
mutual fund had expenses in 1998 of 1.31%, or $13.10 per $1,000 of average net
assets, according to Lipper Inc., which reports on the mutual fund industry.
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FEES AND EXPENSES
The following table describes the fees and expenses you would pay if
you buy and hold shares of the Fund. The expenses shown under Annual Fund
Operating Expenses are based upon those incurred in the fiscal year ended
December 31, 1998.
<TABLE>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
Management Expenses: 0.28%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.31%
</TABLE>
The following example is intended to help you compare the cost of investing
in the Fund with the cost of investing in other mutual funds. It illustrates the
hypothetical expenses that you would incur over various periods if you invest
$10,000 in the Fund. This example assumes that the Fund provides a return of 5%
a year, and applies whether or not you redeem your investment at the end of each
period.
<TABLE>
<CAPTION>
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1 YEAR 3 YEARS 5 YEARS 10 YEARS
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<S> <C> <C> <C>
$32 $100 $174 $393
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</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.
<PAGE> 6
3
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ADDITIONAL INFORMATION
DIVIDENDS AND CAPITAL GAINS
Dividends are distributed in March, June, September, and December; capital
gains, if any, are distributed in December
INVESTMENT ADVISER
Wellington Management Company, LLP, Boston, Mass., since inception
INCEPTION DATE
July 1, 1970
NET ASSETS AS OF DECEMBER 31, 1998
$8.49 billion
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
CUSIP NUMBER
921938106
TICKER SYMBOL
VWINX
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================================================================================
A WORD ABOUT RISK
This prospectus describes the risks you would 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. As you consider an investment in Vanguard Wellesley Income
Fund, you should also take into account your personal tolerance for the daily
fluctuations of the stock market.
Look for this [FLAG] symbol throughout the prospectus. It is used to mark
detailed information about each type of risk that you would confront as a
shareholder of the Fund.
================================================================================
WHO SHOULD INVEST
The Fund may be a suitable investment for you if:
- - You wish to add a balanced fund to your existing holdings, which could
include other stock and bond investments, as well as money market and
tax-exempt investments.
- - You are seeking moderate growth of capital over the long term -- at least
five years -- along with a high level of current income.
- - You want a simple way to invest in a relatively fixed percentage of stocks
and bonds.
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PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are generally "middle-of-the-road" investments that seek to
provide some combination of growth, income, and conservation of capital by
investing in a mix of stocks, bonds, and/or money market instruments. Because
the prices of stocks and bonds often move in different directions, balanced
funds are able to use rewards from one type of investment to help offset the
risks from another.
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<PAGE> 7
4
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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 the 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.
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THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST IN THIS FUND IF
YOU ARE A MARKET-TIMER.
The Fund has adopted the following policies, among others, to discourage
short-term trading:
- - The Fund reserves the right to reject any purchase request -- including
exchanges from other Vanguard funds -- that it 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 and 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.
PRIMARY INVESTMENT STRATEGIES
This section explains the strategies that the investment adviser uses in pursuit
of the Fund's objective, income and moderate growth in capital. It also explains
how the adviser implements these strategies. In addition, this section discusses
several important risks -- income risk, interest rate risk, stock market risk
manager risk, credit risk, call risk, prepayment risk, and investment style risk
- -- faced by investors in the Fund. The Fund's Board of Trustees oversees the
management of the Fund, and may change the investment strategies in the interest
of shareholders.
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PLAIN TALK ABOUT
BONDS AND INTEREST RATES
As a rule, 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 should be able to sell your 5% bond for more than you
paid.
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MARKET EXPOSURE
BONDS
The Fund invests approximately two-thirds of its assets in bonds.
[FLAG] THE FUND IS SUBJECT TO INCOME RISK, WHICH IS THE POSSIBILITY THAT THE
FUND'S DIVIDENDS (INCOME) -- AND THUS ITS TOTAL RETURN -- WILL DECLINE
DUE TO FALLING INTEREST RATES. INCOME RISK IS GENERALLY THE GREATEST
FOR SHORT-TERM BONDS, AND THE LEAST FOR LONG-TERM BONDS.
Changes in interest rates will affect bond prices as well as bond income.
[FLAG] THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE POSSIBILITY
THAT BOND PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN LONG PERIODS
DUE TO RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE HIGH FOR
LONGER-TERM BONDS.
In the past, bond investors have seen the value of their investments
rise and fall -- sometimes significantly -- with changes in interest rates.
Between December 1976 and September 1981, for instance, rising interest rates
caused long-term bond prices to fall by almost 48%.
Because the Wellesley Income Fund invests mainly in bonds, changes in
interest rates will have a significant impact on the value of 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 bonds with a face value
of $1,000; each has a different maturity.
<PAGE> 8
5
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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.
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<TABLE>
<CAPTION>
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HOW INTEREST RATE CHANGES AFFECT BONDS*
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VALUE OF A $1000 BOND VALUE OF A $1,000 BOND
AFTER A 2% INCREASE AFTER A 2% DECREASE
TYPE OF BOND (MATURITY) IN INTEREST RATES IN INTEREST RATES
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<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
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*Assuming a 7% yield.
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</TABLE>
These figures are for illustrative purposes only and should not be regarded
as an indication of future returns from the bond market as a whole, or the Fund
in particular.
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PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies -- and mutual funds that hold these stocks
- -- can be classified by the companies' market value, or capitalization.
Generally, Vanguard defines large-capitalization (large-cap) funds as those
holding stocks of companies whose outstanding shares have a market value
exceeding $10 billion. Mid-cap funds hold stocks of companies with a market
value between $1 billion and $10 billion. Small-cap funds typically hold stocks
of companies with a market value of less than $1 billion.
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STOCKS
Roughly one-third of the 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 LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND
PERIODS OF FALLING PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns for the U.S. stock market over various
periods as measured by the Standard & Poor's 500 Composite Stock Price Index, a
widely used barometer of market activity. (Total returns consist of dividend
income plus change in market price.) 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, that the gap between best and
worst tends to narrow over the long term.
<TABLE>
<CAPTION>
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U.S. STOCK MARKET RETURNS (1926 - 1998)
- --------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 54.2% 24.1% 19.9% 17.7%
Worst - 43.1 - 12.4 - 0.8 3.1
Average 13.1 10.7 11.0 11.0
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</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1998. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.7%, returns for individual 5-year periods
ranged from a - 12.4% average (from 1928 through 1932) to 24.1% (from 1994
through 1998). These average returns reflect past performance on common stocks;
you should not regard them as an indication of future returns from either the
stock market as a whole or this Fund in particular.
The stocks held by Vanguard Wellesley Income Fund are chosen primarily for
their income potential. As a result, the Fund's holdings are not identical to
the S&P 500 Index or any other market index, and the performance of the Fund
will not mirror the returns of any particular index.
<PAGE> 9
6
Because bond prices and stock prices can 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 the 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 65% of the Fund's assets in investment-grade bonds and
approximately 35% to 40% of the Fund's assets in dividend-paying common stocks.
While the mix of stocks and bonds varies 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. To achieve the Fund's objective, income and moderate capital
growth, the adviser follows specific strategies for bond and stock selection.
The Fund is generally managed without regard to tax ramifications.
[FLAG] THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE POSSIBILITY THAT THE
ADVISER MAY DO A POOR JOB OF SELECTING BONDS AND STOCKS.
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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; and mortgage holders issue "mortgage-backed"
bonds such as those issued by the Government National Mortgage Association
(GNMA). Each issuer is responsible for paying back the bond's initial value as
well as periodic interest payments.
- --------------------------------------------------------------------------------
BONDS
WMC selects investment-grade bonds that it believes will generate a high and
sustainable level of current income. These bonds may include intermediate- and
long-term corporate, U.S. Treasury, government agency, mortgage-backed, and
asset-backed bonds. The bonds are bought and sold according to WMC's judgment
about bond issuers and the general direction of interest rates, within the
context of the economy in general. The dollar-weighted average maturity of the
Fund's bonds as of December 31, 1998, was 17.6 years.
A breakdown of the Fund's bond holdings (which amounted to 62% of net assets)
as of December 31, 1998, follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
TYPE OF BOND PERCENTAGE OF FUND'S BOND HOLDINGS
- --------------------------------------------------------------------------------
<S> <C>
Utilities 14.8%
Industrial 33.9
Bank/Finance 24.6
Mortgage 6.5
U.S. Treasury and government agency 16.3
Foreign Issuers 3.9
- --------------------------------------------------------------------------------
</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 PAY INTEREST AND PRINCIPAL IN A TIMELY MANNER.
- --------------------------------------------------------------------------------
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 (for example, 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. All things being equal,
the lower a bond's credit rating, the higher its yield should be to compensate
investors for assuming additional risk. Bonds rated in one of the four highest
ratings categories are considered "investment grade."
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<PAGE> 10
7
[FLAG] THE FUND IS SUBJECT TO CREDIT RISK, WHICH IS THE POSSIBILITY THAT A
BOND ISSUER WILL FAIL TO PAY INTEREST AND PRINCIPAL IN A TIMELY MANNER.
WMC purchases bonds that are investment-grade quality -- that is, bonds that
are rated at least Baa by Moody's Investors Service, Inc., or BBB by Standard &
Poor's Corporation. The dollar-weighted average quality of bonds held by the
Fund, as of December 31, 1998, was Aa3, according to Moody's.
The U.S. government guarantees the timely payment of interest and principal
for its Treasury bonds; many (but not all) agency bonds have the same guarantee.
The government does not, however, guarantee its bonds' prices. In other words,
while Treasury and agency bonds enjoy the highest credit ratings, their prices
- -- like the prices of other bonds in the Fund -- will fluctuate with changes in
interest rates.
While falling interest rates tend to strengthen bond prices, they can cause
another sort of problem for bond fund investors -- bond calls.
[FLAG] THE FUND IS SUBJECT TO CALL RISK, WHICH IS THE POSSIBILITY THAT DURING
PERIODS OF FALLING INTEREST RATES A BOND ISSUER WILL "CALL" -- OR REPAY
-- A HIGH-YIELDING BOND BEFORE ITS MATURITY DATE. FORCED TO REINVEST
THE UNANTICIPATED PROCEEDS AT LOWER INTEREST RATES, THE FUND WOULD
EXPERIENCE A DECLINE IN INCOME AND LOSE THE OPPORTUNITY FOR ADDITIONAL
PRICE APPRECIATION WITH FALLING RATES.
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 A
POTENTIAL LOSS OF ADDITIONAL PRICE APPRECIATION.
STOCKS
The Fund's stocks are chosen primarily for their dividend-producing
capabilities, but must also have the 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. Securities
are sold when an investment has achieved its intended purpose, or because it is
no longer considered attractive.
[FLAG] THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE POSSIBILITY
THAT RETURNS FROM LARGE- AND MID-CAPITALIZATION VALUE STOCKS WILL TRAIL
RETURNS FROM OTHER ASSET CLASSES OR THE OVERALL STOCK MARKET. AS A
GROUP, VALUE STOCKS TEND TO GO THROUGH CYCLES OF DOING BETTER -- OR
WORSE -- THAN COMMON STOCKS IN GENERAL. THESE PERIODS HAVE, IN THE
PAST, LASTED FOR AS LONG AS SEVERAL YEARS.
TURNOVER RATE
Although the Fund generally seeks to invest for the long term, it retains the
right to sell securities regardless of how long the securities have been held.
The Fund's average turnover rate for the past five years has been about 32%. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its net assets within a one-year period.)
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
<PAGE> 11
8
- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
TURNOVER RATE
Before investing in a mutual fund, you should review its turnover rate. This
gives an indication of how transaction costs could affect 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 turnover rates may be more likely
to generate capital gains that must be distributed to shareholders as income
subject to taxes. The average turnover rate for all balanced funds is
approximately 98%, according to Morningstar, Inc.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 types of derivatives. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
- --------------------------------------------------------------------------------
OTHER INVESTMENT POLICIES AND RISKS
Besides investing in bonds and stocks, the Fund may make certain other kinds of
investments to achieve its objective.
Although the Fund typically does not make significant investments in
securities of companies based outside the United States, the Fund reserves the
right to invest up to 20% of stock holdings in foreign common stocks as well as
securities that are convertible into common stocks. These securities may be
traded in U.S. or foreign markets.
To the extent that it owns foreign stocks, the Fund is subject to (1) country
risk, which is the possibility that political events (such as a war), financial
problems (such as government default), or natural disasters (such as an
earthquake) will weaken a country's economy and cause investments in that
country to lose money, and (2) currency risk, which is the possibility that
Americans investing abroad could lose money because of a rise in the value of
the U.S. dollar versus foreign currencies.
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. With respect to its investments in foreign bonds, the Fund is subject
to country risk.
The Fund may also 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 for speculative purposes or as leveraged investments that magnify
the gains or losses of an investment. The value of all futures and options
contracts in which the Fund acquires an interest cannot exceed 20% of total
assets.
The reasons for which the Fund will invest in 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 reduce the Fund's transaction costs or add value when these instruments
are favorably priced.
The Fund may, from time to time, take temporary defensive measures -- such as
holding cash reserves without limit -- that are inconsistent with the Fund's
primary investment strategies, in response to adverse market, economic,
political, or other conditions. In taking such measures, the Fund may not
achieve its investment objective.
<PAGE> 12
9
- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most 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 own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.
- --------------------------------------------------------------------------------
THE FUND AND VANGUARD
The Fund is a member of The Vanguard Group, a family of more than 35 investment
companies with more than 100 distinct investment portfolios holding assets worth
more than $470 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 distribution fees, each fund pays its
allocated share of The Vanguard Group's marketing costs.
- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
THE FUND'S ADVISER
Wellington Management Company, LLP, is an investment advisory firm founded in
1928. As of December 31, 1998, WMC managed more than $209 billion in stock and
bond portfolios, including 14 Vanguard funds. The managers responsible for
overseeing the implementation of WMC's strategy for Vanguard Wellesley Income
Fund are:
EARL E. MCEVOY, Senior Vice President and partner of WMC; has worked in
investment management since 1972; with WMC since 1978; Fund Manager since 1982,
B.A., Dartmouth College; M.B.A., Columbia Business School.
JOHN R. RYAN, CFA, Senior Vice President and Managing Partner of WMC; has
worked in investment management since 1971; with WMC since 1981; Fund Manager
since 1986, B.S., Lehigh University; M.B.A., University of Virginia.
- --------------------------------------------------------------------------------
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 Trustees and officers of the Fund.
WMC's advisory fee is paid quarterly. This fee is based on certain annual
percentage rates applied to the Fund's average month-end assets for each
quarter.
The advisory fee can be increased or decreased based on the difference
between the Fund's total return performance and that of its unmanaged Composite
Index, 65% of which is made up of the Lehman Brothers Long Corporate AA or
Better Bond Index and 35% of which comprises a blended stock composite (75%
S&P/BARRA Value Index, 12.5% S&P Utilities Index, and 12.5% S&P Telephone
Index).
For the year ended December 31, 1998, the investment advisory fee paid to WMC
represented an effective annual rate of 0.05% of the Fund's average net assets,
before an increase of 0.01% based on performance.
The Fund has authorized WMC to choose brokers or dealers to handle the
purchase and sale of securities for the Fund, and to get the best available
price and most favorable execution from these brokers with respect to all
transactions.
In the interest of obtaining better execution of a transaction, WMC may
choose brokers who charge higher commissions. 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. Also, 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.
<PAGE> 13
10
The Board of Trustees 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, any such change will
be communicated to shareholders in writing.
YEAR 2000 CHALLENGE
The common practice in computer programming of using just two digits to identify
a year has resulted in the Year 2000 challenge throughout the information
technology industry. If unchanged, many computer applications and systems could
misinterpret dates occurring after December 31, 1999, leading to errors or
failure. Such failure could adversely affect a fund's operations, including
pricing, securities trading, and the servicing of shareholder accounts.
The Vanguard Group is dedicated to providing uninterrupted,
high-quality performance from our computer systems before, during, and after
2000. In July 1998, we completed the renovation and initial testing of our
internal systems. Vanguard is diligently working with external partners,
suppliers, and vendors, including fund managers and other service providers, to
assure that the systems with which we interact remain operational at all times.
In addition to taking every reasonable step to secure our internal
systems and external relationships, Vanguard is further developing contingency
plans intended to assure that unexpected systems failures will not adversely
affect the Fund's operations. Vanguard intends to monitor these processes
through the rollover of 1999 into 2000 and to quickly implement alternate
solutions if necessary.
However, despite Vanguard's efforts and contingency plans, noncompliant
computer systems could have a material adverse effect on the Fund's business,
operations, or financial condition. Additionally, the Fund's performance could
be hurt if a computer-system failure at a company or governmental unit affects
the price of securities the Fund owns.
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 a capital gains distribution. Income
dividends come from both the dividends that the fund earns from its holdings and
the interest it receives from its money market and bond 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.
DIVIDENDS, CAPITAL GAINS, AND TAXES
The Fund distributes to shareholders virtually all of its net income (interest
and dividends less expenses) as well as any capital gains realized from the sale
of its holdings. Income distributions generally occur in March, June, September,
and December; capital gains distributions generally occur in December. In
addition, the Fund may occasionally be required to make supplemental dividend or
capital gains distributions at other times during the year. You can receive
distributions of income or capital gains in cash, or you can have them
automatically invested in more shares of the Fund. In either case, these
distributions are taxable to you. It is important to note that distributions of
dividends and capital gains that are declared in December -- if paid to you by
the end of January -- are taxed as if they had been paid to you in December.
Vanguard will send you a statement each year showing the tax status of
all your distributions. If you have chosen to receive dividend and/or capital
gains distributions in cash, and the postal or other delivery service is unable
to deliver checks to your address of record, we will change the distribution
option so that all dividends and other distributions are automatically invested
in additional shares. We will not pay interest on uncashed distribution checks.
- - The dividends and short-term capital gains that you receive are
considered ordinary income for tax purposes.
- - 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.
<PAGE> 14
11
PLAIN TALK ABOUT
"BUYING A DIVIDEND"
Unless you are investing through 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 doing so can cost you money in taxes. This is
known a "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 still have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250
shares x $1 = $250 in distributions), but you owe tax on the $250 distribution
you received -- even if you reinvest it in more shares. To avoid "buying a
dividend," check a fund's distribution schedule before you invest.
- - 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 by-products of its ordinary investment activities. Consequently,
distributions may vary considerably from year to year.
- - If you sell or exchange shares, any gain or loss you have is a taxable
event. This means that 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 through a
tax-deferred account such as an IRA or a qualified employee benefit plan.
(Non-U.S. investors may be subject to U.S. withholding and estate tax.) You
should consult your tax adviser about the tax consequences of an investment in
the Fund.
IMPORTANT NOTE: By law, the Fund must withhold 31% of your taxable
distributions and any redemption proceeds if you do not provide your correct
taxpayer identification number, or certify that it is correct, or if the IRS
instructs the Fund to do so.
SHARE PRICE
The Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of trading on the New York Stock Exchange (the NAV
is not calculated on holidays or other days the Exchange is closed). Net asset
value per share is computed by adding up the total value of the Fund's
investments and other assets, subtracting any of its liabilities (debts), and
then dividing by the number of Fund shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = ------------------------------------
NUMBER OF SHARES OUTSTANDING
Knowing the daily net asset value is useful to you as a shareholder
because it indicates the current value of your investment. The Fund's NAV,
multiplied by the number of 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.
A NOTE ON PRICING: The Fund's investments will be priced at their
market value when market quotations are readily available. When these quotations
are not readily available, investments will be priced at their fair value,
calculated according to procedures adopted by the Fund's Board of Trustees.
The Fund's share price can be found daily in the mutual fund listings
of most major newspapers under the heading "Vanguard Funds." Different
newspapers use different abbreviations of the Fund's name, but the most common
is WELLSL.
<PAGE> 15
12
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 1998 with a net asset value (price) of $21.86 per share.
During the year, the Fund earned $1.13 per share from investment income
(interest and dividends) and $1.40 per share from investments that had
appreciated in value or that were sold for higher prices than the Fund paid for
them.
Shareholders received $2.27 per share in the form of dividend and
capital gains distributions. A portion of each year's distributions may come
from the prior year's income or capital gains.
The earnings ($2.53 per share) minus the distributions ($2.27 per
share) resulted in a share price of $22.12 at the end of the year. This was an
increase of $.26 per share (from $21.86 at the beginning of the year to $22.12
at the end of the year). For a shareholder who reinvested the distributions in
the purchase of more shares, the total return from the Fund was 11.84% for the
year.
As of December 31, 1998, the Fund had $8.49 billion in net assets. For
the year, its expense ratio was 0.31% ($3.10 per $1,000 of net assets); and net
investment income amounted to 5.05% of its average net assets. It sold and
replaced securities valued at 32% of its net assets.
FINANCIAL HIGHLIGHTS
The following financial highlights table is intended to help you understand the
Fund's financial performance for the past five years, and certain information
reflects financial results for a single Fund share. The total returns in the
table represent the rate that an investor would have earned or lost each year on
an investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been derived from the financial statements
audited by PricewaterhouseCoopers LLP, independent accountants, whose report --
along with the Fund's financial statements -- is included in the Fund's most
recent annual report to shareholders. You may have the annual report sent to you
without charge by contacting Vanguard.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
VANGUARD WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $ 21.86 $ 20.51 $ 20.44 $ 17.05 $ 19.24
- ---------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 1.13 1.190 1.17 1.13 1.11
Net Realized and Unrealized Gain (Loss)
on Investments 1.40 2.805 .66 3.68 (1.95)
----------------------------------------------------------
Total from Investment Operations 2.53 3.995 1.83 4.81 (.84)
----------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (1.13) (1.200) (1.16) (1.14) (1.11)
Distributions from Realized Capital Gains (1.14) (1.445) (.60) (.28) (.24)
----------------------------------------------------------
Total Distributions (2.27) (2.645) (1.76) (1.42) (1.35)
- ---------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 22.12 $ 21.86 $ 20.51 $ 20.44 $ 17.05
=========================================================================================================
TOTAL RETURN 11.84% 20.19% 9.42% 28.91% -4.44%
=========================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 8,498 $ 7,646 $ 7,013 $ 7,181 $ 5,681
Ratio of Total Expenses to
Average Net Assets 0.31% 0.31% 0.31% 0.35% 0.34%
Ratio of Net Investment Income to
Average Net Assets 5.05% 5.47% 5.74% 5.96% 6.16%
Turnover Rate 32% 36% 26% 32% 32%
=========================================================================================================
</TABLE>
From time to time, the Vanguard funds advertise yield and total return
figures. Yield is a measure of past dividend income. Total return includes both
past dividend income (assuming that it has been reinvested) plus realized and
unrealized capital appreciation (or depreciation). Neither yield nor total
return should be used to predict the future performance of a fund.
"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," and
"500" are trademarks of The McGraw-Hill Companies, Inc.
<PAGE> 16
13
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. Booklets providing detailed information are available on the
services marked with a [BOOK]. Please call us to request copies.
SERVICES AND ACCOUNT FEATURES
Vanguard offers many services that make it convenient to buy, sell, or exchange
shares, or to obtain fund or account information.
TELEPHONE REDEMPTIONS (SALES AND EXCHANGES)
Automatically set up for this Fund unless you notify us otherwise.
VANGUARD DIRECT DEPOSIT SERVICE(TM) [BOOK]
Automatic method for depositing your paycheck or U.S. government payment
(including Social Security and government pension checks) into your account.
VANGUARD AUTOMATIC EXCHANGE SERVICE(TM) [BOOK]
Automatic method for moving a fixed amount of money from one Vanguard fund
account to another.
VANGUARD FUND EXPRESS(R) [BOOK]
Electronic method for buying or selling shares. You can transfer money between
your Vanguard fund account and an account at your bank, savings and loan, or
credit union on a systematic schedule or whenever you wish.
VANGUARD DIVIDEND EXPRESS(TM) [BOOK]
Electronic method for transferring dividend and/or capital gains distributions
directly from your Vanguard fund account to your bank, savings and loan, or
credit union account.
VANGUARD TELE-ACCOUNT(R) 1-800-662-6273 (ON-BOARD) [BOOK]
Toll-free 24-hour access to Vanguard fund and account information -- as well as
some transactions -- by using any touch-tone phone. Tele-Account provides total
return, share price, 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.
ACCESS VANGUARD(TM) www.vanguard.com [COMPUTER]
You can use your personal computer to perform certain transactions for most
Vanguard funds by accessing our website. To establish this service, you must
register through the website. We will then send to you, by mail, an account
access password that allows you to process the following financial and
administrative transactions online:
- - Open a new account.*
- - Buy, sell or exchange shares of most funds.
- - Change your name/address.
- - Add/change fund options (including dividend options, Vanguard Fund
Express, bank instructions, checkwriting, and Vanguard Automatic
Exchange Service).
* Only current Vanguard shareholders can open a new account online, by
exchanging shares from other existing Vanguard accounts.
CLIENT SERVICES DEPARTMENT: 1-800-662-7447 (SHIP) TEXT TELEPHONE: 1-800-952-3335
Call Vanguard for information on our funds, fund services, and retirement
accounts, and to request literature.
CLIENT SERVICES DEPARTMENT: 1-800-662-2739 (CREW) TEXT TELEPHONE: 1-800-662-2738
Call Vanguard for information on your account, account transactions, and account
statements.
SERVICES FOR CLIENTS OF VANGUARD'S INSTITUTIONAL DIVISION: 1-888-809-8102
Vanguard's Institutional Division offers a variety of specialized services for
large institutional investors, including the ability to effect account
transactions through private electronic networks and third-party
recordkeepers.
<PAGE> 17
14
TYPES OF ACCOUNTS
Individuals and institutions can establish a variety of accounts with Vanguard.
FOR ONE OR MORE PEOPLE
Open an account in the name of one (individual) or more (joint tenants) people.
FOR HOLDING PERSONAL TRUST ASSETS [BOOK]
Invest assets held in an existing personal trust.
FOR INDIVIDUAL RETIREMENT ACCOUNTS [BOOK]
Open a traditional IRA account or a Roth IRA account. Eligibility and other
requirements are established by federal law and Vanguard custodial account
agreements. For more information, please call 1-800-662-7447 (SHIP).
FOR AN ORGANIZATION [BOOK]
Open an account as a corporation, partnership, endowment, foundation, or other
entity.
FOR THIRD-PARTY TRUSTEE RETIREMENT INVESTMENTS
Open an account as a retirement trust or plan based on an existing corporate or
institutional plan. These accounts are established by the trustee of the
existing plan.
VANGUARD PROTOTYPE PLANS
Open a variety of retirement accounts using Vanguard prototype plans for
individuals, sole proprietorships, and small businesses. For more information,
please call 1-800-662-2003.
A NOTE ON INVESTING WITH VANGUARD THROUGH OTHER FIRMS
You may purchase or sell Fund shares through a financial intermediary such as a
bank, broker, or investment adviser. If you invest with Vanguard through an
intermediary, please read that firm's program materials carefully to learn of
any special rules that may apply. For example, special terms may apply to
additional service features, fees or other policies. Consult your intermediary
to determine when your order will be priced.
BUYING SHARES
You buy your shares at the Fund's next-determined net asset value after Vanguard
receives your request. As long as your request is received before the close of
trading on the New York Stock Exchange, generally 4 p.m. Eastern time, you will
buy your shares at that day's net asset value.
MINIMUM INVESTMENT TO . . .
open a new account
$3,000 (regular account); $1,000 (traditional IRAs and Roth IRAs).
add to an existing account
$100 by mail or exchange; $1,000 by wire.
A NOTE ON LOW BALANCES
The Fund reserves the right to close any nonretirement account whose balance
falls below the minimum initial investment. The Fund will deduct a $10 annual
fee in June if your nonretirement account balance falls below $2,500. The fee is
waived if your total Vanguard account assets are $50,000 or more.
BY MAIL TO . . . [ENVELOPE]
open a new account
Complete and sign the application form and enclose your check.
add to an existing account
Mail your check with an Invest-By-Mail form detached from your confirmation
statement to the address listed on the form.
<PAGE> 18
15
Make your check payable to: The Vanguard Group - 27
All purchases must be made in U.S. dollars, and checks must be drawn on
U.S. banks.
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2600 455 Devon Park Drive
Valley Forge, PA 19482-2600 Wayne, PA 19087-1815
For clients of Vanguard's Institutional Division . . .
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.
BY TELEPHONE TO . . . [TELEPHONE HANDSET]
open a new account
Call Vanguard Tele-Account* 24 hours a day -- or Client Services during business
hours -- to exchange from another Vanguard fund account with the same
registration (name, address, taxpayer identification number, and account type).
add to an existing account
Call Vanguard Tele-Account* 24 hours a day -- or Client Services during business
hours -- to exchange from another Vanguard fund account with the same
registration (name, address, taxpayer identification number, 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.
Vanguard Tele-Account Client Services
1-800-662-6273 1-800-662-2739
* You must obtain a Personal Identification Number through Tele-Account at least
seven days before you request your first exchange.
IMPORTANT NOTE: Once you've requested a telephone transaction and a confirmation
number has been assigned, the transaction cannot be revoked. We reserve the
right to refuse any purchase request.
BY WIRE TO OPEN A NEW ACCOUNT OR ADD TO AN EXISTING ACCOUNT [WIRE]
Call Client Services to arrange your wire transaction. Wire transactions are not
available for retirement accounts, except for asset transfers and direct
rollovers.
Wire to:
FRB ABA 021001088
HSBC Bank USA
For credit to:
Account: 000112046
Vanguard Incoming Wire Account
In favor of:
Vanguard Wellesley Income Fund - 27
[Account number, or temporary number for a new account]
[Registered account owner/s]
[Registered address]
<PAGE> 19
16
BUYING SHARES (CONTINUED)
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.
A NOTE ON LARGE PURCHASES
It is important that you call Vanguard before you invest a large dollar amount.
We must consider the interests of all Fund shareholders and so reserve the right
to refuse any purchase that will disrupt the Fund's operation or performance.
REDEEMING SHARES
This section describes how you can redeem -- that is, sell or exchange -- a
Fund's shares.
When Selling Shares:
- - Vanguard sends the redemption proceeds to you or a designated third
party.*
- - You can sell all or part of your Fund shares at any time.
* May require a signature guarantee; see footnote on page 18.
When Exchanging Shares:
- - The redemption proceeds are used to purchase shares of a different
Vanguard fund.
- - You must meet the receiving fund's minimum investment requirements.
- - Vanguard reserves the right to revise or terminate the exchange
privilege, limit the amount of an exchange, or reject an exchange at
any time, without notice.
In both cases, your transaction will be based on the Fund's next-determined
share price, subject to any special rules discussed in this prospectus. For
exchanges, the purchase side of the transaction will be based on the receiving
fund's next-determined share price, again subject to any special rules discussed
in this prospectus.
NOTE: Once a redemption is processed and a confirmation number given, the
transaction CANNOT be canceled.
HOW TO REQUEST A REDEMPTION
You can request a redemption from your Fund account in any one of three ways:
online, by telephone, or by mail.
ONLINE REQUESTS [COMPUTER]
ACCESS VANGUARD at www.vanguard.com
You can use your personal computer to sell or exchange shares of most Vanguard
funds by accessing our website. To establish this service, you must register
through the website. We will then send you, by mail, an account access password
that will enable you to sell or exchange shares online (as well as perform other
transactions).
NOTE: The Vanguard funds whose shares you cannot exchange online or by
telephone are VANGUARD U.S. STOCK INDEX FUNDS, VANGUARD BALANCED INDEX FUND,
VANGUARD INTERNATIONAL STOCK INDEX FUNDS, VANGUARD REIT INDEX FUND, VANGUARD
TOTAL INTERNATIONAL STOCK INDEX FUND, and VANGUARD GROWTH AND INCOME FUND. These
funds do, however, permit online and telephone exchanges within IRAs and other
retirement accounts. If you sell shares of these funds online, you will receive
a redemption check at your address of record.
TELEPHONE REQUESTS [TELEPHONE HANDSET]
All Account Types Except Retirement:
Call Vanguard Tele-Account 24 hours a day -- or Client Services during business
hours -- to sell or exchange shares. You can exchange shares from this Fund to
open an account in another Vanguard fund or to add to an existing Vanguard fund
account with an identical registration.
<PAGE> 20
17
Retirement Accounts:
You can exchange -- but not sell -- shares by calling Tele-Account or Client
Services.
Vanguard Tele-Account Client Services
1-800-662-6273 1-800-662-2739
SPECIAL INFORMATION: We will automatically establish the telephone redemption
option for your account, unless you instruct us otherwise in writing. While
telephone redemption is easy and convenient, this account feature involves a
risk of loss from unauthorized or fraudulent transactions. Vanguard will take
reasonable precautions to protect your account from fraud. You should do the
same by keeping your account information private and immediately reviewing any
account statements that we send to you. Make sure to contact Vanguard
immediately about any transaction you believe to be unauthorized.
We reserve the right to refuse a telephone redemption if the caller is unable to
provide:
[CHECK MARK] The ten-digit account number.
[CHECK MARK] The name and address exactly as registered on the account.
[CHECK MARK] The primary Social Security or employer identification number as
registered on the account.
[CHECK MARK] The Personal Identification Number, if applicable.
Please note that Vanguard will not be responsible for any account
losses due to telephone fraud, so long as we have taken reasonable
steps to verify the caller's identity. If you wish to remove the
telephone redemption feature from your account, please notify us in
writing.
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 U.S. 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 this section.
MAIL REQUESTS [ENVELOPE]
All Account Types Except Retirement:
Send a letter of instruction signed by all registered account holders. Include
the fund name and account number and (if you are selling) a dollar amount or
number of shares OR (if you are exchanging) the name of the fund you want to
exchange into and a dollar amount or number of shares. To exchange into an
account with a different registration (including a different name, address,
taxpayer identification number, or account type), you must provide Vanguard with
written instructions that include the guaranteed signatures of all current
owners of the fund from which you wish to redeem.
Vanguard Retirement Accounts:
For information on how to request distributions from:
- - Traditional IRAs and Roth IRAs -- call Client Services.
- - SEP - IRAs, SIMPLE IRAs, 403(b)(7) custodial accounts, and
Profit-Sharing and Money Purchase Pension (Keogh) Plans -- call
Individual Retirement Plans at 1-800-662-2003.
Depending on your account registration type, additional documentation may be
required.
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 1120 455 Devon Park Drive
Valley Forge, PA 19482-1120 Wayne, PA 19087-1815
For clients of Vanguard's Institutional Division . . .
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
<PAGE> 21
18
REDEEMING SHARES (continued)
A NOTE ON LARGE REDEMPTIONS
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 delivery of your redemption proceeds -- up to seven days -- if the
amount will disrupt the Fund's operation or performance.
If you redeem more than $250,000 worth of Fund shares within any 90-day
period, the Fund reserves the right to pay part or all of the redemption
proceeds above $250,000 in kind, i.e., in securities, rather than in cash. If
payment is made in kind, you may incur brokerage commissions if you elect to
sell the securities for cash.
OPTIONS FOR REDEMPTION PROCEEDS
You may receive your redemption proceeds in one of two ways: check, or exchange
to another Vanguard fund.
CHECK REDEMPTIONS
Normally, Vanguard will mail your check within two business days of a
redemption.
EXCHANGE REDEMPTIONS
As described above, an exchange involves using the proceeds of your redemption
to purchase shares of another Vanguard fund.
FOR OUR MUTUAL PROTECTION
For your best interests and ours, Vanguard applies these additional requirements
to redemptions:
REQUEST IN "GOOD ORDER"
All redemption requests must be received by Vanguard in "good order." This means
that your request must include:
[CHECK MARK] The Fund name and account number.
[CHECK MARK] The amount of the transaction (in dollars or shares).
[CHECK MARK] Signatures of all owners exactly as registered on the account
(for mail requests).
[CHECK MARK] Signature guarantees (if required).*
[CHECK MARK] Any supporting legal documentation that may be required.
[CHECK MARK] Any outstanding certificates representing shares to be redeemed.
* For instance, a signature guarantee must be provided by all registered account
shareholders when redemption proceeds are to be sent to a different person or
address. A signature guarantee can be obtained from most banks, credit unions,
and licensed brokers.
TRANSACTIONS ARE PROCESSED AT THE NEXT-DETERMINED SHARE PRICE AFTER VANGUARD HAS
RECEIVED ALL REQUIRED INFORMATION.
LIMITS ON ACCOUNT ACTIVITY
Because excessive account transactions can disrupt management of a Fund and
increase the Fund's costs for all shareholders, Vanguard limits account activity
as follows:
- - You may make no more than TWO SUBSTANTIVE "ROUND TRIPS" THROUGH THE
FUND during any 12-month period.
- - Your round trips through the Fund must be at least 30 days apart.
- - The Fund may refuse a share purchase at any time, for any reason.
- - Vanguard may revoke an investor's telephone exchange privilege at any
time, for any reason.
A "round trip" is a redemption from the Fund followed by a purchase back into
the Fund. Also, "round trip" covers transactions accomplished by any combination
of methods, including transactions conducted by check, wire, or exchange to/from
another Vanguard fund. "Substantive" means a dollar amount that Vanguard
determines, in its sole discretion, could adversely affect the management of the
Fund.
RETURN YOUR SHARE CERTIFICATES
Any portion of your account represented by share certificates cannot be redeemed
until you return the certificates to Vanguard. Certificates must be returned
(unsigned), along with a letter requesting the sale or exchange you wish to
process, via certified mail to:
The Vanguard Group
455 Devon Park Drive
Wayne, PA 19087-1815
<PAGE> 22
19
ALL TRADES FINAL
Vanguard will not cancel any transaction request (including any purchase or
redemption) that we believe to be authentic once the request has been received
and a confirmation number assigned.
TRANSFERRING REGISTRATION
You can transfer the registration of your Fund shares to another owner by
completing a transfer form and sending it to Vanguard.
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 1110 455 Devon Park Drive
Valley Forge, PA 19482-1110 Wayne, PA 19087-1815
For clients of Vanguard's Institutional Division . . .
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
FUND AND ACCOUNT UPDATES
STATEMENTS AND REPORTS
We will send you account and tax statements to help you keep track of your 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 advisers, and the Fund's financial statements which
include a listing of the Fund's holdings.
To keep the Fund's costs as low as possible (so that you and other
shareholders can keep more of the Fund's investment earnings), Vanguard attempts
to eliminate duplicate mailings to the same address. When we find that two or
more Fund shareholders have the same last name and address, we send just one
Fund report to that address -- instead of mailing separate reports to each
shareholder. If you want us to send separate reports, however, you may notify
our Client Services Department at 1-800-662-2739.
CONFIRMATION STATEMENT
Sent each time you buy, sell, or exchange shares; confirms the trade date and
the amount of your transaction.
PORTFOLIO SUMMARY [BOOK]
Mailed quarterly for most accounts; 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 and capital gains
distributions, proceeds from the sale of shares, and distributions from IRAs or
other retirement accounts.
AVERAGE COST REVIEW STATEMENT [BOOK]
Issued quarterly for most taxable accounts (accompanies your Portfolio Summary);
shows the average cost of shares that you redeemed during the calendar year,
using the average cost single category method.
<PAGE> 23
(THIS PAGE INTENTIONALLY LEFT BLANK.)
<PAGE> 24
GLOSSARY OF INVESTMENT TERMS
BALANCED FUND
A mutual fund that seeks to provide some combination of income, capital growth,
and conservation of capital 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. In most instances, the issuer agrees to
pay back the loan by a specific date and to make regular interest payments until
that date.
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized on securities that the
fund has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits, short-term bank deposits, and money market instruments which
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's acceptances.
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 pay interest and principal in a timely
manner.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
DURATION
A measure of the sensitivity of bond -- and bond fund -- prices to interest rate
movements. For example, if a bond has a duration of two years, its price would
fall by about 2% when interest rates rose one percentage point. On the other
hand, the bond's price would rise by about 2% when interest rates fell by 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
distribution 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.
FUND DIVERSIFICATION
Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a fund's
investments.
INVESTMENT GRADE
A bond whose credit quality is considered by independent bond-rating agencies to
be sufficient to ensure timely payment of principal and interest under current
economic circumstances.
MATURITY
The date when a bond issuer agrees to repay the bond's principal, or face value,
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 value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE> 25
[SHIP LOGO]
Post Office Box 2600
Valley Forge, PA 19482-2600
FOR MORE INFORMATION
If you'd like more information about Vanguard Wellesley Income Fund, the
following documents are available free upon request:
ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS
Additional information about the Fund's investments is available in the Fund's
annual and semiannual reports to shareholders. In these reports, you will find a
discussion of the market conditions and investment strategies that significantly
affected the Fund's performance during the most recent fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
The SAI provides more detailed information about all aspects of the Fund.
The current annual and semiannual reports and the SAI are incorporated by
reference into (and are thus legally a part of) this prospectus.
To receive a free copy of the latest annual or semiannual report or the SAI, or
to request additional information about the Fund or other Vanguard funds, please
contact us as follows:
THE VANGUARD GROUP
INVESTOR INFORMATION DEPARTMENT
P.O. BOX 2600
VALLEY FORGE, PA 19482-2600
TELEPHONE: 1-800-662-7447 (SHIP)
TEXT TELEPHONE: 1-800-952-3335
WORLD WIDE WEB: WWW.VANGUARD.COM
If you are a current Fund shareholder and would like information about your
account, account transactions, and/or account statements, please call:
CLIENT SERVICES DEPARTMENT TELEPHONE: 1-800-662-2739 (CREW)
TEXT TELEPHONE: 1-800-662-2738
INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC)
You can review and copy information about the Fund (including the SAI) at the
SEC's Public Reference Room in Washington, D.C. To find out more about this
public service, call the SEC at 1-800-SEC-0330. Reports and other information
about the Funds are also available on the SEC's website (www.sec.gov), or you
can receive copies of this information, for a fee, by writing the Public
Reference Section, Securities and Exchange Commission, Washington, DC
20549-6009.
Fund's Investment Company Act file number: 811-1776
(C) 1999 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing
Corporation, Distributor.
P027N - 04/30/1999
<PAGE> 26
VANGUARD WELLESLEY INCOME FUND
Participant Prospectus
April 30, 1999
A Balanced Mutual Fund
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
1 FUND PROFILE
3 ADDITIONAL INFORMATION
3 A WORD ABOUT RISK
3 WHO SHOULD INVEST
4 PRIMARY INVESTMENT STRATEGIES
9 THE FUND AND VANGUARD
9 INVESTMENT ADVISER
10 YEAR 2000 CHALLENGE
10 DIVIDENDS, CAPITAL GAINS, AND TAXES
11 SHARE PRICE
12 FINANCIAL HIGHLIGHTS
13 INVESTING WITH VANGUARD
13 ACCESSING FUND INFORMATION BY COMPUTER
GLOSSARY (inside back cover)
</TABLE>
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objective, risks, and strategies of Vanguard
Wellesley Income Fund. To highlight terms and concepts important to mutual fund
investors, we have provided "Plain Talk(R)" 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.
IMPORTANT NOTE
This prospectus is intended 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.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<PAGE> 27
1
FUND PROFILE--VANGUARD WELLESLEY INCOME FUND
The following profile summarizes key features of Vanguard Wellesley Income Fund.
INVESTMENT OBJECTIVE
The Fund is a balanced fund that seeks to provide a high and sustainable level
of current income along with moderate long-term capital growth.
INVESTMENT STRATEGIES
The Fund invests approximately 60% to 65% of its assets in investment-grade,
longer-term corporate, U.S. Treasury, government agency, and mortgage-backed
bonds. The remaining 35% to 40% of Fund assets are invested in common stocks of
companies that have a history of above-average dividends or expectations of
increasing dividends.
PRIMARY RISKS
THE FUND'S TOTAL RETURN, LIKE STOCK AND BOND PRICES GENERALLY, WILL FLUCTUATE
WITHIN A WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG
PERIODS. The Fund is also subject to:
- - Interest rate risk, which is the chance that bond prices overall will
decline over short or even long periods due to rising interest rates.
Interest rate risk is generally high for longer-term bonds.
- - Income risk, which is the chance that falling interest rates will cause the
Fund's income to decline. Income risk is generally low for longer-term
bonds.
- - Credit risk, which is the chance that a bond issuer will fail to pay
interest and principal in a timely manner, reducing the Fund's return.
Credit risk should be low for the Fund.
- - Prepayment risk, which is the chance that during periods of falling
interest rates, a bond issuer will repay a high-yielding bond earlier than
scheduled. Forced to reinvest the unanticipated proceeds at lower interest
rates, the Fund would experience a decline in income.
- - Call risk, which is the chance that during periods of falling interest
rates, a bond issuer will "call"--or repay--a high-yielding bond before its
maturity date. Forced to reinvest the unanticipated proceeds at lower
interest rates, the Fund would experience a decline in income. Call risk is
generally high for longer-term bonds.
- - Investment style risk, which is the chance that returns from large- and
mid-capitalization value stocks will trail returns from other asset classes
or the overall stock market. Each type of stock tends to go through cycles
of doing better--or worse--than the stock market in general. These periods
have, in the past, lasted for as long as several years.
- - Manager risk, which is the chance that poor security selection will cause
the Fund to underperform other funds with similar investment objectives.
PERFORMANCE/RISK INFORMATION
The bar chart and table below provide an indication of the risk of investing in
the Fund. The bar chart shows the Fund's performance in each calendar year over
a ten-year period. The table shows how the Fund's average annual returns for
one, five, and ten calendar years compare with those of both the Lehman Long
Corporate AA or Better Bond Index, a broad-based securities market index and a
composite stock/bond index weighted to match the Fund's target allocation. Keep
in mind that the Fund's past performance does not necessarily indicate how it
will perform in the future.
ANNUAL TOTAL RETURNS
[BAR CHART]
<TABLE>
<CAPTION>
12/31/1989 12/31/1990 12/31/1991 12/31/1992 12/31/1993 12/31/1994 12/31/1995
<S> <C> <C> <C> <C> <C> <C> <C>
WELLESLEY INCOME FUND 20.93% 3.76% 21.57% 8.67% 14.65% -4.44% 28.91%
</TABLE>
<TABLE>
<CAPTION>
12/31/1996 12/31/1997 12/31/1998
<S> <C> <C> <C>
WELLESLEY INCOME FUND 9.42% 20.19% 11.84%
</TABLE>
During the period shown in the bar chart, the highest return for a calendar
quarter was 8.77% (quarter ended June 30, 1989) and the lowest return for a
quarter was -4.47% (quarter ended March 31, 1994).
<PAGE> 28
2
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Vanguard Wellesley Income Fund 11.84% 12.62% 13.16%
Wellesley Composite Index(*) 13.87 12.61 12.97
Lehman Long Corporate AA or Better Bond Index 10.52 8.73 10.72
- --------------------------------------------------------------------------------
</TABLE>
(*) Weighted 65% in the Lehman Long Corporate AA or Better Bond Index,
and 35% in a blended stock composite (75% in the S&P/BARRA Value
Index, 12.5% in the S&P Utilities Index, and 12.5% in the S&P
Telephone Index). Note: Prior to June 30, 1996, the S&P Telephone
Index was a part of (and not separate from) the S&P Utilities Index.
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 the fund's buying and selling of securities. These costs
can erode a substantial portion of the gross income or capital appreciation a
fund achieves. Even seemingly small differences in expenses can, over time, have
a dramatic effect 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 1998
was 0.31%, or $3.10 per $1,000 of average net assets. The average balanced
mutual fund had expenses in 1998 of 1.31%, or $13.10 per $1,000 of average net
assets, according to Lipper Inc., which reports on the mutual fund industry.
FEES AND EXPENSES
The following table describes the fees and expenses you would pay if you buy and
hold shares of the Fund. The expenses shown under Annual Fund Operating Expenses
are based upon those incurred in the fiscal year ended December 31, 1998.
SHAREHOLDER FEES (fees paid directly from your investment)
<TABLE>
<S> <C>
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
</TABLE>
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
<TABLE>
<S> <C>
Management Expenses: 0.28%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.31%
</TABLE>
The following example is intended to help you compare the cost of investing
in the Fund with the cost of investing in other mutual funds. It illustrates the
hypothetical expenses that you would incur over various periods if you invest
$10,000 in the Fund. This example assumes that the Fund provides a return of 5%
a year, and applies whether or not you redeem your investment at the end of each
period.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
$32 $100 $174 $393
- --------------------------------------------------------------------------------
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.
<PAGE> 29
3
ADDITIONAL INFORMATION
DIVIDENDS AND CAPITAL GAINS
Dividends are distributed in March, June, September, and December; capital
gains, if any, are distributed in December
INVESTMENT ADVISER
Wellington Management Company, LLP, Boston, Mass., since inception
INCEPTION DATE
July 1, 1970
NET ASSETS AS OF DECEMBER 31, 1998
$8.49 billion
NEWSPAPER ABBREVIATION
Wellsl
VANGUARD FUND NUMBER
027
CUSIP NUMBER
921938106
TICKER SYMBOL
VWINX
A WORD ABOUT RISK
This prospectus describes the risks you would 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. As you consider an investment in Vanguard Wellesley Income
Fund, you should also take into account your personal tolerance for the daily
fluctuations of the stock market.
Look for this [FLAG] symbol throughout the prospectus. It is used to mark
detailed information about each type of risk that you would confront as a
shareholder of the Fund.
WHO SHOULD INVEST
The Fund may be a suitable investment for you if:
- - You wish to add a balanced fund to your existing holdings, which could
include other stock and bond investments, as well as money market and
tax-exempt investments.
- - You are seeking moderate growth of capital over the long term--at least
five years--along with a high level of current income.
- - You want a simple way to invest in a relatively fixed percentage of stocks
and bonds.
PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are generally "middle-of-the-road" investments that seek to
provide some combination of growth, income, and conservation of capital by
investing in a mix of stocks, bonds, and/or money market instruments. Because
the prices of stocks and bonds often move in different directions, balanced
funds are able to use rewards from one type of investment to help offset the
risks from another.
<PAGE> 30
4
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 the 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.
THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST IN THIS FUND
IF YOU ARE A MARKET-TIMER.
The Fund has adopted the following policies, among others, to discourage
short-term trading:
- - The Fund reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it 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 and out of
the Fund (see "Exchanges" in the INVESTING WITH VANGUARD section).
- - The Fund reserves the right to stop offering shares at any time.
PRIMARY INVESTMENT STRATEGIES
This section explains the strategies that the investment adviser uses
in pursuit of the Fund's objective income and moderate growth in capital. It
also explains how the adviser implements these strategies. In addition, this
section discusses several important risks--income risk, interest rate risk,
stock market risk, manager risk, credit risk, call risk, prepayment risk, and
investment style risk--faced by investors in the Fund. The Fund's Board of
Trustees oversees the management of the Fund, and may change the investment
strategies in the interest of shareholders.
PLAIN TALK ABOUT
BONDS AND INTEREST RATES
As a rule, 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 should be able to sell your 5% bond for more than you
paid.
MARKET EXPOSURE
BONDS
The Fund invests approximately two-thirds of its assets in bonds.
[FLAG] THE FUND IS SUBJECT TO INCOME RISK, WHICH IS THE POSSIBILITY THAT THE
FUND'S DIVIDENDS (INCOME)--AND THUS ITS TOTAL RETURN--WILL DECLINE DUE TO
FALLING INTEREST RATES. INCOME RISK IS GENERALLY THE GREATEST FOR
SHORT-TERM BONDS, AND THE LEAST FOR LONG-TERM BONDS.
Changes in interest rates will affect bond prices as well as bond income.
[FLAG] THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE POSSIBILITY THAT
BOND PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN LONG PERIODS DUE TO
RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE 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
long-term bond prices to fall by almost 48%.
Because the Wellesley Income Fund invests mainly in bonds, changes in
interest rates will have a significant impact on the value of 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 bonds with a face value
of $1,000; each has a different maturity.
<PAGE> 31
5
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
HOW INTEREST RATE CHANGES AFFECT BONDS(*)
- --------------------------------------------------------------------------------
VALUE OF A $1,000 BOND VALUE OF A $1,000 BOND
AFTER A 2% INCREASE AFTER A 2% DECREASE
TYPE OF BOND (MATURITY) IN INTEREST RATES IN INTEREST RATES
- --------------------------------------------------------------------------------
<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
- --------------------------------------------------------------------------------
(*)Assuming a 7% yield.
- --------------------------------------------------------------------------------
</TABLE>
These figures are for illustrative purposes 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 the 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 LONG PERIODS. STOCK
MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS
OF FALLING PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns for the U.S. stock market over various
periods as measured by the Standard & Poor's 500 Composite Stock Price Index, a
widely used barometer of market activity. (Total returns consist of dividend
income plus change in market price.) 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, that the gap between best and
worst tends to narrow over the long term.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-1998)
- --------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 54.2% 24.1% 19.9% 17.7%
Worst -43.1 -12.4 -0.8 3.1
Average 13.1 10.7 11.0 11.0
- --------------------------------------------------------------------------------
</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1998. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.7%, returns for individual 5-year periods
ranged from a -12.4% average (from 1928 through 1932) to 24.1% (from 1994
through 1998). These average returns reflect past performance on common stocks;
you should not regard them as an indication of future returns from either the
stock market as a whole or this Fund in particular.
The stocks held by Vanguard Wellesley Income Fund are chosen primarily for
their income potential. As a result, the Fund's holdings are not identical to
the S&P 500 Index or any other market index, and the performance of the Fund
will not mirror the returns of any particular index.
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.
PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies--and mutual funds that hold these
stocks--can be classified by the companies' market value, or capitalization.
Generally, Vanguard defines large-capitalization (large-cap) funds as those
holding stocks of companies whose outstanding shares have a market value
exceeding $10 billion. Mid-cap funds hold stocks of companies with a market
value between $1 billion and $10 billion. Small-cap funds typically hold stocks
of companies with a market value of less than $1 billion.
<PAGE> 32
6
Because bond prices and stock prices can 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 the 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 65% of the Fund's assets in investment-grade bonds and
approximately 35% to 40% of the Fund's assets in dividend-paying common stocks.
While the mix of stocks and bonds varies 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. To achieve the Fund's objective income and moderate
capital growth, the adviser follows specific strategies for bond and stock
selection.
The Fund is generally managed without regard to tax ramifications.
[FLAG] THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE POSSIBILITY THAT THE
ADVISER 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; and mortgage holders issue "mortgage-backed"
bonds such as those issued by the Government National Mortgage Association
(GNMA). Each issuer is responsible for paying back the bond's initial value as
well as periodic interest payments.
BONDS
WMC selects investment-grade bonds that it believes will generate a high and
sustainable level of current income. These bonds may include intermediate- and
long-term corporate, U.S. Treasury, government agency, mortgage-backed, and
asset-backed bonds. The bonds are bought and sold according to WMC's judgment
about bond issuers and the general direction of interest rates, within the
context of the economy in general. The dollar-weighted average maturity of the
Fund's bonds as of December 31, 1998, was 17.6 years.
A breakdown of the Fund's bond holdings (which amounted to 62% of net
assets) as of December 31, 1998, follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
TYPE OF BOND PERCENTAGE OF FUND'S BOND HOLDINGS
- --------------------------------------------------------------------------------
<S> <C>
Utilities 14.8%
Industrial 33.9
Bank/Finance 24.6
Mortgage 6.5
U.S. Treasury and government agency 16.3
Foreign Issuers 3.9
- --------------------------------------------------------------------------------
</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 PAY INTEREST AND PRINCIPAL IN A TIMELY MANNER.
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 (for example, 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. All things being equal,
the lower a bond's credit rating, the higher its yield should be to compensate
investors for assuming additional risk. Bonds rated in one of the four highest
ratings categories are considered "investment grade."
<PAGE> 33
7
WMC purchases bonds that are investment-grade quality--that is, bonds that
are rated at least Baa by Moody's Investors Service, Inc., or BBB by Standard &
Poor's Corporation. The dollar-weighted average quality of bonds held by the
Fund, as of December 31, 1998, was Aa3, according to Moody's.
The U.S. government guarantees the timely payment of interest and principal
for its Treasury bonds; many (but not all) agency bonds have the same guarantee.
The government does not, however, guarantee its bonds' prices. In other words,
while Treasury and agency bonds enjoy the highest credit ratings, their
prices--like the prices of other bonds in the Fund--will fluctuate with changes
in interest rates.
While falling interest rates tend to strengthen bond prices, they can cause
another sort of problem for bond fund investors--bond calls.
[FLAG] THE FUND IS SUBJECT TO CALL RISK, WHICH IS THE POSSIBILITY THAT DURING
PERIODS OF FALLING INTEREST RATES A BOND ISSUER WILL "CALL"--OR REPAY--A
HIGH-YIELDING BOND BEFORE ITS MATURITY DATE. FORCED TO REINVEST THE
UNANTICIPATED PROCEEDS AT LOWER INTEREST RATES, THE FUND WOULD EXPERIENCE
A DECLINE IN INCOME AND LOSE THE OPPORTUNITY FOR ADDITIONAL PRICE
APPRECIATION ASSOCIATED WITH FALLING RATES.
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 A POTENTIAL LOSS OF
ADDITIONAL PRICE APPRECIATION.
STOCKS
The Fund's stocks are chosen primarily for their dividend-producing
capabilities, but must also have the 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. Securities
are sold when an investment has achieved its intended purpose, or because it is
no longer considered attractive.
[FLAG] THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE POSSIBILITY
THAT RETURNS FROM LARGE- AND MID-CAPITALIZATION VALUE STOCKS WILL TRAIL
RETURNS FROM OTHER ASSET CLASSES OR THE OVERALL STOCK MARKET. AS A GROUP,
VALUE STOCKS TEND TO GO THROUGH CYCLES OF DOING BETTER--OR WORSE--THAN
COMMON STOCKS IN GENERAL. THESE PERIODS HAVE, IN THE PAST, LASTED FOR AS
LONG AS SEVERAL YEARS.
TURNOVER RATE
Although the Fund generally seeks to invest for the long term, it retains the
right to sell securities regardless of how long the securities have been held.
The Fund's average turnover rate for the past five years has been about 32%. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its net assets within a one-year period.)
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.
<PAGE> 34
8
PLAIN TALK ABOUT
TURNOVER RATE
Before investing in a mutual fund, you should review its turnover rate. This
gives an indication of how transaction costs could affect 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 turnover rates may be more likely
to generate capital gains that must be distributed to shareholders as income
subject to taxes. The average turnover rate for all balanced funds is
approximately 98%, according to Morningstar, Inc.
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 types of derivatives. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
OTHER INVESTMENT POLICIES AND RISKS
Besides investing in bonds and stocks, the Fund may make certain other kinds of
investments to achieve its objective.
Although the Fund typically does not make significant investments in
securities of companies based outside the United States, the Fund reserves the
right to invest up to 20% of stock holdings in foreign common stocks as well as
securities that are convertible into common stocks. These securities may be
traded in U.S. or foreign markets.
To the extent that it owns foreign stocks, the Fund is subject to (1)
country risk, which is the possibility that political events (such as a war),
financial problems (such as government default), or natural disasters (such as
an earthquake) will weaken a country's economy and cause investments in that
country to lose money, and (2) currency risk, which is the possibility that
Americans investing abroad could lose money because of a rise in the value of
the U.S. dollar versus foreign currencies.
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. With respect to its investments in foreign bonds, the Fund is subject
to country risk.
The Fund may also 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 for speculative purposes or as leveraged
investments that magnify the gains or losses of an investment. The value of all
futures and options contracts in which the Fund acquires an interest cannot
exceed 20% of total assets.
The reasons for which the Fund will invest in 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 reduce the Fund's transaction costs or add value when these instruments
are favorably priced. The Fund may, from time to time, take temporary
defensive measures--such as holding cash reserves without limit--that are
inconsistent with the Fund's primary investment strategies, in response to
adverse market, economic, political, or other conditions. In taking such
measures, the Fund may not achieve its investment objective.
<PAGE> 35
9
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most 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 own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.
THE FUND AND VANGUARD
The Fund is a member of The Vanguard Group, a family of more than 35 investment
companies with more than 100 distinct investment portfolios holding assets worth
more than $470 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 distribution fees, each fund
pays its allocated share of The Vanguard Group's marketing costs.
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 Trustees and officers of the Fund.
WMC's advisory fee is paid quarterly. This fee is based on certain annual
percentage rates applied to the Fund's average month-end assets for each
quarter.
The advisory fee can be increased or decreased based on the difference
between the Fund's total return performance and that of its unmanaged Composite
Index, 65% of which is made up of the Lehman Brothers Long Corporate AA or
Better Bond Index and 35% of which comprises a blended stock composite (75%
S&P/BARRA Value Index, 12.5% S&P Utilities Index, and 12.5% S&P Telephone
Index).
For the year ended December 31, 1998, the investment advisory fee paid to
WMC represented an effective annual rate of 0.05% of the Fund's average net
assets, before an increase of 0.01% based on performance.
The Fund has authorized WMC to choose brokers or dealers to handle the
purchase and sale of securities for the Fund, and to get the best available
price and most favorable execution from these brokers with respect to all
transactions.
In the interest of obtaining better execution of a transaction, WMC may
choose brokers who charge higher commissions. 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. Also, 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.
PLAIN TALK ABOUT
THE FUND'S ADVISER
Wellington Management Company, LLP, is an investment advisory firm founded in
1928. As of December 31, 1998, WMC managed more than $209 billion in stock and
bond portfolios, including 14 Vanguard funds. The managers responsible for
overseeing the implementation of WMC's strategy for Vanguard Wellesley Income
Fund are:
EARL E. MCEVOY, Senior Vice President and partner of WMC; has worked in
investment management since 1972; with WMC since 1978; Fund Manager since 1982;
B.A., Dartmouth College; M.B.A., Columbia Business School.
JOHN R. RYAN, CFA, Senior Vice President and Managing Partner of WMC; has
worked in investment management since 1971; with WMC since 1981; Fund Manager
since 1986; B.S., Lehigh University; M.B.A., University of Virginia.
<PAGE> 36
10
The Board of Trustees 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, any such change will
be communicated to shareholders in writing.
YEAR 2000 CHALLENGE
The common practice in computer programming of using just two digits to identify
a year has resulted in the Year 2000 challenge throughout the information
technology industry. If unchanged, many computer applications and systems could
misinterpret dates occurring after December 31, 1999, leading to errors or
failure. Such failure could adversely affect a fund's operations, including
pricing, securities trading, and the servicing of shareholder accounts.
The Vanguard Group is dedicated to providing uninterrupted, high-quality
performance from our computer systems before, during, and after 2000. In July
1998, we completed the renovation and initial testing of our internal systems.
Vanguard is diligently working with external partners, suppliers, and vendors,
including fund managers and other service providers, to assure that the systems
with which we interact remain operational at all times.
In addition to taking every reasonable step to secure our internal systems
and external relationships, Vanguard is further developing contingency plans
intended to assure that unexpected systems failures will not adversely affect
the Fund's operations. Vanguard intends to monitor these processes through the
rollover of 1999 into 2000 and to quickly implement alternate solutions if
necessary.
However, despite Vanguard's efforts and contingency plans, noncompliant
computer systems could have a material adverse effect on the Fund's business,
operations, or financial condition. Additionally, the Fund's performance could
be hurt if a computer-system failure at a company or governmental unit affects
the price of securities the Fund owns.
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 a capital gains distribution. Income
dividends come from both the dividends that the fund earns from its holdings and
the interest it receives from its money market and bond 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.
DIVIDENDS, CAPITAL GAINS, AND TAXES
The Fund distributes to shareholders virtually all of its net income (interest
and dividends less expenses) as well as any capital gains realized from the sale
of its holdings. Income distributions generally occur in March, June, September,
and December; capital gains distributions generally occur in December. In
addition, the Fund may occasionally be required to make supplemental dividend or
capital gains distributions at other times during the year. You can receive
distributions of income or capital gains in cash, or you can have them
automatically invested in more shares of the Fund.
Dividend and capital gains distributions of Fund shares that are held as an
investment option in an employer-sponsored retirement or savings plan 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 Description, or
your tax adviser about the tax consequences of an investment in the Fund and of
any plan withdrawals.
<PAGE> 37
11
SHARE PRICE
The Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of trading on the New York Stock Exchange (the NAV
is not calculated on holidays or other days the Exchange is closed). Net asset
value per share is computed by adding up the total value of the Fund's
investments and other assets, subtracting any of its liabilities (debts), and
then dividing by the number of Fund shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = --------------------------------------
NUMBER OF SHARES OUTSTANDING
Knowing the daily net asset value is useful to you as a shareholder because
it indicates the current value of your investment. The Fund's NAV, multiplied by
the number of 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.
A NOTE ON PRICING: The Fund's investments will be priced at their market
value when market quotations are readily available. When these quotations are
not readily available, investments will be priced at their fair value,
calculated according to procedures adopted by the Fund's Board of Trustees.
The Fund's share price can be found daily in the mutual fund listings of
most major newspapers under the heading "Vanguard Funds." Different newspapers
use different abbreviations of the Fund's name, but the most common is Wellsl.
<PAGE> 38
12
FINANCIAL HIGHLIGHTS
The following financial highlights table is intended to help you understand the
Fund's financial performance for the past five years, and certain information
reflects financial results for a single Fund share. The total returns in the
table represent the rate that an investor would have earned or lost each year on
an investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been derived from the financial statements
audited by PricewaterhouseCoopers LLP, independent accountants, whose
report--along with the Fund's financial statements--is included in the Fund's
most recent annual report to shareholders. You may have the annual report sent
to you without charge by contacting Vanguard.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
VANGUARD WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $ 21.86 $ 20.51 $ 20.44 $ 17.05 $ 19.24
- --------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 1.13 1.190 1.17 1.13 1.11
Net Realized and Unrealized Gain (Loss)
on Investments 1.40 2.805 .66 3.68 (1.95)
Total from Investment Operations 2.53 3.995 1.83 4.81 (.84)
DISTRIBUTIONS
Dividends from Net Investment Income (1.13) (1.200) (1.16) (1.14) (1.11)
Distributions from Realized Capital Gains (1.14) (1.445) (.60) (.28) (.24)
Total Distributions (2.27) (2.645) (1.76) (1.42) (1.35)
- --------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 22.12 $ 21.86 $ 20.51 $ 20.44 $ 17.05
==========================================================================================================================
TOTAL RETURN 11.84% 20.19% 9.42% 28.91% -4.44%
==========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 8,498 $ 7,646 $ 7,013 $ 7,181 $ 5,681
Ratio of Total Expenses to
Average Net Assets 0.31% 0.31% 0.31% 0.35% 0.34%
Ratio of Net Investment Income to
Average Net Assets 5.05% 5.47% 5.74% 5.96% 6.16%
Turnover Rate 32% 36% 26% 32% 32%
==========================================================================================================================
</TABLE>
From time to time, the Vanguard funds advertise yield and total return
figures. Yield is a measure of past dividend income. Total return includes both
past dividend income (assuming that it has been reinvested) plus realized and
unrealized capital appreciation (or depreciation). 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 1998 with a net asset value (price) of $21.86 per share.
During the year, the Fund earned $1.13 per share from investment income
(interest and dividends) and $1.40 per share from investments that had
appreciated in value or that were sold for higher prices than the Fund paid for
them.
Shareholders received $2.27 per share in the form of dividend and capital
gains distributions. A portion of each year's distributions may come from the
prior year's income or capital gains.
The earnings ($2.53 per share) minus the distributions ($2.27 per share)
resulted in a share price of $22.12 at the end of the year. This was an increase
of $.26 per share (from $21.86 at the beginning of the year to $22.12 at the end
of the year). For a shareholder who reinvested the distributions in the purchase
of more shares, the total return from the Fund was 11.84% for the year.
As of December 31, 1998, the Fund had $8.49 billion in net assets. For the
year, its expense ratio was 0.31% ($3.10 per $1,000 of net assets); and net
investment income amounted to 5.05% of its average net assets. It sold and
replaced securities valued at 32% of its net assets.
"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," and
"500" are trademarks of The McGraw-Hill Companies, Inc.
<PAGE> 39
13
INVESTING WITH VANGUARD
The 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 objective, strategies, or risks, contact Vanguard's Participant
Services Center, toll-free, at 1-800-523-1188.
- - If you have questions about your account, contact your plan administrator
or the organization that provides record-keeping 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.
In all cases, your transaction will be based on the Fund's next-determined
net asset value after Vanguard receives your request (or, in the case of new
contributions, the next-determined net asset value after Vanguard receives the
order from your plan administrator). As long as this request is received before
the close of trading on the New York Stock Exchange, generally 4 p.m. Eastern
time, you will receive that day's net asset value.
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. Although we
make every effort to maintain the exchange privilege, Vanguard reserves the
right to revise or terminate this 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 its transaction
costs, Vanguard limits participant exchange activity to no more than FOUR
SUBSTANTIVE "ROUND TRIPS" THROUGH THE FUND (at least 90 days apart) during any
12-month period. A "round trip" is a redemption from the Fund followed by a
purchase back into the Fund. "Substantive" means a dollar amount that Vanguard
determines, in its sole discretion, could adversely affect the management of the
Fund.
Before making an exchange to or from another fund available in your plan,
consider the following:
- - Certain investment options, particularly funds made up of company stock or
investment contracts, may be subject to unique restrictions.
- - Make sure to 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. Contact your
plan administrator for details on the exchange policies that apply to your
plan.
ACCESSING FUND INFORMATION BY COMPUTER
VANGUARD ON THE WORLD WIDE WEB www.vanguard.com
Use your personal computer to visit Vanguard's education-oriented website, which
provides timely news and information about Vanguard funds and services; an
online "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.
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GLOSSARY OF INVESTMENT TERMS
BALANCED FUND
A mutual fund that seeks to provide some combination of income, capital growth,
and conservation of capital 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. In most instances, the issuer agrees to
pay back the loan by a specific date and to make regular interest payments until
that date.
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized on securities that the
fund has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits, short-term bank deposits, and money market instruments which
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's acceptances.
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 pay interest and principal in a timely
manner.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
DURATION
A measure of the sensitivity of bond--and bond fund--prices to interest rate
movements. For example, if a bond has a duration of two years, its price would
fall by about 2% when interest rates rose one percentage point. On the other
hand, the bond's price would rise by about 2% when interest rates fell by 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
distribution 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.
FUND DIVERSIFICATION
Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a fund's
investments.
INVESTMENT GRADE
A bond whose credit quality is considered by independent bond-rating agencies to
be sufficient to ensure timely payment of principal and interest under current
economic circumstances.
MATURITY
The date when a bond issuer agrees to repay the bond's principal, or face value,
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 value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE> 44
[THE VANGUARD GROUP LOGO]
Institutional Division
Post Office Box 2900
Valley Forge, PA 19482-2900
FOR MORE INFORMATION
If you'd like more information about Vanguard Wellesley Income Fund, the
following documents are available free upon request:
ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS
Additional information about the Fund's investments is available in the Fund's
annual and semiannual reports to shareholders. In these reports, you will find a
discussion of the market conditions and investment strategies that significantly
affected the Fund's performance during its most recent fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
The SAI provides more detailed information about the Fund.
The current annual and semiannual reports and the SAI are incorporated by
reference into (and are thus legally a part of) this prospectus.
To receive a free copy of the latest annual or semiannual report or the SAI, or
to request additional information about the Fund or other Vanguard funds, please
contact us as follows:
THE VANGUARD GROUP
PARTICIPANT SERVICES CENTER
P.O. BOX 2900
VALLEY FORGE, PA 19482-2900
TELEPHONE:
1-800-523-1188
TEXT TELEPHONE:
1-800-523-8004
WORLD WIDE WEB:
www.vanguard.com
INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC)
You can review and copy information about the Fund (including the SAI) at the
SEC's Public Reference Room in Washington, D.C. To find out more about this
public service, call the SEC at 1-800-SEC-0330. Reports and other information
about the Fund are also available on the SEC's website (www.sec.gov), or you can
receive copies of this information, for a fee, by writing the Public Reference
Section, Securities and Exchange Commission, Washington, DC 20549-6009.
Fund's Investment Company Act
file number: 811-1776
(C) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing Corporation,
Distributor.
I027N-04/30/1999
<PAGE> 45
PART B
VANGUARD WELLESLEY INCOME FUND
(THE TRUST)
STATEMENT OF ADDITIONAL INFORMATION
APRIL 30, 1999
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated April 30, 1999). To obtain the Prospectus,
or an additional 1998 Annual Report to Shareholders, which contains the Fund's
financial statements as hereby incorporated by reference, please call:
INVESTOR INFORMATION DEPARTMENT
1-800-662-7447 (SHIP)
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Description of the Trust.................................... B-1
Investment Policies......................................... B-3
Fundamental Investment Limitations.......................... B-9
Share Price................................................. B-10
Purchase of Shares.......................................... B-11
Redemption of Shares........................................ B-11
Yield and Total Return...................................... B-11
Management of the Trust..................................... B-13
Investment Advisory Services................................ B-16
Portfolio Transactions...................................... B-18
Performance Measures........................................ B-19
Financial Statements........................................ B-22
Appendix -- Description and Ratings of Securities........... B-22
</TABLE>
DESCRIPTION OF THE TRUST
ORGANIZATION
The Trust was organized as a Delaware corporation in 1968, reorganized as a
Maryland corporation in 1973, and then reorganized as a Delaware business trust
in May, 1998. Prior to its reorganization as a Delaware business trust, the
Trust was known as Vanguard/Wellesley Income Fund, Inc. The Trust is registered
with the United States Securities and Exchange Commission (the Commission) under
the Investment Company Act of 1940 (the 1940 Act) as an open-end, diversified
management investment company. It currently offers the following fund which has
one class of shares: Vanguard Wellesley Income Fund (the Fund).
The Trust has the ability to offer additional funds or classes of shares.
There is no limit on the number of full and fractional shares that the Trust may
issue for a single fund or class of shares.
SERVICE PROVIDERS
CUSTODIAN. The Chase Manhattan Bank, N.A., 4 Chase MetroTech Center,
Brooklyn, New York 11245 serves as the Fund's custodian. The custodian is
responsible for maintaining the Fund's assets and keeping all necessary accounts
and records.
INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, 30 South 17th Street,
Philadelphia, Pennsylvania 19103, serves as the Fund's independent accountants.
The accountants audit financial statements for the Fund and provide other
related services.
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<PAGE> 46
TRANSFER AND DIVIDEND-PAYING AGENT. The Fund's transfer agent and
dividend-paying agent is The Vanguard Group, Inc., 100 Vanguard Boulevard,
Malvern, Pennsylvania 19355.
CHARACTERISTICS OF THE TRUST'S SHARES
RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions
on the right of shareholders to retain or dispose of the Trust's shares, other
than the possible future termination of the Trust or its Fund. The Trust or its
Fund may be terminated by reorganization into another mutual fund or by
liquidation and distribution of the assets of the Fund. Unless terminated by
reorganization or liquidation, the Trust and its Fund will continue
indefinitely.
SHAREHOLDER LIABILITY. The Trust is organized under Delaware law, which
provides that shareholders of a business trust are entitled to the same
limitations of personal liability as shareholders of a corporation organized
under Delaware law. Effectively, this means that a shareholder of the Trust will
not be personally liable for payment of the Trust's debts except by reason of
his or her own conduct or acts. In addition, a shareholder could incur a
financial loss on account of a Trust obligation only if the Trust itself had no
remaining assets with which to meet such obligation. We believe that the
possibility of such a situation arising is extremely remote.
DIVIDEND RIGHTS. The shareholders of a fund are entitled to receive any
dividends or other distributions declared for such funds. No shares have
priority or preference over any other shares of the same funds with respect to
distributions. Distributions will be made from the assets of a fund, and will be
paid ratably to all shareholders of the fund (or class) according to the number
of shares of such fund (or class) held by shareholders on the record date. The
amount of income dividends per share may vary between separate share classes of
the same fund based upon differences in the way that expenses are allocated
between share classes pursuant to a multiple class plan.
VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (i) a
shareholder vote is required under the 1940 Act; (ii) the matter concerns an
amendment to the Declaration of Trust that would adversely affect to a material
degree the rights and preferences of the shares of any class or fund; or (iii)
the Trustees determine that it is necessary or desirable to obtain a shareholder
vote. The 1940 Act requires a shareholder vote under various circumstances,
including to elect or remove Trustees upon the written request of shareholders
representing 10% or more of the Trust's net assets, and to change any
fundamental policy of the Trust. Shareholders of the Trust receive one vote for
each dollar of net asset value owned on the record date, and a fractional vote
for each fractional dollar of net asset value owned on the record date. However,
only the shares of the fund affected by a particular matter are entitled to vote
on that matter. Voting rights are non-cumulative and cannot be modified without
a majority vote.
LIQUIDATION RIGHTS. In the event of liquidation, shareholders will be
entitled to receive a pro rata share of the net assets of applicable funds of
the Trust.
PREEMPTIVE RIGHTS. There are no preemptive rights associated with shares
of the Trust.
CONVERSION RIGHTS. There are no conversion rights associated with shares
of the Trust.
REDEMPTION PROVISIONS. The Trust's redemption provisions are described in
its current prospectus and elsewhere in this Statement of Additional
Information.
SINKING FUND PROVISIONS. The Trust has no sinking fund provisions.
CALLS OR ASSESSMENT. The Trust's shares, when issued, are fully paid and
non-assessable.
TAX STATUS OF THE TRUST
The Fund intends to qualify as a "regulated investment company" under
Subchapter M of the Internal Revenue Code. This special tax status means that a
fund will not be liable for federal tax on income and capital gains distributed
to shareholders. In order to preserve its tax status, each fund of the Trust
must comply with certain requirements. If a fund fails to meet these
requirements in any taxable
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<PAGE> 47
year, it will be subject to tax on its taxable income at corporate rates, and
all distributions from earnings and profits, including any distributions of net
tax-exempt income and net long-term capital gains, will be taxable to
shareholders as ordinary income. In addition, the fund could be required to
recognize unrealized gains, pay substantial taxes and interest, and make
substantial distributions before regaining its tax status as a regulated
investment company.
INVESTMENT POLICIES
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 fixed-income security (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 Trust's Board of Trustee's
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.
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 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 realization by the Fund on such collateral may be
automatically stayed. Finally, it is possible that 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 issued 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
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<PAGE> 48
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 investment securities to qualified institutional
investors (typically brokers, dealers, banks, or other financial institutions)
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 terms, the
structure and the aggregate amount of such loans must be consistent with the
1940 Act, and the Rules and Regulations or interpretations of the Commission
thereunder. These provisions limit the amount of securities the Fund may lend to
33 1/3% of the Fund's total assets, and 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 Trust's Board of Trustees.
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.
VANGUARD INTERFUND LENDING PROGRAM
The Commission has issued an exemptive order permitting the Fund to
participate in Vanguard's interfund lending program. This program allows the
Vanguard funds to borrow money from and loan money to each other for temporary
or emergency purposes. The program is subject to a number of conditions,
including the requirement that no fund may borrow or lend money through the
program unless it receives a more favorable interest rate than is available from
a typical bank for a comparable transaction. In addition, a fund may participate
in the program only if and to the extent that such participation is consistent
with the fund's investment objective and other investment policies. The Boards
of Trustees of the Vanguard funds are responsible for ensuring that the
interfund lending program operates in compliance with all conditions of the
Commission's exemptive order.
TEMPORARY INVESTMENTS
The Fund may take temporary defensive measures that are inconsistent with
the Fund's normal fundamental or non-fundamental investment policies and
strategies in response to adverse market, economic, political or other
conditions. Such measures could include investments in (a) highly liquid
short-term fixed income securities issued by or on behalf of municipal or
corporate issuers, obligations of the U.S. Government and its agencies,
commercial paper, and bank certificates of deposit; (b) shares of other
investment companies which have investment objectives consistent with those of
the Fund; (c) repurchase agreements involving any such securities; and (d) other
money market instruments. There
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<PAGE> 49
is no limit on the extent to which the Fund may take temporary defensive
measures. In taking such measures, the Fund may fail to achieve its investment
objective.
FOREIGN INVESTMENTS
Vanguard Wellesley Income Fund may invest up to 20% of its equity assets in
foreign common stocks and securities convertible into foreign stocks. The Fund
may also invest in U.S. 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 the 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.
FEDERAL TAX TREATMENT OF NON-U.S. TRANSACTIONS. Special rules govern the
Federal income tax treatment of certain transactions denominated in terms of a
currency other than the U.S. dollar or determined by reference to the value of
one or more currencies other than the U.S. dollar. The types of transactions
covered by the special rules include the following: (i) the acquisition of, or
becoming the obligor under, a bond or other debt instrument (including, to the
extent provided in Treasury regulations, preferred stock); (ii) the accruing of
certain trade receivables and payables; and (iii) the entering into or
acquisition of any forward contract, futures contract, option and similar
financial instrument if such instrument is not marked to market. The disposition
of a currency other than the U.S. dollar by a U.S. taxpayer is also treated as a
transaction subject to the special currency rules. However, foreign
currency-related regulated futures contracts and nonequity options are generally
not subject to the special currency rules if they are or would be treated as
sold for their fair market value at year-end under the marking-to-market rules
applicable to other futures contracts unless an election is made to have such
currency rules apply. With respect to transactions covered by the special rules,
foreign currency gain or loss is calculated separately from any gain or loss on
the underlying transaction and is normally taxable as ordinary gain or loss. A
taxpayer may elect to treat as capital gain or loss foreign currency gain or
loss arising from certain identified forward contracts, futures contracts and
options that are
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<PAGE> 50
capital assets in the hands of the taxpayer and which are not part of a
straddle. The Treasury Department issued regulations under which certain
transactions subject to the special currency rules that are part of a "section
988 hedging transaction" (as defined in the Internal Revenue Code of 1986, as
amended, and the Treasury regulations) will be integrated and treated as a
single transaction or otherwise treated consistently for purposes of the Code.
Any gain or loss attributable to the foreign currency component of a transaction
engaged in by a fund which is not subject to the special currency rules (such as
foreign equity investments other than certain preferred stocks) will be treated
as capital gain or loss and will not be segregated from the gain or loss on the
underlying transaction. It is anticipated that some of the non-U.S.
dollar-denominated investments and foreign currency contracts Vanguard Wellesley
Income Fund may make or enter into will be subject to the special currency rules
described above.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in 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 the Fund's books.
The Fund may invest in restricted, privately placed securities that, under
SEC rules, may be sold only to qualified institutional buyers. Because these
securities can be resold only to qualified institutional buyers, they may be
considered illiquid securities -- meaning that they could be difficult for the
Fund to convert to cash if needed.
If a substantial market develops for a restricted security held by the
Fund, it will be treated as a liquid security, in accordance with procedures and
guidelines approved by the Trust's Board of Trustees. This generally includes
securities that are unregistered that can be sold to qualified institutional
buyers in accordance with Rule 144A under the 1933 Act. While the Fund's
investment adviser determines the liquidity of restricted securities on a daily
basis, the Board oversees and retains ultimate responsibility for the adviser's
decisions. Several factors the Board considers in monitoring these decisions
include the valuation of a security, the availability of qualified institutional
buyers, and the availability of information about the security's issuer.
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
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.
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
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<PAGE> 51
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 except to the
extent that the aggregate initial margins and premiums required to establish any
non-hedging positions do not exceed five percent of the value of the Fund's
portfolio. 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
B-7
<PAGE> 52
result, a 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. The 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. 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.
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 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.
B-8
<PAGE> 53
FUNDAMENTAL INVESTMENT LIMITATIONS
The Fund is subject to the following fundamental investment limitations,
which cannot be changed in any material way without the approval of the holders
of a majority of the Fund's shares. For these purposes, a "majority" of shares
means shares representing the lesser of: (i) 67% or more of the votes cast to
approve a change, so long as shares representing more than 50% of the Fund's net
asset value are present or represented by proxy; or (ii) more than 50% of the
Fund's net asset value.
BORROWING. The Fund may not borrow money, except for temporary or
emergency purposes in an amount not exceeding 15% of the Fund's net assets. The
Fund may borrow money through banks, reverse repurchase agreements, or
Vanguard's interfund lending program only, and must comply with all applicable
regulatory conditions. The Fund may not make any additional investments whenever
its outstanding borrowings exceed 5% of net assets.
COMMODITIES. The Fund may not invest in commodities, except that it may
invest in stock futures contracts and options. No more than 5% of the Fund's
total assets may be used as initial margin deposit for future contracts, and no
more than 20% of the Fund's total assets may be invested in stock futures
contracts or options at any time.
DIVERSIFICATION. With respect to 75% of its total assets, the Fund may
not: (i) purchase more than 10% of the outstanding voting securities of any one
issuer, or (ii) purchase securities of any issuer if, as a result, more than 5%
of the Fund's total assets would be invested in that issuer's securities. This
limitation does not apply to obligations of the United States Government, its
agencies, or instrumentalities.
ILLIQUID OR RESTRICTED SECURITIES. The Fund may not acquire any security
if, as a result, more than 15% of its net assets would be invested in securities
that are illiquid.
INDUSTRY CONCENTRATION. The Fund may not invest more than 25% 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;
INVESTING FOR CONTROL. The Fund may not invest in a company for the
purpose of controlling its management.
INVESTMENT COMPANIES. The Fund may not invest in any other investment
company, except through a merger, consolidation or acquisition of assets, or to
the extent permitted by Section 12 of the 1940 Act. Investment companies whose
shares the Fund acquires pursuant to Section 12 must have investment objectives
and investment policies consistent with those of the Fund.
LOANS. The Fund may not lend money to any person except by purchasing
fixed income securities that are publicly distributed or customarily purchased
by institutional investors or by entering into repurchase agreements, or by
lending its portfolio securities.
MARGIN. The Fund may not purchase securities on margin or sell securities
short, except as permitted by the Fund's investment policies relating to
commodities.
PLEDGING ASSETS. The Fund may not pledge, mortgage or hypothecate more
than 15% of its net assets.
REAL ESTATE. The Fund may not invest directly in real estate, although it
may invest in securities of companies that deal in real estate, or interests
therein.
SENIOR SECURITIES. The Fund may not issue senior securities, except in
compliance with the 1940 Act.
UNDERWRITING. The Fund may not engage in the business of underwriting
securities issued by other persons. The Fund will not be considered an
underwriter when disposing of its investment securities.
B-9
<PAGE> 54
The investment limitations set forth above are considered at the time
investment securities are purchased. If a percentage restriction is adhered to
at the time the investment is made, a later increase in percentage resulting
from a change in the market value of assets will not constitute a violation of
such restriction.
None of these limitations prevents the Fund from participating in The
Vanguard Group, Inc. (Vanguard). As a member of The Vanguard Group of Investment
Companies, the Fund may own securities issued by Vanguard, make loans to
Vanguard, and contribute to Vanguard's costs or other financial requirements.
See "Management of the Trust" for more information.
SHARE PRICE
The Fund's share price, or "net asset value" per share, is calculated by
dividing the total assets of the Fund, less all liabilities, by the total number
of shares outstanding. The net asset value is determined as of the close of the
New York Stock Exchange (the Exchange), generally 4:00 p.m. Eastern time, on
each day that the Exchange is open for trading.
Portfolio securities for which market quotations are readily available
(includes those securities listed on national securities exchanges, as well as
those quoted on the NASDAQ Stock Market) will be valued at the last quoted sales
price on the day the valuation is made. Such securities which are not traded on
the valuation date are valued at the mean of the bid and ask prices. Price
information on exchange-listed securities is taken from the exchange where the
security is primarily traded. Securities may be valued on the basis of prices,
provided by a pricing service when such prices are believed to reflect the fair
market value of such securities.
Short term instruments (those with remaining maturities of 60 days or less)
may be valued at cost, plus or minus any amortized discount or premium, which
approximates market value.
Bonds and other fixed income securities may be valued on the basis of
prices provided by a pricing service when such prices are believed to reflect
the fair market value of such securities. The prices provided by a pricing
service may be determined without regard to bid or last sale prices of each
security, but take into account institutional-size transactions in similar
groups of securities as well as any developments related to specific securities.
Foreign securities are valued at the last quoted sales price, according to
the broadest and most representative market, available at the time the Fund is
valued. If events which materially affect the value of the Fund's investments
occur after the close of the securities markets on which such securities are
primarily traded, those investments may be valued by such methods as the Board
of Trustees deems in good faith to reflect fair value.
In determining the Fund's net asset value per share, all assets and
liabilities initially expressed in foreign currencies will be converted into
U.S. dollars using the officially quoted daily exchange rates used by Morgan
Stanley Capital International in calculating various benchmarking indices. This
officially quoted exchange rate may be determined prior to or after the close of
a particular securities market. If such quotations are not available, the rate
of exchange will be determined in accordance with policies established in good
faith by the Board of Trustees.
Other assets and securities for which no quotations are readily available
or which are restricted as to sale (or resale) are valued by such methods as the
Board of Trustees deems in good faith to reflect fair value.
The share price for the Fund can be found daily in the mutual fund listings
of most major newspapers under the heading of "Vanguard Funds".
B-10
<PAGE> 55
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.
TRADING SHARES THROUGH CHARLES SCHWAB
The Fund has authorized Charles Schwab & Co., Inc. (Schwab) to accept on
its behalf purchase and redemption orders under certain terms and conditions.
Schwab is also authorized to designate other intermediaries to accept purchase
and redemption orders on the Fund's behalf subject to those terms and
conditions. Under this arrangement, the Fund will be deemed to have received a
purchase or redemption order when Schwab or, if applicable, Schwab's authorized
designee, accepts the order in accordance with the Fund's instructions. Customer
orders that are properly transmitted to the Fund by Schwab, or if applicable,
Schwab's authorized designee, will be priced as follows:
Orders received by Schwab before 3 p.m. Eastern time on any business day,
will be sent to Vanguard that day and your share price will be based on the
Fund's net asset value calculated at the close of trading that day. Orders
received by Schwab after 3 p.m. Eastern time, will be sent to Vanguard on the
following business day and your share price will be based on the Fund's net
asset value calculated at the close of trading that day.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the Exchange is closed, or trading on the Exchange is
restricted as determined by 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.
YIELD AND TOTAL RETURN
The yield of the Fund for the 30-day period ended December 31, 1998 was
4.83%.
SEC YIELD
Yield is the net annualized yield based on a specific 30-day (or one month)
period assuming semiannual compounding of income. Yield is calculated by
dividing the net investment income per share earned during the period by the
maximum offering price per share on the last day of the period, according to the
following formula:
YIELD=2[((a-b)/cd+1)(6)-1]
Where:
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
B-11
<PAGE> 56
The average annual total return of the Fund for the one-, five-, and
ten-year periods ended December 31, 1998 was 11.84%, 12.62%, and 13.16%,
respectively.
AVERAGE ANNUAL TOTAL RETURN
Average annual total return is the average annual compounded rate of return
for the periods of one year, five years, ten years, or the life of the Fund, all
ended on the last day of a recent month. Average annual total return quotations
will reflect changes in the price of the Fund's shares and assume that all
dividends and capital gains distributions during the respective periods were
reinvested in Fund shares. Average annual total return is calculated by finding
the average annual compounded rates of return of a hypothetical investment over
such periods according to the following formula (average annual total return is
then expressed as a percentage):
T=(ERV/P)(1/n)-1
Where:
T = average annual total return.
P = a hypothetical initial investment of $1,000.
n = number of years.
ERV = ending redeemable value: ERV is the value, at the end of the
applicable period, of a hypothetical $1,000 investment made at the
beginning of the applicable period.
CUMULATIVE TOTAL RETURN
Cumulative total return is the cumulative rate of return on a hypothetical
initial investment of $1,000 for a specified period. Cumulative total return
quotations reflect changes in the price of the Fund's shares and assume that all
dividends and capital gains distributions during the period were reinvested in
Fund shares. Cumulative total return is calculated by finding the cumulative
rates of a return of a hypothetical investment over such periods, according to
the following formula (cumulative total return is then expressed as a
percentage):
C=(ERV/P)-1
Where:
C = cumulative total return.
P = a hypothetical initial investment of $1,000.
ERV = ending redeemable value: ERV is the value, at the end of the
applicable period, of a hypothetical $1,000 investment made at the
beginning of the applicable period.
B-12
<PAGE> 57
MANAGEMENT OF THE TRUST
OFFICERS AND TRUSTEES
The officers of the Trust manage its day-to-day operations and are
responsible to the Trust's Board of Trustees. The Trustees set broad policies
for the Trust and choose its officers. The following is a list of the Trustees
and officers of the Trust and a statement of their present positions and
principal occupations during the past five years. As a group, the Trust's
Trustees and officers own less than 1% of the outstanding shares of the Trust.
Each Trustee also serves as a Director of The Vanguard Group, Inc., and as a
Trustee of each of the 36 investment companies administered by Vanguard (35 in
the case of Mr. Malkiel and 28 in the case of Mr. MacLaury). The mailing address
of the Trustees and officers of the Trust is Post Office Box 876, Valley Forge,
PA 19482.
JOHN C. BOGLE, (DOB: 5/8/1929) Senior Chairman and Trustee*
Senior Chairman and Director of The Vanguard Group, Inc., and Trustee of each of
the investment companies in The Vanguard Group; Director of The Mead Corp.
(Paper Products), General Accident Insurance, and Chris-Craft Industries, Inc.
(Broadcasting & Plastics Manufacturer).
JOHN J. BRENNAN, (DOB: 7/29/1954) Chairman, Chief Executive Officer, and
Trustee*
Chairman, Chief Executive Officer and Director of The Vanguard Group, Inc., and
Trustee of each of the investment companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN, (DOB: 1/25/1950) Trustee
Vice President, Chief Information Officer, and member of the Executive Committee
of Johnson and Johnson (Pharmaceuticals/Consumer Products), Director of Johnson
& Johnson*MERCK Consumer Pharmaceuticals Co., Women First HealthCare, Inc.
(Research and Education Institution), Recording for the Blind and Dyslexic, The
Medical Center at Princeton, and Women's Research and Education Institute.
BRUCE K. MACLAURY, (DOB: 5/7/1931) Trustee
President Emeritus of The Brookings Institution (Independent Non-Partisan
Research Organization); Director of American Express Bank, Ltd., The St. Paul
Companies, Inc. (Insurance and Financial Services), and National Steel Corp.
BURTON G. MALKIEL, (DOB: 8/28/1932) Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbac Gestinova, Baker Fentress &
Co. (Investment Management), The Jeffrey Co. (Holding Company), and Southern New
England Telecommunications Co.
ALFRED M. RANKIN, JR., (DOB: 10/8/1941) Trustee
Chairman, President, Chief Executive Officer, and Director of NACCO Industries
(Machinery/Coal/Appliances); Director of The BFGoodrich Co. (Aircraft
Systems/Manufacturing/Chemicals), and The Standard Products Co. (Rubber Products
Company).
JOHN C. SAWHILL, (DOB: 6/12/1936) Trustee
President and Chief Executive Officer of The Nature Conservancy (Non-Profit
Conservation Group); Director of Pacific Gas and Electric Co., Procter & Gamble
Co., NACCO Industries (Machinery/Coal/Appliances), and Newfield Exploration Co.
(Energy); formerly, Director and Senior Partner of McKinsey & Co., and President
of New York University.
JAMES O. WELCH, JR., (DOB: 5/13/1931) Trustee
Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman
and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO
Energy, Inc., and Kmart Corp.
B-13
<PAGE> 58
J. LAWRENCE WILSON, (DOB: 3/2/1936) Trustee
Chairman and Chief Executive Officer of Rohm & Haas Co. (Chemicals); Director of
Cummins Engine Co. (Diesel Engine Company), and The Mead Corp. (Paper Products);
and Trustee of Vanderbilt University.
RAYMOND J. KLAPINSKY, (DOB:12/7/1938) Secretary*
Managing Director of The Vanguard Group, Inc.; Secretary of The Vanguard Group,
Inc. and of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS, (DOB: 5/21/1957) Treasurer*
Principal of The Vanguard Group, Inc.; Treasurer of each of the investment
companies in The Vanguard Group.
ROBERT D. SNOWDEN, (DOB: 9/4/1961) 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 1940 Act.
THE VANGUARD GROUP
Vanguard Wellesley Income Fund is a member of The Vanguard Group of
Investment Companies which consists of more than 35 investment companies (the
Trusts). Through their jointly-owned subsidiary, The Vanguard Group, Inc.
(Vanguard), the Trust, and the other Trusts in The Vanguard 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 Trusts.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Trusts and also
furnishes the Trusts with necessary office space, furnishings and equipment.
Each Trust pays its share of Vanguard's total expenses which are allocated among
the Trusts under methods approved by the Board of Trustees of each Trust. In
addition, each Trust bears its own direct expenses such as legal, auditing, and
custodian fees.
The Trust'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 Trusts.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the 1940 Act. 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, and in many cases more restrictive
than, those recommended by a blue ribbon panel of mutual fund industry
executives.
Vanguard was established and operates under Amended and Restated Funds'
Service Agreement which was approved by the shareholders of each of the Trusts.
The amounts which each of the Trusts have invested are adjusted from time to
time in order to maintain the proportionate relationship between each Trust's
relative net assets and its contribution to Vanguard's capital. At December 31,
1998, the Fund had contributed capital of $1,519,000 to Vanguard, representing
0.02% of the Fund's net assets and 2.2% of Vanguard's capitalization. The
Amended and Restated Funds' Service Agreement provides for the following
arrangements: (a) each Vanguard Trust may be called upon to invest up to 0.40%
of its current assets in Vanguard, and (b) there is no other limitation on the
amount that each Vanguard Trust may contribute to Vanguard's capitalization.
B-14
<PAGE> 59
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 Trusts by third parties.
DISTRIBUTION
Vanguard Marketing Corporation, a wholly-owned subsidiary of the Vanguard
Group, Inc. provides all distribution and marketing activities for the Trusts in
the Group. 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 Vanguard Group. The
Trustees and officers of Vanguard determine the amount to be spent annually on
distribution activities, the manner and amount to be spent on each Trust, and
whether to organize new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Trusts based upon relative net assets. The remaining one
half of those expenses is allocated among the Trusts based upon each Trust's
sales for the preceding 24 months relative to the total sales of the Trusts as a
Group. Provided, however, that no Trust'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 Trust shall incur annual distribution expenses in excess of 20/100 of 1% of
its average month-end net assets. During the last three fiscal years, the Trust
incurred approximately $16,751,000, $16,762,000, and $19,534,000, respectively,
of The Vanguard Group's management (including transfer agency), distribution and
marketing expenses.
INVESTMENT ADVISORY SERVICES
Vanguard also provides investment advisory services to several Vanguard
Trusts. 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 Trusts utilizing these services.
TRUSTEE COMPENSATION
The same individuals serve as Trustees of all Vanguard Trusts (with two
exceptions, which are noted in the table appearing on page B-16), and each Trust
pays a proportionate share of the Trustees' compensation. The Trusts employ
their officers on a shared basis, as well. However, officers are compensated by
The Vanguard Group, Inc., not the Trusts.
INDEPENDENT TRUSTEES. The Trusts compensate their independent
Trustees -- that is, the ones who are not also officers of the Trust -- in three
ways:
- The independent Trustees receive an annual fee for their service to the
Trusts, which is subject to reduction based on absences from scheduled
Board meetings.
- The independent Trustees are reimbursed for the travel and other expenses
that they incur in attending Board meetings.
- Upon retirement, the independent Trustees receive an aggregate annual fee
of $1,000 for each year served on the Board, up to fifteen years of
service. This annual fee is paid for ten years following retirement, or
until each Trustee's death.
"INTERESTED" TRUSTEES. The Trusts' interested Trustees -- Messrs. Bogle
and Brennan -- receive no compensation for their service in that capacity.
However, they are paid in their role as Officers of The Vanguard Group, Inc.
B-15
<PAGE> 60
COMPENSATION TABLE. The following table provides compensation details for
each of the Trustees. We list the amounts paid as compensation and accrued as
retirement benefits by the Trust for each Trustee. In addition, the table shows
the total amount of benefits that we expect each Trustee to receive from all
Vanguard Trusts upon retirement, and the total amount of compensation paid to
each Trustee by all Vanguard Trusts. All information shown is for the fiscal
year ended December 31, 1998:
VANGUARD WELLESLEY INCOME FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE PENSION OR RETIREMENT ESTIMATED TOTAL COMPENSATION
COMPENSATION BENEFITS ACCRUED AS ANNUAL BENEFITS FROM ALL VANGUARD TRUSTS
NAME OF DIRECTORS FROM TRUST PART OF TRUST EXPENSES UPON RETIREMENT PAID TO TRUSTEES(1)
----------------- ------------ ---------------------- --------------- ------------------------
<S> <C> <C> <C> <C>
John C. Bogle.................. None None None None
John J. Brennan................ None None None None
Barbara Barnes
Hauptfuhrer(2)............... $1,715 $232 $15,000 $75,000
JoAnn Heffernan Heisen......... $ 858 $101 $15,000 $37,500
Robert E. Cawthorn(2).......... $ 715 $155 $ 6,000 $31,250
Bruce K. MacLaury.............. $1,794 $173 $12,000 $70,000
Burton G. Malkiel.............. $1,727 $167 $15,000 $75,000
Alfred M. Rankin, Jr........... $1,715 $122 $15,000 $75,000
John C. Sawhill................ $1,715 $155 $15,000 $75,000
James O. Welch, Jr............. $1,715 $178 $15,000 $75,000
J. Lawrence Wilson............. $1,715 $129 $15,000 $75,000
</TABLE>
(1) The amounts reported in this column reflect the total compensation paid to
each Trustee for his or her services as Trustee of 36 Vanguard Funds (35 in
the case of Mr. Malkiel; 28 in the case of Mr. MacLaury).
(2) Mr. Cawthorn and Mrs. Hauptfuhrer have retired from the Trust's Board,
effective May 31, 1998 and December 31, 1998, respectively.
INVESTMENT ADVISORY SERVICES
The Trust employs Wellington Management Company, LLP (the Adviser) under an
investment advisory agreement to manage the investment and reinvestment of
Vanguard Wellesley Income Fund's assets and to continuously review, supervise
and administer the Fund's investment program. The Adviser is a professional
investment counseling firm which provides investment services to investment
companies, other institutions and individuals. Among the clients of the Adviser
are more than 14 of the investment companies of The Vanguard Group. The Adviser
and its predecessor organizations have provided investment advisory services to
investment companies since 1928 and to investment counseling clients since 1960.
The Adviser is a Massachusetts limited liability partnership whose managing
partners are Robert W. Doran, Duncan M. McFarland, and John R. Ryan. The Adviser
discharges its responsibilities subject to the control of the officers and
Trustees of the Fund.
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................................... 0.100%
Next $2 billion.................................... 0.050%
Next $7 billion.................................... 0.040%
Over $10 billion................................... 0.030%
</TABLE>
The quarterly payment to the Adviser may be increased or decreased by
applying an incentive/penalty adjustment reflecting the investment performance
of the Fund relative to the investment performance of a "composite index", 65%
of which shall be comprised of the Lehman Brothers Long-Term Corporate AA or
Better Bond Index and 35% of which shall be comprised of 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).
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The following table sets forth the incentive/penalty adjustment to the
basic advisory fee payable by the Fund to the Adviser 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 against average assets over the same time period which the
performance is measured.
Until the quarter ended March 31, 1999, the performance adjustment for the
Adviser was calculated according to the following transition rules:
(a) October 1, 1997 through March 31, 1999. Beginning with the quarter
ended December 31, 1997, and until the quarter ended March 31, 1999, the
Performance adjustment was computed based upon a comparison of the
investment performance of the Fund and that of the Composite Index over the
number of months that had elapsed between April 1, 1996 (the beginning of
the incentive/penalty arrangement with the Fund) 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 increased proportionately from .75 and 1.5, respectively,
for the eighteen months ended October 31, 1997, to 1.5 and 3, for the
thirty-six months ended March 31, 1999.
(b) On and After March 31, 1999. For the quarter ended 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
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<PAGE> 62
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, 1996, 1997, and 1998, the Fund
incurred investment advisory fees of approximately $3,606,000, $3,646,000 before
an increase of $718,000 based on performance, and $4,026,000 before an increase
of $648,000 based on performance, respectively.
The present agreement is renewable for successive one-year periods, only if
such renewal is specifically approved at least annually by a vote of the Trust's
Board of Trustees, including the affirmative votes of a majority of the Trustees
who are not parties to the contract or "interested persons" (as defined in the
1940 Act) of any such party, cast in person at a meeting called for the purpose
of considering such approval. The agreement is automatically terminated if
assigned, and may be terminated without penalty at any time (1) either by vote
of the Board of Trustees of the Trust 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 Trust.
The Trust's Board of Trustees 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 be communicated to shareholders in writing.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the Adviser (with the approval
of the Trust's Board of Trustees) 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 the best available price and the 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 the 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 Trust's Board of Trustees, 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.
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 the best interest of the Fund. Some
brokers or dealers who may receive such
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<PAGE> 63
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
generally 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 executed 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, 1996, 1997, and 1998, the Fund
paid approximately $2,064,000, $2,672,000, and $1,984,000 in brokerage
commissions, respectively.
Some securities considered for investment by the Fund may also be
appropriate for other Vanguard Funds and/or other clients served by the Adviser.
If purchases or sales of securities consistent with the investment policies of
the Fund, the other Vanguard Funds, and/or one or more of these other 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. Although there will be no specified
formula for allocating such transactions, the allocation methods used, and the
results of such allocations, will be subject to periodic review by the Trust's
Board of Trustees.
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 & POOR'S 500 COMPOSITE STOCK PRICE INDEX -- includes stocks
selected by Standard & Poor's Index Committee to include leading companies in
leading industries and to reflect the U.S. stock market.
STANDARD & POOR'S MIDCAP 400 INDEX -- is composed of 400 medium sized
domestic stocks.
STANDARD & POOR'S SMALLCAP 600/BARRA VALUE INDEX -- contains stocks of the
S&P SmallCap 600 Index which have a lower than average price-to-book ratio.
STANDARD & POOR'S SMALLCAP 600/BARRA GROWTH INDEX -- contains stocks of the
S&P SmallCap 600 Index which have a higher than average price-to-book ratio.
RUSSELL 1000 VALUE INDEX -- consists of the stocks in the Russell 1000
Index (comprising the 1,000 largest U.S.-based companies measured by total
market capitalization) with the lowest price-to-book ratios, comprising 50% of
the market capitalization of the Russell 1000.
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, Asia and the Far East.
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<PAGE> 64
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 a market weighted index that
contains individually priced U.S. Treasury securities 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.
LEHMAN CORPORATE (BAA) BOND INDEX -- consists of 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 $100 million outstanding. This
index includes over 1,500 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 $100 million
principal outstanding and maturity greater than 10 years.
BOND BUYER MUNICIPAL BOND INDEX -- is a yield index on current coupon
high-grade general obligation municipal bonds.
MERRILL LYNCH DRD-ELIGIBLE INDEX -- includes preferred stock issues which
are eligible for the corporate dividends-received-deduction.
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, 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 $5 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
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<PAGE> 65
BBB- or better with maturities between 5 and 10 years. The index has a market
value of over $800 billion.
LEHMAN BROTHERS 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 $1.1 trillion.
LIPPER BALANCED FUND AVERAGE -- an industry benchmark of average balanced
funds with similar investment objectives and policies, as measured by Lipper
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 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 Inc.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE -- the average performance of
small company growth funds as defined by Lipper 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. 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 Inc.
LIPPER FIXED INCOME FUND AVERAGE -- an industry benchmark of average fixed
income funds with similar investment objectives and policies, as measured by
Lipper 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.
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<PAGE> 66
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended December 31, 1998,
including the financial highlights for each of the five years in the period
ended December 31, 1998, appearing in the Vanguard Wellesley Income Fund's 1998
Annual Report to Shareholders, and the report thereon of PricewaterhouseCoopers
LLP, independent accountants, also appearing therein, are incorporated by
reference in this Statement of Additional Information. For a more complete
discussion of the performance, please see the Fund's Annual Report to
Shareholders, which may be obtained without charge.
APPENDIX -- DESCRIPTION AND RATINGS OF SECURITIES
I. DESCRIPTION OF BOND RATINGS
The Fund will invest 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. The following are 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; Aa -- together with
the Aaa group, 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 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 they normally
exhibit 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.
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