<PAGE> 1
VANGUARD
WELLESLEY INCOME
FUND
[PHOTO]
ANNUAL
REPORT
DECEMBER 31, 1998
[THE VANGUARD GROUP LOGO]
<PAGE> 2
AT VANGUARD, WE BELIEVE THAT TRADITION MATTERS
Our 8,000 crew members embrace the traditional values on which our success is
built, including integrity, hard work, thrift, teamwork, and fair dealing on
behalf of our clients.
This year, our report cover pays homage to three anniversaries, each of great
significance to The Vanguard Group:
- - The 200th anniversary of the Battle of the Nile, which commenced on August
1, 1798. HMS Vanguard, the victorious British flagship at the Nile, is our
namesake. And its motto--"Leading the way"--serves as a guiding principle
for our company.
- - The 100th birthday, on July 23, of Walter L. Morgan, founder of Wellington
Fund, the oldest member of what became The Vanguard Group. Mr. Morgan was
friend and mentor to Vanguard founder John C. Bogle, and helped to shape the
standards and business principles that Mr. Bogle laid down for Vanguard at
its beginning nearly 25 years ago: a stress on balanced, diversified
investments; insistence on fair dealing and candor with clients; and a focus
on long-term investing. To our great regret, Mr. Morgan died on September 2.
- - The 70th anniversary, on December 28, of the incorporation of Vanguard
Wellington Fund. It is the nation's oldest balanced mutual fund, and one of
only a handful of funds created in the 1920s that are still in operation.
Although Vanguard constantly tackles new challenges, adopts new technology, and
develops new services, we treasure the traditions and values that set us apart
in a crowded, competitive industry. And we salute our shareholders, whose
support and trust we strive to earn each and every day.
[PHOTO]
CONTENTS
A MESSAGE TO
OUR SHAREHOLDERS
1
THE MARKETS IN
PERSPECTIVE
4
REPORT FROM
THE ADVISER
6
FUND PROFILE
8
PERFORMANCE SUMMARY
12
FINANCIAL STATEMENTS
13
REPORT OF
INDEPENDENT ACCOUNTANTS
23
All comparative mutual fund data
are from Lipper or Morningstar,
unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
[PHOTO] [PHOTO]
John J. Brennan John C. Bogle
Chairman & Ceo Senior Chairman
Aided by declining interest rates and escalating stock prices, Vanguard
Wellesley Income Fund earned +11.8% during 1998. Our return was comfortably
ahead of that of the average income fund, although neither we nor our average
peer matched the return of our unmanaged index benchmark.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1998
- -------------------------------------------------------------------------------
<S> <C>
Vanguard Wellesley IncomeFund +11.8%
- -------------------------------------------------------------------------------
Average Income Fund + 8.0%
- -------------------------------------------------------------------------------
Wellesley Composite Index* +13.9%
- -------------------------------------------------------------------------------
</TABLE>
*65% Lehman Long Corporate AA or Better Bond Index, 26% S&P/BARRA Value
Index,4.5% S&P Utilities Index, and 4.5% S&P Telephone Index.
The table at right presents the fund's total return (capital change plus
reinvested dividends) and those of its comparative standards. The Wellesley
Composite Index is constructed of market benchmarks weighted in proportion to
our typical investment mix of 65% bonds and 35% high-yielding stocks.
Our return is based on an increase in net asset value from $21.86 per share
on December 31, 1997, to $22.12 per share on December 31, 1998, adjusted for
dividends totaling $1.13 per share paid from net investment income and
distributions totaling $1.14 per share from net realized capital gains. At
year-end, our annualized yield was 4.8%.
FINANCIAL MARKETS IN REVIEW
The U.S. economy grew at a robust pace--more than 3%--during 1998 as it shrugged
off the effects of serious financial problems in Asia, Russia, and Latin
America. Troubles abroad slowed demand for American exports and boosted demand
for imported goods, widening the U.S. trade deficit. But the domestic economy
got a powerful push from higher consumer spending, which was encouraged by low
unemployment (4.3% at year-end) and higher wages (up about 4%, well above the
1.6% inflation rate).
The optimism that kept shopping malls and automobile showrooms busy was
also a factor in the financial markets. Interest rates declined on balance
during 1998. Bond prices, which move in the opposite direction from rates,
generally rose. Price appreciation accounted for 2 percentage points of the 8.7%
total return of the Lehman Brothers Aggregate Bond Index. The yield on the
benchmark 30-year U.S. Treasury bond ended the year at 5.09%, down 83 basis
points from 5.92% at the beginning of 1998. Treasury bond prices benefited from
a "flight to quality" as many investors shunned riskier securities.
Stock prices shot up during the first half of the year, despite news that
corporate earnings actually declined slightly, and by July 17 the Standard &
Poor's 500 Composite Stock Price Index had gained +23.3%. But fears that Asia's
financial troubles were spreading worldwide touched off a sharp decline: Over
the following six weeks, the S&P 500 Index fell -19.2%. Declines were much
steeper for smaller stocks: The Russell 2000 Index of small-cap stocks declined
nearly -40% from its mid-April peak to its low in October.
The stock market then revived with remarkable speed and vigor. By year-end,
the S&P 500 Index was again in record territory, having gained +28.6% for the
year. This result, however, masked weakness elsewhere in the market. The
Wilshire 4500 Equity
1
<PAGE> 4
Index, which comprises stocks not included in the S&P 500, gained just +8.6%,
while the Russell 2000 Index declined -2.5%. In the entire market, more stocks
declined in price than rose. Among large-cap stocks, there was a huge gap
between returns on growth and value stocks: The S&P 500's growth component
gained +42.2% during the year, nearly three times the +14.7% return on its value
stocks.
1998 PERFORMANCE OVERVIEW
In one sense, Wellesley Income Fund's +11.8% return during 1998 was a very
respectable result, outpacing the average income fund by 3.8 percentage points.
The fixed-income strategy of our investment adviser, Wellington Management
Company, which kept your fund's duration nearly twice as long as that of the
typical income fund, was a factor in this advantage. The longer a fund's
duration, the more its share price fluctuates in response to changes in rates,
so our longer duration meant that our share price benefited more than that of
our average peer from the rate decline during 1998. Of course, when interest
rates rise, our return may suffer more than those of our competitors. We note
that the income-fund category embraces an eclectic group of funds, many of which
pursue investment strategies different from Wellesley's. These differences make
short-term performance comparisons of Wellesley and its peers tricky.
However, while outperforming our average peer, we fell short of the +13.9%
return of our unmanaged composite benchmark. Wellesley Income Fund's bond
holdings earned +10.3%, trailing those in the benchmark by only 0.2 percentage
point, so most of our shortfall to the index was due to our stock segment.
Our stocks gained +15.6% for the year, 3.3 percentage points behind the
equity component of the index--a blend of the S&P/BARRA Value Index, S&P
Utilities Index, and S&P Telephone Index. While our adviser invested heavily in
the utility sector (31.5% of the fund's equity assets at year-end), we did not
own some of the sector's higher-flying telecommunications stocks, many of which
had dividend yields too low for our liking. The upshot was that gains from our
utility holdings, while strong at +25%, were well below the +42% return for the
overall group.
For obvious reasons, your fund also was largely out of the market's hottest
sector, technology, which offers few income-producing stocks. While tech stocks
accounted for 6.3% of the S&P/BARRA Value Index and earned +47%, your fund had
just 0.3% of assets in tech stocks and earned +20% on them. Our strongest
showing relative to the index was in auto & transportation stocks, a sector
where we earned +77% versus +22% for the index.
We conclude with a word on income. The downtrend in interest rates during
1998, which boosted your fund's net asset value and total return, caused its
income return to slip. Per-share dividends from income were 5.8% lower in 1998
than in 1997 ($1.13 versus $1.20). And, as noted, our annualized yield at
year-end was 4.8%, down from 5.3% at year-end 1997.
LONG-TERM PERFORMANCE OVERVIEW
Wellesley Income Fund's long-term record is solid, both on an absolute basis and
in relation to peers. The table on page 3 presents the returns of Wellesley and
our comparative standards during the past decade, showing how an initial $10,000
investment in each would have grown, assuming the reinvestment of income
dividends and capital gain distributions. Wellesley's average return of +13.2%
was 2.2 percentage points higher than that of the average income fund. That
seemingly modest margin resulted in a startling difference of $6,078 in the
ending value of the hypothetical $10,000 investments.
2
<PAGE> 5
Vanguard's low costs contribute significantly to our edge over the average
income fund. During 1998, the fund's operating expenses were 0.31% of average
net assets, or 0.9 percentage point lower than the 1.21% expense ratio charged
by the average income fund.
Wellington Management Company, our adviser, has adroitly carried out the
fund's strategy over the years, helping us to outperform not only our average
peer but also the Wellesley Composite Index. Our annual edge of 0.2 percentage
point over the index is impressive since the index exists only on paper and has
no operating expenses and none of the transaction costs that mutual funds incur
when they buy or sell securities.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED
DECEMBER 31, 1998
-----------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- --------------------------------------------------------------------------------
<S> <C> <C>
Vanguard Wellesley Income Fund +13.2% $34,437
- --------------------------------------------------------------------------------
Average Income Fund +11.0% $28,359
- --------------------------------------------------------------------------------
Wellesley Composite Index* +13.0% $33,854
- --------------------------------------------------------------------------------
</TABLE>
*65% Lehman Long Corporate AA or Better Bond Index, 26% S&P/BARRA Value Index,
4.5% S&P Utilities Index, and 4.5% S&P Telephone Index.
Our annualized return of +13.2% during the decade was well above the
long-term historical average for an asset mix of 65% bonds and 35% stocks. While
we are grateful for these results, they create two potential dangers. The first
is that investors may have unrealistic expectations for future returns.
Investors who base plans on such assumptions may fall well short of their
financial goals if returns revert to lower levels, as we would expect.
The second danger is that investors may underestimate the risks that are
part of investing. In six of the past ten years, Wellesley's total return
exceeded 10%, while we recorded a negative return only once (-4.4% in 1994).
The financial markets are capable of steeper declines. Investors who understand
that downturns will occur, and are a risk that must be endured in pursuit of
investment rewards, may find it easier to stay on an even keel when the seas get
stormy.
IN SUMMARY
The tumultuous events of 1998 amply demonstrated the advantages of a balanced
investment approach. Investors who held a mix of stock funds, bond funds, and
money market funds participated in the markets' bounty but were spared some
measure of the anxiety felt during the midyear downturn in stocks.
We have always believed that investors are well served by selecting a mix
of stocks, bonds, and cash reserves appropriate to their investment time
horizon, goals, and risk tolerance, and then sticking with their plan. A
conservative balance of bonds and stocks is the very idea behind Vanguard
Wellesley Income Fund, and we will "stay the course" in implementing it.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
January 14, 1999
3
<PAGE> 6
THE MARKETS IN PERSPECTIVE
YEAR ENDED DECEMBER 31, 1998
[PHOTO]
Financial markets continued to produce solid overall gains during 1998. After
overcoming a sharp, six-week setback in July and August, the S&P 500 Index
gained 28.6% for the year, marking the first time the index had produced returns
of 20% or more in four consecutive years. Bond prices rose as interest rates
generally declined over the year. Returns from overseas stock markets varied
widely, with big gains in Europe, small gains in the Pacific, and losses in
most emerging markets.
U.S. STOCK MARKETS
Large-capitalization stocks--especially those of large growth companies--were
the best performers during 1998. The 50 largest stocks within the S&P 500 Index
earned more than 40%, while the return of the other 450 stocks was less than
17%. The stock market as a whole, as measured by the Wilshire 5000 Equity Index,
earned 23.4%. Small-cap stocks, represented by the Russell 2000 Index, declined
2.5% for the year.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1998
--------------------------------
1 YEAR 3 YEARS 5 YEARS
- ---------------------------------------------------------------------------
STOCKS
<S> <C> <C> <C>
S&P 500 Index 28.6% 28.2% 24.1%
Russell 2000 Index -2.5 11.6 11.9
MSCI EAFE Index 20.3 9.3 9.5
- ---------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 8.7% 7.3% 7.3%
Lehman 10 Year Municipal Bond Index 6.8 6.8 6.4
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 5.1 5.2 5.1
- ---------------------------------------------------------------------------
OTHER
Consumer Price Index 1.6% 2.2% 2.4%
- ---------------------------------------------------------------------------
</TABLE>
The huge gap between returns of large and small stocks was not the only
oddity during the year. Among large stocks there also was a large disparity in
performance between growth and value stocks. Within the S&P 500 Index, growth
stocks rose 42.2%, while value stocks were up 14.7%. The gap of 27.5 percentage
points is the largest in the 23 years that the growth and value components have
been tracked.
Stocks rose strongly during the first half of the year. But after hitting a
then-record high on July 17, the S&P 500 Index fell by 19.2% during the
following six weeks. Declines were steeper for most smaller stocks. The Russell
2000 Index fell nearly 40% from its peak in April before climbing back during
the fourth quarter.
The summer slump in stock prices reflected several factors that raised
anxiety among investors and prompted a reconsideration of risk that extended
past stocks to bonds. Among these factors were deteriorating corporate earnings;
Russia's default on its debts; sharp swings in currency exchange rates; and
lingering economic weakness in Asia.
Although these sources of uncertainty remained as the year went on, many
investors reacted not by abandoning stocks, but by selecting large, well-known
stocks they perceived as reliable vehicles for long-term growth. The strong
rebound in prices during the fourth quarter was due in large part to the calming
influence on jittery markets of the Federal Reserve Board's decision to cut
short-term interest rates by 0.75 percentage point.
4
<PAGE> 7
Technology stocks led the market's advance during 1998, rising 83%.
Investors were attracted by rapid revenue growth and a belief that consumers and
businesses will keep spending freely on computers, software, and computer
services. Speculation also played a role in the surge. Burgeoning activity on
the Internet sent many stocks, even those with no hint of profitability,
skyrocketing. The bulge in Internet stock prices prompted comparisons with such
historic asset "bubbles" as Japan's stock market in the late 1980s and the
tulip-bulb mania in Holland in the 1630s.
Health care and utilities, especially telecommunications providers, also
soared, achieving returns of more than 43%. Both sectors benefited from rising
demand for their products and a perception that they are somewhat protected from
foreign economic troubles and foreign competition. Consumer-related stocks such
as retailers also did well, reflecting strength in consumer spending. Americans
spent almost every after-tax dollar they earned during 1998. Jobs were abundant;
unemployment fell to 4.3% by year-end.
The worst-performing groups were two directly harmed by falling commodity
prices: oil drilling and services firms in the "other energy" category (-36%)
and materials & processing firms (-1%), such as paper, steel, and chemical
makers. Producer-durables companies, such as machinery and aircraft makers, eked
out a 2% return as companies saw falling sales abroad and rising competition at
home from foreign firms.
U.S. BOND MARKETS
The fall in interest rates during 1998 was steepest for U.S. Treasury
securities, which benefited from heightened aversion to risk among investors
and from a slight decrease in supply, thanks to a $70 billion federal budget
surplus. The low inflation rate--consumer prices were up just 1.6%--gave the
Federal Reserve the flexibility to cut short-term rates even though economic
growth was strong.
Yields on long-term Treasury issues fell by roughly 1 percentage point, and
the 30-year Treasury bond's yield was 5.09% on December 31. Lower rates mean
higher bond prices, and the Lehman Brothers Long U.S. Treasury Index earned a
total return of 13.5%, an astounding margin of nearly 12 percentage points over
the inflation rate.
Bonds lacking the unquestioned credit quality of Treasuries did not fare as
well, reflecting a repricing of risk and a "flight to quality" by investors who
began to feel they had been underestimating risk. One result was price declines
that nearly offset the interest earned on high-yield "junk" bonds. However,
high-quality corporate bonds and mortgage-backed securities generally held up
well. The Lehman Aggregate Bond Index, which encompasses Treasury, mortgage, and
high-quality corporate securities and has an intermediate-term average maturity,
earned a solid 8.7%.
Yields on long-term municipal bonds declined only slightly during the year,
and by December 31 were only a tad lower than yields on long-term Treasuries.
This was striking because the interest on municipals is exempt from federal
income tax.
INTERNATIONAL STOCK MARKETS
Europe's stock markets beat even the S&P 500 Index's gaudy return, gaining 28.7%
in U.S.-dollar terms, with about 5% of the gain due to a fall in the dollar
versus most European currencies. Pacific-region stocks rose 2.6%, although it
took a fall in the dollar's value versus the Japanese yen to overcome losses in
local-currency terms. Overall, developed international markets, as measured by
the MSCI EAFE Index, earned 20.3%.
Investors' confidence in emerging markets continued to evaporate in
1998, and stocks in these markets fell about 25% as a group. The few bright
spots included South Korea (+141%) and the Philippines (+13%), which had
suffered big declines in 1997.
5
<PAGE> 8
REPORT FROM THE ADVISER
[PHOTO]
Vanguard Wellesley Income Fund earned a return of 11.8% in 1998, lagging the
13.9% return of our unmanaged index benchmark.
The fund's stock segment returned 15.6%, which follows increases of 32.8%
in 1997, 24.2% in 1996, and 37.1% in 1995. These equity returns were very
generous by historic standards and have allowed the fund to enjoy strong
absolute returns over the last four years. The 15.6% return for the Wellesley
equities trailed, however, the 18.9% return of our benchmark's equity component,
which is weighted 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. Our shortfall was primarily due to
sector allocation and stock selection in the fourth quarter.
The bond segment's return of 10.3% for the year was marginally behind the
return of 10.5% for the Lehman Long Corporate AA or Better Index, against which
we measure our performance. We reduced the duration of Wellesley's bond
portfolio during the latter half of 1998, and our duration is now slightly
shorter than that of the Lehman index. This posture should help our relative
performance if long-term rates rise. The shorter a bond portfolio's duration,
the less its principal value fluctuates in response to a given change in
interest rates. We emphasize, however, that if interest rates rise, our
absolute performance will be hurt, even if we perform better than our
benchmark.
The fund has maintained its traditional allocations, investing 60%-65% of
assets in longer-term, investment-grade bonds and 35%-40% of assets in
dividend-paying equities. In general, the fund's performance is extremely
sensitive to changes in long-term interest rates because of the long average
maturity of our bonds and because of our meaningful weighting in high-yielding,
interest-rate-sensitive stocks.
OUTLOOK FOR THE FIRST HALF OF 1999
We believe the U.S. economy will experience reasonably solid domestic demand in
1999, but not at the robust rates that have prevailed recently. The consumer
will, as usual, be the deciding factor for the economy's performance in 1999.
During the past two years, consumer spending has consistently exceeded even the
most optimistic expectations, while U.S. exporters continue to see shrinking
demand for all types of goods. Deteriorating economic conditions in Latin
America, a minirecession in the United Kingdom, and a continued decline in
Japan's economy will all contribute to a weak export picture in 1999. Inflation
remains a "nonissue," and any surprises are likely to be on the low side. We
anticipate another year of very low inflation: We expect the Consumer Price
Index to rise 1.4% after its 1.6% increase in 1998.
While stresses in the financial system have eased for now, we continue to
believe that moderating eco-
6
<PAGE> 9
nomic growth and very low inflation will provide the backdrop necessary for
additional reductions in short-term interest rates by the Federal Reserve Board
during the first half of 1999. We expect the federal funds rate, a proxy for
short-term rates, to fall to 4% by midyear from its current level of 4.75%.
Interest rates on long-term bonds, however, already reflect the market's
expectation of lower short rates. Therefore, we don't expect further declines in
long-term interest rates. The political climate in Washington is such that very
little in the way of policy changes will be accomplished in 1999. In the absence
of such changes, the federal budget surplus will continue to mount, and Treasury
debt will continue to be paid down. We expect the federal budget surplus to
reach $115 billion or more in the current fiscal year, compared with $70 billion
in fiscal year 1998, which ended September 30. This is a favorable scenario for
bond investors.
On the stock side, we anticipate that after a 1% decline in 1998,
operating earnings on S&P 500 Index companies will increase by 1% on average in
1999. This view is slightly less optimistic than the consensus of other market
participants.
STRATEGY IN 1999
Our strategy for the fund is unchanged. The percentage of assets invested
in stocks and bonds varies only marginally, and the fund's bonds continue to be
long-term securities with call protection to provide a consistent income stream.
We purchase only investment-grade issues denominated in U.S. dollars, and we
emphasize securities from issuers with stable or improving credit fundamentals.
As of December 31, approximately 85% of the bond portfolio was rated "A" or
better in credit quality.
Our strategy for the stock portfolio is to purchase shares of companies
with above-market yields across different industries. Our largest purchases
recently have been in the energy, financial, and electric utilities sectors. In
the second half of 1998, we focused on selling stocks that had reached our
target prices, particularly in the fourth quarter as the market climbed. The
majority of Wellesley's stocks are New York Stock Exchange-listed issues with
above-average dividend yields. The average yield on our stocks is 3.4%, which is
162% higher than the 1.3% dividend yield on the S&P 500 Index.
The dominant principle guiding the fund's investment strategy is our
ongoing obligation to shareholders to provide an attractive level of income by
investing in high-quality securities. Our long-term goal is to achieve increases
in Wellesley's dividend by purchasing stocks of strong companies that are able
to pass along higher dividends generated from rising earnings. Since we wrote to
you six months ago, there have been 14 dividend increases on stocks in our
equity portfolio. We avoid stocks with ultrahigh dividends that may not be
sustainable over the long term.
SUMMARY
In light of the volatility that occurred in the markets in 1998, we were pleased
to end the year with positive results. We will continue to focus on maintaining
the fund's charter while trying to outperform the composite benchmark.
Increasing the fund's income remains an objective in 1999.
Earl E. McEvoy John R. Ryan
Senior Vice President Senior Vice President
Wellington Management Company, LLP
January 14, 1999
INVESTMENT PHILOSOPHY
The fund reflects a belief that relatively high current income and moderate
long-term growth in income and capital can be achieved without undue risk by
holding 60% to 65% of assets in fixed-income securities and the balance in
income-oriented common stocks. Consistent with this approach, the fund's bond
segment comprises intermediate- and long-term U.S. Treasury securities and
high-quality corporate bonds; its equity segment is dominated by stocks with
above-average dividend yields and strong potential for dividend increases.
7
<PAGE> 10
FUND PROFILE
WELLESLEY INCOME FUND
This Profile provides a snapshot of the fund's characteristics as of December
31, 1998, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on pages 10 and 11.
<TABLE>
<CAPTION>
TOTAL FUND CHARACTERISTICS
- -------------------------------------------
<S> <C>
Yield 4.8%
Turnover Rate 32%
Expense Ratio 0.31%
Cash Reserves 2.4%
</TABLE>
<TABLE>
<CAPTION>
FUND ASSET ALLOCATION
- --------------------------
<S> <C>
BONDS 62%
STOCKS 36%
CASH RESERVES 2%
</TABLE>
<TABLE>
<CAPTION>
TOTAL FUND VOLATILITY MEASURES
- -------------------------------------------
WELLESLEY S&P 500
- -------------------------------------------
<S> <C> <C>
R-Squared 0.52 1.00
Beta 0.31 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST STOCKS (% OF EQUITIES)
- -----------------------------------------
<S> <C>
Bell Atlantic Corp. 5.4%
First Union Corp. 4.6
Amoco Corp. 4.5
Ford Motor Co. 4.0
National City Corp. 3.9
GTE Corp. 3.9
GPU, Inc. 3.5
USX-Marathon Group 3.4
Pharmacia & Upjohn, Inc. 3.3
Royal Dutch Petroleum Co. ADR 2.7
- -----------------------------------------
Top Ten 39.2%
- -----------------------------------------
Top Ten as % of Total Net Assets 14.1%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- ----------------------------------------------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1998
-----------------------------------------------------
WELLESLEY WELLESLEY S&P 500
-----------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation ................. 6.4% 4.0% 2.5%
Consumer Discretionary ................ 7.3 6.1 12.0
Consumer Staples ...................... 5.8 5.0 9.8
Financial Services .................... 28.5 20.5 16.2
Health Care ........................... 3.8 5.7 12.5
Integrated Oils ....................... 13.8 17.5 5.2
Other Energy .......................... 0.0 0.0 0.9
Materials & Processing ................ 8.9 7.4 3.7
Producer Durables ..................... 0.0 0.0 3.2
Technology ............................ 0.0 0.0 16.6
Utilities ............................. 23.9 31.5 11.7
Other ................................. 1.6 2.3 5.7
- ----------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
<TABLE>
<CAPTION>
EQUITY CHARACTERISTICS
- -------------------------------------------------------
WELLESLEY S&P 500
- -------------------------------------------------------
<S> <C> <C>
Number of Stocks 68 500
Median Market Cap $20.3B $60.3B
Price/Earnings Ratio 21.3x 28.0x
Price/Book Ratio 2.7x 4.9x
Dividend Yield 3.4% 1.3%
Return on Equity 17.2% 22.5
Earnings Growth Rate 7.5% 17.2%
Foreign Holdings 5.0% 1.6%
</TABLE>
EQUITY INVESTMENT FOCUS
- -------------------------------------------------------
[GRAPH]
<TABLE>
<CAPTION>
FIXED-INCOME CHARACTERISTICS
- -------------------------------------------------------
WELLESLEY LEHMAN*
- -------------------------------------------------------
<S> <C> <C>
Number of Bonds 182 7,257
Yield to Maturity 6.1% 5.7%
Average Coupon 7.0% 6.9%
Average Maturity 17.6 years 8.6 years
Average Quality Aa3 Aaa
Average Duration 8.7 years 4.4 years
</TABLE>
*Lehman Aggregate Bond Index.
FIXED-INCOME INVESTMENT FOCUS
- -------------------------------------------------------
[GRAPH]
<TABLE>
<CAPTION>
DISTRIBUTION BY ISSUER (% OF BONDS)
- -----------------------------------------
<S> <C>
Asset-Backed 0.0%
Finance 24.6
Foreign 3.9
Industrial 33.9
Mortgage 6.5
Treasury/Agency 16.3
Utilities 14.8
- -----------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY CREDIT QUALITY (% OF BONDS)
- -------------------------------------------
<S> <C>
Treasury/Agency 16.3%
Aaa 9.3
Aa 19.8
A 38.7
Baa 15.9
Ba 0.0
B 0.0
Not Rated 0.0
- -------------------------------------------
Total 100.0%
</TABLE>
9
<PAGE> 12
AVERAGE COUPON. The average interest rate paid on the securities held by a fund.
It is expressed as a percentage of face value.
AVERAGE DURATION. An estimate of how much a bond fund's share price will
fluctuate in response to a change in interest rates. To see how the price could
shift, multiply the fund's duration by the change in rates. If interest rates
rise by one percentage point, the share price of a fund with an average duration
of five years would decline by about 5%. If rates decrease by a percentage
point, the fund's share price would rise by 5%.
AVERAGE MATURITY. The average length of time until bonds held by a fund reach
maturity (or are called) and are repaid. In general, the longer the average
maturity, the more a fund's share price will fluctuate in response to changes in
market interest rates.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
ratings assigned to a fund's securities holdings by credit-rating agencies. The
agencies make their judgment after appraising an issuer's ability to meet its
obligations. Quality is graded on a scale, with Aaa or AAA indicating the most
creditworthy bond issuers and A-1 or MIG-1 indicating the most creditworthy
issuers of money market securities.
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock and
bond investments.
DISTRIBUTION BY CREDIT QUALITY. This breakdown of a fund's securities by credit
rating can help in gauging the risk that returns could be affected by defaults
or other credit problems.
DISTRIBUTION BY ISSUER. A breakdown of a fund's holdings by type of issuer or
type of instrument.
DIVIDEND YIELD. The current, annualized rate of dividends paid on a share of
stock, divided by its current share price. For a portfolio, the weighted average
yield for stocks it holds.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
EQUITY INVESTMENT FOCUS. This grid indicates the focus of a fund's equity
holdings in terms of two attributes: market capitalization (large, medium, or
small) and relative valuation (growth, value, or a blend).
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FIXED-INCOME INVESTMENT FOCUS. This grid indicates the focus of a fund's
fixed-income holdings in terms of two attributes: average maturity (short,
medium, or long) and average credit quality (Treasury/agency, investment-grade
corporate, or below investment-grade).
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
FUND ASSET ALLOCATION. This chart shows the proportions of a fund's holdings
allocated to different types of assets.
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
10
<PAGE> 13
NUMBER OF BONDS. An indicator of diversification. The more separate issues a
fund holds, the less susceptible it is to a price decline stemming from the
problems of a particular bond issuer.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come from
each of the major industry groups that compose the stock market.
TEN LARGEST STOCKS. The percentage of equity assets that a fund has invested in
its ten largest stocks. As this percentage rises, a fund's returns are likely to
be more volatile because they are more dependent on the fortunes of a few
companies.
TURNOVER RATE. An indication of trading activity during the past year. Funds
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year.
YIELD TO MATURITY. The rate of return an investor would receive if the
securities held by a fund were held to their maturity dates.
11
<PAGE> 14
PERFORMANCE SUMMARY
WELLESLEY INCOME FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely, so an investment in the fund could
lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: DECEMBER 31, 1978-DECEMBER 31, 1998
- ---------------------------------------------------
WELLESLEY INCOME FUND COMPOSITE*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ---------------------------------------------------
<S> <C> <C> <C> <C>
1979 -2.6% 8.8% 6.2% 3.5%
1980 0.9 11.0 11.9 9.4
1981 -3.1 11.8 8.7 -1.7
1982 10.1 13.2 23.3 36.3
1983 7.1 11.5 18.6 13.2
1984 4.9 11.7 16.6 13.8
1985 16.0 11.4 27.4 29.4
1986 9.2 9.1 18.3 19.9
1987 -8.1 6.2 -1.9 2.5
1988 4.7 8.9 13.6 13.7
1989 11.8 9.1 20.9 21.0
1990 -4.3 8.1 3.8 2.5
1991 12.9 8.7 21.6 20.5
1992 1.6 7.1 8.7 9.2
1993 8.2 6.4 14.6 14.6
1994 -10.2 5.8 -4.4 -4.6
1995 21.6 7.3 28.9 30.7
1996 3.3 6.1 9.4 6.8
1997 13.8 6.4 20.2 19.4
1998 6.4 5.4 11.8 13.9
- ---------------------------------------------------
</TABLE>
*65% Lehman Long-Term Corporate Bond Index and 35% S&P 500 Index through
December 31, 1985; 65% Lehman Long Corporate AA or Better Bond Index, 26%
S&P/BARRA Value Index, and 9% S&P Utilities Index through June 30, 1996, when
the S&P Utilities component was separated into the S&P Utilities Index and the
S&P Telephone Index. See Financial Highlights table on page 20 for dividend and
capital gains information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: DECEMBER 31, 1988-DECEMBER 31, 1998
- -----------------------------------------------------------
Lehman Long
Wellesley Average Wellesley Corp AA or
Income Income Composite Better Bond
Fund Fund Index Index
<S> <C> <C> <C> <C>
1988 12 10000 10000 10000 10000
1989 03 10341 10304 10327 10110
1989 06 11248 10955 11351 11113
1989 09 11642 11341 11737 11196
1989 12 12093 11595 12096 11553
1990 03 11847 11126 11762 11307
1990 06 12172 11571 12162 11779
1990 09 11717 10866 11616 11668
1990 12 12548 11425 12395 12352
1991 03 13214 12271 13165 12873
1991 06 13350 12479 13244 13038
1991 09 14267 13331 14115 13987
1991 12 15254 14046 14939 14848
1992 03 14731 13996 14660 14586
1992 06 15513 14467 15344 15217
1992 09 16378 14986 16014 15972
1992 12 16577 15278 16314 16137
1993 03 17709 16044 17413 16974
1993 06 18250 16582 17979 17576
1993 09 19173 16922 18853 18358
1993 12 19005 17138 18693 18228
1994 03 18156 16588 17841 17392
1994 06 18092 16723 17607 16973
1994 09 18236 16876 17726 16962
1994 12 18162 16637 17840 17179
1995 03 19465 17603 19186 18341
1995 06 21119 18813 20861 19973
1995 09 22010 19473 21848 20487
1995 12 23413 20241 23312 21766
1996 03 23123 20853 22888 20759
1996 06 23360 21477 23149 20809
1996 09 24035 21596 23476 21191
1996 12 25618 22569 24898 22081
1997 03 25463 22669 24635 21583
1997 06 27287 24793 26604 22722
1997 09 29304 25831 28233 23897
1997 12 30791 26265 29731 25067
1998 03 32215 27706 31222 25426
1998 06 32835 28252 31934 26362
1998 09 33377 26585 31854 27404
1998 12 34437 28359 33906 27696
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1998
--------------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Wellesley Income Fund 11.84% 12.62% 13.16% $34,437
Average Income Fund 7.97 10.60 10.99 28,359
Wellesley Composite Index* 13.87 12.61 12.97 33,854
Lehman Long Corporate AA or Better Bond Index 10.52 8.73 10.72 27,696
- ------------------------------------------------------------------------------------------------------------
</TABLE>
*65% Lehman Long Corporate AA or Better Bond Index, 26% S&P/BARRA Value Index,
and 9% S&P Utilities Index through June 30, 1996, when the S&P Utilities
component was separated into the S&P Utilities Index and the S&P Telephone
Index.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1998
- -------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Wellesley Income Fund 7/1/1970 11.84% 12.62% 6.14% 7.02% 13.16%
- -------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE> 15
FINANCIAL STATEMENTS
DECEMBER 31, 1998
[PHOTO]
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
industry sector. Other assets are added to, and liabilities are subtracted from,
the value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital (money invested
by shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date. Any Accumulated Net Realized Losses, and any cumulative
excess of distributions over net income or net realized gains, will appear as
negative balances. Unrealized Appreciation (Depreciation) is the difference
between the market value of the fund's investments and their cost, and reflects
the gains (losses) that would be realized if the fund were to sell all of its
investments at their statement-date values.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
WELLESLEY INCOME FUND (000) (000)
- ---------------------------------------------------------
<S> <C> <C>
CORPORATE BONDS (45.1%)
- ---------------------------------------------------------
FINANCE (15.1%)
Allstate Corp.
6.75%, 5/15/2018 $ 30,000 $ 30,851
7.50%, 6/15/2013 20,000 22,073
Ambac, Inc.
7.50%, 5/1/2023 5,500 5,927
American Re Corp.
7.45%, 12/15/2026 34,095 38,389
Associates Corp. of North America
6.25%, 11/1/2008 25,000 25,809
Banc One Corp.
7.75%, 7/15/2025 50,000 57,575
8.00%, 4/29/2027 15,000 17,806
BankBoston Corp.
6.625%, 12/1/2005 15,000 15,261
6.875%, 7/15/2003 10,000 10,272
Boatmen's Bancshares Inc.
7.625%, 10/1/2004 10,000 10,857
CIGNA Corp.
7.875%, 5/15/2027 25,000 27,059
Cincinnati Financial Corp.
6.90%, 5/15/2028 25,000 25,188
Citigroup
6.625%, 1/15/2028 25,000 24,637
6.65%, 12/15/2010 25,000 26,344
7.125%, 9/1/2005 15,000 15,984
CoreStates Capital Corp.
6.625%, 3/15/2005 20,000 20,833
Equitable Companies Inc.
7.00%, 4/1/2028 25,000 25,824
Farmers Exchange Capital
7.05%, 7/15/2028 25,000 25,030
Fifth Third Bancorp
6.75%, 7/15/2005 25,000 26,357
First Bank N.A.
7.55%, 6/15/2004 8,000 8,663
First Bank System
6.625%, 5/15/2003 10,000 10,323
7.625%, 5/1/2005 7,500 8,222
First Chicago Corp.
7.625%, 1/15/2003 15,000 15,980
First Union Corp.
6.00%, 10/30/2008 15,000 15,286
7.50%, 4/15/2035 11,000 12,043
Fleet Financial Group, Inc.
6.875%, 3/1/2003 30,000 31,126
6.875%, 1/15/2028 25,000 25,852
General Electric Capital Corp.
8.125%, 5/15/2012 10,000 12,180
General Electric Capital Services
7.50%, 8/21/2035 14,000 16,645
General Electric Global Insurance
Holdings Corp.
7.00%, 2/15/2026 60,000 65,926
GMAC
7.00%, 9/15/2002 30,000 31,420
John Hancock Mutual Life
Insurance Co.
7.375%, 2/15/2024 50,000 55,445
Liberty Mutual Group
8.50%, 5/15/2025 35,000 40,615
Lumbermens Mutual Casualty Co.
9.15%, 7/1/2026 45,000 53,057
</TABLE>
13
<PAGE> 16
<TABLE>
<CAPTION>
- ---------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
WELLESLEY INCOME FUND (000) (000)
- ---------------------------------------------------------
<S> <C> <C>
MBIA Inc.
7.00%, 12/15/2025 $ 19,500 $ 20,250
Massachusetts Mutual Life
7.50%, 3/1/2024 8,690 9,660
7.625%, 11/15/2023 14,500 16,331
Metropolitan Life Insurance Co.
7.80%, 11/1/2025 40,000 44,954
J.P. Morgan & Co., Inc.
5.75%, 10/15/2008 20,000 19,760
6.25%, 1/15/2009 20,000 20,430
NBD Bank N.A.
6.25%, 8/15/2003 20,000 20,457
National City Bank Cleveland
6.50%, 5/1/2003 10,000 10,312
National City Bank Pennsylvania
7.25%, 10/21/2011 22,000 24,614
National City Corp.
7.20%, 5/15/2005 20,000 21,379
NationsBank Corp.
7.25%, 10/15/2025 10,000 10,824
7.75%, 8/15/2004 20,000 21,839
Republic New York Corp.
5.875%, 10/15/2008 15,000 14,958
SunTrust Banks, Inc.
6.00%, 2/15/2026 25,000 25,434
6.125%, 2/15/2004 20,000 20,422
Transamerica Financial Corp.
6.125%, 11/1/2001 25,000 25,177
Travelers Property Casualty Corp.
7.75%, 4/15/2026 25,000 27,960
Unum Corp.
6.75%, 12/15/2028 25,000 24,560
Wachovia Corp.
6.375%, 4/15/2003 20,000 20,588
6.605%, 10/1/2025 30,000 31,712
----------
1,286,480
----------
INDUSTRIAL (20.9%)
Air Products & Chemicals, Inc.
8.75%, 4/15/2021 12,550 15,270
AirTouch Communications, Inc.
6.35%, 6/1/2005 25,000 25,924
Aluminum Co. of America
6.75%, 1/15/2028 25,000 25,601
Baxter International, Inc.
7.65%, 2/1/2027 25,000 28,195
Bestfoods
6.625%, 4/15/2028 30,000 31,753
Bristol-Myers Squibb Co.
6.80%, 11/15/2026 40,000 44,364
Burlington Northern Santa Fe Corp.
6.375%, 12/15/2005 12,500 12,945
6.875%, 12/1/2027 25,000 26,249
CPC International, Inc.
7.25%, 12/15/2026 30,000 33,768
CSX Corp.
7.95%, 5/1/2027 35,000 40,320
Caterpillar Inc.
6.625%, 7/15/2028 25,000 25,278
Champion International Corp.
7.35%, 11/1/2025 30,000 30,032
Chrysler Corp.
7.45%, 3/1/2027 25,000 28,803
Coca Cola Enterprises
5.75%, 11/1/2008 25,000 25,069
Comcast Cable Communications
6.20%, 11/15/2008 25,000 25,437
The Walt Disney Co.
6.75%, 3/30/2006 15,000 16,309
E.I. du Pont de Nemours & Co.
6.50%, 1/15/2028 25,000 25,937
6.75%, 9/1/2007 25,000 27,195
Eastman Chemical Co.
7.25%, 1/15/2024 25,000 24,604
7.60%, 2/1/2027 5,000 5,064
Eaton Corp.
6.50%, 6/1/2025 10,000 10,443
7.625%, 4/1/2024 10,000 11,197
Ferro Corp.
7.125%, 4/1/2028 10,000 9,920
Ford Motor Co.
7.50%, 8/1/2026 20,000 22,719
8.90%, 1/15/2032 20,000 26,527
General Motors Corp.
7.40%, 9/1/2025 30,000 33,438
9.40%, 7/15/2021 20,000 26,695
Georgia-Pacific Group
7.25%, 6/1/2028 25,000 24,730
Gillette Co.
5.75%, 10/15/2005 35,000 35,702
6.25%, 8/15/2003 10,000 10,351
Hershey Foods Corp.
6.95%, 3/1/2007 13,000 14,303
Hubbell Inc.
6.625%, 10/1/2005 10,000 10,660
International Business
Machines Corp.
7.00%, 10/30/2025 60,000 66,741
International Paper Co.
7.625%, 1/15/2007 15,000 16,225
Johnson & Johnson
6.73%, 11/15/2023 15,000 16,529
Kimberly-Clark Corp.
6.25%, 7/15/2018 25,000 25,744
Eli Lilly & Co.
7.125%, 6/1/2025 50,000 57,115
Lockheed Corp.
6.75%, 3/15/2003 7,000 7,259
Masco Corp.
6.625%, 4/15/2018 20,000 19,647
Mead Corp.
7.35%, 3/1/2017 10,350 11,061
Merck & Co.
6.30%, 1/1/2026 30,000 31,446
Minnesota Mining &
Manufacturing Corp.
6.375%, 2/15/2028 35,000 36,598
Mobil Corp.
8.625%, 8/15/2021 20,000 25,166
Monsanto Co.
6.75%, 12/15/2027 25,000 25,514
Motorola, Inc.
7.50%, 5/15/2025 50,000 56,679
</TABLE>
14
<PAGE> 17
<TABLE>
<CAPTION>
- ---------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ---------------------------------------------------------
<S> <C> <C>
New York Times Co.
8.25%, 3/15/2025 $ 26,000 $ 29,693
News America Holdings Inc.
8.00%, 10/17/2016 50,000 55,470
Norfolk Southern Corp.
7.80%, 5/15/2027 35,000 40,655
PPG Industries, Inc.
6.875%, 2/15/2012 10,200 10,894
9.00%, 5/1/2021 15,000 19,405
Phelps Dodge Corp.
7.125%, 11/1/2027 12,500 12,401
Praxair, Inc.
6.75%, 3/1/2003 25,000 25,508
Procter & Gamble Co.
5.25%, 9/15/2003 15,000 15,026
6.45%, 1/15/2026 30,000 31,425
Procter & Gamble Co. ESOP
9.36%, 1/1/2021 30,000 39,921
Raytheon Co.
7.20%, 8/15/2027 25,000 27,054
E.W. Scripps Co.
6.625%, 10/15/2007 20,000 20,963
Tenneco Inc.
7.625%, 6/15/2017 30,000 30,856
7.875%, 4/15/2027 20,000 21,019
Texaco Capital
8.625%, 4/1/2032 30,000 38,435
Time Warner Inc.
6.625%, 5/15/2029 25,000 25,213
Tribune Co.
6.875%, 11/1/2006 20,000 21,015
USA Waste Services Inc.
7.00%, 7/15/2028 25,000 25,506
USX Corp.
6.85%, 3/1/2008 40,000 40,369
Ultramar Diamond Shamrock
7.20%, 10/15/2017 25,000 24,870
Weyerhaeuser Co.
8.50%, 1/15/2025 10,000 11,868
Whirlpool Corp.
9.00%, 3/1/2003 10,000 11,132
Worthington Industries, Inc.
6.70%, 12/1/2009 20,500 20,957
7.125%, 5/15/2006 20,000 21,008
----------
1,771,189
----------
UTILITIES (9.1%)
Alabama Power Co.
5.49%, 11/1/2005 8,250 8,258
Arizona Public Service Co.
6.625%, 3/1/2004 10,000 10,338
Baltimore Gas & Electric Co.
7.25%, 7/1/2002 15,000 15,996
BellSouth Telecommunications
6.25%, 5/15/2003 12,000 12,416
7.00%, 10/1/2025 10,000 11,193
Chesapeake & Potomac Telephone
Co. (VA)
7.875%, 1/15/2022 16,000 19,512
Cincinnati Gas & Electric Co.
6.90%, 6/1/2025 9,500 9,830
Consolidated Edison Co. of
New York, Inc.
6.375%, 4/1/2003 20,000 20,692
Duke Energy Corp.
6.00%, 12/1/2028 25,000 24,192
El Paso Natural Gas Co.
7.50%, 11/15/2026 25,000 26,714
Enron Corp.
6.875%, 10/15/2007 20,000 20,816
Florida Power Corp.
6.75%, 2/1/2028 22,380 24,061
GTE California Inc.
6.70%, 9/1/2009 25,000 27,325
GTE Southwest, Inc.
6.00%, 1/15/2006 10,000 10,299
Illinois Power Co.
6.50%, 8/1/2003 10,000 10,339
Indiana Bell Telephone Co., Inc.
7.30%, 8/15/2026 30,000 34,600
Kentucky Utilities Co.
7.92%, 5/15/2007 5,000 5,707
MCI Communications Corp.
7.50%, 8/20/2004 15,000 16,346
Michigan Bell Telephone Co.
7.85%, 1/15/2022 25,000 29,203
NGC Corp.
7.125%, 5/15/2018 20,000 19,659
New Jersey Bell Telephone Co.
8.00%, 6/1/2022 40,000 48,603
New York Telephone Co.
6.50%, 3/1/2005 30,000 31,583
Northern States Power Co.
6.375%, 4/1/2003 8,000 8,308
7.125%, 7/1/2025 30,000 33,931
Ohio Bell Telephone Co.
6.125%, 5/15/2003 15,000 15,536
Oklahoma Gas & Electric Co.
6.50%, 4/15/2028 12,770 13,302
Pacific Bell
7.125%, 3/15/2026 25,000 27,878
PacifiCorp
6.625%, 6/1/2007 10,000 10,568
6.71%, 1/15/2026 12,500 12,689
Pennsylvania Power & Light Co.
6.50%, 4/1/2005 15,000 15,758
PECO Energy
6.50%, 5/1/2003 30,000 30,874
Southern California Edison Co.
6.25%, 6/15/2003 6,050 6,275
Southwestern Public Service Co.
7.25%, 7/15/2004 10,000 10,793
Sprint Capital Corp.
6.875%, 11/15/2028 35,000 36,388
Tennessee Gas Pipeline Co.
7.50%, 4/1/2017 25,000 26,757
Texas Utilities Electric Co.
6.75%, 7/1/2005 10,000 10,516
Union Electric Co.
6.875%, 8/1/2004 10,000 10,694
U S WEST Capital Funding, Inc.
6.875%, 7/15/2028 25,000 26,672
</TABLE>
15
<PAGE> 18
<TABLE>
<CAPTION>
- ---------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
WELLESLEY INCOME FUND (000) (000)
- ---------------------------------------------------------
<S> <C> <C>
Wisconsin Electric Power Co.
6.50%, 6/1/2028 $ 25,000 $ 25,700
Wisconsin Power & Light
5.70%, 10/15/2008 12,650 12,875
----------
773,196
----------
- ---------------------------------------------------------
TOTAL CORPORATE BONDS
(COST $3,566,523) 3,830,865
- ---------------------------------------------------------
FOREIGN BONDS (U.S. Dollar
DENOMINATED)(2.4%)
- ---------------------------------------------------------
Province of British Columbia
6.50%, 1/15/2026 15,000 15,607
Husky Oil Ltd.
7.55%, 11/15/2016 20,000 18,808
Province of Manitoba
6.125%, 1/19/2004 7,000 7,246
8.875%, 9/15/2021 24,041 32,142
Province of Ontario
6.00%, 2/21/2006 25,000 25,907
Province of Quebec
7.50%, 7/15/2023 30,000 34,221
Saga Petroleum ASA
7.25%, 9/23/2027 12,795 11,937
Province of Saskatchewan
8.50%, 7/15/2022 15,000 19,153
Talisman Energy, Inc.
7.125%, 6/1/2007 20,000 20,631
7.25%, 10/15/2027 20,000 19,550
- ---------------------------------------------------------
TOTAL FOREIGN BONDS
(COST $194,717) 205,202
- ---------------------------------------------------------
U.S. GOVERNMENT AND AGENCY
OBLIGATIONS (14.0%)
- ---------------------------------------------------------
U.S. GOVERNMENT SECURITIES (8.3%)
U.S. Treasury Bonds
6.25%, 8/15/2023 75,000 83,815
7.25%, 5/15/2016 150,000 181,713
U.S. Treasury Notes
6.25%, 8/31/2002 200,000 210,398
6.875%, 5/15/2006 200,000 226,022
----------
- ---------------------------------------------------------
701,948
----------
AGENCY BONDS & NOTES (1.8%)
Federal Home Loan Bank
Global Notes
5.125%, 9/15/2003 50,000 49,992
Federal Home Loan Mortgage
Corp. Global
5.75%, 7/15/2003 50,000 51,346
Federal National Mortgage Assn.
Global Bond
5.75%, 6/15/2005 50,000 51,371
----------
152,709
----------
MORTGAGE OBLIGATIONS (3.9%)
Federal National Mortgage Assn.
(1) 5.735%, 1/1/2009 15,000 14,845
Government National
Mortgage Assn.
(1) 6.00%, 7/15/2028-1/1/2029 325,251 322,354
----------
337,199
----------
- ---------------------------------------------------------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS
(COST $1,121,731) 1,191,856
- ---------------------------------------------------------
COMMON STOCKS (36.1%)
- ---------------------------------------------------------
AUTO & TRANSPORTATION (1.4%)
Ford Motor Co. 2,073,800 121,706
----------
CONSUMER DISCRETIONARY (2.2%)
Eastman Kodak Co. 916,000 65,952
May Department Stores Co. 640,000 38,640
J.C. Penney Co., Inc. 1,732,600 81,216
----------
185,808
----------
CONSUMER STAPLES (1.8%)
Flowers Industries, Inc. 2,718,300 65,069
H.J. Heinz Co. 800,800 45,345
Philip Morris Cos., Inc. 820,000 43,870
----------
154,284
----------
FINANCIAL SERVICES (7.4%)
BankAmerica Corp. 511,064 30,728
Brandywine Realty Trust REIT 484,500 8,660
CBL & Associates Properties,
Inc. REIT 613,100 15,826
Camden Property Trust REIT 832,972 21,657
Colonial Properties
Trust REIT 1,004,900 26,755
FelCor Lodging
Trust, Inc. REIT 630,000 14,529
First Union Corp. 2,311,400 140,562
General Growth Properties
Inc. REIT 812,300 30,766
HSB Group Inc. 260,000 10,676
Highwood Properties, Inc. REIT 245,000 6,309
IPC Holdings Ltd. 290,300 6,731
KeyCorp 976,400 31,245
Kimco Realty Corp. REIT 218,700 8,680
The Macerich Co. REIT 619,100 15,864
Marsh & McLennan Cos., Inc. 370,000 21,622
National City Corp. 1,665,000 120,713
Nationwide Health
Properties, Inc. REIT 616,000 13,283
Sun Communities, Inc. REIT 520,600 18,123
Urban Shopping Centers,
Inc. REIT 617,000 20,207
Wachovia Corp. 766,900 67,056
----------
629,992
----------
HEALTH CARE (2.1%)
Baxter International, Inc. 1,147,700 73,811
Pharmacia & Upjohn, Inc. 1,808,500 102,406
----------
176,217
----------
INTEGRATED OIL (6.3%)
Amoco Corp. 2,320,000 136,880
Atlantic Richfield Co. 736,000 48,024
- - Conoco Inc. 774,100 16,159
Equitable Resources, Inc. 1,496,200 43,577
Mobil Corp. 420,000 36,592
Royal Dutch
Petroleum Co. ADR 1,713,000 82,010
Texaco Inc. 1,279,000 67,627
USX-Marathon Group 3,495,200 105,293
----------
536,162
----------
MATERIALS & PROCESSING (2.7%)
BOC Group PLC ADR 900,000 24,525
Consolidated Papers 503,200 13,838
Dow Chemical Co. 360,000 32,738
Eastman Chemical Co. 633,400 28,345
</TABLE>
16
<PAGE> 19
<TABLE>
<CAPTION>
- ---------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------
<S> <C> <C>
The Timber Co. 1,877,000 $ 44,696
Westvaco Corp. 1,000,000 26,813
Weyerhaeuser Co. 964,000 48,983
Witco Chemical Corp. 435,900 6,947
----------
226,885
----------
UTILITIES (11.4%)
AT&T Corp. 865,000 65,091
American Electric Power
Co., Inc. 760,000 35,767
Ameritech Corp. 666,000 42,208
Bell Atlantic Corp. 3,136,400 166,229
Central & South West Corp. 2,332,300 63,992
Consolidated Edison Inc. 707,400 37,404
DQE Inc. 1,601,650 70,373
DTE Energy Co. 1,238,200 53,088
GPU, Inc. 2,428,000 107,287
GTE Corp. 1,827,700 118,801
MCN Energy Group Inc. 501,100 9,552
National Fuel Gas Co. 122,500 5,535
New England Electric System 550,000 26,469
NICOR, Inc. 722,300 30,517
Questar Corp. 1,140,000 22,088
SBC Communications Inc. 359,000 19,251
SCANA Corp. 188,000 6,063
Southern Co. 1,400,000 40,687
Telecom Corporation of
New Zealand Ltd. 4,400,000 19,710
Telecom Corporation of
New Zealand Ltd. IR 703,200 1,542
U S WEST, Inc. 405,000 26,173
----------
967,827
----------
OTHER (0.8%)
Cooper Industries, Inc. 895,900 42,723
Shell Transport & Trading
Co. ADR 700,000 26,031
----------
68,754
----------
- ---------------------------------------------------------
TOTAL COMMON STOCKS
(COST $2,143,199) 3,067,635
- ---------------------------------------------------------
<CAPTION>
FACE
AMOUNT
(000)
- ---------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENTS (4.3%)
- ---------------------------------------------------------
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
4.76%, 1/4/1999 $212,975 212,975
4.77%-4.78%, 1/4/1999--Note G 148,190 148,190
- ---------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $361,165) 361,165
- ---------------------------------------------------------
TOTAL INVESTMENTS (101.9%)
(COST $7,387,335) 8,656,723
- ---------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-1.9%)
- ---------------------------------------------------------
Other Assets--Note C 171,763
Liabilities--Note G (330,706)
----------
(158,943)
- ---------------------------------------------------------
NET ASSETS (100%)
- ---------------------------------------------------------
Applicable to 384,140,873 outstanding
$.001 par value shares of beneficial
interest (unlimited authorization) $8,497,780
=========================================================
NET ASSET VALUE PER SHARE $22.12
=========================================================
</TABLE>
*See Note A in Notes to Financial Statements.
- -Non-Income-Producing Security.
(1)The average maturity is shorter than the final maturity shown due to
scheduled interim principal payments.
ADR--American Depositary Receipt.
IR--Installment Receipt.
REIT--Real Estate Investment Trust.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
AT DECEMBER 31, 1998, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------
<S> <C> <C>
Paid in Capital $7,164,130 $18.65
Overdistributed Net
Investment Income (2,469) (.01)
Accumulated Net Realized Gains 66,731 .17
Unrealized Appreciation--
Note F 1,269,388 3.31
- ---------------------------------------------------------
NET ASSETS $8,497,780 $22.12
=========================================================
</TABLE>
17
<PAGE> 20
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31, 1998
(000)
- --------------------------------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 98,236
Interest 329,890
Security Lending 230
----------
Total Income 428,356
----------
EXPENSES
Investment Advisory Fee--Note B
Basic Fee 4,026
Performance Adjustment 648
The Vanguard Group
Management and Administrative 17,994
Marketing and Distribution 1,540
Taxes (other than income taxes) 241
Custodian Fees 107
Auditing Fees 11
Shareholders' Reports 158
Annual Meeting and Proxy Costs 33
Trustees' Fees and Expenses 15
----------
Total Expenses 24,773
Expenses Paid Indirectly--Note D (395)
----------
Net Expenses 24,378
- --------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME 403,978
- --------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 397,100
- --------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 96,210
==============================================================================================================
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $897,288
==============================================================================================================
</TABLE>
18
<PAGE> 21
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997
(000) (000)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 403,978 $ 391,105
Realized Net Gain 397,100 512,072
Change in Unrealized Appreciation (Depreciation) 96,210 425,482
---------------------------------
Net Increase in Net Assets Resulting from Operations 897,288 1,328,659
---------------------------------
DISTRIBUTIONS
Net Investment Income (402,480) (395,073)
Realized Capital Gain (413,626) (476,586)
---------------------------------
Total Distributions (816,106) (871,659)
CAPITAL SHARE TRANSACTIONS(1) ---------------------------------
Issued 1,254,529 803,337
Issued in Lieu of Cash Distributions 705,454 759,182
Redeemed (1,189,285) (1,386,341)
---------------------------------
Net Increase from Capital Share Transactions 770,698 176,178
- -------------------------------------------------------------------------------------------------------------------------
Total Increase 851,880 633,178
- -------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 7,645,900 7,012,722
---------------------------------
End of Year $8,497,780 $7,645,900
=========================================================================================================================
(1)Shares Issued (Redeemed)
Issued 55,868 37,413
Issued in Lieu of Cash Distributions 31,680 35,385
Redeemed (53,098) (65,083)
---------------------------------
Net Increase in Shares Outstanding 34,450 7,715
=========================================================================================================================
</TABLE>
19
<PAGE> 22
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 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 Year (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%
Portfolio Turnover Rate 32% 36% 26% 32% 32%
=======================================================================================================================
</TABLE>
20
<PAGE> 23
NOTES TO FINANCIAL STATEMENTS
Vanguard Wellesley Income Fund is registered under the Investment Company Act of
1940 as a diversified open-end investment company, or mutual fund. Certain of
the fund's investments are in long-term corporate debt instruments; the issuers'
abilities to meet these obligations may be affected by economic developments in
their respective industries.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid and
asked prices. Prices are taken from the primary market in which each security
trades. Bonds are valued using the latest bid prices or using valuations based
on a matrix system (which considers such factors as security prices, yields,
maturities, and ratings), both as furnished by independent pricing services.
Temporary cash investments are valued at cost, which approximates market value.
Securities for which market quotations are not readily available are valued by
methods deemed by the Board of Trustees to represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold. Premiums and discounts on debt
securities purchased are amortized and accreted, respectively, to interest
income over the lives of the respective securities.
B. Wellington Management Company, LLP provides investment advisory services
to the fund for a fee calculated at an annual percentage rate of average net
assets. The basic fee is subject to quarterly adjustments based on performance
relative to a combined index comprising the Lehman Brothers Long Corporate AA or
Better Bond Index, the S&P/BARRA Value Index, the S&P Utilities Index, and the
S&P Telephone Index. For the year ended December 31, 1998, the advisory fee
represented an effective annual basic rate of 0.05% of the fund's average net
assets before an increase of $648,000 (0.01%) based on performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At December 31, 1998, the fund had contributed capital of $1,519,000
to Vanguard (included in Other Assets), representing 0.02% of the fund's
net assets and 2.2% of Vanguard's capitalization. The fund's Trustees and
officers are also Directors and officers of Vanguard.
21
<PAGE> 24
NOTES TO FINANCIAL STATEMENTS (continued)
D. Vanguard has asked the fund's investment adviser to direct certain security
trades, subject to obtaining the best price and execution, to brokers who have
agreed to rebate to the fund part of the commissions generated. Such rebates are
used solely to reduce the fund's administrative expenses. For the year ended
December 31, 1998, directed brokerage arrangements reduced the fund's expenses
by $391,000.
The fund's custodian bank has agreed to reduce its fees when the fund
maintains cash on deposit in the noninterest-bearing custody account. For the
year ended December 31, 1998, custodian fee offset arrangements reduced expenses
by $4,000.
E. During the year ended December 31, 1998, the fund purchased $1,757,443,000 of
investment securities and sold $1,748,098,000 of investment securities, other
than U.S. government securities and temporary cash investments. Purchases and
sales of U.S. government securities were $1,025,254,000 and $777,098,000,
respectively.
F. At December 31, 1998, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $1,269,388,000,
consisting of unrealized gains of $1,307,798,000 on securities that had risen in
value since their purchase and $38,410,000 in unrealized losses on securities
that had fallen in value since their purchase.
G. The market value of securities on loan to broker/dealers at December 31,
1998, was $144,060,000, for which the fund held cash collateral of $148,190,000.
Cash collateral received is invested in repurchase agreements.
22
<PAGE> 25
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Wellesley Income Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Wellesley Income Fund (the "Fund") at December 31, 1998, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for each
of the five years in the period then ended, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at December 31, 1998 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 2, 1999
23
<PAGE> 26
SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR VANGUARD WELLESLEY INCOME FUND
This information for the fiscal year ended December 31, 1998, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $361,181,000 as capital gain dividends (from net
long-term capital gains) to shareholders during the fiscal year ended December
1998, all of which is designated as a 20% rate gain distribution.
For corporate shareholders, 20.2% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
24
<PAGE> 27
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director/Trustee of The Vanguard
Group, Inc., and each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman of the Board, Chief Executive Officer, and Director/Trustee of The
Vanguard Group, Inc., and each of the investment companies in The Vanguard
Group.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc.,
Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and
Ladies Professional Golf Association; Trustee Emerita of Wellesley College.
JOANN HEFFERNAN HEISEN
Vice President, Chief Information Officer, and a member of the Executive
Committee of Johnson & Johnson; Director of Johnson & JohnsonoMerck Consumer
Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and
Dyslexic, The Medical Center at Princeton, and Women's Research and Education
Institute.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress &
Co., The Jeffrey Co., and Southern New England Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co.,
NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"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. Frank Russell Company
is the owner of trademarks and copyrights relating to the Russell Indexes.
"Wilshire 4500" and "Wilshire 5000" are trademarks of Wilshire Associates.
<PAGE> 28
VANGUARD
MILESTONES
[GRAPHIC]
The Vanguard Group is
named for HMS Vanguard,
Admiral Horatio Nelson's
flagship at the Battle of the Nile
on August 1, 1798. Our founder, John C.
Bogle, chose the name
after reading Nelson's inspiring
tribute to his fleet: "Nothing could
withstand the squadron . . .
with the judgment of the captains,
together with their valour, and that
of the officers and men of every
description, it was absolutely irresistible."
[GRAPHIC]
Walter L. Morgan, founder of
Wellington Fund, the nation's
oldest balanced mutual fund
and forerunner of today's family
of some 100 Vanguard funds,
celebrated his 100th birthday on
July 23, 1998. Mr. Morgan,
a true investment pioneer, died
six weeks later on September 2.
[GRAPHIC]
Wellington Fund,
The Vanguard Group's oldest fund,
was incorporated by Mr. Morgan
70 years ago, on December 28, 1928.
The fund was named after
the Duke of Wellington,
whose forces defeated
Napoleon Bonaparte at the
Battle of Waterloo in 1815.
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
www.vanguard.com
[email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other
expenses and should be read carefully before you invest or send money.
Prospectuses can be obtained directly from The Vanguard Group.
Q270-02/22/1999
(C) 1999 Vanguard Marketing
Corporation, Distributor.
All rights reserved.
