<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 2-88116) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. [X]
POST-EFFECTIVE AMENDMENT NO. 24
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 26
VANGUARD SPECIALIZED PORTFOLIOS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
POST OFFICE BOX 2600, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
On May 22, 1998 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 January 31, 1998 on April 30, 1998.
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<PAGE> 2
VANGUARD SPECIALIZED PORTFOLIOS, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <S> <C>
Item 1. Cover Page........................................... Cover Page
Item 2. Synopsis............................................. Highlights; Fund Expenses
Item 3. Condensed Financial Information...................... Financial Highlights; Fund Expenses
Item 4. General Description of Registrant.................... Investment Objectives; Investment
Policies; Investment Limitations;
General Information
Item 5. Management of the Fund............................... Management of the Fund; Investment
Advisers
Item 5A. Management's Discussion of Fund Performance.......... Herein incorporated by reference to
Registrant's Annual Report to
Shareholders dated January 31, 1998
filed with the Securities & Exchange
Commission's EDGAR system on April 1,
1998
Item 6. Capital Stock and Other Securities................... Opening an Account and Purchasing
Shares; Selling Your Shares; The
Share Price of each Portfolio;
Dividends, Capital Gains and Taxes;
General Information
Item 7. Purchase of Securities Being Offered................. Cover Page; Opening an Account and
Purchasing Shares
Item 8. Redemption or Repurchase............................. Selling Your Shares
Item 9. Pending Legal Proceedings............................ Not Applicable
FORM N-1A
ITEM NUMBER LOCATION IN STATEMENT
OF ADDITIONAL INFORMATION
Item 10. Cover Page........................................... Cover Page
Item 11. Table of Contents.................................... Cover Page
Item 12. General Information and History...................... Investment Objectives and Policies;
General Information
Item 13. Investment Objective and Policies.................... Investment Objectives and Policies;
Investment Limitations
Item 14. Management of the Registrant......................... Management of the Fund
Item 15. Control Persons and Principal Holders of
Securities........................................... Management of the Fund; General
Information
Item 16. Investment Advisory and Other Services............... Management of the Fund; Investment
Advisory Services
Item 17. Brokerage Allocation................................. Not Applicable
Item 18. Capital Stock and Other Securities................... Financial Statements
Item 19. Purchase, Redemption and Pricing of Securities Being
Offered.............................................. Purchase of Shares; Redemption of
Shares
Item 20. Tax Status........................................... Appendix
Item 21. Underwriters......................................... Not Applicable
Item 22. Calculations of Performance Data..................... Yield and Total Return
Item 23. Financial Statements................................. Financial Statements
</TABLE>
<PAGE> 3
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Vanguard Specialized Portfolios Logo A Member of The Vanguard Group
- --------------------------------------------------------------------------------
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PROSPECTUS -- MAY 22, 1998
- --------------------------------------------------------------------------------
NEW ACCOUNT INFORMATION: INVESTOR INFORMATION DEPARTMENT -- 1-800-662-7447
(SHIP)
- --------------------------------------------------------------------------------
SHAREHOLDER ACCOUNT SERVICES: CLIENT SERVICES DEPARTMENT -- 1-800-662-2739
(CREW)
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE
AND POLICIES Vanguard Specialized Portfolios, Inc. (the "Fund") is an
open-end diversified investment company. The Fund consists
of five Portfolios that invest primarily in common stocks
and other equity securities concentrated in a particular
industry or group of related industries. Three Portfolios
of the Fund (Energy, Gold & Precious Metals, and Health
Care) seek to provide long-term capital appreciation. Two
Portfolios (Utilities Income and REIT Index) seek to
provide current income and moderate growth of capital and
income. This Prospectus relates only to the Energy, Gold &
Precious Metals and Health Care Portfolios (the
"Portfolios"). The REIT Index and Utilities Income
Portfolios are described in separate Prospectuses. Given
their specialized focus, the Portfolios should not be
considered a complete investment program. There is no
assurance that the Portfolios will achieve their stated
objectives. Shares of the Fund are neither insured nor
guaranteed by any agency of the U.S. Government, including
the FDIC.
- --------------------------------------------------------------------------------
OPENING AN
ACCOUNT To open a regular (non-retirement) account, please
complete and return the Account Registration Form. If you
need assistance in completing this Form, please call our
Investor Information Department. To open an Individual
Retirement Account (IRA), please use a Vanguard IRA
Adoption Agreement. To obtain a copy of this form, call
1-800-662-7447, Monday through Friday, from 8:00 a.m. to
9:00 p.m. (Eastern time), and Saturday, from 9:00 a.m. to
4:00 p.m. (Eastern time). The minimum initial investment
is $3,000 per Portfolio or $1,000 for Uniform
Gifts/Transfers to Minors Act accounts. The Fund is
offered on a no-load basis (i.e., there are no sales
commissions or 12b-1 fees). However, the Fund incurs
expenses for investment advisory, management,
administrative, and distribution services.
IMPORTANT NOTE:
1% REDEMPTION FEE If shares of the Portfolios are redeemed or exchanged
prior to being held for one year, they will be subject to
a 1% redemption fee. See "Fund Expenses."
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ABOUT THIS
PROSPECTUS This Prospectus is designed to set forth concisely the
information you should know about the Fund before you
invest. It should be retained for future reference. A
"Statement of Additional Information" containing
additional information about the Fund has been filed with
the Securities and Exchange Commission. Such Statement is
dated May 22, 1998, and has been incorporated by reference
into this Prospectus. A copy may be obtained without
charge by writing to the Fund, by calling the Investor
Information Department at 1-800-662-7447, or visiting the
Securities and Exchange Commission's website
(www.sec.gov).
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page Page Page
<S> <C> <C> <C> <C> <C>
Highlights.................... 2 Who Should Invest................ 11 SHAREHOLDER GUIDE
Fund Expenses................. 4 Implementation of Policies....... 12 Opening an Account and
Financial Highlights.......... 5 Investment Limitations........... 14 Purchasing Shares................ 22
Yield and Total Return........ 7 Management of the Fund........... 15 When Your Account Will Be 25
Credited.........................
FUND INFORMATION Investment Advisers.............. 15 Selling Your Shares.............. 26
Investment Objectives......... 7 Dividends, Capital Gains and 18 Exchanging Your Shares........... 28
Taxes............................
Investment Policies........... 7 The Share Price of Each 19 Important Information About
Portfolio........................
Investment Risks.............. 9 General Information.............. 20 Telephone Transactions........... 30
Transferring Registration........ 30
Other Vanguard Services.......... 31
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
<PAGE> 4
HIGHLIGHTS
OBJECTIVE AND
POLICIES The Fund is an open-end diversified investment company.
The Fund consists of five Portfolios that invest primarily
in common stocks and other equity securities concentrated
in a particular industry or group of related industries.
This Prospectus relates only to the Energy, Gold &
Precious Metals, and Health Care Portfolios. These
Portfolios seek to provide long-term capital appreciation.
There is no assurance that any Portfolio will achieve its
stated objective. PAGE 7
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RISK
CHARACTERISTICS Each Portfolio of the Fund is subject to market risk and
industry risk. Market risk is the possibility that stock
prices will decline over short or even extended periods.
The stock market tends to be cyclical, with periods when
stock prices generally rise and periods when stock prices
generally decline. Each Portfolio is expected to be
strongly influenced by these broad fluctuations in stock
prices.
In addition, unlike more widely-diversified mutual funds,
the Portfolios are subject to industry risk, the
possibility that a particular group of related stocks will
decline in price due to industry-specific developments.
Securities held by the Energy Portfolio will be influenced
by cyclical fluctuations in the supply and demand for oil,
as well as tax and regulatory policies, conservation
trends, and international oil politics. The Gold &
Precious Metals Portfolio will be subject to the highly
volatile and often erratic markets for gold and precious
metals and for the common stocks of mining companies.
Investments relating to gold and precious metals or
minerals are considered speculative, and are affected by a
host of world-wide economic, financial and political
factors. Stocks held by the Health Care Portfolio will be
affected by government policies on health care
reimbursements, regulatory approval for new drugs and
medical instruments, and similar matters. PAGE 9
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THE VANGUARD
GROUP The Fund is a member of The Vanguard Group of Investment
Companies, a group of more than 30 investment companies
with more than 95 distinct investment portfolios and total
assets in excess of $370 billion. The Vanguard Group, Inc.
("Vanguard"), a subsidiary jointly owned by the Vanguard
funds, provides on an at-cost basis all corporate
management, administrative, distribution, marketing and
shareholder accounting services to the funds in the
Group. PAGE 15
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INVESTMENT
ADVISERS Wellington Management Company, LLP serves as investment
adviser to the Energy and Health Care Portfolios. M&G
Investment Management Limited serves as investment adviser
to the Gold & Precious Metals Portfolio. PAGE 15
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DIVIDENDS, CAPITAL
GAINS AND TAXES Distributions of net investment income are expected to be
made annually for the Energy, Gold & Precious Metals, and
Health Care Portfolios. Capital gains, if any, will be
distributed annually. Dividend and capital gains
distributions are generally subject to federal, state and
local income taxes. Also, a sale of shares -- whether by
outright redemption or exchange -- is a taxable event and
may result in a capital gain or loss. PAGE 18
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2
<PAGE> 5
PURCHASING
SHARES You may purchase shares by mail, wire, or exchange from
another Vanguard Fund. The minimum initial investment is
$3,000 per Portfolio; the minimum for subsequent
investments is $100. There are no sales commissions or
12b-1 fees. PAGE 22
- --------------------------------------------------------------------------------
SELLING SHARES You may redeem shares of each Portfolio by mail or by
telephone. The Energy, Gold & Precious Metals, and Health
Care Portfolios assess a 1% redemption fee on shares held
less than 12 months. Each Portfolio's share price is
expected to fluctuate, and at the time of redemption may
be more or less than at the time of initial purchase,
resulting in a gain or loss. PAGE 26
- --------------------------------------------------------------------------------
EXCHANGING
SHARES You may exchange a Portfolio's shares for those of another
Portfolio of the Fund or other available Vanguard Funds.
An exchange from the Energy, Gold & Precious Metals, and
Health Care Portfolios will be subject to a 1% redemption
fee on shares held for less than 12 months. PAGE 28
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SPECIAL
CONSIDERATIONS (1) Under normal circumstances, at least 80% of the assets
of each Portfolio will be invested in equity securities
concentrated in a particular industry or group of
industries. As a result, a Portfolio of the Fund may be
subject to greater fluctuations in market value than a
mutual fund which invests in a more widely-diversified
group of stocks. Due to the specialized focus of the
individual Portfolios, an investment in a Portfolio should
not be considered a complete investment program. PAGE 7
(2) The Gold & Precious Metals Portfolio may invest all of
its assets in foreign securities, and each of the other
Portfolios of the Fund may invest a portion of its assets
in foreign securities. Each Portfolio may enter into
forward foreign exchange contracts in order to protect
against uncertainty in the level of future foreign
exchange rates, but not for speculative purposes. PAGE 11
(3) Each Portfolio may lend its securities. PAGE 13
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3
<PAGE> 6
FUND EXPENSES The following table illustrates ALL expenses and fees that
you would incur as a shareholder of the respective
Portfolios. The expenses and fees set forth in the table
are based upon expenses incurred in the fiscal year ended
January 31, 1998.
<TABLE>
<CAPTION>
GOLD & PRECIOUS HEALTH
ENERGY METALS CARE
SHAREHOLDER TRANSACTION EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO
-----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales Load Imposed on Purchases.............. None None None
Sales Load Imposed on Reinvested Dividends... None None None
Redemption Fees*............................. 1% 1% 1%
Exchange Fees**.............................. None None None
*The 1% fee withheld from redemption proceeds of shares held for less than one year is
paid to the Portfolio.
** Exchanges will be treated as redemptions for purposes of imposing the redemption fees.
</TABLE>
<TABLE>
<CAPTION>
GOLD & PRECIOUS HEALTH
ENERGY METALS CARE
ANNUAL OPERATING EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO
-----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Management & Administrative Expenses......... 0.25% 0.34% 0.27%
Investment Advisory Fees..................... 0.08 0.20 0.08
12b-1 Fees................................... None None None
Other Expenses
Distribution Costs......................... 0.02 0.03 0.02
Miscellaneous Expenses..................... 0.03 0.05 0.03
--------- ------------ ----------
Total Other Expenses......................... 0.05% 0.08% 0.05%
--------- ------------ ----------
TOTAL OPERATING EXPENSES................. 0.38% 0.62% 0.40%
========= ============ ==========
</TABLE>
1% REDEMPTION FEE The Energy, Gold & Precious Metals, and Health Care
Portfolios are intended for long-term investors who can
withstand substantial price fluctuation. For this reason,
the Portfolios assess a 1% redemption fee on shares that
are redeemed or exchanged before they have been held for
one year. Solely for purposes of calculating the one-year
holding period, the Portfolio uses the "first-in,
first-out" (FIFO) method. That is, the date of any
redemption or exchange will be compared to the earliest
purchase date. If this holding period is less than one
year, the fee will be assessed. The fee will be prorated
if a portion of the shares being redeemed or exchanged has
been held for more than one year. Shares acquired through
reinvested dividend or capital gain distributions are
exempt from the fee.
The following example illustrates the expenses that you
would incur on a $1,000 investment over various periods,
assuming (1) a 5% annual rate of return and (2) redemption
at the end of each period. The 1% redemption fee is not
included in the expenses because the time periods
illustrated are one year or more.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Energy Portfolio...................... $4 $12 $21 $48
Gold & Precious Metals Portfolio...... $6 $20 $35 $77
Health Care Portfolio................. $4 $13 $22 $51
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR PERFORMANCE. ACTUAL EXPENSES
MAY BE HIGHER OR LOWER THAN THOSE SHOWN.
- --------------------------------------------------------------------------------
4
<PAGE> 7
FINANCIAL
HIGHLIGHTS The following financial highlights for a share outstanding
throughout each period have been derived from financial
statements which were audited by Price Waterhouse LLP,
independent accountants, whose report on the financial
statements which include this information was unqualified.
This information should be read in conjunction with the
Fund's financial statements and notes thereto, which
together with the remaining portions of the Fund's 1998
Annual Report to Shareholders, are incorporated by
reference in the Statement of Additional Information and
in this Prospectus, and which appear, along with the
report of Price Waterhouse LLP, in the Fund's 1998 Annual
Report to Shareholders. For a more complete discussion of
the Fund's performance, please see the Fund's 1998 Annual
Report to Shareholders which may be obtained without
charge by writing to the Fund or by calling our Investor
Information Department at 1-800-662-7447.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
ENERGY PORTFOLIO
-------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
-------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993 1992 1991 1990 1989
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF
YEAR............................... $23.44 $17.19 $13.82 $15.77 $13.82 $12.73 $13.39 $14.94 $12.29 $10.22
----- ------ ------ ------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.............. .32 .25 .27 .23 .31 .34 .42 .45 .38 .36
Net Realized and Unrealized Gain
(Loss) on Investments............ .57 6.64 3.68 (1.65) 3.31 1.29 (.24) (.66) 3.20 2.08
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL FROM INVESTMENT
OPERATIONS..................... .89 6.89 3.95 (1.42) 3.62 1.63 .18 (.21) 3.58 2.44
- ---------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income................ (.32) (.24) (.28) (.24) (.29) (.36) (.42) (.46) (.36) (.37)
Distributions from Realized
Capital Gains.................... (1.33) (.40) (.30) (.29) (1.38) (.18) (.42) (.88) (.57) --
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL DISTRIBUTIONS.............. (1.65) (.64) (.58) (.53) (1.67) (.54) (.84) (1.34) (.93) (.37)
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR........ $22.68 $23.44 $17.19 $13.82 $15.77 $13.82 $12.73 $13.39 $14.94 $12.29
=================================================================================================================================
TOTAL RETURN*....................... 3.80% 40.32% 28.68% (9.15)% 27.31% 13.02% 1.27% (1.64)% 28.98% 24.16%
=================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions)......................... $1,090 $989 $505 $433 $339 $164 $124 $114 $80 $43
Ratio of Total Expenses to Average
Net Assets......................... 0.38% 0.39% 0.51% 0.30% 0.17% 0.21% 0.30% 0.35% 0.38% 0.40%
Ratio of Net Investment Income to
Average Net Assets................. 1.36% 1.36% 1.55% 1.66% 1.87% 2.47% 2.78% 3.24% 3.05% 3.07%
Portfolio Turnover Rate............. 19% 15% 21% 13% 41% 37% 42% 40% 44% 46%
Average Commission Rate Paid........ $.0508 $.0484 N/A N/A N/A N/A N/A N/A N/A N/A
</TABLE>
*Returns exclude 1% fee applied to shares redeemed or exchanged within one
year of purchase.
5
<PAGE> 8
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
GOLD & PRECIOUS METALS PORTFOLIO
--------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993 1992 1991 1990 1989
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF
YEAR.............................. $10.94 $14.07 $10.71 $13.58 $7.29 $9.41 $8.29 $12.49 $9.65 $9.35
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income............. .14 .13 .17 .27 .20 .19 .24 .29 .27 .27
Net Realized and Unrealized Gain
(Loss) on Investments........... (3.42) (2.98) 3.36 (2.83) 6.30 (2.13) 1.13 (4.17) 2.91 .29
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL FROM INVESTMENT
OPERATIONS.................... (3.28) (2.85) 3.53 (2.56) 6.50 (1.94) 1.37 (3.88) 3.18 .56
- ---------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income............... (.13) (.21) (.17) (.31) (.21) (.18) (.25) (.32) (.34) (.26)
Distributions from Realized
Capital Gains................... -- (.07) -- -- -- -- -- -- -- --
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL DISTRIBUTIONS............. (.13) (.28) (.17) (.31) (.21) (.18) (.25) (.32) (.34) (.26)
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR....... $7.53 $10.94 $14.07 $10.71 $13.58 $7.29 $9.41 $8.29 $12.49 $9.65
=================================================================================================================================
TOTAL RETURN*...................... (29.85)% (20.51)% 33.24% (19.20)% 89.24% (20.58)% 16.67% (31.21)% 33.38% 6.14%
=================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions)........................ $327 $463 $648 $531 $613 $175 $178 $144 $223 $126
Ratio of Total Expenses to Average
Net Assets........................ 0.62% 0.50% 0.60% 0.25% 0.26% 0.36% 0.35% 0.42% 0.45% 0.48%
Ratio of Net Investment Income to
Average Net Assets................ 1.41% 1.07% 1.38% 2.04% 2.04% 2.50% 2.54% 2.78% 3.01% 2.67%
Portfolio Turnover Rate............ 26% 19% 5% 4% 14% 2% 3% 10% 17% 18%
Average Commission Rate Paid....... $.0117 $.0085 N/A N/A N/A N/A N/A N/A N/A N/A
*Returns exclude 1% fee applied to shares redeemed or exchanged within one year of purchase.
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
HEALTH CARE PORTFOLIO
-------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
-------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993 1992 1991 1990 1989
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF
YEAR............................... $60.65 $52.09 $37.01 $36.51 $32.66 $35.54 $27.32 $22.16 $19.46 $17.53
-
----- ------ ------ ------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.............. .80 .71 .61 .55 .79 .70 .53 .52 .48 .36
Net Realized and Unrealized Gain
(Loss) on Investments............ 15.49 9.88 16.06 2.83 5.79 (1.68) 8.75 6.03 3.43 3.20
-
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL FROM INVESTMENT
OPERATIONS..................... 16.29 10.59 16.67 3.38 6.58 (.98) 9.28 6.55 3.91 3.56
- ---------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income................ (.78) (.74) (.57) (.57) (.76) (.70) (.53) (.55) (.49) (.34)
Distributions from Realized
Capital Gains.................... (2.14) (1.29) (1.02) (2.31) (1.97) (1.20) (.53) (.84) (.72) (1.29)
-
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL DISTRIBUTIONS.............. (2.92) (2.03) (1.59) (2.88) (2.73) (1.90) (1.06) (1.39) (1.21) (1.63)
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR........ $74.02 $60.65 $52.09 $37.01 $36.51 $32.66 $35.54 $27.32 $22.16 $19.46
=================================================================================================================================
TOTAL RETURN*....................... 27.37% 20.65% 45.47% 9.79% 21.21% (2.92)% 33.97% 30.09% 20.22% 21.43%
=================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions)......................... $4,720 $2,846 $1,654 $771 $638 $562 $553 $189 $76 $58
Ratio of Total Expenses to Average
Net Assets......................... 0.40% 0.38% 0.46% 0.40% 0.19% 0.22% 0.30% 0.36% 0.39% 0.62%
Ratio of Net Investment Income to
Average Net Assets................. 1.28% 1.41% 1.57% 1.58% 2.37% 2.06% 1.98% 2.54% 2.34% 1.85%
Portfolio Turnover Rate............. 10% 7% 13% 25% 19% 15% 7% 17% 28% 19%
Average Commission Rate Paid........ $.0516 $.0504 N/A N/A N/A N/A N/A N/A N/A N/A
*Returns exclude 1% fee applied to shares redeemed or exchanged within one year of purchase.
</TABLE>
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6
<PAGE> 9
YIELD AND
TOTAL RETURN From time to time a Portfolio may advertise its yield and
total return. Both yield and total return figures are
based on historical earnings and are not intended to
indicate future performance. The "total return" of a
Portfolio refers to the average annual compounded rates of
return over one-, five- and ten-year periods or for the
life of the Portfolio (as stated in the advertisement)
that would equate an initial amount invested at the
beginning of a stated period to the ending redeemable
value of the investment, assuming the reinvestment of all
dividend and capital gains distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day
yield" of a Portfolio is calculated by dividing net
investment income per share earned during a 30-day period
by the net asset value per share on the last day of the
period. Net investment income includes interest and
dividend income earned on a Portfolio's securities; it is
net of all expenses and all recurring and nonrecurring
charges that have been applied to all shareholder
accounts. The yield calculation assumes that net
investment income earned over 30 days is compounded
monthly for six months and then annualized. Methods used
to calculate advertised yields are standardized for all
stock and bond mutual funds. However, these methods differ
from the accounting methods used by a Portfolio to
maintain its books and records, and so the advertised
30-day yield may not fully reflect the income paid to an
investor's account or the yield reported in a Portfolio's
financial statements.
Also, the Portfolios may compare their performance to that
of various stock market indices, including the Standard &
Poor's 500 Index.
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVES
THE PORTFOLIOS SEEK
TO PROVIDE LONG-TERM
GROWTH The Fund is an open-end diversified investment company.
The Portfolios invest primarily in common stocks and other
equity securities concentrated in a particular industry or
group of related industries.
The Energy, Gold & Precious Metals, and Health Care
Portfolios seek to provide long-term capital appreciation.
Although these three Portfolios may generate dividend
income to a limited extent, current income will be
secondary to these Portfolios' primary objective of
achieving capital appreciation.
There is no assurance that any Portfolio will achieve its
stated objective.
The investment objective of each Portfolio is fundamental
and so cannot be changed without the approval of a
majority of a Portfolio's shareholders.
- --------------------------------------------------------------------------------
INVESTMENT
POLICIES
EACH PORTFOLIO
CONCENTRATES ITS
INVESTMENTS IN A
PARTICULAR INDUSTRY Under normal circumstances, the Energy, Gold & Precious
Metals, and Health Care Portfolios will each invest at
least 80% of their net assets in the equity securities
(common stocks and securities convertible into common
stocks) of companies in a particular industry or group of
related industries. The Gold & Precious Metals Portfolio
may also invest up to 20% of its assets in gold or other
precious metal bullion and coins. A security will
generally be considered appropriate for a given Portfolio
if, as determined by the investment adviser, at least 50%
of the company's assets, revenues or net income are
related to or derived from the
7
<PAGE> 10
industry or industries designated for the Portfolio. The
Fund is managed without regard to tax ramifications.
The Energy and Health Care Portfolios of the Fund will
invest primarily in securities that trade in U.S. markets.
However, both of these Portfolios may invest up to 30% of
their assets in foreign securities. The Gold & Precious
Metals Portfolio may invest up to 100% of its assets in
foreign securities. In order to protect against
fluctuations in foreign exchange rates, each Portfolio may
invest in forward foreign currency exchange contracts.
Besides investing primarily in equity securities, each
Portfolio may hold certain short-term fixed income
securities as cash reserves. Each Portfolio may also
invest in stock futures contracts and options to a limited
extent. See "Implementation of Policies" for a description
of these and other investment practices of the Fund.
The specific investment policies of the three Portfolios
are listed below:
The ENERGY PORTFOLIO invests in the equity securities of
companies engaged in the following energy-related
activities: the production, transmission, marketing,
control or measurement of energy or energy fuels; the
making of component products for such activities; energy
research or experimentation; and activities related to
energy conservation and pollution control. Such activities
may involve newer sources of energy, such as geothermal,
nuclear and solar power, as well as more traditional
sources of energy, such as oil, natural gas and coal. As
new sources of energy are developed and current methods of
exploiting and developing energy are advanced, then
companies in these new areas will also be considered for
the Energy Portfolio. The Portfolio, however, will not
purchase the securities of electric utility companies,
although it may invest in natural gas distributors and
natural gas pipeline concerns.
The GOLD & PRECIOUS METALS PORTFOLIO invests in the equity
securities of foreign and domestic companies engaged in
the exploration, mining, fabrication, processing, or
marketing and distribution of gold, silver, platinum,
diamonds or other precious and rare metals and minerals.
The Portfolio may also invest up to 20% of its assets
directly in gold, silver or other precious metal bullion
and coins.
Bullion and coins for the Gold & Precious Metals Portfolio
will only be bought from and sold to banks (both U.S. and
foreign), and dealers who are members of, or affiliated
with members of, a regulated U.S. commodities exchange, in
accordance with applicable investment laws. Gold, silver
or other precious metal bullion will not be purchased in
any form that is not readily marketable. Coins will not be
purchased for their numismatic value and will not be
considered for the Portfolio if they cannot be bought or
sold in an active market. Any bullion or coins purchased
by the Portfolio will be delivered to and stored with a
qualified custodian bank in the U.S.
Investors should be aware that bullion and coins do not
generate income, offering only the potential for capital
appreciation or depreciation, and may subject the
Portfolio to higher custody and transactions costs than
those normally associated
8
<PAGE> 11
with the ownership of securities. Investments relating to
gold and other precious metals or minerals are considered
speculative. See "Investment Risks."
The HEALTH CARE PORTFOLIO invests in securities of
companies engaged in the development, production or
distribution of products and services related to the
treatment or prevention of diseases and other medical
infirmities. Companies in these fields include, but are
not limited to, pharmaceutical firms; companies that
design, manufacture or sell medical supplies, equipment
and support services; and companies that operate hospitals
and other health care facilities. The Portfolio will also
consider companies engaged in medical, diagnostic,
biochemical, and biotechnological research and
development.
* * *
The Fund is responsible for voting the shares of all
securities it holds.
The investment policies of the Fund are not fundamental
and so may be changed by the Board of Directors without
shareholder approval. However, shareholders would be
notified prior to a material change in the Fund's
policies.
- --------------------------------------------------------------------------------
INVESTMENT
RISKS
EACH PORTFOLIO IS
SUBJECT TO MARKET AND
INDUSTRY RISK As mutual funds specializing in specific industries or
groups of industries, the Portfolios of the Fund are
subject primarily to two types of risk: market risk and
industry risk. Since the Portfolios may invest in foreign
securities, investors are also exposed to currency risk
and other risks of international investing.
MARKET RISK is the possibility that stock prices in
general will decline over short or even extended periods.
The stock market tends to be cyclical, with periods when
stock prices generally rise and periods when stock prices
generally decline. Stocks have provided annual total
returns (capital appreciation plus dividend income)
averaging +10.9% for all 10-year periods from 1926 to
1997, as measured by the Standard & Poor's 500 Composite
Stock Price Index. In contrast, the return on stocks in
individual years has varied from a low of -43.3% to a high
of +53.9%, reflecting the short-term volatility of stock
prices.
These fluctuations in stock market prices are expected to
have a substantial influence on the value of each
Portfolio. Moreover, the Energy, Gold & Precious Metals,
and Health Care Portfolios are likely to exhibit greater
volatility than the broad stock market, largely as a
result of their industry-specific holdings and, in several
of the Portfolios, an emphasis on the stocks of smaller
companies.
In addition to stock market risk, each Portfolio is
subject to INDUSTRY RISK -- i.e., the possibility that a
particular group of related stocks will decline in price
due to industry-specific developments. The special
industry risks of the Energy Portfolio are that earnings
and dividends of companies in the energy industry are
greatly affected by changes in the prices and supplies of
oil and other energy fuels. Prices and supplies can
fluctuate significantly over a short period due to changes
in international politics, policies of the Organization of
Petroleum Exporting Countries (OPEC), relationships among
OPEC members and between OPEC and oil-importing nations,
energy conser-
9
<PAGE> 12
vation, the regulatory environment, governmental tax
policies, and the economic growth and stability of the
main energy-consuming countries.
The industry risks of the Gold & Precious Metals Portfolio
include the sharp price volatility of gold and other
precious metals and of mining company shares. Investments
related to gold or other precious metals or minerals are
considered speculative and are affected by a host of
worldwide economic, financial and political factors.
Prices of gold and other precious metals may fluctuate
sharply over short periods due to several factors: changes
in inflation or expectations regarding inflation in
various countries; currency fluctuations; metal sales by
governments, central banks or international agencies;
investment speculation; changes in industrial and
commercial demand; and governmental prohibitions or
restrictions on the private ownership of certain precious
metals or minerals.
Political and economic conditions in gold-producing
countries may also have a direct effect on the mining and
distribution of gold and, consequently, its price. At
present, there are only five major producers of gold
bullion. In order of magnitude, they are: South Africa,
the United States, Australia, Canada, and Russia.
Events in South Africa are of particular importance since
the Portfolio intends to invest a substantial portion of
its assets in securities of South African mining companies
(16% of the Portfolio's net assets as of January 31,
1998). In South Africa, the activities of gold-mining
companies are subject to policies promulgated by the
Ministry of Mines. The Reserve Bank of South Africa, as
the sole authorized agent for South African gold,
influences the price and timing of sales of South African
gold. The South African government has also from time to
time imposed restrictions on the flow of international
capital.
Political and social problems in South Africa may also
pose certain risks to the Portfolio's investments in South
African issuers. These include the effect of social and
political unrest on mining production and gold prices, as
well as the threat of nationalization or expropriation by
the government of South Africa.
The special industry risks of the Health Care Portfolio
are that the economic prospects of health care companies
can fluctuate dramatically due to changes in the
regulatory and competitive environment. A substantial
portion of health care services are funded or subsidized
by the government, and so changes in governmental policies
at the federal or state level may affect the demand for
health care products and services. Regulatory approvals,
which often entail lengthy application and testing
procedures, are generally required before new drugs and
certain medical instrumentation may be introduced. Health
care companies may face lawsuits related to product
liability issues. Also, many products and services
provided by health care companies are subject to rapid
obsolescence.
THE PORTFOLIOS
ARE SUBJECT TO
MANAGER RISK The investment advisers for the Portfolios manage each
Portfolio according to the traditional methods of "active"
investment management, which involve the buying and
selling of securities based upon economic, financial and
market analysis and investment judgment. MANAGER RISK
refers to the possibility that each Portfolio's
10
<PAGE> 13
investment adviser may fail to execute the Portfolio's
investment strategy effectively. As a result, each of the
Portfolios may fail to achieve its stated objective.
FOREIGN SECURITIES
ENTAIL CURRENCY AND
OTHER RISKS Since each Portfolio may invest in foreign securities,
investors in the Fund are also exposed to the unique risks
of international investing. For U.S. investors, the
returns of foreign securities are influenced by not only
the returns on foreign common stocks themselves, but also
by CURRENCY RISK -- i.e., changes in the value of the
currencies in which the stocks are denominated. In a
period when the U.S. dollar rises against foreign
currencies, the returns on foreign stocks for a U.S.
investor are diminished. By contrast, in a period when the
U.S. dollar declines, the returns on foreign stocks are
enhanced.
Other risks and considerations of international investing
include the following: differences in accounting, auditing
and financial reporting standards; generally higher
commission rates on foreign portfolio transactions; the
smaller trading volumes and generally lower liquidity of
foreign stock markets, which may result in greater price
volatility; foreign withholding taxes payable on a
Portfolio's foreign securities, which may reduce dividend
income payable to shareholders; the possibility of
expropriation or confiscatory taxation; adverse changes in
investment or exchange control regulations; political
instability which could affect U.S. investment in foreign
countries; difficulty in obtaining and enforcing foreign
court judgements; and potential restrictions on the flow
of international capital.
- --------------------------------------------------------------------------------
WHO SHOULD
INVEST The Fund is designed for investors who are seeking the
potential rewards, and who are willing to accept the risks
associated with equity investments concentrated in
specific industries. Because of the risks associated with
common stock and bond investments, the Fund is intended to
be a long-term investment vehicle and is not designed to
provide investors with a means of speculating on
short-term stock and bond market movements. Investors who
engage in excessive account activity generate additional
costs which are borne by all of the Fund's shareholders.
In order to minimize such costs the Fund has adopted the
following policies. The Fund reserves the right to reject
any purchase request (including exchange purchases from
other Vanguard portfolios) that is reasonably deemed to be
disruptive to efficient portfolio management, either
because of the timing of the investment or previous
excessive trading by the investor. Additionally, the Fund
has adopted exchange privilege limitations as described in
the section "Exchange Privilege Limitations." Finally, the
Fund reserves the right to suspend the offering of its
shares.
The Energy, Gold & Precious Metals, and Health Care
Portfolios are intended for investors with substantial
financial resources who have the perspective and patience
to assume above-average interim investment risks in
pursuit of long-term capital growth. Since many of the
securities owned by these three Portfolios may be
considered speculative in nature by traditional investment
standards, substantially greater-than-average investment
risk is involved. The share prices of these three
Portfolios are expected to be volatile.
There can be no assurance that a Portfolio will achieve
its stated objective. Shareholders will be exposed to the
substantial risks inherent in equity investing.
11
<PAGE> 14
Investors may wish to reduce the potential risk of
investing in a Portfolio by purchasing shares on a
periodic basis (dollar-cost averaging) rather than
investing in one lump sum.
Since each Portfolio concentrates its holdings in a
particular industry or group of industries, the Fund
should not be considered a complete investment program.
Most investors should maintain diversified holdings of
securities with different risk characteristics --
including common stocks, bonds and money market
instruments.
- --------------------------------------------------------------------------------
IMPLEMENTATION
OF POLICIES
EACH PORTFOLIO MAY
HOLD FOREIGN
SECURITIES Each Portfolio follows a number of investment practices in
an effort to achieve its objective of long-term capital
growth.
Each Portfolio may invest up to 30% of its assets, and the
Gold & Precious Metals Portfolio may invest up to 100% of
its assets, in foreign securities. Such a policy expands
the investment opportunities available to the Portfolios
and may result in improved diversification and
performance.
All or a portion of the foreign securities purchased by a
Portfolio may be in the form of American Depository
Receipts (ADRs) or European Depository Receipts (EDRs).
ADRs are receipts typically issued by a U.S. bank or trust
company that evidence ownership of underlying securities
issued by a foreign corporation. EDRs are receipts issued
in Europe that evidence a similar ownership arrangement.
Generally, ADRs are designed for trading in the United
States securities markets and EDRs are designed for
trading in European securities markets.
EACH PORTFOLIO MAY
ENTER INTO FORWARD
CURRENCY CONTRACTS Each Portfolio of the Fund may enter into forward foreign
currency exchange contracts in order to protect against
uncertainty in the level of future foreign exchange rates
in the purchase and sale of investment securities. A
Portfolio may not enter into such contracts for
speculative purposes.
A forward foreign currency exchange contract is an
obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a
price set at the time of the contract. These contracts may
be bought or sold to protect a Portfolio to a limited
extent against adverse changes in exchange rates between
foreign currencies and the U.S. dollar. Such contracts,
which protect the value of a Portfolio's investment
securities against a decline in the value of a currency,
do not eliminate fluctuations in the underlying prices of
the securities. They simply establish an exchange rate at
a future date. Also, although such contracts tend to
minimize the risk of loss due to a decline in the value of
the hedged currency, at the same time they tend to limit
any potential gain that might be realized should the value
of such currency increase.
EACH PORTFOLIO MAY
INVEST IN SHORT-TERM
FIXED INCOME
SECURITIES Although they normally seek to remain substantially fully
invested in equity securities, the Portfolios of the Fund
may invest temporarily in certain short-term fixed income
securities. Such securities may be used to invest
uncommitted cash balances, to maintain liquidity to meet
shareholder redemptions, or to take a temporary defensive
position against potential stock market declines. These
securities include: obligations of the United States
Government and its agencies or
12
<PAGE> 15
instrumentalities; commercial paper, bank certificates of
deposit, and bankers' acceptances; and repurchase
agreements collateralized by these securities.
The use of repurchase agreements involves certain risks,
including the risk of losses caused by the default or
insolvency of the other party to the agreement. However,
each Portfolio expects that it can control this risk
through careful evaluation of the creditworthiness of the
other party to any repurchase agreement and careful
monitoring procedures.
DERIVATIVE INVESTING Derivatives are instruments whose values are linked to or
derived from an underlying security or index. The most
common and conventional types of derivative securities are
futures and options.
THE FUND MAY INVEST
IN DERIVATIVE
SECURITIES The Fund may invest in futures contracts and options, but
only to a limited extent. Specifically, a Portfolio of the
Fund may enter into futures contracts provided that not
more than 5% of its assets are required as a futures
contract deposit; in addition, a Portfolio may enter into
futures contracts and options transactions only to the
extent that obligations under such contracts or
transactions represent not more than 20% of the
Portfolio's assets.
Futures contracts and options may be used for several
common fund management strategies: to maintain cash
reserves while simulating full investment, to facilitate
trading, to reduce transaction costs, or to seek higher
investment returns when a specific futures contract is
priced more attractively than other futures contracts or
the underlying security or index.
The Portfolios may use futures contracts for bona fide
"hedging" purposes. In executing a hedge, a manager sells,
for example, stock index futures to protect against a
decline in the stock market. As such, if the market drops,
the value of the futures position will rise, thereby
offsetting the decline in value of the Portfolio's stock
holdings.
FUTURES CONTRACTS
AND OPTIONS POSE
CERTAIN RISKS The primary risks associated with the use of futures
contracts and options are: (i) imperfect correlation
between the change in market value of the stocks held by a
Portfolio and the prices of futures contracts and options;
and (ii) possible lack of a liquid secondary market for a
futures contract and the resulting inability to close a
futures position prior to its maturity date. The risk of
imperfect correlation will be minimized by investing in
those contracts whose price fluctuations are expected to
resemble those of the Portfolio's underlying securities.
The risk that a Portfolio will be unable to close out a
futures position will be minimized by entering into such
transactions on a national exchange with an active and
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
leveraging involved in futures pricing. As a result, a
relatively small price movement in a futures contract may
result in immediate and substantial loss or gain. However,
a Portfolio will not use futures contracts or options for
speculative purposes.
EACH PORTFOLIO MAY
LEND ITS SECURITIES Each Portfolio may lend its securities on a short-term or
long-term basis to qualified institutional investors for
the purpose of realizing additional income. With any loan
13
<PAGE> 16
of portfolio securities, there is a risk that the
borrowing institution will fail to redeliver the
securities when due. However, loans of securities by a
Portfolio will be collateralized by cash, letters of
credit, or securities issued or guaranteed by the U.S.
Government or its agencies. The collateral will equal at
least 100% of the current market value of the loaned
securities.
EACH PORTFOLIO MAY
BORROW MONEY Each Portfolio may borrow money, subject to the limits set
forth below, for temporary or emergency purposes,
including the meeting of redemption requests which might
otherwise require the untimely disposition of securities.
PORTFOLIO TURNOVER IS
NOT EXPECTED TO EXCEED
100% Although they generally seek to invest for the long term,
the Portfolios of the Fund retain the right to sell
securities irrespective of how long they have been held.
It is anticipated that the annual portfolio turnover of
each Portfolio will not exceed 100%. A turnover rate of
100% would occur, for example, if all the securities of a
Portfolio were replaced within one year.
- --------------------------------------------------------------------------------
INVESTMENT
LIMITATIONS
THE FUND HAS ADOPTED
CERTAIN FUNDAMENTAL
LIMITATIONS Each Portfolio has adopted limitations on some of its
investment policies. Some of these limitations are that a
Portfolio will not:
(a) with respect to 75% of the value of its total assets,
invest more than 5% of its assets in the securities of
any single company or purchase more than 10% of the
voting securities of any issuer (except for securities
issued or guaranteed by the U.S. Government or any of
its agencies or instrumentalities).
(b) borrow money, except from banks (or through reverse
repurchase agreements) for temporary or emergency (not
leveraging) purposes, and then not in an amount
exceeding 15% of the value of the Fund's net assets at
the time the borrowing is made. Whenever borrowing
exceeds 5% of the value of the Fund's net assets, the
Fund will not make any additional investments;
(c) purchase or otherwise acquire any security if, as a
result, more than 15% of its net assets would be
invested in securities that are illiquid; and
(d) make loans except (i) by purchasing bonds, debentures
or similar obligations (including repurchase
agreements) which are either publicly distributed or
customarily purchased by institutional investors, and
(ii) by lending its securities to banks, brokers,
dealers and other financial institutions so long as
such loans are not inconsistent with the Investment
Company Act or the Rules and Regulations or
interpretations of the Commission thereunder and the
aggregate value of all securities loaned does not
exceed 33 1/3% of the market value of the Portfolio's
total assets.
A complete list of the Portfolios' investment limitations
can be found in the Statement of Additional Information.
These limitations are fundamental and may be changed only
by approval of a majority of the Portfolio's shareholders.
- --------------------------------------------------------------------------------
14
<PAGE> 17
MANAGEMENT OF
THE FUND
VANGUARD ADMINISTERS
AND DISTRIBUTES THE
FUND The Fund is a member of The Vanguard Group of Investment
Companies, a family of more than 30 investment companies
with more than 95 distinct investment portfolios and total
assets in excess of $370 billion. Through their
jointly-owned subsidiary, The Vanguard Group, Inc.
("Vanguard"), the Fund and the other funds in the Group
obtain at cost virtually all of their corporate
management, administrative and distribution services.
Vanguard also provides investment advisory services on an
at-cost basis to certain Vanguard funds. As a result of
Vanguard's unique corporate structure, the Vanguard funds
have costs substantially lower than those of most
competing mutual funds. In 1997, the average expense ratio
(annual costs including advisory fees divided by total net
assets) for the Vanguard funds amounted to approximately
.28% compared to an average of 1.24% for the mutual fund
industry (data provided by Lipper Analytical Services).
The Officers of the Fund manage its day-to-day operations
and are responsible to the Fund's Board of Directors. The
Directors set broad policies for the Fund and choose its
Officers. A list of the Directors and Officers of the Fund
and a statement of their present positions and principal
occupations during the past five years can be found in the
Statement of Additional Information.
Vanguard employs a supporting staff of management and
administrative personnel needed to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings and equipment. Each
fund pays its share of Vanguard's net expenses, which are
allocated among the funds under methods approved by the
Board of Directors (Trustees) of each fund. In addition,
each fund bears its own direct expenses, such as legal,
auditing and custodian fees.
Vanguard provides distribution and marketing services to
the funds. The funds are available on a no-load basis
(i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears its share of the Group's
distribution costs.
- --------------------------------------------------------------------------------
INVESTMENT
ADVISERS The Portfolios employ two external investment advisers.
Wellington Management Company, LLP serves as investment
adviser to the Energy and Health Care Portfolios of the
Fund. M&G Investment Management Limited serves as
investment adviser to the Gold & Precious Metals
Portfolio.
WELLINGTON
MANAGEMENT COMPANY,
LLP MANAGES
INVESTMENTS FOR TWO
PORTFOLIOS Under an investment advisory agreement with the Fund,
Wellington Management Company, LLP ("WMC"), 75 State
Street, Boston, MA 02109, manages the investment and
reinvestment of the assets of the Fund's Energy and Health
Care Portfolios and continuously reviews, supervises and
administers each Portfolio's investment program. WMC
discharges its responsibilities subject to the control of
the Officers and Directors of the Fund.
WMC is a professional investment advisory firm which
globally provides services to investment companies,
institutions and individuals. Among the clients of WMC are
more than 14 of the investment companies of The Vanguard
Group. As of January 31, 1998, WMC held discretionary
management authority with respect to more than $177
billion of assets. WMC and its predecessor organizations
have
15
<PAGE> 18
provided investment advisory services to investment
companies since 1928 and to investment counseling clients
since 1960.
Ernst H. von Metzsch, Senior Vice President of WMC, serves
as the portfolio manager of the Energy Portfolio. Mr. von
Metzsch has been an investment professional with WMC since
1973. Edward P. Owens, Senior Vice President of WMC,
serves as portfolio manager of the Health Care Portfolio.
Mr. Owens has been an investment professional with WMC
since 1974. Messrs. von Metzsch and Owens have served as
portfolio managers of the Energy and Health Care
Portfolios, respectively, since the Fund's inception in
May 1984. WMC's portfolio managers are supported by
research and other investment services provided by the
professional staff of WMC.
Under the investment advisory agreement, the two
Portfolios and the Fund's Utilities Income Portfolio,
which is also advised by WMC, are required to pay WMC an
aggregate fee at the end of the fiscal quarter, calculated
by applying the following annual percentage rates to the
average month-end net assets for the quarter of these
three Portfolios:
<TABLE>
<CAPTION>
NET ASSETS RATE
----------------------------------- ------
<S> <C>
First $500 million 0.150%
Next $500 million 0.125%
Next $1 billion 0.100%
Next $1 billion 0.075%
Over $3 billion 0.050%
</TABLE>
In addition, once the advisory fee to WMC is calculated
for the three Portfolios under this schedule, the total
fee will be reduced in order that the advisory fee paid by
the Utilities Income Portfolio does not exceed 0.08%.
The advisory fee is based on the total assets of the three
Portfolios and is allocated, except as noted above, to
each Portfolio based on the net assets of each. For the
fiscal year ended January 31, 1998, the investment
advisory fee represented an effective annual rate of .08
of 1% of average net assets for the Energy and Health Care
Portfolios. These fees were paid pursuant to the terms of
a previous investment advisory agreement, which called for
a higher rate of fees.
M&G INVESTMENT
MANAGEMENT LTD.
MANAGES THE GOLD &
PRECIOUS METALS
PORTFOLIO The Fund has also entered into an investment advisory
agreement with M&G Investment Management Limited ("M&G"),
3 Minster Court, Great Tower Street, London, England EC3R
7XH. Under that investment advisory agreement, M&G manages
the investment and reinvestment of the assets of the
Fund's Gold & Precious Metals Portfolio and continuously
reviews, supervises and administers the Portfolio's
investment program. M&G discharges its responsibilities
subject to the control of the Officers and Directors of
the Fund.
M&G is a wholly-owned subsidiary of the M&G Group Plc and
is authorized to carry on investment business under
English law by the Investment Management Regulatory
Organisation Limited. The M&G Group, an independent group
of companies, began providing investment advisory services
to the public over 50 years ago, when they launched Great
Britain's first unit trust (mutual fund). Today, the
principal
16
<PAGE> 19
operating subsidiaries of the M&G Group manage funds for
over 180 accounts, including individual investors, company
pension plans and charitable foundations. In total, the
M&G Group manages or advises over $28 billion in assets.
Among these assets are two unit trusts that invest in the
securities of gold and precious metals-related companies.
Graham E. French, an Investment Manager of M&G and
assistant portfolio manager of the Gold & Precious Metals
Portfolio since 1991, was named portfolio manager of the
Portfolio in December 1996. Mr. French took over
responsibility for the Portfolio from David J. Hutchins,
who had managed the Portfolio since January, 1987.
Under the investment advisory agreement dated December 1,
1996, the Gold & Precious Metals Portfolio pays M&G a fee
at the end of each fiscal quarter, calculated by applying
the following annual percentage rates to the average
month-end net assets of the Portfolio for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
------------------------------------ -----
<S> <C>
First $100 million 0.30%
Next $150 million 0.20%
Next $250 million 0.15%
Over $500 million 0.10%
</TABLE>
For the fiscal year ended January 31, 1998, the investment
advisory fee paid by the Gold & Precious Metals Portfolio
represented an effective annual rate of .20 of 1% of
average net assets.
The Fund has authorized WMC and M&G to choose brokers or
dealers to handle the purchase and sale of the Fund's
securities, and are directed to get the best available
price and most favorable execution from these brokers with
respect to all transactions. At times, the advisers may
choose brokers who charge higher commissions in the
interests of obtaining better execution of a transaction.
If more than one broker can obtain the best available
price and favorable execution of a transaction, then the
advisers are authorized to choose a broker who, in
addition to executing the transaction, will provide
research services to advisers or the Fund. However,
advisors will not pay higher commissions specifically for
the purpose of obtaining research services. The Fund may
direct the advisers to use a particular broker for certain
transactions in exchange for commission rebates or
research services provided to the Fund.
The Fund's Board of Directors may, without the approval of
shareholders, provide for: (a) the employment of a new
investment adviser pursuant to the terms of a new advisory
agreement, either as a replacement for an existing adviser
or as an additional adviser; (b) a change in the terms of
an advisory agreement; and (c) the continued employment of
an existing adviser on the same advisory contract terms
where a contract has been assigned because of a change in
control of the adviser. Any such change will only be made
upon not less than 30 days' prior written notice to
shareholders of the Fund which shall include substantially
the information concerning the adviser that would have
normally been included in a proxy statement.
- --------------------------------------------------------------------------------
17
<PAGE> 20
DIVIDENDS,
CAPITAL GAINS
AND TAXES
THE THREE PORTFOLIOS
PAY DIVIDENDS
ANNUALLY The Energy, Gold & Precious Metals, and Health Care
Portfolios pay dividends annually. Capital gains
distributions for all Portfolios, if any, are also made
annually.
Dividend and capital gains distributions may be
automatically reinvested or received in cash. See
"Choosing a Distribution Option" for a description of
these distribution methods.
In order to satisfy certain distribution requirements of
the Tax Reform Act of 1986, each Portfolio may declare
year-end dividend and capital gains distributions during
December. Such distributions, if received by shareholders
by January 31, are deemed to have been paid by the
Portfolio and received by shareholders on December 31 of
the prior year.
Each Portfolio of the Fund intends to continue to qualify
for taxation as a "regulated investment company" under the
Internal Revenue Code so that each Portfolio will not be
subject to federal income tax to the extent its income is
distributed to shareholders. Dividends paid by a Portfolio
from net investment income, whether received in cash or
reinvested in additional shares, will be taxable to
shareholders as ordinary income. For corporate investors,
dividends from net investment income will generally
qualify in part for the intercorporate dividends-received
deduction. However, the portion of the dividends so
qualified depends on the aggregate taxable qualifying
dividend income received by the Portfolio from domestic
(U.S.) sources.
Distributions paid by a Portfolio from long-term capital
gains, whether received in cash or reinvested in
additional shares, are taxable as long-term capital gains,
regardless of the length of time you have owned shares in
the Portfolio. Long-term capital gains may be taxed at
different rates depending on how long the Portfolio held
the securities. Capital gains distributions are made when
a Portfolio realizes net capital gains on sales of
portfolio securities during the year. A Portfolio does not
seek to realize any particular amount of capital gains
during a year; rather, realized gains are a by-product of
portfolio management activities. Consequently, capital
gains distributions may be expected to vary considerably
from year to year; there will be no capital gains
distributions in years when a Portfolio realizes net
capital losses.
Note that if you accept capital gains distributions in
cash, instead of reinvesting them in additional shares,
you are in effect reducing the capital at work for you in
a Portfolio. Also, keep in mind that if you purchase
shares in a Portfolio shortly before the record date for a
dividend or capital gains distribution, a portion of your
investment will be returned to you as a taxable
distribution, regardless of whether you are reinvesting
your distributions or receiving them in cash.
The Fund will notify you annually as to the tax status of
dividend and capital gains distributions paid by a
Portfolio.
18
<PAGE> 21
THE GOLD & PRECIOUS
METALS PORTFOLIO MAY
"PASS THROUGH"
FOREIGN TAXES The Gold & Precious Metals Portfolio may elect to "pass
through" to the Portfolio's shareholders the amount of
foreign income taxes paid by the Portfolio. The
Portfolio will make such an election only if it deems it
to be in the best interests of its shareholders.
If this election is made, shareholders of the Gold &
Precious Metals Portfolio will be required to include in
their gross income their pro rata share of foreign taxes
paid by the Portfolio. However, shareholders will be able
to treat their pro rata share of foreign taxes as either
an itemized deduction or a foreign tax credit against U.S.
income taxes on their tax return.
A CAPITAL GAIN OR LOSS
MAY BE REALIZED
UPON EXCHANGE OR
REDEMPTION A sale of shares of a Portfolio of the Fund is a taxable
event and may result in a capital gain or loss. A capital
gain or loss may be realized from an ordinary redemption
of shares or an exchange of shares between two mutual
funds (or two portfolios of a mutual fund).
Dividend distributions, capital gains distributions, and
capital gains or losses from redemptions and exchanges may
be subject to state and local taxes.
The Fund is required to withhold 31% of taxable dividends,
capital gains distributions, and redemptions paid to
shareholders who have not complied with IRS taxpayer
identification regulations. You may avoid this withholding
requirement by certifying on your Account Registration
Form your proper Social Security or employer
identification number and by certifying that you are not
subject to backup withholding.
The Fund has obtained a Certificate of Authority to do
business as a foreign corporation in Pennsylvania and does
business and maintains an office in that state. In the
opinion of counsel, the shares of the Fund are exempt from
Pennsylvania personal property taxes.
The tax discussion set forth above is included for general
information only. Prospective investors should consult
their own tax advisers concerning the tax consequences of
an investment in the Fund.
- --------------------------------------------------------------------------------
THE SHARE PRICE OF
EACH PORTFOLIO Each Portfolio's share price, or "net asset value" per
share, is calculated by dividing the total assets of the
Portfolio, 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 (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.
19
<PAGE> 22
Short term instruments (those acquired 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 Portfolio is valued. If
events which materially affect the value of a Portfolio'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 Directors deems in good faith to reflect fair
value.
In determining the Portfolio'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 Directors.
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
Directors deems in good faith to reflect fair value.
The share price for each Portfolio can be found daily in
the mutual fund listings of most major newspapers under
the heading of Vanguard Funds.
- --------------------------------------------------------------------------------
GENERAL
INFORMATION The Fund is a Maryland corporation. The Articles of
Incorporation permit the Directors to issue 6,000,000,000
shares of common stock, with a $.001 par value. The Board
of Directors has the power to designate one or more
classes ("Portfolios") of shares of common stock and to
classify or reclassify any unissued shares with respect to
such classes. Currently the Fund is offering five classes
of shares.
The shares of each Portfolio are fully paid and
non-assessable; have no preference as to conversion,
exchange, dividends, retirement or other features; and
have no preemptive rights. Such shares have non-cumulative
voting rights, meaning that the holders of more than 50%
of the shares voting for the election of Directors can
elect 100% of the Directors if they so choose.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other
applicable law. An annual meeting will be held to vote on
the removal of a Director or Directors of the Fund if
requested in writing by the holders of not less than 10%
of the outstanding shares of the Fund.
All securities and cash for the Energy and Health Care
Portfolios are held by State Street Bank and Trust
Company, Boston, MA. All securities and cash for the
Gold &
20
<PAGE> 23
Precious Metals Portfolio are held by Chase Manhattan, New
York, NY. CoreStates Bank, N.A., Philadelphia, PA, holds
daily cash balances that are used by the Fund's Portfolios
to invest in repurchase agreements or securities acquired
in these transactions. The Vanguard Group, Inc., Valley
Forge, PA, serves as the Fund's Transfer and Dividend
Disbursing Agent. Price Waterhouse LLP serves as
independent accountants for the Fund and will audit its
financial statements annually. The Fund is not involved in
any material litigation.
- --------------------------------------------------------------------------------
21
<PAGE> 24
SHAREHOLDER GUIDE
OPENING AN
ACCOUNT AND
PURCHASING
SHARES You may open a regular (non-retirement) account, either by
mail or wire. Simply complete and return an Account
Registration Form and any required legal documentations
indicating the amount you wish to invest. Your purchase
must be equal to or greater than the $3,000 minimum
initial investment requirement for each Portfolio ($1,000
for Uniform Gifts/Transfers to Minors Act accounts, $500
minimum for an Education IRA). You must open a new
Individual Retirement Account by mail (IRAs may not be
opened by wire) using a Vanguard IRA Adoption Agreement.
Your purchase must be equal to or greater than the $1,000
minimum initial investment requirement for IRAs, but no
more than $2,000 if you are making a regular IRA
contribution. Rollover contributions are generally limited
to the amount withdrawn within the past 60 days from an
IRA or other qualified Retirement Plan. If you need
assistance with the forms or have any questions about the
Fund, please call our Investor Information Department
(1-800-662-7447). NOTE: For other types of account
registrations (e.g., corporations, associations, other
organizations, trusts, or powers of attorney), please call
us to determine which additional forms you may need.
The Fund's shares are purchased at the next-determined net
asset value after your investment has been received. The
Fund is offered on a no-load basis (i.e., there are no
sales commissions or 12b-1 fees).
PURCHASE
RESTRICTIONS 1) Because of the risks associated with common stock
investments, the Fund is intended to be a long-term
investment vehicle and is not designed to provide
investors with a means of speculating on short-term
stock market movements. Consequently, the Fund reserves
the right to reject any specific purchase (and exchange
purchase) request. The Fund also reserves the right to
suspend the offering of shares for a period of time.
2) Vanguard will not accept third-party checks to purchase
shares of the Fund. Please be sure your purchase check
is made payable to The Vanguard Group.
IMPORTANT NOTE:
1% REDEMPTION FEE Potential investors should note that a 1% redemption fee
is charged by the Energy, Gold & Precious Metals and
Health Care Portfolios. This fee, which is paid to the
Portfolios, applies to redemptions or exchanges from these
Portfolios of shares held for less than 12 months.
ADDITIONAL
INVESTMENTS Subsequent investments to regular accounts may be made by
mail ($100 minimum), wire ($1,000 minimum), exchange from
another Vanguard Fund account ($100 minimum), or Vanguard
Fund Express. Subsequent investments to Individual
Retirement Accounts may be made by mail ($100 minimum) or
exchange from another Vanguard Fund account. In some
instances, contributions may be made by wire or Vanguard
Fund Express. Please call us for more information on these
options.
- --------------------------------------------------------------------------------
22
<PAGE> 25
<TABLE>
<S> <C> <C>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
PURCHASING BY MAIL Please include the amount of Additional investments should
your initial investment and the include the Invest-by-Mail
Complete and sign the name of the Portfolio(s) you remittance form attached to your
enclosed Account have selected on the Fund confirmation statements.
Registration Form registration form, make your Please make your check payable
check payable to The Vanguard to The Vanguard Group-(Portfolio
Group-(Portfolio Number) (see Number) (see below), write your
below), and mail to: account number on your check
and, using the return envelope
THE VANGUARD GROUP provided, mail to the address
P.O. BOX 2600 indicated on the Invest-by-Mail
VALLEY FORGE, PA 19482-2600 Form.
For express or THE VANGUARD GROUP All written requests should be
registered mail, 455 DEVON PARK DRIVE mailed to one of the addresses
send to: WAYNE, PA 19087-1815 indicated for new accounts. Do
not send registered or express
mail to the post office box
address.
Vanguard Specialized Portfolio
Numbers:
Energy Portfolio-51
Health Care Portfolio-52
Gold & Precious Metals
Portfolio-53
- --------------------------------------------------------------------------------
PURCHASING BY WIRE CORESTATES BANK, N.A.
ABA 031000011
Money should be CORESTATES NO. 0101 9897
wired to: ATTN: VANGUARD
VANGUARD SPECIALIZED PORTFOLIOS
BEFORE WIRING PORTFOLIO NAME
ACCOUNT NUMBER
Please contact ACCOUNT REGISTRATION
Client Services
(1-800-662-2739)
To assure proper receipt, please be sure your bank
includes the Portfolio name, the account number Vanguard
has assigned to you and the eight-digit CoreStates number.
If you are opening a new account, please complete the
Account Registration Form and mail it to the "New Account"
address above after completing your wire arrangement.
Note: Federal Funds wire purchase orders will be accepted
only when the Fund and Custodian Bank are open for
business.
- --------------------------------------------------------------------------------
PURCHASING BY
EXCHANGE (from a
Vanguard account) You may open a new account or purchase additional shares
by making an exchange from an existing Vanguard account.
However, the Fund reserves the right to refuse any
exchange purchase request. Call our Client Services
Department (1-800-662-2739). The new account will have the
same registration as the existing account.
- --------------------------------------------------------------------------------
</TABLE>
23
<PAGE> 26
PURCHASING BY
FUND EXPRESS
Special Purchase and
Automatic Investment The Fund Express Special Purchase option lets you move
money from your bank account to your Vanguard account on
an "as needed" basis. Or if you choose the Automatic
Investment option, money will be moved automatically from
your bank account to your Vanguard account on the schedule
(monthly, bimonthly [every other month], quarterly,
semiannually or annually) you select. To establish these
Fund Express options, please provide the appropriate
information on the Account Registration Form. We will send
you a confirmation of your Fund Express service; please
wait three weeks before using the service.
- --------------------------------------------------------------------------------
CHOOSING A
DISTRIBUTION
OPTION
You must select one of four distribution options:
1. AUTOMATIC REINVESTMENT OPTION -- Both dividend and
capital gains distributions will be reinvested in
additional Fund shares. This option will be selected
for you automatically unless you specify one of the
other options.
2. CASH DIVIDEND OPTION -- Your dividends will be paid in
cash and your capital gains will be reinvested in
additional Fund shares.
3. CASH CAPITAL GAIN OPTION -- Your capital gains
distributions will be paid in cash and your dividends
will be reinvested in additional Fund shares.
4. ALL CASH OPTION -- Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client Service
Department (1-800-662-2739).
If a shareholder has chosen to receive dividend and/or
capital gains distributions in cash, and the postal or
other delivery service is unable to deliver checks to the
shareholder's address of record, we will change the
distribution option so that all dividends and other
distributions are automatically reinvested in additional
shares. We will not pay interest on uncashed distribution
checks.
In addition, an option to invest your cash dividend and/or
capital gains distributions in another Vanguard Fund
account is available. Please call our Client Services
Department (1-800-662-2739) for information. You may also
elect Vanguard Dividend Express which allows you to
transfer your cash dividend and/or capital gains
distributions automatically to your bank account. Please
see "Other Vanguard Services" for more information.
- --------------------------------------------------------------------------------
TAX CAUTION
Investors should ask
about the timing of
capital gains and
dividend distributions
before investing Under Federal tax laws, the Fund is required to distribute
net capital gains and dividend income to Fund
shareholders. These distributions are made to all
shareholders who own Fund shares as of the distribution's
record date, regardless of how long the shares have been
owned. Purchasing shares just prior to the record date
could have a significant impact on your tax liability for
the year. For example, if you purchase shares immediately
prior to the record date of a sizable capital gain or
income dividend distribution, you will be assessed taxes
on the amount of the capital gain and/or dividend
distribution later paid even though you owned the Fund
shares for just a short period of time. (Taxes are due on
the distributions even
24
<PAGE> 27
if the dividend or capital gain is reinvested in
additional Fund shares.) While the total value of your
investment will be the same after the distribution -- the
amount of the distribution will offset the drop in the net
asset value of the shares -- you should be aware of the
tax implications the timing of your purchase may have.
Prospective investors should, therefore, inquire about
potential distributions before investing. The Fund's
annual dividend and capital gains distribution normally
occurs in December for the Energy, Gold & Precious Metals,
and Health Care Portfolios. In addition, the Portfolios
may occasionally be required to make supplemental dividend
or capital gains distributions at some other time during
the year. For additional information on distributions and
taxes, see the section titled "Dividends, Capital Gains,
and Taxes."
- --------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ESTABLISHING OPTIONAL
SERVICES The easiest way to establish optional Vanguard services on
your account is to select the options you desire when you
complete your Account Registration Form.
IF YOU WISH TO ADD SHAREHOLDER OPTIONS LATER, YOU MAY NEED
TO PROVIDE VANGUARD WITH ADDITIONAL INFORMATION AND A
SIGNATURE GUARANTEE. PLEASE CALL OUR CLIENT SERVICES
DEPARTMENT (1-800-662-2739) FOR FURTHER ASSISTANCE.
SIGNATURE
GUARANTEES For our mutual protection, we may require a signature
guarantee on certain written transaction requests. A
signature guarantee verifies the authenticity of your
signature and may be obtained from banks, brokers and any
other guarantor that Vanguard deems acceptable. A
SIGNATURE GUARANTEE CANNOT BE PROVIDED BY A NOTARY PUBLIC.
CERTIFICATES Share certificates will be issued upon request. If a
certificate is lost, you may incur an expense to replace
it.
BROKER/DEALER
PURCHASES If you purchase shares in Vanguard Funds through a
registered broker/dealer or investment adviser, the
broker/dealer or adviser may charge a service fee.
CANCELLING TRADES The Fund will not cancel any trade (e.g., a purchase,
exchange or redemption) believed to be authentic, once the
trade request has been received in writing or by
telephone.
ELECTRONIC
PROSPECTUS
DELIVERY You may receive a prospectus for the Fund or any of the
Vanguard Funds in an electronic format through Vanguard's
website at www.vanguard.com. For additional information
please see "Other Vanguard Services -- Computer Access."
- --------------------------------------------------------------------------------
WHEN YOUR
ACCOUNT WILL BE
CREDITED Your trade date is the date on which your account is
credited. If your purchase is made by check, Federal Funds
wire or exchange, and is received by the close of trading
on the New York Stock Exchange (the "Exchange"), generally
4:00 p.m. Eastern time, your trade date is the day of
receipt. If your purchase is received after the close of
the Exchange, your trade date is the next business day.
Your shares are purchased at the net asset value
determined on your trade date.
In order to prevent lengthy processing delays caused by
the clearing of foreign checks, Vanguard will only accept
a foreign check which has been drawn in U.S. dollars and
has been issued by a foreign bank with a U.S.
correspondent bank.
25
<PAGE> 28
The name of the U.S. correspondent bank must be printed on
the face of the foreign check.
- --------------------------------------------------------------------------------
SELLING YOUR
SHARES You may withdraw any portion of the funds in your account
by redeeming shares at any time. (Please see "Important
Redemption Information.") You generally may initiate a
request by writing or by telephoning. Your redemption
proceeds are normally mailed within two business days
after the receipt of the request in Good Order. No
interest will accrue on amounts represented by uncashed
redemption checks.
IMPORTANT NOTE: For investors in the Energy, Gold &
Precious Metals, and Health Care Portfolios, a redemption
fee amounting to 1% of the value of the shares redeemed
will be deducted from the redemption proceeds of any
shares held for less than one year. This fee is paid
directly to the Portfolio.
- --------------------------------------------------------------------------------
SELLING BY MAIL Requests should be mailed to THE VANGUARD GROUP, VANGUARD
SPECIALIZED PORTFOLIOS, P.O. BOX 1120, VALLEY FORGE, PA
19482-1120. (For express or registered mail, send your
request to The Vanguard Group, Vanguard Specialized
Portfolios, 455 Devon Park Drive, Wayne, PA 19087-1815.)
The redemption price of shares will be the Portfolio's net
asset value next determined after Vanguard has received
all required documents in Good Order.
- --------------------------------------------------------------------------------
DEFINITION OF
GOOD ORDER GOOD ORDER means that the request includes the following:
1. The account number and Portfolio name.
2. The amount of the transaction (specified in dollars or
shares).
3. The signatures of all owners EXACTLY as they are
registered on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that may be
required, in the case of estates, corporations, trusts,
and certain other accounts.
6. Any certificates you are holding for the account.
IF YOU HAVE QUESTIONS ABOUT THIS DEFINITION AS IT PERTAINS
TO YOUR REQUEST, PLEASE CALL OUR CLIENT SERVICES
DEPARTMENT AT 1-800-662-2739.
- --------------------------------------------------------------------------------
SELLING BY
TELEPHONE To sell shares by telephone, you or your pre-authorized
representative may call our Client Services Department at
1-800-662-2739. The proceeds will be sent to you by mail.
PLEASE NOTE: As a protection against fraud, your telephone
mail redemption privilege will be suspended for 15
calendar days following any expedited address change to
your account. An expedited address change is one that is
made by telephone or in writing, without the signatures of
all account owners. Please see "Important Information
About Telephone Transactions."
- --------------------------------------------------------------------------------
SELLING BY FUND
EXPRESS
Automatic Withdrawal
& Special Redemption If you select the Fund Express Automatic Withdrawal
option, money will be automatically moved from your
Vanguard Fund account to your bank account according to
the schedule you have selected. The Special Redemption
option lets you move money from your Vanguard account to
your bank account on an "as needed"
26
<PAGE> 29
basis. To establish these Fund Express options, please
provide the appropriate information on the Account
Registration Form. We will send you a confirmation of your
Fund Express service; please wait two weeks before using
the service.
- --------------------------------------------------------------------------------
SELLING BY EXCHANGE You may sell shares by making an exchange into another
Vanguard Fund account. Please see "Exchanging Your Shares"
for details.
- --------------------------------------------------------------------------------
IMPORTANT REDEMPTION
INFORMATION Shares purchased by check or Fund Express may be redeemed
at any time. However, your redemption proceeds will not be
paid until payment for the purchase is collected, which
may take up to ten calendar days.
- --------------------------------------------------------------------------------
DELIVERY OF
REDEMPTION
PROCEEDS Redemption requests received by telephone prior to the
close of trading on the Exchange are processed on the day
of receipt and the redemption proceeds are normally sent
on the following business day.
Redemption requests received by telephone after the close
of the Exchange are processed on the business day
following receipt and the proceeds are normally sent on
the second business day following receipt.
Redemption proceeds must be sent to you within seven days
of receipt of your request in Good Order, except as
described above in "Important Redemption Information."
If you experience difficulty in making a telephone
redemption during periods of drastic economic or market
changes, your redemption request may be made by regular or
express mail. It will be implemented at the net asset
value next determined after your request has been received
by Vanguard in Good Order. The Fund reserves the right to
revise or terminate the telephone redemption privilege at
any time.
The Fund may suspend the redemption right or postpone
payment at times when the New York Stock Exchange is
closed or under any emergency circumstances as determined
by the United States Securities and Exchange Commission.
If the Board of Directors determines that it would be
detrimental to the best interests of the Fund's remaining
shareholders to make payment in cash, the Fund may pay
redemption proceeds in whole or in part by a distribution
in kind of readily marketable securities.
- --------------------------------------------------------------------------------
VANGUARD'S AVERAGE
COST STATEMENT If you make a redemption from a qualifying account,
Vanguard will send you an Average Cost Statement which
provides you with the tax basis of the shares you
redeemed. Please see "Statements and Reports" for
additional information.
- --------------------------------------------------------------------------------
LOW BALANCE FEE
AND MINIMUM
ACCOUNT BALANCE
REQUIREMENT Due to the relatively high cost of maintaining smaller
accounts, the Fund will automatically deduct a $10 annual
fee in either June or December from non-retirement
accounts with balances falling below $2,500 ($500 for
Uniform Gifts/Transfers to Minors Act accounts). The fee
generally will be waived for investors whose aggregate
Vanguard assets exceed $50,000.
27
<PAGE> 30
In addition, the Fund reserves the right to liquidate any
non-retirement account that is below the minimum initial
investment amount of $3,000. If at any time your total
investment does not have a value of at least $3,000, you
may be notified that your account is below the Fund's
minimum account balance requirement. You would then be
allowed 60 days to make an additional investment before
the account is liquidated. Proceeds would be promptly paid
to the registered shareholder.
Vanguard will not liquidate your account if it has fallen
below $3,000 solely as a result of declining markets
(i.e., a decline in a Portfolio's net asset value).
- --------------------------------------------------------------------------------
EXCHANGING YOUR
SHARES Should your investment goals change, you may exchange your
shares of Vanguard Specialized Portfolios for those of
other available Vanguard Funds.
IMPORTANT NOTE: For investors in the Energy, Gold &
Precious Metals and Health Care Portfolios, a redemption
fee amounting to 1% of the value of the shares exchanged
will be deducted from the exchange proceeds if shares held
for less than one year are exchanged. This fee is paid
directly to the Portfolio.
EXCHANGING BY
TELEPHONE
Call Client Services
(1-800-662-2739) When exchanging shares by telephone, please have ready the
Portfolio name, account number, Social Security number or
employer identification number listed on the account and
exact name and address in which the account is registered.
Only the registered shareholder or his or her
pre-authorized representative may complete such an
exchange. Requests for telephone exchanges received prior
to the close of trading on the Exchange are processed at
the close of business that same day. Requests received
after the close of the Exchange are processed the next
business day. TELEPHONE EXCHANGES FOR NON-RETIREMENT
INVESTMENTS ARE NOT ACCEPTED INTO OR FROM VANGUARD INDEX
TRUST, VANGUARD BALANCED INDEX FUND, VANGUARD
INTERNATIONAL EQUITY INDEX FUND, VANGUARD REIT INDEX
PORTFOLIO, VANGUARD TOTAL INTERNATIONAL PORTFOLIO, and
VANGUARD GROWTH AND INCOME PORTFOLIO (formerly known as
Vanguard Quantitative Portfolios). If you experience
difficulty in making a telephone exchange, your exchange
request may be made by regular or express mail, and it
will be implemented at the closing net asset value on the
date received by Vanguard, provided the request is
received in Good Order.
EXCHANGING BY MAIL Please be sure to include on your exchange request the
name and account number of your current Portfolio, the
name of the Fund you wish to exchange into, the amount you
wish to exchange, and the signatures of all registered
account holders. Send your request to THE VANGUARD GROUP,
VANGUARD SPECIALIZED PORTFOLIOS, P.O. BOX 1120, VALLEY
FORGE, PA 19482-1120. (For express or registered mail,
send your request to The Vanguard Group, Vanguard
Specialized Portfolios, 455 Devon Park Drive, Wayne, PA
19087-1815.)
EXCHANGING ONLINE You may use your personal computer to exchange shares of
most Vanguard funds by accessing our website
(www.vanguard.com). To establish this service on your
account, you must first register through the website. We
will then send to you by mail, an account access password
that will enable you to make online exchanges.
The Vanguard funds that you cannot purchase or sell
through online exchange are VANGUARD INDEX TRUST, VANGUARD
BALANCED INDEX FUND, VANGUARD INTERNATIONAL
28
<PAGE> 31
EQUITY INDEX FUND, VANGUARD REIT INDEX PORTFOLIO, VANGUARD
TOTAL INTERNATIONAL PORTFOLIO, and VANGUARD GROWTH AND
INCOME PORTFOLIO (formerly known as Vanguard Quantitative
Portfolios). These funds do permit online exchanges within
IRAs and other retirement accounts.
- --------------------------------------------------------------------------------
IMPORTANT EXCHANGE
INFORMATION Before you make an exchange, you should consider the
following:
- Please read the Fund's prospectus before making an
exchange. For a copy and for answers to any questions
you may have, call our Investor Information Department
(1-800-662-7447).
- An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on
the transaction.
- Exchanges by telephone are accepted only if the
registrations and the taxpayer identification numbers of
the two accounts are identical.
- To exchange into an account with a different
registration (including a different name, address, or
taxpayer identification number), you must provide
Vanguard with written instructions that include the
guaranteed signatures of all current account owners.
- The shares to be exchanged must be on deposit and not
held in certificate form.
- New accounts are not currently accepted in
Vanguard/Windsor Fund or Vanguard/PRIMECAP Fund.
- The redemption price of shares redeemed by exchange is
the net asset value next determined after Vanguard has
received the required documentation in Good Order.
- When opening a new account by exchange, you must meet
the minimum investment requirement of the new Fund.
Every effort will be made to maintain the exchange
privilege. However, the Fund reserves the right to revise
or terminate its provisions, limit the amount of, or
reject any exchange, as deemed necessary, at any time.
The Fund's exchange privilege is only available in states
in which the shares of the Fund are registered for sale.
The Fund's shares are currently registered for sale in all
50 states and the Fund intends to maintain such
registration.
- --------------------------------------------------------------------------------
EXCHANGE
PRIVILEGE
LIMITATIONS The Fund's exchange privilege is not intended to afford
shareholders a way to speculate on short-term movements in
the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive
exchange activity.
Exchange activity generally will not be deemed excessive
if limited to TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (at
least 30 days apart) from a Portfolio of the Fund during
any twelve-month period. "Substantive" means either a
dollar amount or a series of movements between Vanguard
funds that Vanguard determines, in its
29
<PAGE> 32
sole discretion, could have an adverse impact on the
management of the Fund. Notwithstanding these limitations,
the Fund reserves the right to reject any purchase request
(including exchange purchases from other Vanguard
Portfolios) that is reasonably deemed to be disruptive to
efficient portfolio management.
- --------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ABOUT TELEPHONE
TRANSACTIONS The ability to initiate redemptions (except wire or Fund
Express redemptions) and exchanges by telephone is
automatically established on your account unless you
request in writing that telephone transactions on your
account not be permitted.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions,
Vanguard adheres to the following security procedures:
1. SECURITY CHECK. To request a transaction by telephone,
the caller must know (i) the name of the Portfolio;
(ii) the 10-digit account number; (iii) the exact name
and address used in the registration; and (iv) the
Social Security or employer identification number
listed on the account.
2. PAYMENT POLICY. The proceeds of any telephone
redemption by mail will be made payable to the
registered shareowner and mailed to the address of
record only.
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by
telephone, provided that reasonable security procedures
have been followed. Vanguard believes that the security
procedures described above are reasonable, and that if
such procedures are followed, you will bear the risk of
any losses resulting from unauthorized or fraudulent
telephone transactions on your account.
- --------------------------------------------------------------------------------
TRANSFERRING
REGISTRATION You may transfer the registration of any of your Fund
shares to another person by completing a transfer form and
sending it to: THE VANGUARD GROUP, ATTENTION: TRANSFER
DEPARTMENT, P.O. BOX 1110, VALLEY FORGE, PA 19482-1110.
The request must be in Good Order. TO REQUEST A TRANSFER
FORM AND FULL INSTRUCTIONS PLEASE CALL OUR CLIENT SERVICES
DEPARTMENT (1- 800-662-2739).
- --------------------------------------------------------------------------------
STATEMENTS AND
REPORTS Vanguard will send you a confirmation statement each time
you initiate a transaction in your account except for
checkwriting redemptions from Vanguard money market
accounts. You will also receive a comprehensive account
statement at the end of each calendar quarter. The
fourth-quarter statement will be a year-end statement,
listing all transaction activity for the entire calendar
year.
Vanguard's Average Cost Statement provides you with the
average cost of shares redeemed from your account during
the calendar year using the average cost single category
method. This service is available for most taxable
accounts opened since January 1, 1986. In general,
investors who redeemed shares from a qualifying Vanguard
account may expect to receive their Average Cost Statement
along with their Portfolio Summary Statement. Please call
our Client Services Department (1-800-662-2739) for
information.
Financial reports on the Fund will be mailed to you
semi-annually, according to the Fund's fiscal year-end. To
keep the Fund's costs as low as possible (so that you and
30
<PAGE> 33
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 Investor Information
Department at 1-800-662-7447.
- --------------------------------------------------------------------------------
OTHER VANGUARD
SERVICES For more information about any of these services, please
call our Investor Information Department at
1-800-662-7447.
VANGUARD DIRECT
DEPOSIT SERVICE With Vanguard's Direct Deposit Service, most U.S.
Government checks (including Social Security and military
pension checks) and private payroll checks may be
automatically deposited into your Vanguard Fund account.
Separate brochures and forms are available for direct
deposit of U.S. Government and private payroll checks.
VANGUARD AUTOMATIC
EXCHANGE SERVICE Vanguard's Automatic Exchange Service allows you to move
money automatically among your Vanguard Fund accounts. For
instance, the service can be used to "dollar cost average"
from a money market portfolio into a stock or bond fund or
to contribute to an IRA or other retirement plan. Please
contact our Client Services Department at 1-800-662-2739
for additional information.
VANGUARD FUND
EXPRESS Vanguard's Fund Express allows you to transfer money
between your Fund account and your account at a bank,
savings and loan association, or a credit union that is a
member of the Automated Clearing House (ACH) system. You
may elect this service on the Account Registration Form or
call our Investor Information Department (1-800-662-7447)
for a Fund Express application.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition,
some services of Fund Express cannot be used with specific
Vanguard Funds. For more information, please refer to the
Vanguard Fund Express brochure.
VANGUARD DIVIDEND
EXPRESS Vanguard's Dividend Express allows you to transfer your
dividend and/or capital gains distributions automatically
from your Fund account, one business day after the Fund's
payable date, to your account at a bank, savings and loan
association, or a credit union that is a member of the
Automated Clearing House (ACH) system. You may elect this
service on the Account Registration Form or call our
Investor Information Department (1-800-662-7447) for a
Vanguard Dividend Express application.
VANGUARD
TELE-ACCOUNT(R) Vanguard's Tele-Account is a convenient, automated service
that provides share price, price change and yield
quotations on Vanguard Funds through any TouchTone(TM)
telephone. This service also lets you obtain information
about your account balance, your last transaction, and
your most recent dividend or capital gains payment. In
addition, you may perform investment exchanges of Vanguard
Fund shares and redemptions by check using Tele-Account.
To contact Vanguard's Tele-Account service, dial
1-800-ON-BOARD (1-800-662-6273). A brochure offering
detailed operating instructions is available from our
Investor Information Department (1-800-662-7447).
31
<PAGE> 34
COMPUTER ACCESS
VANGUARD ONLINE
www.vanguard.com Use your personal computer to learn more about Vanguard's
funds and services; keep in touch with your Vanguard
accounts; map out a long-term investment strategy;
initiate certain transactions; and ask questions, make
suggestions, and send messages to Vanguard.
Our education-oriented website provides timely news and
information about Vanguard's 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.
- --------------------------------------------------------------------------------
32
<PAGE> 35
[This page intentionally left blank.]
<PAGE> 36
[Vanguard Specialized Portfolio Logo]
-----------------------------------------------
THE VANGUARD GROUP
P.O. Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT:
1-800-662-7447 (SHIP)
CLIENT SERVICES
DEPARTMENT:
1-800-662-2739 (CREW)
TELE-ACCOUNT FOR
24-HOUR ACCESS:
1-800-662-6273 (ON BOARD)
TELECOMMUNICATION SERVICE
FOR THE HEARING IMPAIRED:
1-800-662-2738
TRANSFER AGENT:
The Vanguard Group, Inc.
P.O. Box 2600
Valley Forge, PA 19482
[Flag Logo]
[Flag Logo]
P R O S P E C T U S
MAY 22, 1998
[Vanguard Group Logo]
P051
- --------------------------------------------------------------------------------
<PAGE> 37
================================================================================
[Vanguard Specialized Portfolios - Utilities Income Portfolio]
A Member of The Vanguard Group
================================================================================
PROSPECTUS -- MAY 22, 1998
- --------------------------------------------------------------------------------
NEW ACCOUNT INFORMATION: INVESTOR INFORMATION DEPARTMENT -- 1-800-662-7447
(SHIP)
- --------------------------------------------------------------------------------
SHAREHOLDER ACCOUNT SERVICES: CLIENT SERVICES DEPARTMENT -- 1-800-662-2739
(CREW)
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE
AND POLICIES Vanguard Specialized Portfolios, Inc. (the "Fund") is an
open-end diversified investment company which consists of
five Portfolios. This prospectus relates only to the
Utilities Income Portfolio (the "Portfolio"). The
objective of the Portfolio is to provide current income
and moderate growth of capital and income. The Portfolio
invests primarily in common stocks and bonds of utilities
companies. Given its specialized focus, the Portfolio
should not be considered a complete investment program.
There is no assurance that the Portfolio will achieve its
stated objective. Shares of the Fund are neither insured
nor guaranteed by any agency of the U.S. Government,
including the FDIC.
- --------------------------------------------------------------------------------
OPENING AN
ACCOUNT To open a regular (non-retirement) account, please
complete and return the Account Registration Form. If you
need assistance in completing this Form, please call our
Investor Information Department. To open an Individual
Retirement Account (IRA), please use a Vanguard IRA
Adoption Agreement. To obtain a copy of this form, call
1-800-662-7447 Monday through Friday, from 8:00 a.m. to
9:00 p.m. (Eastern time), and Saturday, from 9:00 a.m. to
4:00 p.m. (Eastern time). The minimum initial investment
is $3,000 or $1,000 for Uniform Gifts/Transfers to Minors
Act accounts. The Portfolio is offered on a no-load basis
(i.e., there are no sales commissions or 12b-1 fees).
However, the Portfolio incurs expenses for investment
advisory, management, administrative and distribution
services.
- --------------------------------------------------------------------------------
ABOUT THIS
PROSPECTUS This Prospectus is designed to set forth concisely the
information you should know about the Portfolio before you
invest. It should be retained for future reference. A
"Statement of Additional Information" containing
additional information about the Portfolio has been filed
with the Securities and Exchange Commission. Such
Statement is dated May 22, 1998, and has been incorporated
by reference into this Prospectus. A copy may be obtained
without charge by writing to the Portfolio, calling the
Investor Information Department at 1-800-662-7447, or
visiting the Securities and Exchange Commission's website
(www.sec.gov).
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page Page Page
<S> <C> <C> <C> <C> <C>
Portfolio Expenses............ 2 Who Should Invest................ 7 SHAREHOLDER GUIDE
Financial Highlights.......... 2 Implementation of Policies....... 7 Opening an Account and
Yield and Total Return........ 3 Investment Limitations........... 10 Purchasing Shares................ 16
FUND INFORMATION Management of the Portfolio...... 11 When Your Account Will Be 19
Credited.........................
Investment Objective.......... 4 Investment Adviser............... 11 Selling Your Shares.............. 19
Investment Policies........... 4 Dividends, Capital Gains and 13 Exchanging Your Shares........... 21
Taxes............................
Investment Risks.............. 4 The Share Price of the 14 Important Information About
Portfolio........................
General Information.............. 15 Telephone Transactions........... 23
Transferring Registration........ 24
Other Vanguard Services.......... 24
</TABLE>
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
<PAGE> 38
PORTFOLIO
EXPENSES The following table illustrates ALL expenses and fees that
you would incur as a shareholder of the Portfolio. The
expenses and fees set forth below are based upon expenses
incurred in the fiscal year ended January 31, 1998.
<TABLE>
<S> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
-----------------------------------------------------------------------------
Sales Load Imposed on Purchases............................. None
Sales Load Imposed on Reinvested Dividends.................. None
Redemption Fees............................................. None
Exchange Fees............................................... None
ANNUAL OPERATING EXPENSES
-----------------------------------------------------------------------------
Management & Administrative Expenses........................ 0.32%
Investment Advisory Fees.................................... 0.08%
12b-1 Fees.................................................. None
Other Expenses
Distribution Costs........................................ 0.02%
Miscellaneous Expenses.................................... 0.02%
----
Total Other Expenses........................................ 0.04%
-----
TOTAL OPERATING EXPENSES........................... 0.44%
=====
The purpose of this table is to assist you in understanding
the various costs and expenses that you would bear directly
or indirectly as an investor in the Portfolio.
The following example illustrates the expenses that you
would incur on a $1,000 investment over various periods,
assuming (1) a 5% annual rate of return and (2) redemption
at the end of each period.
</TABLE>
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------- ------- ------- --------
<S> <C> <C> <C>
$5 $14 $25 $55
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A
REPRESENTATION OF PAST OR FUTURE EXPENSES OR
PERFORMANCE. ACTUAL EXPENSES MAY BE HIGHER OR
LOWER THAN THOSE SHOWN.
- --------------------------------------------------------------------------------
FINANCIAL
HIGHLIGHTS The following financial highlights for a share outstanding
throughout each period, have been derived from financial
statements which were audited by Price Waterhouse LLP,
independent accountants, whose report on the financial
statements which include this information was unqualified.
This information should be read in conjunction with the
Fund's financial statements and notes thereto, which,
together with the remaining portions of the Fund's 1998
Annual Report to Shareholders, are incorporated by
reference in the Statement of Additional Information and
in this Prospectus, and which appear, along with the
report of Price Waterhouse LLP, in the Fund's 1998 Annual
Report to Shareholders. For a more complete discussion of
the Fund's performance, please see the Fund's 1998 Annual
Report to Shareholders which may be obtained without
charge by writing to the Fund or by calling our Investor
Information Department at 1-800-662-7447.
2
<PAGE> 39
<TABLE>
<CAPTION>
------------------------------------------------------------------
UTILITIES INCOME PORTFOLIO
------------------------------------------------------------------
YEAR ENDED JANUARY 31, MAY 15, 1992+, TO
1998 1997 1996 1995 1994 JAN. 31, 1993
<S> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD..... $12.93 $12.84 $10.42 $11.67 $11.18 $10.00
------ ------- ------- ------- ------- ------------
INVESTMENT OPERATIONS
Net Investment Income.................. .58 .58 .56 .56 .57 .41
Net Realized and Unrealized Gain (Loss)
on Investments....................... 2.32 .09 2.42 (1.10) .88 1.03
------ ------ ------ ------ ------ -----------
TOTAL FROM INVESTMENT OPERATIONS..... 2.90 .67 2.98 (.54) 1.45 1.44
- -------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income... (.60) (.56) (.56) (.59) (.56) (.24)
Distributions from Realized Capital
Gains................................ (.26) (.02) -- (.12) (.40) (.02)
------ ------ ------ ------ ------ -----------
TOTAL DISTRIBUTIONS.................. (.86) (.58) (.56) (.71) (.96) (.26)
- -------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD........... $14.97 $12.93 $12.84 $10.42 $11.67 $11.18
=============================================================================================================
TOTAL RETURN............................. 23.17% 5.51% 29.47% (4.47)% 13.08% 14.51%
=============================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)..... $699 $644 $781 $593 $738 $361
Ratio of Total Expenses to Average Net
Assets................................. 0.44% 0.40% 0.44% 0.50% 0.42% 0.45%*
Ratio of Net Investment Income to Average
Net Assets............................. 4.30% 4.63% 4.88% 5.43% 4.82% 4.70%*
Portfolio Turnover Rate.................. 41% 38% 35% 35% 46% 20%
Average Commission Rate Paid............. $.0583 $.0568 N/A N/A N/A N/A
* Annualized
+ Commencement of operations.
</TABLE>
- --------------------------------------------------------------------------------
YIELD AND TOTAL
RETURN From time to time the Portfolio may advertise its yield
and total return. Both yield and total return figures are
based on historical earnings and are not intended to
indicate future performance. The "total return" of the
Portfolio refers to the average annual compounded rates of
return over one-, five- and ten-year periods or for the
life of the Portfolio (as stated in the advertisement)
that would equate an initial amount invested at the
beginning of a stated period to the ending redeemable
value of the investment, assuming the reinvestment of all
dividend and capital gains distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day
yield" of the Portfolio is calculated by dividing net
investment income per share earned during a 30-day period
by the net asset value per share on the last day of the
period. Net investment income includes interest and
dividend income earned on the Portfolio's securities; it
is net of all expenses and all recurring and nonrecurring
charges that have been applied to all shareholder
accounts. The yield calculation assumes that net
investment income earned over 30 days is compounded
monthly for six months and then annualized. Methods used
to calculate advertised yields are standardized for all
stock and bond mutual funds. However, these methods differ
from the accounting methods used by the Portfolio to
maintain its books and records, and so the advertised
30-day yield may not fully reflect the income paid to an
investor's account or the yield reported in the
Portfolio's financial statements.
3
<PAGE> 40
Also, the Portfolio may compare its performance to that of
various stock market indices, including the Standard &
Poor's 500 Index and the Standard & Poor's Utility Index.
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE
THE PORTFOLIO SEEKS
CURRENT INCOME The primary objective of the Portfolio is to provide
current income. Its secondary objective is to provide
moderate growth of capital and income. There can be no
assurance that the Portfolio will achieve its stated
objective. The Portfolio is one of five Portfolios of
Vanguard Specialized Portfolios, Inc. (the "Fund").
The investment objective of the Portfolio is fundamental
and so cannot be changed without the approval of a
majority of the Portfolio's shareholders.
- --------------------------------------------------------------------------------
INVESTMENT
POLICIES
THE PORTFOLIO INVESTS
IN UTILITY STOCKS AND
BONDS Under normal circumstances, the Portfolio will invest at
least 75% of its assets in equity securities of companies
in the utilities industries. The remainder of the
Portfolio's assets will be invested in utility bonds rated
BBB or better by Standard & Poor's Corporation or Baa or
better by Moody's Investors Service, Inc. The Portfolio
may also invest in bonds issued by multi-national
entities, foreign governments, their agencies and
instrumentalities and companies domiciled outside the
United States; however, these securities must be valued in
U.S. dollars and be rated A or better. Because of its
emphasis on higher-yielding utility stocks and its
holdings of utility bonds, the Portfolio is expected to
offer a dividend yield well above the stock market
average. The Portfolio is managed without regard to tax
ramifications.
FOREIGN SECURITIES The Portfolio will invest primarily in securities that
trade in U.S. markets. The Portfolio may invest up to 30%
of its equity assets in foreign securities. In order to
protect against fluctuations in foreign exchange rates,
the Portfolio may invest in forward foreign currency
exchange contracts.
Besides investing primarily in equity securities, the
Portfolio may hold certain short-term fixed income
securities as cash reserves. The Portfolio may also invest
in stock futures contracts and options to a limited
extent. See "Implementation of Policies" for a description
of these and other investment practices of the Fund.
The Portfolio is responsible for voting the shares of all
securities it holds.
The investment policies of the Portfolio are not
fundamental and so may be changed by the Board of
Directors without shareholder approval. However,
shareholders would be notified prior to a material change
in the Portfolio's policies.
- --------------------------------------------------------------------------------
INVESTMENT RISKS As a mutual fund specializing in utility stocks and bonds,
the Portfolio is subject primarily to four types of risk:
stock market risk, interest rate risk, industry risk, and
manager risk. Since the Portfolio may invest in foreign
securities, investors are also exposed to currency risk
and other risks of international investing.
MARKET RISK MAY BE
SUBSTANTIAL MARKET RISK is the possibility that stock prices in
general will decline over short or even extended periods.
The stock market tends to be cyclical, with periods when
stock prices generally rise and periods when stock prices
generally decline. Stocks have provided annual total
returns (capital appreciation plus dividend income)
averaging +10.9% for all 10-year periods from 1926 to
1997, as measured by the
4
<PAGE> 41
Standard & Poor's 500 Composite Stock Price Index. In
contrast, the return on stocks in individual years has
varied from a low of -43.3% to a high of +53.9%,
reflecting the short-term volatility of stock prices.
However, the Portfolio is expected to exhibit somewhat
less volatility than the stock market as a whole.
Historically, utility stocks have been one of the least
volatile sectors of the stock market (when measured by
such statistics as standard deviation of returns or
industry "beta"). Moreover, the Portfolio's investment in
utility bonds is expected to further dampen the stock
market's influence on the Portfolio.
INTEREST RATE RISK MAY
BE SUBSTANTIAL In addition to stock market risk, utility stocks and bonds
are also subject to INTEREST RATE RISK -- price
fluctuations due to changing market interest rates. In
general, fixed income investments, such as bonds, vary
inversely with interest rates, falling in price when
interest rates rise, and rising in price when interest
rates fall. Utility stocks, more so than other stock
market sectors, are often influenced by these trends in
interest rates, rather than price movements in the stock
market. At the same time, the Portfolio's bond holdings
are subject to interest rate risk. This combination of
interest rate-sensitive stocks and bonds means that the
Portfolio may at times move in tandem with the bond
market, rising and falling as interest rates change,
independent of the stock market.
INVESTORS ARE EXPOSED
TO INDUSTRY RISK In addition to stock market and interest rate risk, the
Portfolio is subject to INDUSTRY RISK -- i.e., the
possibility that a particular group of related stocks will
decline in price due to industry-specific developments.
Changing regulation constitutes one of the key
industry-specific risks for the Portfolio. Regulators
(largely at the state level) monitor and control utility
revenues and costs, and therefore may limit utility
profits and dividends paid to investors. Regulatory
authorities may also restrict a company's access to new
markets, thereby diminishing the firm's long-term
prospects. Individual sectors of the utility market are
subject to the following additional risks:
- Electric utilities may be burdened by unexpected
increases in fuel and other operating costs. They are
also adversely affected when long-term interest rates
rise. Long-term borrowings are used to finance most
utility investment, and rising interest rates lead to
higher financing costs and reduced earnings. There are
also the considerable costs associated with
environmental compliance, nuclear waste clean-up, and
safety regulation. Increasingly, electric utilities are
being called upon by regulators to bear these added
costs, and there is a risk that these costs will not be
fully recovered through an increase in revenues.
- Telephone utilities have been affected by technological
development leading to increased competition, as well as
changing regulation of long-distance telephone service
and other telecommunications businesses. While certain
companies have benefitted from the new competitive
climate, others have not, and increased competition in
the future may hinder the growth of more
traditionally-oriented telephone companies.
5
<PAGE> 42
- Among gas transmission and distribution companies, there
has been a move to diversify into oil and gas
exploration and development, making investment returns
more sensitive to energy prices. In the case of the
water utility sector, the industry is highly fragmented,
and most water supply companies find themselves in
mature markets, with little potential for growth.
THE PORTFOLIO IS
SUBJECT TO MANAGER
RISK In addition to the risks described above, the Portfolio is
subject to MANAGER RISK. The investment adviser manages
the Portfolio according to the traditional methods of
"active" investment management, which involve the buying
and selling of securities based upon economic, financial
and market analysis and investment judgment. Manager risk
refers to the possibility that the Portfolio's investment
adviser may fail to execute the Portfolio's investment
strategy effectively. As a result, the Portfolio may fail
to achieve its stated objective.
FOREIGN SECURITIES
ENTAIL CURRENCY AND
OTHER RISKS Since the Portfolio may invest in foreign securities,
investors are also exposed to the unique risks of
international investing. For U.S. investors, the returns
of foreign securities are influenced by not only the
returns on foreign common stocks themselves, but also by
CURRENCY RISK -- i.e., changes in the value of the
currencies in which the stocks are denominated. In a
period when the U.S. dollar rises against foreign
currencies, the returns on foreign stocks for a U.S.
investor are diminished. By contrast, in a period when the
U.S. dollar declines, the returns on foreign stocks are
enhanced.
Other risks and considerations of international investing
include the following: differences in accounting, auditing
and financial reporting standards; generally higher
commission rates on foreign portfolio transactions; the
smaller trading volumes and generally lower liquidity of
foreign stock markets, which may result in greater price
volatility; foreign withholding taxes payable on a
Portfolio's foreign securities, which may reduce dividend
income payable to shareholders; the possibility of
expropriation or confiscatory taxation; adverse changes in
investment or exchange control regulations; political
instability which could affect U.S. investment in foreign
countries; difficulty in obtaining and enforcing foreign
court judgments; and potential restrictions on the flow of
international capital.
YIELDS AND
RETURNS RELATIVE
TO THE BROAD STOCK
MARKET WILL VARY Investors in the Portfolio should be aware that while
utility stocks have historically provided above-average
dividend yields, there is no guarantee that they will
continue to do so in the future. For example, as of
January 31, 1998, the Standard & Poor's Utility Index,
which includes electric, gas and water utilities, provided
a current yield of 4.6%, and the Standard & Poor's
Telephone Index, which is comprised of telephone
utilities, provided a current yield of 3.0%. In contrast,
the broad stock market (as measured by the Standard &
Poor's 500 Index) yielded 1.6%. Many of the risks
enumerated above have made it increasingly difficult for
utility companies to sustain such generous dividend
pay-outs, and future dividend yields of the utility sector
could decline.
Similarly, while utilities stocks may outperform the broad
stock market for certain periods, investors should not
anticipate long-term outperformance by utilities
securities because of their generally limited growth
prospects.
- --------------------------------------------------------------------------------
6
<PAGE> 43
WHO SHOULD
INVEST
INVESTORS SEEKING AN
INCOME-ORIENTED STOCK
INVESTMENT The Utilities Income Portfolio is designed for investors
who are seeking a more conservative, income-oriented stock
market investment. The Portfolio is likely to offer higher
dividend yields than the stock market average, with
substantially lower volatility in share price. The
Portfolio may also offer modest growth in income and
capital over time. Nonetheless, because utility stock and
bond prices will fluctuate, sometimes substantially,
investors should be willing to accept moderate to high
fluctuations in principal value. Because of the risks
associated with common stock and bond investments, the
Portfolio is intended to be a long-term investment vehicle
and is not designed to provide investors with a means of
speculating on short-term common stock and bond market
movements. Investors who engage in excessive account
activity generate additional costs which are borne by all
of the Portfolio shareholders. In order to minimize such
costs the Portfolio has adopted the following policies.
The Portfolio reserves the right to reject any purchase
request (including exchange purchases from other Vanguard
portfolios) that is reasonably deemed to be disruptive to
efficient portfolio management, either because of the
timing of the investment or previous excessive trading by
the investor. Additionally, the Portfolio has adopted
exchange privilege limitations as described in the section
"Exchange Privilege Limitations." Finally, the Portfolio
reserves the right to suspend the offering of its shares.
There can be no assurance that the Portfolio will achieve
its stated objective. Shareholders will be exposed to the
substantial risks inherent in equity investing. Investors
may wish to reduce the potential risk of investing in the
Portfolio by purchasing shares on a periodic basis
(dollar-cost averaging) rather than investing in one lump
sum.
Since the Portfolio concentrates its holdings in equity
securities of companies in the utilities industry, the
Portfolio should not be considered a complete investment
program. Most investors should maintain diversified
holdings of securities with different risk
characteristics -- including common stocks, bonds and
money market instruments.
- --------------------------------------------------------------------------------
IMPLEMENTATION OF
POLICIES The Portfolio follows a number of investment practices in
an effort to achieve its objective of long-term capital
growth.
THE PORTFOLIO INVESTS
IN A RANGE OF UTILITY
STOCKS AND BONDS The Portfolio invests in equity and debt securities of
companies engaged in the generation, transmission, or
distribution of electricity, telecommunications, gas, or
water. Such investments will be selected on the basis of
fundamental analysis to identify those securities that the
adviser believes will provide both current income and the
potential for growth in income and capital over time.
The Portfolio's primary investments will be drawn from two
sectors of the stock market: utilities and telephones.
(Prior to mid-1996, these sectors were combined within the
utility sector of the Standard & Poor's 500 Composite
Stock Index.) The market for utility bonds is dominated by
telephone and electric utility issuers. For example, as of
January 31, 1998, telephone company bonds represented 44%
of the outstanding utility bonds rated Baa or better
(measured in terms of market value by the Lehman Brothers
Investment Grade Utility Bond Index). Electric utility
issues
7
<PAGE> 44
accounted for 28% of Baa-or-better utility bonds, while
gas, water and other utilities represented the remaining
28%.
Historically, utilities have been subject to strict
regulatory oversight. However, in recent years, changes in
the regulatory climate have allowed utilities to provide
products and services outside their traditional geographic
areas, leading to increased competition and expanded
prospects for growth. The Portfolio seeks to take
advantage of favorable opportunities that are expected to
arise from these structural changes in regulation.
THE PORTFOLIO MAY
HOLD FOREIGN
SECURITIES The Portfolio may invest up to 30% of its equity assets in
foreign securities. Such a policy expands the investment
opportunities available to the Portfolio and may result in
improved diversification and performance.
All or a portion of the foreign securities purchased by
the Portfolio may be in the form of American Depository
Receipts (ADRs) or European Depository Receipts (EDRs).
ADRs are receipts typically issued by a U.S. bank or trust
company that evidence ownership of underlying securities
issued by a foreign corporation. EDRs are receipts issued
in Europe that evidence a similar ownership arrangement.
Generally, ADRs are designed for trading in the United
States securities markets and EDRs are designed for
trading in European securities markets.
THE PORTFOLIO MAY
ENTER INTO FORWARD
CURRENCY CONTRACTS The Portfolio may enter into forward foreign currency
exchange contracts in order to protect against uncertainty
in the level of future foreign exchange rates in the
purchase and sale of investment securities. The Portfolio
may not enter into such contracts for speculative
purposes.
A forward foreign currency exchange contract is an
obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a
price set at the time of the contract. These contracts
may be bought or sold to protect the Portfolio to a
limited extent against adverse changes in exchange rates
between foreign currencies and the U.S. dollar. Such
contracts, which protect the value of the Portfolio's
investment securities against a decline in the value of a
currency, do not eliminate fluctuations in the underlying
prices of the securities. They simply establish an
exchange rate at a future date. Also, although such
contracts tend to minimize the risk of loss due to a
decline in the value of the hedged currency, at the same
time they tend to limit any potential gain that might be
realized should the value of such currency increase.
THE PORTFOLIO MAY
INVEST IN SHORT-TERM
FIXED INCOME
SECURITIES The Portfolio may invest temporarily in certain short-term
fixed income securities. Such securities may be used to
invest uncommitted cash balances, to maintain liquidity to
meet shareholder redemptions, or to take a temporary
defensive position against potential stock market
declines. These securities include: obligations of the
United States Government and its agencies or
instrumentalities; commercial paper, bank certificates of
deposit, and bankers' acceptances; and repurchase
agreements collateralized by these securities.
8
<PAGE> 45
The use of repurchase agreements involves certain risks,
including the risk of losses caused by the default or
insolvency of the other party to the agreement. However,
the Portfolio expects that it can control this risk
through careful evaluation of the creditworthiness of the
other party to any repurchase agreement and careful
monitoring procedures.
DERIVATIVE INVESTING Derivatives are instruments whose values are linked to or
derived from an underlying security or index. The most
common and conventional types of derivative securities are
futures and options.
THE FUND MAY INVEST
IN DERIVATIVE
SECURITIES The Fund may invest in futures contracts and options, but
only to a limited extent. Specifically, a Portfolio of the
Fund may enter into futures contracts provided that not
more than 5% of its assets are required as a futures
contract deposit; in addition, a Portfolio may enter into
futures contracts and options transactions only to the
extent that obligations under such contracts or
transactions represent not more than 20% of the
Portfolio's assets.
Futures contracts and options may be used for several
common fund management strategies: to maintain cash
reserves while simulating full investment, to facilitate
trading, to reduce transaction costs, or to seek higher
investment returns when a specific futures contract is
priced more attractively than other futures contracts or
the underlying security or index.
The Portfolio may use futures contracts for bona fide
"hedging" purposes. In executing a hedge, a manager sells,
for example, stock index futures to protect against a
decline in the stock market. As such, if the market drops,
the value of the futures position will rise, thereby
offsetting the decline in value of the Portfolio's stock
holdings.
FUTURES CONTRACTS
AND OPTIONS POSE
CERTAIN RISKS The primary risks associated with the use of futures
contracts and options are: (i) imperfect correlation
between the change in market value of the stocks held by a
Portfolio and the prices of futures contracts and options;
and (ii) possible lack of a liquid secondary market for a
futures contract and the resulting inability to close a
futures position prior to its maturity date. The risk of
imperfect correlation will be minimized by investing in
those contracts whose price fluctuations are expected to
resemble those of the Portfolio's underlying securities.
The risk that the Portfolio will be unable to close out a
futures position will be minimized by entering into such
transactions on a national exchange with an active and
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
leveraging involved in futures pricing. As a result, a
relatively small price movement in a futures contract may
result in immediate and substantial loss or gain. However,
the Portfolio will not use futures contracts or options
for speculative purposes.
THE PORTFOLIO MAY
LEND ITS SECURITIES The Portfolio may lend its investment securities on a
short-term or long-term basis to qualified institutional
investors for the purpose of realizing additional income.
With any loan of portfolio securities, there is a risk
that the borrowing institution will fail to redeliver the
securities when due. However, loans of securities by the
9
<PAGE> 46
Portfolio will be collateralized by cash, letters of
credit, or securities issued or guaranteed by the U.S.
Government or its agencies. The collateral will equal at
least 100% of the current market value of the loaned
securities.
THE PORTFOLIO MAY
BORROW MONEY The Portfolio may borrow money, subject to the limits set
forth below, for temporary or emergency purposes,
including the meeting of redemption requests which might
otherwise require the untimely disposition of securities.
PORTFOLIO TURNOVER IS
NOT EXPECTED TO
EXCEED 100% Although it generally seeks to invest for the long term,
the Portfolio retains the right to sell securities
irrespective of how long they have been held. It is
anticipated that the annual portfolio turnover of the
Portfolio will not exceed 100%. A turnover rate of 100%
would occur, for example, if all of the securities held by
the Portfolio were replaced within one year.
- --------------------------------------------------------------------------------
INVESTMENT
LIMITATIONS
THE FUND HAS ADOPTED
CERTAIN FUNDAMENTAL
LIMITATIONS The Portfolio has adopted limitations on some of its
investment policies. Some of these limitations are that
the Portfolio will not:
(a) with respect to 75% of the value of its total assets,
invest more than 5% of its assets in the securities of
any single company or purchase more than 10% of the
voting securities of any issuer (except for securities
issued or guaranteed by the U.S. Government or any of
its agencies or instrumentalities);
(b) borrow money, except from banks (or through reverse
repurchase agreements) for temporary or emergency (not
leveraging) purposes, and then not in an amount
exceeding 15% of the value of the Portfolio's net
assets at the time the borrowing is made. Whenever
borrowing exceeds 5% of the value of the Portfolio's
net assets, the Portfolio will not make any additional
investments;
(c) engage in the business of underwriting securities
issued by other persons, except to the extent that the
Portfolio may technically be deemed to be an
underwriter under the Securities Act of 1933, as
amended, in disposing of investment securities;
(d) purchase or otherwise acquire any security if, as a
result, more than 15% of its net assets would be
invested in securities that are illiquid; and
(e) make loans except (i) by purchasing bonds, debentures
or similar obligations (including repurchase
agreements) which are either publicly distributed or
customarily purchased by institutional investors, and
(ii) by lending its securities to banks, brokers,
dealers and other financial institutions so long as
such loans are not inconsistent with the Investment
Company Act or the Rules and Regulations or
interpretations of the Commission thereunder and the
aggregate value of all securities loaned does not
exceed 33 1/3% of the market value of the Portfolio's
total assets.
A complete list of the Portfolio's investment limitations
can be found in the Statement of Additional Information.
These limitations are fundamental and may be changed only
by approval of a majority of the Portfolio's shareholders.
- --------------------------------------------------------------------------------
10
<PAGE> 47
MANAGEMENT OF
THE PORTFOLIO
VANGUARD ADMINISTERS
AND DISTRIBUTES THE
PORTFOLIO The Portfolio is one of five Portfolios of Vanguard
Specialized Portfolios, Inc. (the "Fund"), a member of The
Vanguard Group of Investment Companies, a family of more
than 30 investment companies with more than 95 distinct
investment portfolios and total assets in excess of $370
billion. Through their jointly-owned subsidiary, The
Vanguard Group, Inc. ("Vanguard"), the Fund and the other
funds in the Group obtain at cost virtually all of their
corporate management, administrative and distribution
services. Vanguard also provides investment advisory
services on an at-cost basis to certain Vanguard funds. As
a result of Vanguard's unique corporate structure, the
Vanguard funds have costs substantially lower than those
of most competing mutual funds. In 1997, the average
expense ratio (annual costs including advisory fees
divided by total net assets) for the Vanguard funds
amounted to approximately .28% compared to an average of
1.24% for the mutual fund industry (data provided by
Lipper Analytical Services).
The Officers of the Fund manage the day-to-day operations
of the Fund and are responsible to the Fund's Board of
Directors. The Directors set broad policies for the
Portfolio and choose its Officers. A list of the Directors
and Officers of the Fund and a statement of their present
positions and principal occupations during the past five
years can be found in the Statement of Additional
Information.
Vanguard employs a supporting staff of management and
administrative personnel needed to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings and equipment. Each
fund pays its share of Vanguard's net expenses, which are
allocated among the funds under methods approved by the
Board of Directors (Trustees) of each fund. In addition,
each fund bears its own direct expenses, such as legal,
auditing and custodian fees.
Vanguard provides distribution and marketing services to
the funds. The funds are available on a no-load basis
(i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears its share of the Group's
distribution costs.
- --------------------------------------------------------------------------------
INVESTMENT
ADVISER
WELLINGTON
MANAGEMENT
COMPANY, LLP
MANAGES INVESTMENTS
FOR THE PORTFOLIO Under an investment advisory agreement with the Fund,
Wellington Management Company, LLP ("WMC"), 75 State
Street, Boston, MA 02109, manages the investment and
reinvestment of the assets of the Utilities Income
Portfolio, and continuously reviews, supervises and
administers the Portfolio's investment program. WMC
discharges its responsibilities subject to the control of
the Officers and Directors of the Fund.
WMC is a professional investment advisory firm which
globally provides services to investment companies,
institutions and individuals. Among the clients of WMC are
more than 14 of the investment companies of The Vanguard
Group. As of January 31, 1998, WMC held discretionary
management authority with respect to more than $177
billion of assets. WMC and its predecessor organizations
have provided advisory services to investment companies
since 1928 and to investment counseling clients since
1960.
Mark J. Beckwith, Vice President of WMC, is portfolio
manager of the Utilities Income Portfolio. Mr. Beckwith,
who has served on the Portfolio's investment team
11
<PAGE> 48
since 1995, has more than ten years investment experience.
Prior to joining WMC in 1995, Mr. Beckwith was an electric
utility analyst and assistant portfolio manager at Silcap
Inc./Taylor & Co. since 1989. Mr. Beckwith is assisted by
Earl E. McEvoy, Senior Vice President of WMC, who manages
the Portfolio's fixed income investments. Mr. McEvoy has
served as portfolio manager of the Utilities Income
Portfolio since April 1997, and has been an investment
professional with WMC since 1979. WMC's portfolio managers
are supported by research and other investment services
provided by the professional staff of WMC.
Under the Fund's investment advisory agreement, the fee
paid to WMC is based on the total assets of the Utilities
Income Portfolio and the total assets of two other
Portfolios of Vanguard Specialized Portfolios, Inc.
managed by WMC (the Energy and Health Care Portfolios).
The three Portfolios are required to pay WMC an aggregate
fee at the end of the fiscal quarter, calculated by
applying the following annual percentage rates to the
average month-end net assets for the quarter of the three
Portfolios:
<TABLE>
<CAPTION>
NET ASSETS RATE
<S> <C>
------------------- ------
First $500 million 0.150%
Next $500 million 0.125%
Next $1 billion 0.100%
Next $1 billion 0.075%
Over $3 billion 0.050%
</TABLE>
In addition, once the advisory fee to WMC is calculated
for the three Portfolios under this schedule, the total
fee will be reduced in order that the advisory fee paid by
the Utilities Income Portfolio does not exceed 0.08%.
The advisory fee is based on the total assets for the
three Portfolios and is allocated, except as noted above,
to each Portfolio based on the net assets of each. For
the fiscal year ended January 31, 1998, the investment
advisory fee represented an effective annual rate of .08
of 1% of average net assets for the Utilities Income
Portfolio.
The Fund has authorized WMC to choose brokers or dealers
to handle the purchase and sale of the Fund's securities,
and is directed to get the best available price and most
favorable execution from these brokers with respect to all
transactions. At times, WMC may choose brokers who charge
higher commissions in the interests of obtaining better
execution of a transaction. If more than one broker can
obtain the best available price and favorable execution of
a transaction, then WMC is authorized to choose a broker
who, in addition to executing the transaction, will
provide research services to WMC or the Fund. However, WMC
will not pay higher commissions specifically for the
purpose of obtaining research services. The Fund may
direct WMC to use a particular broker for certain
transactions in exchange for commission rebates or
research services provided to the Fund.
The Portfolio's Board of Directors may, without the
approval of shareholders, provide for: (a) the employment
of a new investment adviser pursuant to the terms of a new
12
<PAGE> 49
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; and (c) the
continued employment of an existing adviser on the same
advisory contract terms where a contract has been assigned
because of a change in control of the adviser. Any such
change will only be made upon not less than 30 days' prior
written notice to shareholders of the Portfolio which
shall include substantially the information concerning the
adviser that would have normally been included in a proxy
statement.
- --------------------------------------------------------------------------------
DIVIDENDS,
CAPITAL GAINS
AND TAXES
THE UTILITIES INCOME
PORTFOLIO PAYS
QUARTERLY DIVIDENDS The Utilities Income Portfolio pays dividends consisting
of ordinary income on a quarterly basis. Capital gains
distributions, if any, are made annually.
Dividend and capital gains distributions may be
automatically reinvested or received in cash. See
"Choosing a Distribution Option" for a description of
these distribution methods.
In order to satisfy certain distribution requirements of
the Tax Reform Act of 1986, the Portfolio may declare
year-end dividend and capital gains distributions during
December. Such distributions, if received by shareholders
by January 31, are deemed to have been paid by the
Portfolio and received by shareholders on December 31 of
the prior year.
The Portfolio intends to continue to qualify for taxation
as a "regulated investment company" under the Internal
Revenue Code so that the Portfolio will not be subject to
federal income tax to the extent its income is distributed
to shareholders. Dividends paid by the Portfolio from net
investment income, whether received in cash or reinvested
in additional shares, will be taxable to shareholders as
ordinary income. For corporate investors, dividends from
net investment income will generally qualify in part for
the intercorporate dividends-received deduction. However,
the portion of the dividends so qualified depends on the
aggregate taxable qualifying dividend income received by
the Portfolio from domestic (U.S.) sources.
Distributions paid by the Portfolio from long-term capital
gains, whether received in cash or reinvested in
additional shares, are taxable as long-term capital gains,
regardless of the length of time you have owned shares in
the Portfolio. Long-term capital gains may be taxed at
different rates depending on how long the Portfolio held
the securities. Capital gains distributions are made when
the Portfolio realizes net capital gains on sales of
portfolio securities during the year. The Portfolio does
not seek to realize any particular amount of capital gains
during a year; rather, realized gains are a by-product of
portfolio management activities. Consequently, capital
gains distributions may be expected to vary considerably
from year to year; there will be no capital gains
distributions in years when the Portfolio realizes net
capital losses.
Note that if you accept capital gains distributions in
cash, instead of reinvesting them in additional shares,
you are in effect reducing the capital at work for you in
the Portfolio. Also, keep in mind that if you purchase
shares in a Portfolio shortly before the record date for a
dividend or capital gains distribution, a portion of your
13
<PAGE> 50
investment will be returned to you as a taxable
distribution, regardless of whether you are reinvesting
your distributions or receiving them in cash.
The Portfolio will notify you annually as to the tax
status of dividend and capital gains distributions paid by
the Portfolio.
A CAPITAL GAIN OR
LOSS MAY BE REALIZED
UPON EXCHANGE OR
REDEMPTION A sale of shares of the Portfolio is a taxable event and
may result in a capital gain or loss. A capital gain or
loss may be realized from an ordinary redemption of shares
or an exchange of shares between two mutual funds (or two
portfolios of a mutual fund).
Dividend distributions, capital gains distributions, and
capital gains or losses from redemptions and exchanges may
be subject to state and local taxes.
The Fund is required to withhold 31% of taxable dividends,
capital gains distributions, and redemptions paid to
shareholders who have not complied with IRS taxpayer
identification regulations. You may avoid this withholding
requirement by certifying on your Account Registration
Form your proper Social Security or employer
identification number and by certifying that you are not
subject to backup withholding.
The Portfolio has obtained a Certificate of Authority to
do business as a foreign corporation in Pennsylvania and
does business and maintains an office in that state. In
the opinion of counsel, the shares of the Portfolio are
exempt from Pennsylvania personal property taxes.
The tax discussion set forth above is included for general
information only. Prospective investors should consult
their own tax advisers concerning the tax consequences of
an investment in the Fund.
- --------------------------------------------------------------------------------
THE SHARE PRICE
OF THE PORTFOLIO The Portfolio's share price, or "net asset value" per
share, is calculated by dividing the total assets of the
Portfolio, 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 (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. Any
foreign securities are valued at the latest quoted sales
price available before the time when assets are valued.
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 acquired 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.
14
<PAGE> 51
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.
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
Directors deems in good faith to reflect fair value.
The Portfolio's share price can be found daily in the
mutual fund listings of most major newspapers under the
heading of Vanguard Funds.
- --------------------------------------------------------------------------------
GENERAL
INFORMATION The Portfolio is one of five Portfolios of Vanguard
Specialized Portfolios, Inc. (the "Fund"). The Fund is a
Maryland corporation. The Articles of Incorporation permit
the Directors to issue 6,000,000,000 shares of common
stock, with a $.001 par value. The Board of Directors has
the power to designate one or more classes ("Portfolios")
of shares of common stock and to classify or reclassify
any unissued shares with respect to such classes.
Currently the Fund is offering five classes of shares.
The shares of each Portfolio are fully paid and
non-assessable; have no preference as to conversion,
exchange, dividends, retirement or other features; and
have no preemptive rights. Such shares have non-cumulative
voting rights, meaning that the holders of more than 50%
of the shares voting for the election of Directors can
elect 100% of the Directors if they so choose.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other
applicable law. An annual meeting will be held to vote on
the removal of a Director or Directors of the Fund if
requested in writing by the holders of not less than 10%
of the outstanding shares of the Fund.
All securities and cash for the Utilities Income Portfolio
are held by State Street Bank and Trust Company, Boston,
MA. CoreStates Bank, N.A., Philadelphia, PA, holds daily
cash balances that are used by the Fund's Portfolios to
invest in repurchase agreements or securities acquired in
these transactions. The Vanguard Group, Inc., Valley
Forge, PA, serves as the Fund's Transfer and Dividend
Disbursing Agent. Price Waterhouse LLP serves as
independent accountants for the Fund and will audit its
financial statements annually. The Fund is not involved in
any material litigation.
- --------------------------------------------------------------------------------
15
<PAGE> 52
SHAREHOLDER GUIDE
OPENING AN
ACCOUNT AND
PURCHASING
SHARES You may open a regular (non-retirement) account, either by
mail or wire. Simply complete and return an Account
Registration Form and any required documentation,
indicating the amount you wish to invest. Your purchase
must be equal to or greater than the $3,000 minimum
initial investment requirement for the Portfolio ($1,000
for Uniform Gifts/Transfers to Minors Act accounts; $500
minimum for an Education IRA). You must open a new
Individual Retirement Account by mail (IRAs may not be
opened by wire) using a Vanguard IRA Adoption Agreement.
Your purchase must be equal to or greater than the $1,000
minimum initial investment requirement for IRAs, but no
more than $2,000 if you are making a regular IRA
contribution. Rollover contributions are generally limited
to the amount withdrawn within the past 60 days from an
IRA or other qualified retirement plan. If you need
assistance with the forms or have any questions about the
Portfolio, please call our Investor Information Department
(1-800-662-7447). NOTE: For other types of account
registrations (e.g., corporations, associations, other
organizations, trusts, or powers of attorney), please call
us to determine which additional forms you may need.
The Portfolio's shares are purchased at the
next-determined net asset value after your investment has
been received. The Portfolio is offered on a no-load basis
(i.e., there are no sales commissions or 12b-1 fees).
PURCHASE
RESTRICTIONS 1) Because of the risks associated with common stock and
bond investments, the Portfolio is intended to be a
long-term investment vehicle and is not designed to
provide investors with a means of speculating on
short-term stock and bond market movements.
Consequently, the Portfolio reserves the right to
reject any specific purchase (and exchange purchase)
request. The Portfolio also reserves the right to
suspend the offering of shares for a period of time.
2) Vanguard will not accept third-party checks to purchase
shares of the Fund. Please be sure your purchase check
is made payable to The Vanguard Group.
ADDITIONAL
INVESTMENTS Subsequent investments to regular accounts may be made by
mail ($100 minimum), wire ($1,000 minimum), exchange from
another Vanguard Fund account ($100 minimum), or Vanguard
Fund Express. Subsequent investments to Individual
Retirement Accounts may be made by mail ($100 minimum) or
exchange from another Vanguard Fund account. In some
instances, contributions may be made by wire or Vanguard
Fund Express. Please call us for more information on these
options.
- --------------------------------------------------------------------------------
16
<PAGE> 53
<TABLE>
<S> <C> <C>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
PURCHASING BY MAIL Please include the amount of Additional investments should
your initial investment on the include the Invest-by-Mail
Complete and sign the registration form, make your remittance form attached to your
enclosed Account check payable to The Vanguard Fund confirmation statements.
Registration Form Group - 57, and mail to: Please make your check payable
to The Vanguard Group - 57,
THE VANGUARD GROUP write your account number on
P.O. BOX 2600 your check and, using the return
VALLEY FORGE, PA 19482-2600 envelope provided, mail to the
address indicated on the In-
vest-by-Mail Form.
For express or THE VANGUARD GROUP All written requests should be
registered mail, 455 DEVON PARK DRIVE mailed to one of the addresses
send to: WAYNE, PA 19087-1815 indicated for new accounts. Do
not send registered or express
mail to the post office box
address.
----------------------------------------------------------------------------
</TABLE>
PURCHASING BY WIRE
Money should be
wired to:
BEFORE WIRING
Please contact
Client Services
(1-800-662-2739) CORESTATES BANK, N.A.
ABA 031000011
CORESTATES NO. 0101 9897
ATTN: VANGUARD
VANGUARD SPECIALIZED PORTFOLIOS
UTILITIES INCOME PORTFOLIO
ACCOUNT NUMBER
ACCOUNT REGISTRATION
To ensure proper receipt, please be sure your bank
includes the Portfolio name, the account number Vanguard
has assigned to you and the eight-digit CoreStates number.
If you are opening a new account, please complete the
Account Registration Form and mail it to the "New Account"
address above after completing your wire arrangement.
NOTE: Federal Funds wire purchase orders will be accepted
only when the Fund and Custodian Bank are open for
business.
- --------------------------------------------------------------------------------
PURCHASING BY
EXCHANGE (from a
Vanguard account) You may open a new account or purchase additional shares
by making an exchange from an existing Vanguard account.
However, the Portfolio reserves the right to refuse any
exchange purchase request. Call our Client Services
Department (1-800-662-2739). The new account will have the
same registration as the existing account.
- --------------------------------------------------------------------------------
PURCHASING BY
FUND EXPRESS
Special Purchase and
Automatic Investment The Fund Express Special Purchase option lets you move
money from your bank account to your Vanguard account on
an "as needed" basis. Or if you choose the Automatic
Investment option, money will be moved automatically from
your bank account to your Vanguard account on the schedule
(monthly, bimonthly [every other month], quarterly,
semi-annually or annually) you select. To establish these
17
<PAGE> 54
Fund Express options, please provide the appropriate
information on the Account Registration Form. We will send
you a confirmation of your Fund Express service; please
wait two weeks before using the service.
- --------------------------------------------------------------------------------
CHOOSING A
DISTRIBUTION
OPTION You must select one of four distribution options:
1. AUTOMATIC REINVESTMENT OPTION -- Both dividend and
capital gains distributions will be reinvested in
additional Fund shares. This option will be selected
for you automatically unless you specify one of the
other options.
2. CASH DIVIDEND OPTION -- Your dividends will be paid in
cash and your capital gains will be reinvested in
additional Fund shares.
3. CASH CAPITAL GAIN OPTION -- Your capital gains
distributions will be paid in cash and your dividends
will be reinvested in additional Fund Shares.
4. ALL CASH OPTION -- Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client Services
Department (1-800-662-2739).
If a shareholder has chosen to receive dividend and/or
capital gains distributions in cash, and the postal or
other delivery service is unable to deliver checks to the
shareholder's address of record, we will change the
distribution option so that all dividends and other
distributions are automatically reinvested in additional
shares. We will not pay interest on uncashed distribution
checks.
In addition, an option to invest your cash dividend and/or
capital gains distributions in another Vanguard Fund
account is available. Please call our Client Services
Department (1-800-662-2739) for information. You may also
elect Vanguard Dividend Express which allows you to
transfer your cash dividend and/or capital gains
distributions automatically to your bank account. Please
see "Other Vanguard Services" for more information.
- --------------------------------------------------------------------------------
TAX CAUTION
INVESTORS SHOULD ASK
ABOUT THE TIMING OF
CAPITAL GAINS AND
DIVIDEND DISTRIBUTIONS
BEFORE INVESTING Under Federal tax laws, the Portfolio is required to
distribute net capital gains and dividend income to
Portfolio shareholders. These distributions are made to
all shareholders who own Portfolio shares as of the
distribution's record date, regardless of how long the
shares have been owned. Purchasing shares just prior to
the record date could have a significant impact on your
tax liability for the year. For example, if you purchase
shares immediately prior to the record date of a sizable
capital gain or income dividend distribution, you will be
assessed taxes on the amount of the capital gain and/or
dividend distribution later paid even though you owned the
Portfolio shares for just a short period of time. (Taxes
are due on the distributions even if the dividend or
capital gain is reinvested in additional Portfolio
shares.) While the total value of your investment will be
the same after the distribution -- the amount of the
distribution will offset the drop in the net asset value
of the shares -- you should be aware of the tax
implications the timing of your purchase may have.
18
<PAGE> 55
Prospective investors should, therefore, inquire about
potential distributions before investing. The Portfolio's
annual capital gains distribution normally occurs in
December, while income dividends are generally paid
quarterly in March, June, September and December. In
addition, the Portfolio may occasionally be required to
make supplemental dividend or capital gains distributions
at some other time during the year. For additional
information on distributions and taxes, see the section
titled "Dividends, Capital Gains, and Taxes."
- --------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ESTABLISHING OPTIONAL
SERVICES The easiest way to establish optional Vanguard services on
your account is to select the options you desire when you
complete your Account Registration Form.
IF YOU WISH TO ADD SHAREHOLDER OPTIONS LATER, YOU MAY NEED
TO PROVIDE VANGUARD WITH ADDITIONAL INFORMATION AND A
SIGNATURE GUARANTEE. PLEASE CALL OUR CLIENT SERVICES
DEPARTMENT (1-800-662-2739) FOR FURTHER ASSISTANCE.
SIGNATURE
GUARANTEES For our mutual protection, we may require a signature
guarantee on certain written transaction requests. A
signature guarantee verifies the authenticity of your
signature and may be obtained from banks, brokers and any
other guarantor that Vanguard deems acceptable. A
SIGNATURE GUARANTEE CANNOT BE PROVIDED BY A NOTARY PUBLIC.
CERTIFICATES Share certificates are not available for the Utilities
Income Portfolio.
BROKER/DEALER
PURCHASES If you purchase shares in Vanguard Funds through a
registered broker/dealer or investment adviser, the
broker/dealer or adviser may charge a service fee.
CANCELLING TRADES The Fund will not cancel any trade (e.g., a purchase,
exchange or redemption) believed to be authentic, once the
trade request has been received in writing or by
telephone.
ELECTRONIC
PROSPECTUS
DELIVERY You may receive a prospectus for the Fund or any of the
Vanguard Funds in an electronic format through Vanguard's
website at www.vanguard.com. For additional information
please see "Other Vanguard Services -- Computer Access."
- --------------------------------------------------------------------------------
WHEN YOUR
ACCOUNT WILL BE
CREDITED Your trade date is the date on which your account is
credited. If your purchase is made by check, Federal Funds
wire or exchange, and is received by the close of trading
on the New York Stock Exchange (the "Exchange"), generally
4:00 p.m. Eastern time, your trade date is the day of
receipt. If your purchase is received after the close of
the Exchange, your trade date is the next business day.
Your shares are purchased at the net asset value
determined on your trade date.
In order to prevent lengthy processing delays caused by
the clearing of foreign checks, Vanguard will only accept
a foreign check which has been drawn in U.S. dollars and
has been issued by a foreign bank with a U.S.
correspondent bank. The name of the U.S. correspondent
bank must be printed on the face of the foreign check.
- --------------------------------------------------------------------------------
SELLING YOUR
SHARES You may withdraw any portion of the funds in your account
by redeeming shares at any time. (Please see "Important
Redemption Information.") You generally may initiate a
request by writing or by telephoning. Your redemption
proceeds are normally mailed
19
<PAGE> 56
within two business days after the receipt of the request
in Good Order. No interest will accrue on amounts
represented by uncashed redemption checks.
SELLING BY MAIL Requests should be mailed to THE VANGUARD GROUP, VANGUARD
SPECIALIZED PORTFOLIOS, P.O. BOX 1120, VALLEY FORGE, PA
19482-1120. (For express or registered mail, send your
request to The Vanguard Group, Vanguard Specialized
Portfolios, 455 Devon Park Drive, Wayne, PA 19087-1815.)
The redemption price of shares will be the Portfolio's net
asset value next determined after Vanguard has received
all required documents in Good Order.
- --------------------------------------------------------------------------------
DEFINITION OF
GOOD ORDER GOOD ORDER means that the request includes the following:
1. The account number and Portfolio name.
2. The amount of the transaction (specified in dollars or
shares).
3. The signatures of all owners EXACTLY as they are
registered on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that may be
required in the case of estates, corporations, trusts,
and certain other accounts.
IF YOU HAVE QUESTIONS ABOUT THIS DEFINITION AS IT PERTAINS
TO YOUR REQUEST, PLEASE CALL OUR CLIENT SERVICES
DEPARTMENT AT 1-800-662-2739.
- --------------------------------------------------------------------------------
SELLING BY
TELEPHONE To sell shares by telephone you or your pre-authorized
representative may call our Client Services Department at
1-800-662-2739. The proceeds will be sent to you by mail.
PLEASE NOTE: As a protection against fraud, your telephone
mail redemption privilege will be suspended for 15
calendar days following any expedited address change to
your account. An expedited address change is one that is
made by telephone or in writing, without the signatures of
all account owners. Please see "Important Information
About Telephone Transactions."
- --------------------------------------------------------------------------------
SELLING BY FUND
EXPRESS
Automatic
Withdrawal
& Special Redemption If you select the Fund Express Automatic Withdrawal
option, money will be automatically moved from your
Vanguard Fund account to your bank account according to
the schedule you have selected. The Special Redemption
option lets you move money from your Vanguard account to
your bank account on an "as needed" basis. To establish
these Fund Express options, please provide the appropriate
information on the Account Registration Form. We will send
you a confirmation of your Fund Express service; please
wait two weeks before using the service.
- --------------------------------------------------------------------------------
SELLING BY
EXCHANGE You may sell shares by making an exchange into another
Vanguard Fund account. Please see "Exchanging Your Shares"
for details.
- --------------------------------------------------------------------------------
IMPORTANT REDEMPTION
INFORMATION Shares purchased by check or Fund Express may be redeemed
at any time. However, your redemption proceeds will not be
paid until payment for the purchase is collected, which
may take up to ten calendar days.
- --------------------------------------------------------------------------------
DELIVERY OF
REDEMPTION
PROCEEDS Redemption requests received by telephone prior to the
close of trading on the Exchange are processed on the day
of receipt and the redemption proceeds are normally sent
on the following business day.
20
<PAGE> 57
Redemption requests received by telephone after the close
of the Exchange are processed on the business day
following receipt and the proceeds are normally sent on
the second business day following receipt.
Redemption proceeds must be sent to you within seven days
of receipt of your request in Good Order, except as
described above in "Important Redemption Information."
If you experience difficulty in making a telephone
redemption during periods of drastic economic or market
changes, your redemption request may be made by regular or
express mail. It will be implemented at the net asset
value next determined after your request has been received
by Vanguard in Good Order. The Fund reserves the right to
revise or terminate the telephone redemption privilege at
any time.
The Fund may suspend the redemption right or postpone
payment at times when the New York Stock Exchange is
closed or under any emergency circumstances as determined
by the United States Securities and Exchange Commission.
If the Board of Directors determines that it would be
detrimental to the best interests of the Fund's remaining
shareholders to make payment in cash, the Fund may pay
redemption proceeds in whole or in part by a distribution
in kind of readily marketable securities.
- --------------------------------------------------------------------------------
VANGUARD'S AVERAGE
COST STATEMENT If you make a redemption from a qualifying account,
Vanguard will send you an Average Cost Statement which
provides you with the tax basis of the shares you
redeemed. Please see "Statement and Reports" for
additional information.
- --------------------------------------------------------------------------------
LOW-BALANCE FEE
AND MINIMUM ACCOUNT
BALANCE REQUIREMENT Due to the relatively high cost of maintaining smaller
accounts, the Fund will automatically deduct a $10 annual
fee in either June or December from non-retirement
accounts with balances falling below $2,500 ($500 for
Uniform Gifts/Transfers to Minors Act accounts). The fee
generally will be waived for investors whose aggregate
Vanguard Assets exceed $50,000. In addition, the Fund
reserves the right to liquidate any non-retirement account
that is below the minimum initial investment amount of
$3,000. If at any time your total investment does not have
a value of at least $3,000, you may be notified that your
account is below the Fund's minimum account balance
requirement. You would then be allowed 60 days to make an
additional investment before the account is liquidated.
Proceeds would be promptly paid to the registered
shareholder.
Vanguard will not liquidate your account if it has fallen
below $3,000 solely as a result of declining markets
(i.e., a decline in a Portfolio's net asset value).
- --------------------------------------------------------------------------------
EXCHANGING YOUR
SHARES Should your investment goals change, you may exchange your
shares of the Utilities Income Portfolio of Vanguard
Specialized Portfolios for those of other available
Vanguard Funds.
EXCHANGING BY
TELEPHONE
Call Client Services
(1-800-662-2739) When exchanging shares by telephone, please have ready the
Portfolio name, account number, Social Security number or
employer identification number listed on the account, and
exact name and address in which the account is registered.
Only the registered shareholder or his or her
pre-authorized representative may complete such an
exchange. Requests for telephone exchanges received prior
to the close of trading
21
<PAGE> 58
on the Exchange are processed at the close of business
that same day. Requests received after the close of the
Exchange are processed the next business day. FOR NON-
RETIREMENT INVESTMENTS, TELEPHONE EXCHANGES ARE NOT
ACCEPTED INTO OR FROM VANGUARD INDEX TRUST, VANGUARD
BALANCED INDEX FUND, VANGUARD INTERNATIONAL EQUITY INDEX
FUND, VANGUARD REIT INDEX PORTFOLIO, VANGUARD TOTAL
INTERNATIONAL PORTFOLIO, and VANGUARD GROWTH AND INCOME
PORTFOLIO (formerly known as Vanguard Quantitative
Portfolios). If you experience difficulty in making a
telephone exchange, your exchange request may be made by
regular or express mail, and it will be implemented at the
closing net asset value on the date received by Vanguard,
provided the request is received in Good Order.
- --------------------------------------------------------------------------------
EXCHANGING BY MAIL Please be sure to include on your exchange request the
name and account number of your current Portfolio, the
name of the Fund you wish to exchange into, the amount you
wish to exchange, and the signatures of all registered
account holders. Send your request to THE VANGUARD GROUP,
VANGUARD SPECIALIZED PORTFOLIOS, P.O. BOX 1120, VALLEY
FORGE, PA 19482-1120. (For express or registered mail,
send your request to The Vanguard Group, Vanguard
Specialized Portfolios, 455 Devon Park Drive, Wayne, PA
19087-1815.)
- --------------------------------------------------------------------------------
EXCHANGING ONLINE You may use your personal computer to exchange shares of
most Vanguard funds by accessing our website
(www.vanguard.com). To establish this service on your
account, you must first register through the website. We
will then send to you by mail, an account access password
that will enable you to make online exchanges.
The Vanguard funds that you cannot purchase or sell
through online exchange are VANGUARD INDEX TRUST, VANGUARD
BALANCED INDEX FUND, VANGUARD INTERNATIONAL EQUITY INDEX
FUND, VANGUARD REIT INDEX PORTFOLIO, VANGUARD TOTAL
INTERNATIONAL PORTFOLIO, and VANGUARD GROWTH AND INCOME
PORTFOLIO (formerly known as Vanguard Quantitative
Portfolios). These funds do permit online exchanges within
IRAs and other retirement accounts.
- --------------------------------------------------------------------------------
IMPORTANT EXCHANGE
INFORMATION Before you make an exchange, you should consider the
following:
- Please read the Fund's prospectus before making an
exchange. For a copy and for answers to any questions
you may have, call our Investor Information Department
(1-800-662-7447).
- An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on
the transaction.
- Exchanges by telephone are accepted only if the
registrations and taxpayer identification numbers of the
two accounts are identical.
- To exchange into an account with a different
registration (including a different name, address, or
taxpayer identification number), you must provide
Vanguard with written instructions that include the
guaranteed signatures of all current account owners.
- The shares to be exchanged must be on deposit and not
held in certificate form.
22
<PAGE> 59
- New accounts are not currently accepted in
Vanguard/Windsor Fund or Vanguard/ PRIMECAP Fund.
- The redemption price of shares redeemed by exchange is
the net asset value next determined after Vanguard has
received the required documentation in Good Order.
- When opening a new account by exchange, you must meet
the minimum investment requirement of the new Fund.
Every effort will be made to maintain the exchange
privilege. However, the Fund reserves the right to revise
or terminate its provisions, limit the amount of, or
reject any exchange, as deemed necessary, at any time.
The Fund's exchange privilege is only available in states
in which the shares of the Fund are registered for sale.
The Fund's shares are currently registered for sale in all
50 states and the Fund intends to maintain such
registration.
- --------------------------------------------------------------------------------
EXCHANGE
PRIVILEGE
LIMITATIONS The Fund's exchange privilege is not intended to afford
shareholders a way to speculate on short-term movements in
the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive
exchange activity.
Exchange activity generally will not be deemed excessive
if limited to TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (at
least 30 days apart) from the Portfolio during any
twelve-month period. "Substantive" means either a dollar
amount or a series of movements between Vanguard funds
that Vanguard determines, in its sole discretion, could
have an adverse impact on the management of the Fund.
Notwithstanding these limitations, the Portfolio reserves
the right to reject any purchase request (including
exchange purchases from other Vanguard portfolios) that is
reasonably deemed to be disruptive to efficient portfolio
management.
- --------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ABOUT TELEPHONE
TRANSACTIONS The ability to initiate redemptions (except wire or Fund
Express redemptions) and exchanges by telephone is
automatically established on your account unless you
request in writing that telephone transactions on your
account not be permitted.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions,
Vanguard adheres to the following security procedures:
1. SECURITY CHECK. To request a transaction by telephone,
the caller must know (i) the name of the Portfolio;
(ii) the 10-digit account number; (iii) the exact name
and address used in the registration; and (iv) the
Social Security or employer identification number
listed on the account.
2. PAYMENT POLICY. The proceeds of any telephone
redemption by mail will be made payable to the
registered shareowner and mailed to the address of
record only.
Neither the Portfolio nor Vanguard will be responsible for
the authenticity of transaction instructions received by
telephone, provided that reasonable security
23
<PAGE> 60
procedures have been followed. Vanguard believes that the
security procedures described above are reasonable, and
that if such procedures are followed, you will bear the
risk of any losses resulting from unauthorized or
fraudulent telephone transactions on your account.
- --------------------------------------------------------------------------------
TRANSFERRING
REGISTRATION You may transfer the registration of any of your Fund
shares to another person by completing a transfer form and
sending it to: THE VANGUARD GROUP, ATTENTION: TRANSFER
DEPARTMENT, P.O. BOX 1110, VALLEY FORGE, PA 19482-1110.
The request must be in Good Order. TO REQUEST A TRANSFER
FORM AND FULL INSTRUCTIONS PLEASE CALL OUR CLIENT SERVICES
DEPARTMENT (1-800-662-2739).
- --------------------------------------------------------------------------------
STATEMENTS AND
REPORTS Vanguard will send you a confirmation statement each time
you initiate a transaction in your account except for
checkwriting redemptions from Vanguard money market
accounts. You will also receive a comprehensive account
statement at the end of each calendar quarter. The fourth
quarter statement will be a year-end statement, listing
all transaction activity for the entire calendar year.
Vanguard's Average Cost Statement provides you with the
average cost of shares redeemed from your account during
the calendar year, using the average cost single category
method. This service is available for most taxable
accounts opened since January 1, 1986. In general,
investors who redeemed shares from a qualifying Vanguard
account may expect to receive their Average Cost Statement
along with their Portfolio Summary Statement. Please call
our Client Services Department (1-800-662-2739) for
information.
Financial reports on the Fund will be mailed to you
semi-annually, according to the Fund's fiscal year-end. 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 Investor Information
Department at 1-800-662-7447.
- --------------------------------------------------------------------------------
OTHER VANGUARD
SERVICES For more information about any of these services, please
call our Investor Information Department at
1-800-662-7447.
VANGUARD DIRECT
DEPOSIT SERVICE With Vanguard's Direct Deposit Service, most U.S.
Government checks (including Social Security and military
pension checks) and private payroll checks may be
automatically deposited into your Vanguard Fund account.
Separate brochures and forms are available for direct
deposit of U.S. Government and private payroll checks.
VANGUARD AUTOMATIC
EXCHANGE SERVICE Vanguard's Automatic Exchange Service allows you to move
money automatically among your Vanguard Fund accounts. For
instance, the service can be used to "dollar cost average"
from a money market portfolio into a stock or bond fund or
to contribute to an IRA or other retirement plan. Please
contact our Client Services Department at 1-800-662-2739
for additional information.
24
<PAGE> 61
VANGUARD FUND
EXPRESS Vanguard's Fund Express allows you to transfer money
between your Fund account and your account at a bank,
savings and loan association, or a credit union that is a
member of the Automated Clearing House (ACH) system. You
may elect this service on the Account Registration Form or
call our Investor Information Department (1-800-662-7447)
for a Fund Express application.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition,
some services of Fund Express cannot be used with specific
Vanguard Funds. For more information, please refer to the
Vanguard Fund Express brochure.
VANGUARD DIVIDEND
EXPRESS Vanguard's Dividend Express allows you to transfer your
dividend and/or capital gains distributions automatically
from your Fund account, one business day after the Fund's
payable date, to your account at a bank, savings and loan
association, or a credit union that is a member of the
Automated Clearing House (ACH) system. You may elect this
service on the Account Registration Form or call our
Investor Information Department (1-800-662-7447) for a
Vanguard Dividend Express application.
VANGUARD
TELE-ACCOUNT(R) Vanguard's Tele-Account is a convenient, automated service
that provides share price, price change and yield
quotations on Vanguard Funds through any TouchTone(TM)
telephone. This service also lets you obtain information
about your account balance, your last transaction, and
your most recent dividend or capital gains payment. In
addition, you may perform investment exchanges of Vanguard
Fund shares and redemptions by check using Tele-Account.
To contact Vanguard's Tele-Account service, dial
1-800-ON-BOARD (1-800-662-6273). A brochure offering
detailed operating instructions is available from our
Investor Information Department (1-800-662-7447).
COMPUTER ACCESS
VANGUARD ONLINE
www.vanguard.com Use your personal computer to learn more about Vanguard's
funds and services; keep in touch with your Vanguard
accounts; map out a long-term investment strategy;
initiate certain transactions; and ask questions, make
suggestions, and send messages to Vanguard.
Our education-oriented website provides timely news and
information about Vanguard's 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.
- --------------------------------------------------------------------------------
25
<PAGE> 62
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<PAGE> 63
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<PAGE> 64
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<PAGE> 65
[Vanguard Specialized Portfolios - Utilities Income
Portfolio]
-----------------------------------------------
THE VANGUARD GROUP
P.O. Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT:
1-800-662-7447 (SHIP)
CLIENT SERVICES
DEPARTMENT:
1-800-662-2739 (CREW)
TELE-ACCOUNT FOR
24-HOUR ACCESS:
1-800-662-6273 (ON-BOARD)
TELECOMMUNICATION SERVICE
FOR THE HEARING-IMPAIRED:
1-800-662-2738
TRANSFER AGENT:
The Vanguard Group, Inc.
P.O. Box 2600
Valley Forge, PA 19482
[Flag Logo]
[Vanguard Specialized Portfolios -
Utilities Income Portfolio]
P R O S P E C T U S
MAY 22, 1998
[Vanguard Group Logo]
P057
- --------------------------------------------------------------------------------
<PAGE> 66
VANGUARD
REIT INDEX
PORTFOLIO
Prospectus
May 22, 1998
A Portfolio of Vanguard
Specialized Portfolios
This prospectus
contains financial data
for the Portfolio through
the period ended
January 31, 1998.
[GRAPHIC OF SHIP]
[VANGUARD GROUP LOGO]
<PAGE> 67
VANGUARD REIT INDEX PORTFOLIO A Real Estate Stock Mutual Fund
CONTENTS
Portfolio Profile 1
Portfolio Expenses 2
Financial Highlights 3
A Word About Risk 4
The Portfolio's
Objectives 4
Who Should Invest 4
Investment Strategy 5
Investment Policies 8
Investment Limitations 9
Investment
Performance 9
Share Price 10
Distributions and Taxes 10
The Portfolio and
Vanguard 12
Investment Adviser 12
General Information 12
Investing
with Vanguard 14
Services and
Account Features 14
Types of Accounts 15
Distribution Options 16
Buying Shares 17
Redeeming Shares 18
Transferring
Registration 21
Portfolio and Account
Updates 21
Prospectus Postscript 23
Investment Primer 24
Glossary Inside Back Cover
INVESTMENT OBJECTIVES AND POLICIES
Vanguard REIT Index Portfolio (the "Portfolio") is a diversified mutual fund, a
part of Vanguard Specialized Portfolios, Inc. (the "Fund"), an open-end
investment company.
The Portfolio seeks to provide a high level of income and moderate long-term
capital growth by investing at least 98% of its assets in stocks issued by real
estate investment trusts (known as "REITs"); these stocks make up the Morgan
Stanley REIT Index (the "Index"), a benchmark of U.S. property trusts. The
Portfolio's remaining assets are invested in cash reserves.
IT IS IMPORTANT TO NOTE THAT THE PORTFOLIO'S SHARES ARE NOT GUARANTEED OR
INSURED BY THE FDIC OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT. AS WITH ANY
INVESTMENT IN COMMON STOCKS, WHICH ARE SUBJECT TO WIDE FLUCTUATIONS IN MARKET
VALUE, YOU COULD LOSE MONEY BY INVESTING IN THE PORTFOLIO.
FEES AND EXPENSES
The Portfolio is offered on a no-load basis, which means that you pay no sales
commissions or 12b-1 marketing fees. You will, however, incur expenses for
investment advisory, management, administrative, and distribution services,
which are included in the expense ratio.
Vanguard REIT Index Portfolio charges a 1% transaction fee if you redeem
(that is, sell or exchange) shares held less than one year.
ADDITIONAL INFORMATION ABOUT THE PORTFOLIO
A Statement of Additional Information (dated May 22, 1998) containing more
information about the Portfolio is, by reference, part of this prospectus and
may be obtained, along with other information about the Portfolio, without
charge by writing to Vanguard, calling our Investor Information Department at
1-800-662-7447, or visiting the Securities and Exchange Commission's website
(www.sec.gov).
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objectives, risks, and strategy of Vanguard REIT
Index Portfolio. To highlight terms and concepts important to mutual fund
investors, we have provided "Plain Talk" explanations along the way. Reading the
prospectus will help you to decide whether the Portfolio is the right investment
for you. We suggest that you keep it for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<PAGE> 68
PORTFOLIO PROFILE Vanguard REIT Index Portfolio
WHO SHOULD INVEST (page 4)
- - Investors looking for a simple, low-cost way to diversify their stock, bond,
and cash investments with indirect exposure to real estate.
- - Investors seeking a stock fund that offers the potential for above-average
income. (Historically, the securities that comprise the Index have provided
above-average income relative to the S&P 500 Index.)
- - Investors wanting modest growth of their capital over the long term -- at
least five years.
WHO SHOULD NOT INVEST
- - Investors unwilling to accept significant fluctuations in share price.
- - Investors seeking a mutual fund that invests in a variety of industries.
RISKS OF THE PORTFOLIO (pages 4 - 9)
The Portfolio's total return will fluctuate, so an investor could lose money
over short or even extended periods. The Portfolio is subject to, among other
risks:
- - Real estate industry risk (the chance that property values will fall due to a
variety of factors, such as a decline in rental rates).
- - Market risk (the chance that stock market prices will fall, sometimes
suddenly and sharply).
- - Interest rate risk (the chance that changes in interest rates will hurt real
estate values).
INVESTMENT ADVISER (page 12)
Vanguard Core Management Group, Valley Forge, Pa.
DISTRIBUTIONS* (page 10)
Distributions are paid in March, June, September, and December. These
distributions may include dividends and capital gains (which are taxable) and a
return of capital (which is generally nontaxable).
INCEPTION DATE: May 13, 1996
NET ASSETS AS OF 1/31/1998: $1.3 billion
PORTFOLIO'S EXPENSE RATIO FOR THE YEAR ENDED 1/31/1998: 0.24%
LOADS, 12b-1 MARKETING FEES: None
SUITABLE FOR IRAs: Yes
MINIMUM INITIAL INVESTMENT: $3,000; $1,000 for IRAs and custodial accounts for
minors
NEWSPAPER ABBREVIATION: SPReit
VANGUARD FUND NUMBER: 123
CUSIP NUMBER: 921908703
QUOTRON SYMBOL: VGSIX.Q
ACCOUNT FEATURES (page 14)
- - Telephone Redemption (sales, not exchanges)
- - Vanguard Direct Deposit Service(TM)
- - Vanguard Automatic Exchange Service(TM)
- - Vanguard Fund Express(R)
- - Vanguard Dividend Express(TM)
AVERAGE ANNUAL TOTAL RETURNS --
PERIODS ENDED JANUARY 31, 1998
<TABLE>
<CAPTION>
SINCE
1 YEAR INCEPTION**
------ -----------
<S> <C> <C>
Vanguard REIT Index Portfolio 17.1% 27.9%
Morgan Stanley REIT Index 16.5 27.6
**5/13/1996.
</TABLE>
IN EVALUATING PAST PERFORMANCE, REMEMBER THAT IT IS NOT INDICATIVE OF FUTURE
PERFORMANCE. NOTE, TOO, THAT BOTH THE RETURN AND PRINCIPAL VALUE OF AN
INVESTMENT WILL FLUCTUATE, SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE
WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
*IMPORTANT INFORMATION ABOUT DISTRIBUTIONS AND TAXES
Because REITs cannot provide complete information about the taxability of
their distributions until after the end of the calendar year, Vanguard will
ask the Internal Revenue Service each year for an extension on issuing Forms
1099-DIV ("1099s") for Vanguard REIT Index Portfolio. If this request is
approved, we expect to mail 1099s to Portfolio shareholders in nonretirement
accounts during February. See page 10 for details.
1
<PAGE> 69
PORTFOLIO EXPENSES
The examples below are designed to help you understand the various costs you
would bear, directly or indirectly, as an investor in the Portfolio.
As noted in this table, you do not pay a load or sales commission when you
buy, sell, or exchange shares of the Portfolio.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Dividends: None
Redemption Fees*: None
Exchange Fees*: None
</TABLE>
The next table illustrates the operating expenses that you would incur as a
shareholder of the Portfolio. These expenses are deducted from the Portfolio's
income before it is paid to you, and include investment advisory expenses as
well as the costs of maintaining accounts, administering the Portfolio,
providing shareholder services, and other activities. The expenses shown in the
table are based upon those incurred in the fiscal year ended January 31, 1998.
ANNUAL PORTFOLIO OPERATING EXPENSES
<TABLE>
<S> <C> <C>
Management and Administrative Expenses: 0.20%
Investment Advisory Expenses: None
12b-1 Marketing Fees: None
Other Expenses
Marketing and Distribution Costs: 0.02%
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.02%
----
Total Other Expenses: 0.04%
----
TOTAL OPERATING EXPENSES (EXPENSE RATIO): 0.24%
====
</TABLE>
The following example is intended to help you compare the cost of investing
in the Portfolio with the cost of investing in other mutual funds, by
illustrating the hypothetical expenses that you would incur on a $1,000
investment over various periods. The example assumes that (1) the Portfolio
provides a return of 5% a year and (2) you redeem your investment at the end of
each period.
PLAIN TALK ABOUT
VANGUARD'S
REDEMPTION FEES
Some Vanguard portfolios charge a redemption fee on shares held less than one
year. Unlike a sales charge or load paid to a broker or fund management company,
the fee is paid directly to the portfolio to offset the costs of buying and
selling securities. The fee, which is intended to discourage short-term trading,
ensures that short-term investors pay their share of the portfolio's transaction
costs and that long-term investors do not subsidize the activities of short-term
traders.
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 a
fund. Vanguard REIT Index Portfolio's expense ratio in fiscal year 1998 was
0.24%, or $2.40 per $1,000 of average net assets. As of January 31, 1998, the
average real estate mutual fund had expenses of 1.68%, or $16.80 per $1,000 of
average net assets, according to Lipper Analytical Services, which reports on
the mutual fund industry.
* Vanguard REIT Index Portfolio charges a 1% transaction fee on redemptions
(sales and exchanges) of shares that have been held less than one year. The
fee is deducted before your redemption proceeds are mailed to you or used to
purchase shares of another Vanguard fund. You cannot pay the fee separately.
If some of the shares that you are redeeming have been held one year or more,
the fee will apply to only those shares held less than one year. The fee does
not apply to shares acquired through reinvested dividend or capital gains
distributions.
2
<PAGE> 70
<TABLE>
<CAPTION>
---------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------------------------------------------
<S> <C> <C> <C>
$2 $8 $14 $31
---------------------------------------------
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE, WHICH MAY BE HIGHER OR LOWER THAN
THOSE SHOWN.
FINANCIAL HIGHLIGHTS
The following financial highlights table shows the results for a share
outstanding of the Portfolio for the fiscal year ended January 31, 1998, and the
period from May 13, 1996 (the Portfolio's inception date) to January 31, 1997.
The financial statements that include these financial highlights were audited by
Price Waterhouse LLP, independent accountants. You should read this information
in conjunction with the Portfolio's financial statements and accompanying notes,
which appear in the Portfolio's most recent annual report to shareholders. The
report is incorporated by reference in the Statement of Additional Information
and in this prospectus, and contains a more complete discussion of the
Portfolio's performance. You may have the report sent to you without charge by
writing to Vanguard or by calling our Investor Information Department.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
YEAR ENDED MAY 13, 1996,*
JANUARY 31, 1998 TO JAN. 31, 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 12.64 $ 10.00
----------- -----------
INVESTMENT OPERATIONS
Net Investment Income .590 .341
Net Realized and Unrealized Gain (Loss) on Investments 1.520 2.659
----------- -----------
TOTAL FROM INVESTMENT OPERATIONS 2.110 3.000
- ---------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.590) (.341)
Distributions from Realized Capital Gains (.086) (.005)
Return of Capital (.094) (.014)
----------- -----------
TOTAL DISTRIBUTIONS (.770) (.360)
- ---------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 13.98 $ 12.64
=============================================================================================
TOTAL RETURN** 17.08% 30.33%
=============================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 1,317 $ 655
Ratio of Total Expenses to Average Net Assets 0.24% 0.36%+
Ratio of Net Investment Income to Average Net Assets 4.66% 5.55%+
Portfolio Turnover Rate 2% 0%
Average Commission Rate Paid $ .0262 $ .0242
- ---------------------------------------------------------------------------------------------
</TABLE>
*Inception date
**Total return figures do not reflect the 1% fee that is assessed on redemptions
of shares that are held in the Portfolio for less than one year.
+ Annualized.
From time to time, the Vanguard funds advertise yield and total return
figures. Yield is a historical measure of dividend income, and total return is a
measure of past dividend income (assuming that it has been reinvested) plus
realized and unrealized capital appreciation (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
Vanguard REIT Index Portfolio began fiscal year 1998 with a net asset value
(price) of $12.64 per share. As of January 31, 1998, the Portfolio earned $.590
per share from investment income (interest and dividends) and $1.520 per share
from investments that had appreciated in value or that were sold for higher
prices than the Portfolio paid for them. This resulted in total earnings of
$2.110 per share, of which $.770 was returned to shareholders in the form of
distributions ($.590 in dividends, $.086 in capital gains and $.094 in return of
capital). The earnings ($2.110 per share) less distributions ($.770 per share)
resulted in a share price of $13.98 on January 31, 1998, an increase of $1.34
per share (from $12.64 at the beginning of the year to $13.98 at the end of the
year). Total return from Vanguard REIT Index Portfolio was 17.08% for the
period.
As of January 31, 1998, the Portfolio had $1,317 million in net assets; an
expense ratio of 0.24% ($2.40 per $1,000 of net assets); and net investment
income amounting to 4.66% of its average net assets.
3
<PAGE> 71
PLAIN TALK ABOUT
REITS
Rather than owning properties directly -- which can be costly and difficult to
convert into cash when needed -- some investors buy shares in a company that
owns and manages real estate. This company is known as a real estate investment
trust, or REIT. Unlike corporations, REITs do not have to pay income taxes if
they meet certain Internal Revenue Code requirements. To qualify, a REIT must
distribute at least 95% of its taxable income to its shareholders and receive at
least 75% of that income from rents, mortgages, and sales of property. REITs
offer investors greater liquidity and diversification than direct ownership of a
handful of properties, as well as greater income potential than an investment in
common stocks. Like any investment in real estate, however, a REIT's performance
depends on several factors, such as its ability to find tenants for its
properties, to renew leases, and to finance property purchases and renovations.
A WORD ABOUT RISK
This prospectus describes the risks you would face as an investor in Vanguard
REIT Index Portfolio. 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 REIT Index
Portfolio, you should also take into account your personal tolerance for the
daily fluctuations of the stock market.
Look for this "warning flag" symbol [FLAG GRAPHIC] throughout the prospectus.
It is used to mark detailed information about each type of risk that you, as a
shareholder of the Portfolio, would confront.
THE PORTFOLIO'S OBJECTIVES
Vanguard REIT Index Portfolio seeks to provide above-average income (relative to
the Standard & Poor's 500 Composite Stock Price Index) and long-term growth of
capital. These objectives are fundamental, which means that they cannot be
changed unless a majority of shareholders vote to do so.
[FLAG] BECAUSE OF THE SEVERAL TYPES OF RISK DESCRIBED ON THE FOLLOWING
PAGES, YOUR INVESTMENT IN THE PORTFOLIO, AS WITH ANY INVESTMENT IN
COMMON STOCKS, COULD LOSE MONEY.
WHO SHOULD INVEST
Vanguard REIT Index Portfolio may be a suitable investment for you if:
- - You want to add indirect real estate exposure to your existing mix of stock,
bond, and money market mutual funds.
- - You want a stock fund that seeks to provide a high level of income and
long-term capital growth.
- - You are looking for an investment that performs differently than a
diversified stock or bond fund.
- - You characterize your investment temperament as "somewhat conservative."
This Portfolio is not an appropriate investment if you are a "market-timer."
Investors who engage in excessive in-and-out trading activity generate
additional costs that are borne by all of the Portfolio's shareholders. To
minimize such costs, which reduce the ultimate returns achieved by you and other
shareholders, the Portfolio has adopted the following policies:
- - The Portfolio charges a 1% redemption fee on shares held less than one year.
4
<PAGE> 72
- - The Portfolio 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 Portfolio. This could be because of the timing of
the investment or because of a history of excessive trading by the investor.
- - There is a limit on the number of times you can exchange into or out of the
Portfolio (see "Redeeming Shares" in the INVESTING WITH VANGUARD section).
- - Telephone and online exchanges are not accepted for nonretirement accounts.
- - The Portfolio reserves the right to stop offering shares at any time.
PLAIN TALK ABOUT
INVESTING FOR THE LONG TERM
Vanguard REIT Index Portfolio is intended to be a long-term investment vehicle
and is not designed to provide investors with a means of speculating on
short-term fluctuations in the stock or real estate markets.
INVESTMENT STRATEGY
This section explains how the investment adviser pursues the Portfolio's
objectives of above-average income and long-term capital growth. It also
explains three important risks -- real estate industry risk, market risk, and
interest rate risk -- faced by investors in the Portfolio. Unlike the
Portfolio's investment objectives, the adviser's investment strategy is not
fundamental and can be changed by the Fund's Board of Directors without
shareholder approval. However, before making any important change in its
strategy, the Portfolio will give shareholders 30 days' notice, in writing.
MARKET EXPOSURE
The Portfolio intends to remain at least 98% invested in the stocks of real
estate investment trusts; the remaining assets will be invested in cash reserves
to maintain liquidity for shareholder redemptions.
[FLAG] THE PORTFOLIO IS SUBJECT TO REAL ESTATE INDUSTRY RISK, WHICH IS THE
POSSIBILITY THAT A REIT'S PROPERTIES COULD FALL IN VALUE.
Because of its emphasis on REIT stocks, the Portfolio's performance is
strongly linked to the ups and downs of the real estate market. In general, real
estate values are affected by a variety of factors, including supply and demand
for properties; the economic health of the country as well as different regions;
and the strength of specific industries renting properties. Ultimately, a REIT's
performance depends on the types and locations of the properties it owns and on
how well the REIT manages its properties. For instance, rental income could
decline because of extended vacancies, increased competition from nearby
properties, tenants' failure to pay rent, or incompetent management. Property
values could decrease because of overbuilding, environmental liabilities,
uninsured damages caused by natural disasters, loss of IRS status as a qualified
REIT, a general decline in the neighborhood, losses due to casualty or
condemnation, increases in property taxes, or changes in zoning laws.
PLAIN TALK ABOUT
TYPES OF REITS
An equity REIT, which owns properties, generates income (from rental and lease
payments) and offers the potential for growth (from property appreciation) as
well as occasional capital gains from the sale of property. A mortgage REIT
makes loans to commercial real estate developers. Mortgage REITs earn interest
income and are subject to credit risk (that is, the chance that a developer will
fail to repay a loan). A hybrid REIT holds properties and mortgages.
5
<PAGE> 73
[FLAG] THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT
STOCK PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING STOCK
PRICES AND PERIODS OF FALLING STOCK PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns (dividend income plus change in market
value) for the U.S. stock market over various periods as measured by the
Standard & Poor's 500 Composite Stock Price Index, a widely used barometer of
stock market activity. Note that the returns shown do not include the costs of
buying and selling stocks or other expenses that a real-world investment
portfolio would incur. Note, also, how the gap between best and worst tends to
narrow over the long term.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926 - 1997)
- -----------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- -----------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 53.9% 23.9% 20.1% 16.9%
Worst -43.3 -12.5 -0.9 3.1
Average 13.0 10.5 10.9 10.9
- -----------------------------------------------------------------
</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1997. For example, while the average return on stocks for all of the
5-year periods was 10.5%, returns for the 5-year periods ranged from a -12.5%
average (from 1928 through 1932), to 23.9% (from 1950 through 1954). These
average returns reflect past performance on common stocks and should not be
regarded as an indication of future returns from either the stock market as a
whole or Vanguard REIT Index Portfolio in particular.
REITs in the Morgan Stanley REIT Index tend to be medium-size and small
companies; their market capitalizations generally range from $75 million to $4
billion. Like small-cap stocks in general, REIT stocks can be more volatile than
- -- and at times will perform differently from -- the large-cap stocks found in
the S&P 500 Index.
In addition, because small-cap stocks are typically less liquid than
large-cap stocks, REIT stocks may sometimes experience greater share-price
fluctuations than the stocks of larger companies. Historically, however, the
significant amount of dividend income provided by REITs has tended to soften the
impact of this volatility.
[FLAG] THE PORTFOLIO IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE
POSSIBILITY THAT CHANGES IN INTEREST RATES COULD HURT REIT PERFORMANCE.
PLAIN TALK ABOUT
INDEXES
An index is a group of securities whose overall performance is used as a
standard to measure investment performance.
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. Vanguard
defines large-capitalization, or large-cap, funds as those holding stocks of
companies with a median total market value exceeding $7.5 billion. Mid-cap funds
hold stocks of companies with a median market value between $1 billion and $7.5
billion. Small-cap funds hold stocks of companies with a median market value of
less than $1 billion.
In general, during periods of high interest rates, REITs may lose some of
their appeal for investors who may be able to obtain higher yields from other
income-producing investments, such as long-term bonds. Higher interest rates
also mean that financing
6
<PAGE> 74
for property purchases and improvements is more costly and difficult to obtain.
SECURITY SELECTION AND PORTFOLIO DIVERSIFICATION
Vanguard REIT Index Portfolio employs a "passively" managed investment approach.
The Portfolio's adviser, Vanguard Core Management Group, invests at least 98% of
the Portfolio's assets in an attempt to parallel the performance of the
Portfolio's target benchmark, the Morgan Stanley REIT Index.
The Portfolio holds each stock contained in the Morgan Stanley REIT Index in
roughly the same proportions as in the Index itself. For example, if 5% of the
Morgan Stanley REIT Index were made up of the stock of a specific REIT, the
Portfolio would invest the same percentage of its noncash assets in that stock.
[FLAG] AN INDEX FUND HAS OPERATING EXPENSES; AN UNMANAGED MARKET INDEX DOES
NOT. THEREFORE, AN INDEX FUND -- WHILE EXPECTED TO PARALLEL ITS TARGET
INDEX AS CLOSELY AS POSSIBLE -- WILL NOT BE ABLE TO MATCH THE
PERFORMANCE OF THE TARGET INDEX EXACTLY. THE CORRELATION BETWEEN THE
PERFORMANCE OF THE REIT INDEX PORTFOLIO AND ITS TARGET INDEX IS
EXPECTED TO BE AT LEAST 0.95.
The Morgan Stanley REIT Index is made up of the stocks of all publicly traded
equity REITs (except health-care REITs) that meet certain criteria. For example,
to be included in the Index, a REIT must have a total market capitalization of
at least $100 million and have enough shares and trading volume to be considered
liquid. Vanguard REIT Index Portfolio invests in equity REITs only.
As of January 31, 1998, 125 equity REITs were included in the Index. The
Index is rebalanced every calendar quarter as well as each time that a REIT is
removed from the Index because the REIT's market capitalization falls below $75
million or because of corporate activity such as a merger, acquisition,
leveraged buyout, bankruptcy, IRS removal of REIT status, fundamental change in
business, or change in shares outstanding.
Stocks in the Morgan Stanley REIT Index represent a broadly diversified range
of property types and regions. The Index's makeup, as of December 31, 1997,
follows.
<TABLE>
<S> <C>
----------------------------
Retail 24%
Residential Apartments 24
Office 24
Industrial 15
Hotels 9
Diversified 4
----------------------------
</TABLE>
The Index's ten largest stocks make up about 31% of its market value. The
Index's largest stocks, as of January 31, 1998, follow.
PLAIN TALK ABOUT
ACTIVE VERSUS PASSIVE MANAGEMENT
Vanguard index portfolios are not actively managed by investment advisers who
buy and sell securities based on research and analysis. Instead, each "passively
managed" portfolio tries to match, as closely as possible, the performance of a
target index by either holding all the securities in the index or by holding a
representative sample. Indexing appeals to many investors because of its
simplicity (indexing is a straightforward market-matching strategy);
diversification (indexes generally cover a wide variety of companies and
industries); relative performance predictability (an index portfolio is expected
to move in the same direction -- up or down -- as its target index); and low
cost (index funds do not have many of the expenses of an actively managed fund
- -- such as research -- and their relatively low turnover of securities helps
keep brokerage commissions to a minimum).
PLAIN TALK ABOUT
PORTFOLIO DIVERSIFICATION
In general, the more diversified a fund's portfolio of stocks, the less likely
that a specific stock's poor performance will hurt the fund. One measure of a
fund's level of diversification is the percentage of assets represented by its
ten largest holdings. The average U.S. equity mutual fund has about 31% of its
assets invested in its ten largest holdings, while some less-diversified mutual
funds have more than 50% of their assets invested in the stocks of just ten
companies.
7
<PAGE> 75
PLAIN TALK ABOUT
PORTFOLIO TURNOVER
Before investing in a mutual fund, you should review its portfolio turnover rate
for an indication of the potential effect of transaction costs on the fund's
future returns. In general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and other transaction
costs will have on its return. Also, funds with high portfolio turnover rates
may be more likely than low-turnover funds to generate capital gains that must
be distributed to shareholders as taxable income. The average turnover rate for
all domestic stock funds is approximately 80%.
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on (or "derived" from)
another 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.
1. Equity Office Properties Trust REIT
2. Equity Residential Properties Trust REIT
3. Crescent Real Estate, Inc. REIT
4. Public Storage, Inc. REIT
5. Simon DeBartolo Group, Inc. REIT
6. Vornado Realty Trust REIT
7. Security Capital Industrial Trust REIT
8. Starwood Lodging Trust REIT
9. Spieker Properties, Inc. REIT
10. Security Capital Pacific, Inc. REIT
Vanguard REIT Index Portfolio is not sponsored, sold, promoted, or endorsed
by Morgan Stanley. The Morgan Stanley REIT Index is the exclusive property of
Morgan Stanley and is a service mark of Morgan Stanley Group Inc. It has been
licensed for use by The Vanguard Group.
PORTFOLIO TURNOVER
Although the Portfolio generally seeks to invest for the long term, it retains
the right to sell securities regardless of how long they have been held.
Generally, a passively managed portfolio sells securities only to respond to
redemption requests or to adjust the number of shares held to reflect a change
in the portfolio's target index. Because of this, the Portfolio's turnover rate
is expected to be less than 25%. (A rate of 100% would occur, for example, if
the Portfolio sold or replaced securities valued at 100% of its total net assets
within a one-year period.)
INVESTMENT POLICIES
Besides normally investing at least 98% of its assets in REIT stocks, the
Portfolio may follow other investment policies to achieve its objectives.
[FLAG] THE PORTFOLIO RESERVES THE RIGHT TO INVEST, TO A LIMITED EXTENT, IN
STOCK FUTURES AND OPTIONS CONTRACTS, AND SWAP AGREEMENTS. STOCK FUTURES
AND OPTIONS CONTRACTS ARE TRADITIONAL TYPES OF DERIVATIVES THAT ARE
PUBLICLY TRADED ON EXCHANGES. SWAP AGREEMENTS ARE CUSTOMIZED CONTRACTS,
OFTEN ARRANGED THROUGH A BROKER, BETWEEN TWO INSTITUTIONS. SWAP
AGREEMENTS FUNCTION LIKE FUTURES, BUT ARE NOT PUBLICLY TRADED ON AN
EXCHANGE.
Losses (or gains) involving contracts can sometimes be substantial -- in part
because a relatively small price movement in a contract may result in an
immediate and substantial loss (or gain) for a portfolio.
The Portfolio will not use futures, options, or swap agreements for
speculative purposes or as leveraged investments that magnify the gains or
losses of an investment. Rather, the Portfolio will keep
8
<PAGE> 76
separate cash reserves or other liquid portfolio securities in the amount of the
obligation underlying the contract. Only a limited percentage of the Portfolio's
assets -- 5% -- may be applied toward the deposits required on futures
contracts, and the value of all futures contracts in which the Portfolio
acquires an interest cannot exceed 20% of the Portfolio's total assets. To the
extent that such contracts are utilized, the Portfolio will not have 98% of its
assets invested in REIT stocks. However, such contracts will only be utilized to
mirror the performance of the Index.
The reasons for which the Portfolio may use futures, options, and swap
agreements are:
- - To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in stocks.
- - To reduce the Portfolio's transaction costs or to add value when these
instruments are favorably priced.
Although up to 2% of its assets will be invested in cash reserves to maintain
liquidity, the Portfolio will not invest in cash reserves, futures, options, or
swap agreements to protect against a decline in the values of REITs.
INVESTMENT LIMITATIONS
The Portfolio has adopted limitations on some of its investment practices. Some
of these limitations are that the Portfolio will not:
- - Invest more than 25% of its assets in any one industry other than real
estate.
- - Borrow money, except for temporary or emergency purposes in an amount not
exceeding 15% of its net assets. Whenever the Portfolio's outstanding
borrowing is more than 5% of its assets, it will stop making investments.
With respect to 75% of its assets, the Portfolio will not:
- - Invest more than 5% of its assets in the securities of any one company.
- - Buy more than 10% of the outstanding voting securities of any company.
A complete list of the Portfolio's investment limitations can be found in the
Statement of Additional Information. These limitations are fundamental and may
be changed only by approval of a majority of the Portfolio's shareholders.
INVESTMENT PERFORMANCE
Vanguard REIT Index Portfolio invests primarily in stocks of real estate
investment trusts, so its performance may not be correlated to the performance
of the overall stock market. Historically, stock market performance has been
characterized by sharp up-and-down swings in the short term and by more stable
growth over the long term. There may be periods, however, when REITs perform
quite differently from the broader market.
9
<PAGE> 77
AVERAGE ANNUAL TOTAL RETURNS
FOR PERIODS ENDED JANUARY 31, 1998
[GRAPH OMITTED]
SHARE PRICE
The Portfolio'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,
generally 4 p.m. Eastern time. Net asset value per share is computed by adding
up the total value of the Portfolio's investments and other assets, subtracting
any of its liabilities, or debts, and then dividing by the total number of
Portfolio shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = ---------------------------------
NUMBER OF SHARES OUTSTANDING
Daily net asset value is useful to you as a shareholder because the NAV,
multiplied by the number of Portfolio shares you own, gives you the dollar
amount you would have received had you sold all of your shares back to the
Portfolio that day.
The Portfolio'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 Portfolio's name, but the most common is
SPREIT.
DISTRIBUTIONS AND TAXES
Each March, June, September, and December, Vanguard REIT Index Portfolio will
provide shareholders with virtually all of the distributions it receives from
its REIT investments. Any capital gains realized from the sale of securities
will be distributed in December. In addition, the Portfolio may occasionally be
required to make supplemental dividend or capital gains distributions at some
other time during the year.
You may receive distributions in cash, or you may have them automatically
reinvested in more shares of the Portfolio.
If you own Portfolio shares in a nonretirement account, Vanguard will notify
you each year of the amount and taxability of the Portfolio's distributions paid
during the previous year (that is, the amount of dividends, capital gains, and
return of capital that you
PLAIN TALK ABOUT
PAST PERFORMANCE
Whenever you see information on a fund's performance, do not consider the
figures to be an indication of the performance you could expect by making an
investment in the fund today. The past is an imperfect guide to the future;
history does not repeat itself in neat, predictable patterns.
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your share of the Portfolio's earnings.
You receive such earnings from the Portfolio as either a quarterly distribution
or as an annual capital gains distribution. The Portfolio's quarterly payments
come from distributions that the Portfolio receives from its REIT holdings and
interest it earns from any cash reserves. Capital gains are realized when the
Portfolio sells REIT stocks for higher prices than its adjusted cost basis in
the stocks. These gains may be short-term or long-term, depending on whether the
Portfolio held the securities for less than or more than one year.
10
<PAGE> 78
receive). You will also be notified of the amount, if any, of federal income
taxes withheld from the distribution.
REITs do not provide complete information about the taxability of their
distributions until after the calendar year-end. As a result, Vanguard cannot
determine how much of the Portfolio's annual distributions is taxable for
shareholders until after the traditional January 31 deadline for issuing Forms
1099-DIV ("1099"). Therefore, we will request permission each year from the
Internal Revenue Service (IRS) for an extension. IF OUR REQUEST IS APPROVED, WE
EXPECT TO MAIL FORMS 1099-DIV TO VANGUARD REIT INDEX PORTFOLIO SHAREHOLDERS WITH
NONRETIREMENT ACCOUNTS IN FEBRUARY.
TAXABILITY OF DISTRIBUTIONS
The portions of your distributions that are classified as dividends and
short-term capital gains are taxable to you as ordinary dividend income. Any
distributions of net long-term capital gains by the Portfolio are taxable to you
as long-term capital gains, no matter how long you've owned shares in the
Portfolio. Both dividends and capital gains are taxable to you whether received
in cash or reinvested in additional shares. In addition, distributions 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.
Although the Portfolio 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 and distributions paid by
REITs. Consequently, distributions may vary from year to year.
If you sell or exchange shares of the Portfolio, any gain or loss you have is
generally a taxable event, which means that you may have a capital gain or a
capital loss to report when you complete your federal income tax return.
Distributions -- as well as capital gains or losses from your sale or exchange
of Portfolio shares -- may be subject to state and local income taxes, too.
Note that any dividends distributed by REITs -- and funds that invest in
REITs -- are not eligible for the dividends-received deduction for corporations.
RETURN OF CAPITAL
The portion of your distributions that is classified as a return of capital is
generally not taxable to you. However, when you receive a return of capital,
your cost basis (that is, the adjusted cost of your investment, which is used to
determine a capital gain or loss) is decreased by the amount of the return of
capital. This, in turn, will affect the capital gain or loss you realize when
you sell or exchange any of your Vanguard REIT Index Portfolio shares.
Two other important tax considerations about return of capital:
- - If you do not reinvest your distributions (that is, you receive your
distributions in cash), your original investment in the Portfolio will be
reduced by the amount of return of capital and capital gains included in the
distribution.
PLAIN TALK ABOUT
RETURN OF CAPITAL
The Internal Revenue Code requires a REIT to distribute at least 95% of its
taxable income to investors. In many cases, however, because of "noncash"
expenses such as property depreciation, an equity REIT's cash flows will exceed
its taxable income. The REIT may distribute this excess cash to offer a more
competitive yield (in other words, provide investors with a higher
distribution). This portion of the distribution is classified as a return of
capital.
11
<PAGE> 79
- - A return of capital is generally not taxable to you; however, any return of
capital distribution would be taxable as a capital gain once your cost basis
is reduced to zero (which could happen if you do not reinvest your
distributions and return of capital in those distributions is significant).
Keep in mind that the tax information in this prospectus is provided as
general information. You should consult your own tax adviser about the tax
consequences of an investment in the Portfolio.
THE PORTFOLIO AND VANGUARD
Vanguard REIT Index Portfolio, a part of Vanguard Specialized Portfolios, Inc.
(the "Fund"), is a member of The Vanguard Group, a family of more than 30
investment companies with more than 95 distinct investment portfolios and total
net assets of more than $370 billion. All of the Vanguard funds share in the
expenses associated with business operations, such as personnel, office space,
equipment, and advertising.
Vanguard also provides marketing services to the funds. Although shareholders
do not pay sales commissions or 12b-1 marketing fees, each fund pays its
allocated share of The Vanguard Group's costs.
A list of the Fund's Directors and officers, and their present positions and
principal occupations during the past five years, can be found in the Statement
of Additional Information.
INVESTMENT ADVISER
Vanguard Core Management Group, P.O. Box 2600, Valley Forge, PA 19482, provides
investment advisory services on an at-cost basis to the Portfolio.
The Group is authorized to choose brokers and dealers to handle the purchase
and sale of the Portfolio's securities, and is directed to get the best
available price and most favorable execution from these brokers with respect to
all transactions.
GENERAL INFORMATION
Vanguard REIT Index Portfolio is one of five Portfolios of Vanguard Specialized
Portfolios, Inc. (the "Fund"), a corporation organized under the laws of the
state of Maryland. The other Portfolios are the Energy, Gold & Precious Metals,
Health Care, and Utilities Income Portfolios. The Portfolios are all combined
under one corporation for administrative purposes, but operate as separate
entities in virtually all other respects.
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group, Inc., is the only MUTUAL mutual fund company. It is owned
jointly by the funds it oversees and by the shareholders in those funds. Other
mutual funds are operated by for-profit management companies that may be owned
by one person, by a group of individuals, or by investors who bought the
management company's publicly traded stock. Because of its structure, Vanguard
operates its funds at cost. Instead of distributing profits as other mutual fund
companies do, Vanguard returns profits to fund shareholders in the form of lower
operating expenses.
PLAIN TALK ABOUT
THE PORTFOLIO'S ADVISER
Vanguard Core Management Group provides investment advisory services to many
Vanguard Funds; as of January 31, 1998, the Group managed $100 billion in
assets. The individual who oversees Vanguard REIT Index Portfolio is:
GEORGE U. SAUTER, Managing Director of Vanguard; has worked in investment
management since 1985; with Vanguard since 1987, including primary
responsibility for Vanguard Core Management Group since 1987; A.B., Dartmouth
College, M.B.A., University of Chicago.
12
<PAGE> 80
Shareholders of Vanguard REIT Index Portfolio have rights and privileges
similar to those enjoyed by other corporate shareholders. For example,
shareholders will not be responsible for any liabilities of the corporation. If
any matters are to be voted on by shareholders (such as a change in a
fundamental investment objective or the election of Directors), each share
outstanding at that point would be entitled to one vote. The Portfolio will not
hold annual meetings except as required by the Investment Company Act of 1940. A
meeting will be scheduled (for example, to vote on the removal of a Director) if
the holders of at least 10% of the Fund's shares request a meeting in writing.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc.
13
<PAGE> 81
INVESTING WITH VANGUARD
Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information? Establish an account for a
minor child or for your retirement savings?
Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.
The following sections of the prospectus briefly explain the many services we
offer you as a Vanguard REIT Index Portfolio shareholder. Booklets providing
detailed information are available on the services marked with a [BOOK GRAPHIC].
Please call us to request copies.
SERVICES AND ACCOUNT FEATURES
Vanguard offers many services that make it convenient to buy, sell, or exchange
shares.
<TABLE>
<S> <C>
TELEPHONE REDEMPTIONS Automatically set up for this Portfolio unless you notify us otherwise.
(SALES FOR NONRETIREMENT
ACCOUNTS ONLY; EXCHANGES FOR
RETIREMENT ACCOUNTS ONLY)
VANGUARD DIRECT DEPOSIT Automatic method for depositing your paycheck or U.S. government payment
SERVICE(TM) (including Social Security and government pension checks) into your account.
[BOOK GRAPHIC]
VANGUARD AUTOMATIC EXCHANGE SERVICE(TM) Automatic method for moving a fixed amount of money from one
[BOOK GRAPHIC] Vanguard fund account to another.*
VANGUARD FUND EXPRESS(R) Electronic method for buying or selling shares. You can transfer money
[BOOK GRAPHIC] 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) Electronic method for transferring distributions directly from your Vanguard
[BOOK GRAPHIC] fund account to your bank, savings and loan, or credit union account.
VANGUARD BROKERAGE SERVICES A cost-effective way to trade stocks, bonds, and options on major
(VBS) exchanges, Nasdaq, and other domestic over-the-counter markets at reduced
[BOOK GRAPHIC] rates, and to buy and sell shares of non-Vanguard mutual funds. Call VBS
(1-800-992-8327) for additional information and the appropriate forms.
</TABLE>
"Can be used to "dollar cost average" [BOOK GRAPHIC] or to contribute to an IRA
or other retirement plan.
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
14
<PAGE> 82
TYPES OF ACCOUNTS
INDIVIDUAL OR OTHER ENTITY
Vanguard's account registration form can be used to establish a variety of
nonretirement accounts.
<TABLE>
<S> <C>
FOR ONE OR MORE PEOPLE To open an account in the name of one (individual) or more (joint
tenants) people. $3,000 minimum initial investment.
FOR A MINOR CHILD To open an account as an UGMA/UTMA (Uniform Gifts/Transfers to Minors Act). Age
[BOOK GRAPHIC] of majority and other requirements are set by state law. $1,000 minimum initial
investment.
FOR A MINOR CHILD To open an account as an Education IRA. Eligibility and other
(Vanguard Fiduciary Trust requirements are established by federal tax law and the Vanguard Education IRA.
Company is the custodian.) (Note: You should establish this type of account with a Vanguard adoption
[BOOK GRAPHIC] agreement -- not an account registration form.) Please call Investor Information
to request the appropriate brochure and forms. $500 minimum initial investment.
FOR HOLDING TRUST ASSETS To invest assets held in an existing trust. $3,000 minimum initial
[BOOK GRAPHIC] investment.
FOR THIRD-PARTY TRUSTEE To open an account as a retirement trust or plan based on an existing corporate
RETIREMENT INVESTMENTS or institutional plan. These accounts are established by the custodian or
(Vanguard is not the custodian trustee of the existing plan. $1,000 minimum initial investment.
or trustee.)
1-800-662-2003
Individual Retirement Plans
FOR AN ORGANIZATION To open an account as a corporation, partnership, or other entity. These
accounts may require a corporate resolution or other documents to name the
individuals authorized to act. $3,000 minimum initial investment.
</TABLE>
RETIREMENT
You establish these accounts with a Vanguard adoption agreement -- not a
Vanguard account registration form. To request the appropriate adoption
agreement and forms, or to receive answers to your questions about investing for
retirement, call Investor Information.
<TABLE>
<S> <C>
FOR A TRADITIONAL INDIVIDUAL To open a retirement account in the name of an individual. Traditional IRAs can
RETIREMENT ACCOUNT be established with a contribution, a direct rollover from an employer's plan
(TRADITIONAL IRA) such as a 401(k), or an asset transfer or rollover from another financial
(Vanguard Fiduciary Trust institution, such as a bank or mutual fund company. $1,000 minimum initial
Company is the custodian.) investment.
FOR A ROTH INDIVIDUAL To open an after-tax retirement savings account in the name of an individual.
RETIREMENT ACCOUNT Roth IRAs can be established with an after-tax contribution, an asset transfer
(ROTH IRA) or rollover from another financial institution such as a bank or mutual fund
(Vanguard Fiduciary Trust company, or a conversion of an existing IRA. Eligibility and other requirements
Company is the custodian.) are established by federal tax law. $1,000 minimum initial investment.
</TABLE>
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
15
<PAGE> 83
TYPES OF ACCOUNTS (continued)
<TABLE>
<S> <C>
FOR A SIMPLIFIED EMPLOYEE To open a retirement account in the name of an employee. SEPs allow employers to
PENSION PLAN ACCOUNT (SEP - IRA) make deductible contributions directly to IRAs established by their employees.
(Vanguard Fiduciary Trust SEPs can be established by people who are self-employed, small-business owners,
Company is the custodian.) partnerships, or corporations.
1-800-662-2003
Individual Retirement Plans
FOR A SAVINGS INCENTIVE MATCH To open a retirement account in the name of an employee. Created as part of the
PLAN FOR EMPLOYEES ACCOUNT Small Business Job Protection Act of 1996, SIMPLEs replace SAR - SEPs. SIMPLEs
(SIMPLE IRA) are exclusively for employers that had 100 or fewer employees in the most recent
(Vanguard Fiduciary Trust calendar year and that do not maintain another employer-sponsored retirement
Company is the custodian.) plan. SIMPLEs can be established by people who are self-employed, small-business
1-800-662-2003 owners, partnerships, or corporations. Salary reduction contributions may be
Individual Retirement Plans made by the employee, with matching or nonmatching contributions from the
employer.
FOR A QUALIFIED RETIREMENT To open a retirement account that allows small-business owners or people who are
PROGRAM ACCOUNT self-employed to make tax-deductible retirement contributions for themselves and
(Vanguard Fiduciary Trust their employees into Profit-Sharing and Money Purchase Pension (Keogh) plans.
Company can be the custodian.)
1-800-662-2003
Individual Retirement Plans
FOR A 403(b)(7) CUSTODIAL ACCOUNT To open a retirement account that allows employees of tax-exempt institutions
(Vanguard Fiduciary Trust (for example, schools or hospitals) to make pretax retirement contributions.
Company is the custodian.)
1-800-662-2003
Individual Retirement Plans
</TABLE>
DISTRIBUTION OPTIONS
You can receive Portfolio distributions in two ways:
<TABLE>
<S> <C>
REINVESTMENT Distributions are automatically reinvested in additional shares of the Portfolio
unless you request a different distribution method.
DISTRIBUTIONS IN CASH Distributions are paid by check and mailed to your account's address of record.
NOTE: If you do not reinvest your distributions, your original investment will
be reduced by the amount of the return of capital in the distribution. See
"Distributions and Taxes."
</TABLE>
To electronically transfer cash distributions to your bank, savings and loan, or
credit union account, see Vanguard Dividend Express under "Services and Account
Features." To transfer cash distributions to another Vanguard fund, call Client
Services.
If you have elected to receive distributions in cash, but the Postal Service is
unable to make delivery to your address of record, your distribution option will
be changed to reinvestment. No interest will accrue on amounts represented by
uncashed distribution checks.
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
16
<PAGE> 84
BUYING SHARES
You buy your shares at the Portfolio's next-determined net asset value after
Vanguard receives your request, provided we receive your request before the
close of trading on the New York Stock Exchange (the "Exchange"), generally 4
p.m. Eastern time. The Portfolio is offered on a no-load basis, meaning that you
do not pay sales commissions or 12b-1 marketing fees.
<TABLE>
<CAPTION>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
<S> <C> <C> <C>
MINIMUM INVESTMENT $3,000 (regular account); $1,000 $100 by mail or exchange; $1,000 by
(Traditional IRAs, Roth IRAs, and wire.
custodial accounts for minors);
$500 (Education IRAs).
BY MAIL Complete and sign the application Mail your check with an
[ENVELOPE GRAPHIC] form. Invest-By-Mail form detached from
FIRST-CLASS mail to: your confirmation statement to the
The Vanguard Group address listed on the form.
P.O. Box 2600
Valley Forge, PA 19482-2600 Make your check payable to: Make your check payable to:
The Vanguard Group - 123 The Vanguard Group - 123
EXPRESS or REGISTERED mail to: All purchases must be made in U.S. All purchases must be made in U.S.
The Vanguard Group dollars, and checks must be dollars, and checks must be drawn
455 Devon Park Drive drawn on U.S. banks. on U.S. banks.
Wayne, PA 19087-1815
</TABLE>
IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.
<TABLE>
<S> <C> <C>
BY TELEPHONE Call Vanguard Tele-Account* 24 Call Vanguard Tele-Account* 24
[TELEPHONE GRAPHIC] hours a day -- or Client Services hours a day -- or Client Services
1-800-662-6273 during business hours -- to during business hours -- to
Vanguard Tele-Account(R) exchange from another Vanguard fund exchange from another Vanguard fund
account with the same registration account with the same registration
1-800-662-2739 (name, address, taxpayer I.D., and (name, address, taxpayer I.D., and
Client Services account type). account type).
Telephone exchanges for Telephone exchanges for
nonretirement accounts are not nonretirement accounts are not
permitted. permitted.
</TABLE>
*You must obtain a Personal Identification
Number through Tele-Account at least
seven days before you request your
first exchange.
IMPORTANT NOTE: Once a telephone transaction has been approved by you and a
confirmation number assigned, it cannot be revoked. We reserve the right to
refuse any purchase.
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
17
<PAGE> 85
BUYING SHARES (continued)
<TABLE>
<CAPTION>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
<S> <C> <C>
BY WIRE Call Client Services to arrange your Call Client Services to arrange your
[WIRE GRAPHIC] wire transaction. wire transaction.
Wire to:
CoreStates Bank, N.A. Wire transactions are not available Wire transactions are not available
ABA 031000011 for retirement accounts, except for for retirement accounts, except for
CoreStates No. 0101 9897 asset transfers and direct asset transfers and direct
[Temporary Account Number] rollovers. rollovers.
Vanguard REIT Index Portfolio
[Account Registration]
Attention: Vanguard
AUTOMATICALLY -- Vanguard offers a variety of
[ARROWS GRAPHIC] ways that you can add to your
account automatically. See
"Services and Account Features."
</TABLE>
You can redeem (that is, sell or exchange) shares purchased by check or Vanguard
Fund Express at any time. However, while your redemption request will be
processed as soon as 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.
IMPORTANT NOTE: If you buy Portfolio shares through a registered broker/dealer
or investment adviser, the broker/dealer or adviser may charge you a service
fee.
It is important that you call Vanguard before you invest a large dollar
amount by wire or check. We must consider the interests of all Portfolio
shareholders and so reserve the right to delay or refuse any purchase that will
disrupt the Portfolio's operation or performance.
REDEEMING SHARES
IMPORTANT TAX NOTE: Any sale or exchange of shares in a nonretirement account
could result in a taxable gain or a loss.
A 1% fee is charged for all redemptions (sales and exchanges) of Portfolio
shares held less than one year. This fee is paid to the Portfolio.
The ability to sell Portfolio shares by telephone is automatically established
for your nonretirement account unless you tell us in writing that you do not
want this option.
To protect your account from unauthorized or fraudulent telephone
instructions, Vanguard follows specific security procedures. When we receive a
call requesting an account transaction, we require the caller to provide:
- - Portfolio name.
- - 10-digit account number.
- - Name and address exactly as registered on that account.
- - Social Security or employer identification number as registered on that
account.
If you call to sell shares, the sale proceeds will be made payable to you, as
the registered shareholder, and mailed to your account's address of record.
If we follow reasonable security procedures, neither the Portfolio nor
Vanguard will be responsible for the authenticity of transaction instructions
received by telephone. We believe that
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
18
<PAGE> 86
REDEEMING SHARES (continued)
these procedures are reasonable and that, if we follow them, you bear the risk
of any losses resulting from unauthorized or fraudulent telephone transactions
on your account.
HOW TO SELL SHARES
You may withdraw any part of your account, at any time, by selling shares.
Sale proceeds are normally mailed within two business days after Vanguard
receives your request. The sale price of your shares will be the Portfolio's
next-determined net asset value after Vanguard receives all required documents
in good order.
Good order means that the request includes:
- - Portfolio name and account number.
- - Amount of the transaction (in dollars or shares).
- - Signatures of all owners exactly as registered on the account.
- - Signature guarantees (if required).
- - Any supporting legal documentation that may be required.
- - Any certificates you are holding for the account.
Sales or exchange requests received after the close of trading on the
Exchange are processed at the next business day's net asset value. No interest
will accrue on amounts represented by uncashed redemption checks. The Portfolio
will not cancel any trade (e.g., purchase, redemption, or exchange) believed to
be authentic once the trade request has been received in writing or by
telephone.
The Portfolio reserves the right to close any nonretirement or UGMA/UTMA
account in which the balance falls below the minimum initial investment. The
Portfolio will deduct a $10 annual fee in either June or December if your
nonretirement account balance falls below $2,500 or if your UGMA/UTMA account
balance falls below $500. The fee is waived if your total Vanguard fund account
assets are $50,000 or more.
Some written requests require a signature guarantee from a bank, broker, or
other acceptable financial institution. A notary public cannot provide a
signature guarantee.
HOW TO EXCHANGE SHARES
An exchange is the selling of shares of one Vanguard fund to purchase shares of
another.
Although every effort will be made to maintain the exchange privilege,
Vanguard reserves the right to revise or terminate the exchange privilege, limit
the amount of an exchange, or reject any exchange, at any time, without notice.
Because excessive exchanges can potentially disrupt the management of the
Portfolio and increase transaction costs, Vanguard limits exchange activity to
TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (at least 30 days apart) from the Portfolio
during any 12-month period. "Substantive" means either a dollar amount or a
series of movements between Vanguard funds that Vanguard determines, in its sole
discretion, could have an adverse impact on the management of the Portfolio.
Before you exchange into a new Vanguard fund, be sure to read its prospectus.
For a copy and for answers to questions you might have, call Investor
Information.
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
19
<PAGE> 87
REDEEMING SHARES (continued)
<TABLE>
<CAPTION>
SELLING OR EXCHANGING SHARES ACCOUNT TYPE
<S> <C>
BY TELEPHONE ALL TYPES EXCEPT RETIREMENT:
[TELEPHONE GRAPHIC] Call Vanguard Tele-Account* 24 hours a day -- or Client
1-800-662-6273 Services during business hours -- to request a sale of
Vanguard Tele-Account shares. You cannot exchange shares of this Portfolio by telephone.
1-800-662-2739 RETIREMENT:
Client Services You can exchange -- but not sell -- shares by calling Tele-Account or Client
Services.
*You must obtain a Personal Identification Number through
Tele-Account at least seven days before you request your
first sale of shares.
BY MAIL ALL TYPES EXCEPT RETIREMENT:
[ENVELOPE GRAPHIC] Send a letter of instruction signed by all registered
FIRST-CLASS mail to: account holders. Include the Portfolio name and account
The Vanguard Group number and (if you are selling) a dollar amount or number of
Vanguard REIT Index Portfolio shares OR (if you are exchanging) the name of the fund you
P.O. Box 1120 want to exchange into and a dollar amount or number of
Valley Forge, PA 19482-1120 shares. To exchange into an account with a different
registration (including a different name, address, or
taxpayer identification number), you must provide Vanguard
with written instructions that include the guaranteed
signatures of all current account owners.
EXPRESS or REGISTERED mail to:
The Vanguard Group
Vanguard REIT Index Portfolio RETIREMENT:
455 Devon Park Drive For information on how to request distributions from:
Wayne, PA 19087-1815 - Traditional IRAs, Roth IRAs, Education 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.
EXCHANGING SHARES ONLINE You may use your personal computer to exchange shares of most Vanguard funds by
[COMPUTER GRAPHIC] accessing our website (www.vanguard.com). To establish this service for your
account, you must first register through the website. We will then send to you,
by mail, an account access password that will enable you to make online exchanges.
The Vanguard funds that you cannot purchase or sell through online exchange are
VANGUARD INDEX TRUST, VANGUARD BALANCED INDEX FUND, VANGUARD INTERNATIONAL
EQUITY INDEX FUND, VANGUARD REIT INDEX PORTFOLIO, VANGUARD TOTAL INTERNATIONAL
PORTFOLIO, and VANGUARD GROWTH AND INCOME PORTFOLIO (formerly known as Vanguard
Quantitative Portfolios). These funds do permit online exchanges within IRAs and
other retirement accounts.
AUTOMATICALLY ALL TYPES EXCEPT RETIREMENT:
[ARROWS GRAPHIC] Vanguard offers several ways to sell or exchange shares automatically (see
"Services and Account Features"). Call Investor Information for the appropriate
booklet and application if you did not elect this feature when you opened your account.
</TABLE>
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
20
<PAGE> 88
REDEEMING SHARES (continued)
It is important that you call Vanguard before you redeem a large dollar
amount. We must consider the interests of all Portfolio shareholders and so
reserve the right to delay delivery of your redemption proceeds -- up to seven
days -- if the amount will disrupt the Portfolio's operation or performance.
A NOTE ON UNUSUAL CIRCUMSTANCES
Vanguard reserves the right to revise or terminate the telephone redemption
privilege at any time, without notice. In addition, Vanguard can stop selling
shares or postpone payment at times when the New York Stock Exchange is closed
or under any emergency circumstances as determined by the 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 the "Redeeming Shares" section.
TRANSFERRING REGISTRATION
HOW TO TRANSFER SHARES
You may transfer the registration of your Portfolio shares to another owner by
completing a transfer form and sending it to: The Vanguard Group, Attention:
Transfer Department, P.O. Box 1110, Valley Forge, PA 19482-1110.
PORTFOLIO AND ACCOUNT UPDATES
STATEMENTS AND REPORTS
We will send you clear, concise account and tax statements to help you keep
track of your Portfolio account throughout the year as well as when you are
preparing your income tax returns.
In addition, you will receive financial reports about Vanguard REIT Index
Portfolio twice a year. These comprehensive reports include an assessment of the
Portfolio's performance (and a comparison to its industry benchmark), an
overview of the markets, a report from the adviser, a listing of the Portfolio's
holdings, and other financial statements. To keep the Portfolio's costs as low
as possible (so that you and other shareholders can keep more of the Portfolio's
investment earnings), Vanguard attempts to eliminate duplicate mailings to the
same address. When we find that two or more Portfolio shareholders have the same
last name and address, we send just one Portfolio 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 Investor Information Department at
1-800-662-7447.
<TABLE>
<S> <C>
CONFIRMATION STATEMENT Sent each time you buy, sell, or exchange shares; confirms the trade date and
the amount of your transaction.
PORTFOLIO SUMMARY Mailed quarterly; shows the market value of your account at the close of the
[BOOK GRAPHIC] statement period, as well as distributions, purchases, sales, and exchanges for
the current calendar year.
FUND FINANCIAL REPORTS Mailed in March and September for this Portfolio.
TAX STATEMENTS Generally mailed in January; report previous year's distributions, proceeds from
the sale of shares, and distributions from IRAs or other retirement accounts.
</TABLE>
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
21
<PAGE> 89
PORTFOLIO AND ACCOUNT UPDATES (continued)
<TABLE>
<S> <C>
AVERAGE COST STATEMENT Issued annually for most taxable accounts; shows the average cost of shares
[BOOK GRAPHIC] that you redeemed during the calendar year, using the average-cost
single-category method.
AUTOMATED TELEPHONE ACCESS
VANGUARD TELE-ACCOUNT Toll-free access to Vanguard fund and account information -- as well as some
1-800-662-6273 transactions -- through any touch-tone telephone. Tele-Account provides total
Any time, seven days a week, return, share price, price change, and yield quotations for all Vanguard funds;
from anywhere in the continental gives your account balances and history (e.g., last transaction and latest
United States. distribution); and allows you to sell or exchange fund shares.
[BOOK GRAPHIC]
COMPUTER ACCESS
VANGUARD ONLINE(R) Use your personal computer to learn more about Vanguard's funds and services;
www.vanguard.com keep in touch with your Vanguard accounts; map out a long-term investment
strategy; initiate certain transactions; and ask questions, make suggestions,
and send messages to Vanguard.
Our education-oriented website provides timely news and information about
Vanguard's 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.
</TABLE>
Investor Information 1-800-662-7447
Client Services 1-800-662-2739
Tele-Account 1-800-662-6273
22
<PAGE> 90
PROSPECTUS POSTSCRIPT
This prospectus is designed to provide you with pertinent information about
Vanguard REIT Index Portfolio, including its investment objectives, risks,
strategy, and expenses, as well as services available to you as a shareholder.
It is important that you understand these facts so that you can decide
whether an investment in the Portfolio is right for you. The following questions
offer a quick review of some of the subjects covered by this prospectus.
IN READING THE PROSPECTUS, DID YOU LEARN:
- The Portfolio's objectives? (page 4)
- The Portfolio's investment strategy? (page 5)
- Who should invest in the Portfolio? (page 4)
- The risks associated with the Portfolio? (pages 4 - 9)
- Whether the Portfolio is federally insured?
(inside front cover)
- The Portfolio's expenses? (page 2)
- The background of the Portfolio's investment adviser?
(page 12)
- How to open an account? (page 17)
- How to sell or exchange shares? (pages 18 - 19)
- How often you'll receive statements and financial reports?
(pages 21 - 22)
PLAIN TALK ABOUT
KEEPING YOUR PROSPECTUS
Reading this prospectus will help you to decide whether Vanguard REIT Index
Portfolio is suitable for your investment goals. If you decide to invest, don't
throw the prospectus out; you will no doubt need it for future reference.
23
<PAGE> 91
AN INVESTMENT PRIMER
Whether you are investing for the short or long term, keep these three points in
mind:
1. INVEST IN ALL THREE OF THE MAJOR ASSET CLASSES.
Most people use a combination of ...
- - Stocks, which are considered the "riskiest" of the three asset classes. Day
to day, or even year to year, stocks tend to have wide price swings. Despite
this potential for significant price fluctuation, however, stocks have
historically offered higher returns than the other major asset classes over
longer periods.
- - Bonds, which are chiefly influenced by changes in interest rates. When
interest rates climb, bond prices drop; when interest rates fall, bond prices
rise.
- - Cash reserves, which offer more share-price (or capital) stability than
stocks or bonds -- but also generate lower returns. Some examples are
Treasury bills and money market funds.
2. REMEMBER THAT SAFETY HAS A PRICE.
Many people want a "no-risk" investment. Remember, though, that the more safety
you seek, the less potential reward you can expect -- and the less you can
expect in returns after inflation. Inflation affects not only the price you pay
for goods and services; it also eats away at your investment returns over time.
What is left is known as your "real" return -- the actual return you receive
after you factor in inflation (see the chart at left).
3. LONG TERM INVESTORS USUALLY CAN AFFORD TO TAKE MORE RISK.
As the chart shows, inflation cuts into the returns of all three asset classes.
However, stocks and bonds have had an easier time of outpacing inflation over
time -- which means that, to beat inflation, you may need to invest more
aggressively.
Don't be put off by potential downswings in the value of your investment when
you are investing for long periods. Time acts as a shock absorber, letting you
ride out the short-term bumps that investments often provide. The longer you
hold an investment, the more likely it is that you will earn a positive return.
PLAIN TALK ABOUT
INFLATION AND YOUR
INVESTMENTS
No matter how you invest your money, inflation -- the rising cost of living --
is a constant threat to your investment returns. The chart below shows how
stocks, bonds, and cash reserves have fared against inflation over time.
INFLATION'S EFFECT ON
INVESTMENT RETURNS
(1926 - 1997)
[CHART OMITTED]
Source: (C) Stocks, Bonds, Bills, and Inflation 1998 Yearbook(TM), Ibbotson
Associates, Chicago (annually updates work by Roger G. Ibbotson and Rex A.
Sinquefield). Used with permission. All rights reserved.
24
<PAGE> 92
GLOSSARY OF INVESTMENT TERMS
ACTIVE MANAGEMENT
An investment approach that seeks to exceed the average returns of the financial
markets. Active managers rely on research, market forecasts, and their own
judgment and experience in selecting securities to buy and sell.
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) or gains distributed by
the fund's holdings themselves.
COMMON STOCK
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which are paid out as
dividends.
COST BASIS
The adjusted cost of an investment used to determine a capital gain or loss for
tax purposes.
DISTRIBUTIONS
Payments to shareholders of dividend income, capital gains, and return of
capital generated by the fund's investment activities and distribution policies,
after expenses.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by the
fund's investments. For tax purposes, dividend income also includes short-term
capital gains.
EQUITY REIT
A type of real estate investment trust (REIT) that earns rental income by
investing in land and buildings.
EXPENSE RATIO
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
marketing fees.
FIXED-INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
INDUSTRY CONCENTRATION
Focusing on the securities of a specific industry (such as real estate,
technology, or utilities).
LIQUIDITY
The degree of a security's marketability (that is, how quickly the security can
be sold at a fair price and converted to cash).
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.
PASSIVE MANAGEMENT
A low-cost investment strategy in which a mutual fund tries to match -- rather
than outperform -- a particular market index. Also known as indexing.
PRINCIPAL
The amount of your own money you put into an investment.
REAL ESTATE INVESTMENT TRUST (REIT)
A company that owns and manages a portfolio of properties, mortgages, or both.
RETURN OF CAPITAL
A nontaxable portion of distributions. In general, the cost basis of an
investment is reduced when a return of capital is distributed, deferring taxes
until the investment is sold.
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
Current income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE> 93
[SHIP GRAPHIC]
THE VANGUARD GROUP
Post Office Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT
1-800-662-7447 (SHIP)
TEXT TELEPHONE:
1-800-952-3335
For information on our funds,
fund services, and retirement
accounts; requests for
literature
CLIENT SERVICES DEPARTMENT
1-800-662-2739 (CREW)
TEXT TELEPHONE:
1-800-662-2738
For information on your
account, account transactions,
and account statements
VANGUARD BROKERAGE
SERVICES
1-800-992-8327
For information on trading
stocks, bonds, and options
at reduced commissions
VANGUARD TELE-ACCOUNT(R)
1-800-662-6273 (ON-BOARD)
For 24-hour automated access
to price and yield, information
on your account, and certain
transactions
ELECTRONIC ACCESS TO THE
VANGUARD MUTUAL FUND
EDUCATION AND INFORMATION
CENTER
World Wide Web
www.vanguard.com
E-mail
[email protected]
(C) 1998 Vanguard Marketing
Corporation, Distributor
P123N
<PAGE> 94
PART B
VANGUARD SPECIALIZED PORTFOLIOS
STATEMENT OF ADDITIONAL INFORMATION
MAY 22, 1998
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated May 22, 1998). To obtain the Prospectus
please call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and Policies.......................... B-1
Investment Policies......................................... B-2
Investment Limitations...................................... B-6
Management of the Fund...................................... B-8
Investment Advisory Services................................ B-11
Securities Transactions..................................... B-12
Purchase of Shares.......................................... B-13
Redemption of Shares........................................ B-14
Share Price of Each Portfolio............................... B-14
Performance Measures........................................ B-15
Yield and Total Return...................................... B-17
Financial Statements........................................ B-17
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
The following policies supplement the Fund's investment objectives and
policies set forth in the Prospectus.
FOREIGN INVESTMENTS. As indicated in the Prospectus, each Portfolio (with
the exception of the REIT Index Portfolio) may include foreign securities to a
certain extent. Investors should recognize that investing in foreign companies
involves certain special considerations which are not typically associated with
investing in U.S. companies. Since the stocks of foreign companies are
frequently denominated in foreign currencies, and since the Portfolio may
temporarily hold uninvested reserves in bank deposits in foreign currencies, the
Portfolio 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 each
Portfolio permit it to enter into forward foreign currency exchange contracts in
order to hedge the Portfolio's 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.
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 each Portfolio will endeavor to achieve most favorable execution
costs in its portfolio transactions in foreign securities, fixed commissions on
many foreign stock exchanges are generally higher than
B-1
<PAGE> 95
negotiated commissions on U.S. exchanges. In addition, it is expected that the
expenses for custodial arrangements of the Portfolio's foreign securities will
be somewhat greater than the expenses for the custodial arrangements 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 Portfolio receives from its foreign investments. However, these
foreign withholding taxes are not expected to have a significant impact on the
Portfolios, since each Portfolio's investment objective is to seek long-term
capital appreciation and any income should be considered incidental.
ILLIQUID SECURITIES. Each Portfolio may invest 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 a Portfolio's books. An illiquid
security includes repurchase agreements which have a maturity of longer than
seven days, securities which are illiquid by virtue of the absence of a readily
available market, and demand instruments with a demand notice exceeding seven
days. Illiquid securities may include securities that are not registered under
the Securities Act of 1933 (the "1933 Act"); however, unregistered securities
that can be sold to "qualified institutional buyers" in accordance with Rule
144A under the 1933 Act will not be considered illiquid so long as it is
determined by a Portfolio's adviser that an adequate trading market exists for
the security.
PORTFOLIO TURNOVER. While the rate of Portfolio turnover is not a limiting
factor when management deems changes appropriate, it is anticipated that each
Portfolio's annual portfolio turnover rate will not normally exceed 100% (25%
for Vanguard REIT Index Portfolio). A portfolio turnover rate of 100% would
occur if all of the Portfolio's securities, exclusive of U.S. Government
securities and other securities whose maturities at the time of acquisition are
one year or less, were replaced within the period of one year. Turnover rates
may vary greatly from year to year as well as within a particular year and may
also be affected by cash requirements for redemptions of each Portfolio's shares
and by requirements which enable the Fund to receive certain favorable tax
treatments. The portfolio turnover rates will, of course, depend in large part
on the level of purchases and redemptions of shares of each Portfolio. Higher
portfolio turnover can result in corresponding increases in brokerage costs to
the Portfolios and their shareholders.
INVESTMENT POLICIES
FUTURES CONTRACTS. Each Portfolio may enter into futures contracts,
options, and options on futures contracts for several reasons: to maintain cash
reserves while remaining fully invested, to facilitate trading, to reduce
transaction costs, or to seek higher investment returns when a futures contract
is priced more attractively than the underlying equity security or index.
Futures contracts provide for the future sale by one party and purchase by
another party of a specified amount of a specific security at a specified future
time and at a specified price. Futures contracts which are standardized as to
maturity date and underlying financial instrument are traded on national futures
exchanges. Futures exchanges and trading are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a U.S.
Government Agency. Assets committed to futures contracts will be segregated at
the Fund's custodian bank to the extent required by law.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold," or "selling" a contract previously
purchased) in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
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. The Fund's margin deposits will be placed in a
segregated account maintained by the Fund's custodian bank. 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
B-2
<PAGE> 96
exchange and may be changed. Brokers may establish deposit requirements which
are higher than the exchange minimums. Futures contracts are customarily
purchased and sold on margin which may range upward from less than 5% of the
value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the prices of underlying securities.
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. A Portfolio 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 Portfolio upon sale of
open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the use
of futures contracts may be a more effective means of hedging this exposure.
While a Portfolio 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. A Portfolio 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 its total assets. In addition, a Portfolio will not enter into
futures contracts to the extent that its outstanding obligations to purchase
securities under these contracts would exceed 20% of the its 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, a Portfolio would continue to be required to make daily cash payments
to maintain its required margin. In such situations, if the Portfolio 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, a
Portfolio 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.
Each Portfolio will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a 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
B-3
<PAGE> 97
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. However, because the futures strategies of the
Fund are engaged in only for hedging purposes, the Adviser does not believe that
the Portfolios are subject to the risks of loss frequently associated with
futures transactions. A Portfolio 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 a Portfolio 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 a Portfolio 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 a Portfolio of margin deposits in the event of bankruptcy of a
broker with whom the Portfolio has an open position in a futures contract or
related option. Additionally, investments in futures contracts and options
involve the risk that the investment advisers 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. Each Portfolio 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 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 a Portfolio may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. A Portfolio 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 Portfolio.
In order for a Portfolio 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 foreign currencies or other income derived with respect to the
Fund's business of investing in securities or currencies. It is anticipated that
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.
A Portfolio 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 Portfolio's other investments and shareholders will be advised on the nature
of the transactions.
REPURCHASE AGREEMENTS. Each Portfolio may invest in repurchase agreements
with commercial banks, brokers or dealers either for defensive purposes due to
market conditions or to generate income from its excess cash balances. A
repurchase agreement is an agreement under which the Fund acquires a money
market instrument (generally a security issued by the U.S Government or an
agency thereof, a banker's acceptance or a certificate of deposit) from a
commercial bank, broker or dealer, subject to resale to the seller at an agreed
upon price and date (normally, the next business day). A repurchase agreement
may be considered a loan collateralized by securities. The resale price reflects
an agreed upon interest rate effective for the period the instrument is held by
the Portfolio and is unrelated to the interest rate on the underlying
instrument. In these
B-4
<PAGE> 98
transactions, the securities acquired by the Portfolio (including accrued
interest earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by a custodian bank until repurchased. In
addition, the Fund's Board of Directors will monitor each Portfolio'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 any Portfolio of the Fund. No more
than an aggregate of 15% of a net Portfolio's assets, at the time of investment,
will be invested in repurchase agreements having maturities longer than seven
days and securities subject to legal or contractual restrictions on resale for
which there are no readily available market quotations. From time to time, the
Fund's Board of Directors may determine that certain restricted securities known
as Rule 144A securities are liquid and not subject to the 15% limitation
described above. See "Illiquid Securities" on p.2.
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
Portfolio 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 Portfolio not within the
control of the Portfolio and therefore the realization by the Portfolio on such
collateral may be automatically stayed. Finally, it is possible that the
Portfolio 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.
LENDING OF SECURITIES. Each Portfolio may lend its securities on a
short-term basis or long-term basis to qualified institutional investors who
need to borrow securities in order to complete certain transactions, such as
covering short sales, avoiding failures to deliver securities or completing
arbitrage operations. By lending its securities, the Portfolio will be
attempting 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
Portfolio. Each Portfolio may lend its portfolio securities to qualified
brokers, dealers, banks or other financial institutions, so long as the terms,
the structure and the aggregate amount of such loans are not inconsistent with
the Investment Company Act of 1940, or the Rules and Regulations or
interpretations of the Securities and Exchange Commission (the "Commission")
thereunder, which currently require that (a) the borrower pledge and maintain
with the Fund collateral consisting of cash, an irrevocable letter of credit 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 Portfolio at any time and (d) the
Portfolio receives reasonable interest on the loan which may include the
Portfolio's investing any cash collateral in interest bearing short-term
investments, any distribution on the loaned securities and any increase in their
market value. A Portfolio will not lend its portfolio securities, if as a
result, the aggregate value of such loans exceeds 33 1/3% of the value of the
Portfolio's total assets (including any collateral obtained as a result of such
loans). Loan arrangements made by a Portfolio will comply with all other
applicable regulatory requirements, including the rules of the New York Stock
Exchange, which rules presently require the borrower, after notice, to redeliver
the securities within the normal settlement time of three business days. All
relevant facts and circumstances, including the creditworthiness of the broker,
dealer or institution, will be considered in making decisions with respect to
the lending of securities, subject to review by the Fund's Board of Directors.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonably 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 (Trustees). 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.
B-5
<PAGE> 99
INVESTMENT LIMITATIONS
The following policies supplement the Fund's investment limitations set
forth in the Prospectus. It is a fundamental policy of each Portfolio not to
engage in any of the following activities or business practices. These
restrictions may not be changed with respect to a particular Portfolio without
the approval of a majority of the outstanding shares (as defined in the
Investment Company Act of 1940 (the "1940 Act")) of that Portfolio. A Portfolio
may not:
1) Issue senior securities;
2) Borrow money, except from banks (or through reverse repurchase
agreements), for temporary or emergency (not leveraging) purposes,
including the meeting of redemption requests which might otherwise
require the untimely disposition of securities, in an amount not in
excess of 15% of the value of the net assets of the Portfolio
(including the amount borrowed and the value of any outstanding reverse
repurchase agreements) at the time the borrowing is made. Whenever
borrowings exceed 5% of the value of the net assets of the Portfolio,
the Portfolio will not make any additional investments;
3) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if as a result the Portfolio
would hold more than 10% of the outstanding voting securities of the
issuer, or more than 5% of the value of the Portfolio's total assets
would be invested in the securities of such issuer;
4) Engage in the business of underwriting securities issued by others,
except to the extent that the Portfolio may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in
disposing of portfolio securities;
5) Purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are illiquid
(including the Fund's investment in The Vanguard Group, Inc., as
described on page 9);
6) Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements, subject to the limitation
described in (5) above) which are either publicly distributed or
customarily purchased by institutional investors, and (ii) by lending
its securities to banks, brokers, dealers and other financial
institutions so long as such loans are not inconsistent with the
Investment Company Act or the Rules and Regulations or interpretations
of the Commission thereunder and the aggregate value of all securities
loaned does not exceed 33 1/3% of the market value of the Portfolio's
total assets;
7) Pledge, mortgage, or hypothecate its assets, except to secure
borrowings permitted by limitation (2) above;
8) Buy any securities or other property on margin (except for such
short-term credits as are necessary for the clearance of transactions),
or engage in short sales (unless by virtue of its ownership of other
securities it has a right to obtain at no added cost securities
equivalent in kind and amount to the securities sold) except as set
forth below in (12);
9) Purchase or sell puts or calls, or combinations thereof; provided
however, that a Portfolio may enter into forward foreign currency
exchange transactions except as set forth below in (12);
10) Purchase or sell real estate or real estate limited partnerships
(although it may purchase securities secured by real estate or
interests therein, or issued by companies or investment trusts which
invest in real estate or interests therein), except in the case of the
REIT Index Portfolio, which may invest 100% of its assets in real
estate investment trusts;
11) The Fund will not invest in securities of other investment companies,
except as may be acquired as a part of a merger, consolidation or
acquisition of assets approved by the Fund's shareholders or otherwise
to the extent permitted by Section 12 of the 1940 Act. The Fund will
invest only in
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<PAGE> 100
investment companies which have investment objectives and investment
policies consistent with those of the Fund;
12) Purchase or sell commodities or commodity contracts; provided, however,
that a Portfolio may enter into forward foreign currency exchange
transactions and that each Portfolio may invest in futures contracts
and options to the extent that not more than 5% of the portfolios
assets are required as deposit to secure obligations under futures
contracts and not more than 20% of a portfolio's assets are invested in
futures contracts and options at any time, the Portfolio may also
invest in bullion as described in the prospectus;
13) Purchase or retain securities of an issuer if an officer or director of
such issuer is an officer or Director of the Fund or its investment
adviser and one or more of such officers or Directors of the Fund or
its investment adviser owns beneficially more than 1/2% of such shares
or securities of such issuer and all such directors and officers owning
more than 1/2% of such shares or securities together own more than 5%
of such shares or securities; and
14) Invest in companies for the purpose of exercising control of
management.
Notwithstanding these limitations, the Fund may own all or any portion of
the securities of, make loans to, or contribute to the costs or other financial
requirements of, any company which will be wholly owned by the Fund and one or
more other investment companies and is primarily engaged in the business of
providing at cost services, such as management, administrative, distribution or
other related services to the Fund and other investment companies. (See
"Management of the Fund").
In addition, no Portfolio may engage in any of the following activities;
however, these restrictions may be changed by the Directors without shareholder
approval or prior notification:
1) Invest directly in oil, gas, or other mineral exploration or
development programs, including oil & gas or other mineral leases;
provided, however, that if consistent with the designated business
activities of a particular Portfolio, a Portfolio may purchase
securities of issuers whose principal business activities fall within
such areas;
2) Purchase warrants, valued at the lower of cost or market, in excess of
5% of the value of the Fund's net assets. Including within that amount,
but not to exceed 2% of the value of the Fund's net assets, may be
warrants which are not listed on the New York or American Stock
Exchange. Warrants acquired by a Portfolio at any time in units or
attached to securities are not subject to this restriction;
3) Invest more than 5% of its assets, at the time of investment, in the
securities of any issuers which have records of less than three years'
continuous operation, including the operation of any predecessor (other
than obligations issued or guaranteed as to interest and principal by
the U.S. Government or its agencies or instrumentalities).
The above-mentioned investment limitations are considered at the time
investment securities are purchased.
B-7
<PAGE> 101
MANAGEMENT OF THE FUND
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Directors. The Directors set broad policies
for each Fund and choose its Officers. The following is a list of the Directors
and Officers of the Fund and a brief statement of their present positions and
principal occupations during the past five years. The mailing address of the
Directors and Officers of the Fund is Post Office Box 876, Valley Forge, PA
19482.
DIRECTORS AND OFFICERS
<TABLE>
<S> <C>
JOHN C. BOGLE, (DOB: 5/8/1929) Senior Chairman ALFRED M. RANKIN, JR., (DOB: 10/8/1941)
and Director* Director
Senior Chairman and Director of The Vanguard Chairman, President, Chief Executive Officer,
Group, Inc. and of each of the investment and Director of NACCO Industries, Inc.;
companies in The Vanguard Group; Director of Director of The BFGoodrich Company, and The
The Mead Corporation, General Accident Standard Products Company.
Insurance, and Chris-Craft Industries, Inc. JOHN C. SAWHILL, (DOB: 6/12/1936) Director
JOHN J. BRENNAN, (DOB: 3/29/1954) Chairman, President and Chief Executive Officer of The
Chief Executive Officer and Director* Nature Conservancy; formerly, Director and
Chairman, Chief Executive Officer and Senior Partner of McKinsey & Co., and
Director of The Vanguard Group, Inc. and of President of New York University; Director
each of the investment companies in The of Pacific Gas and Electric Company, Procter
Vanguard Group. & Gamble Company, and NACCO Industries.
ROBERT E. CAWTHORN, (DOB: 9/28/1935) Director JAMES O. WELCH, JR., (DOB: 5/13/1931) Director
Chairman Emeritus and Director of Rhone- Retired Chairman of Nabisco Brands, Inc.;
Poulenc Rorer, Inc.; Managing Director of retired Vice Chairman and Director of RJR
Global Health Care Partners/DLJ Merchant Nabisco; Director of TECO Energy, Inc., and
Banking Partners; Director of Sun Company, Kmart Corporation.
Inc., and Westinghouse Electric Corporation. J. LAWRENCE WILSON, (DOB: 3/2/1936) Director
BARBARA BARNES HAUPTFUHRER, Chairman and Chief Executive Officer of Rohm &
(DOB: 10/11/1928) Director Haas Company; Director of Cummins Engine
Director of The Great Atlantic and Pacific Company, and The Mead Corporation; Trustee
Tea Company, IKON Office Solutions, Inc., of Vanderbilt University.
Raytheon Company, Knight-Ridder, Inc.,
Massachusetts Mutual Life Insurance Co., and RAYMOND J. KLAPINSKY, (DOB: 12/7/1938)
Ralies Professional Golf Association; and Secretary*
Trustee Emerita of Wellesley College. Managing Director and Secretary of The
Vanguard Group, Inc.; Secretary of each of the
BRUCE K. MACLAURY, (DOB: 5/7/1931) Director investment companies in The Vanguard Group.
President Emeritus of The Brookings
Institution; Director of American Express RICHARD F. HYLAND, (DOB: 3/22/1937) Treasurer*
Bank, Ltd., The St. Paul Companies, Inc., Treasurer of The Vanguard Group, Inc. and of
and National Steel Corporation. each of the investment companies in The
BURTON G. MALKIEL, (DOB: 8/28/1932) Director Vanguard Group.
Chemical Bank Chairman's Professor of KAREN E. WEST, (DOB: 9/13/1946) Controller*
Economics, Princeton University; Director of Principal of The Vanguard Group, Inc.;
Prudential Insurance Co. of America, Amdahl Controller of each of the investment companies
Corporation, Baker Fentress & Co., The in The Vanguard Group.
Jeffrey Co., and Southern New England ---------------
Telecommunications Company. *Officers of the Fund are "interested persons"
as defined in the Investment Company Act of
1940.
</TABLE>
THE VANGUARD GROUP. The Fund is a member of The Vanguard Group of
Investment Companies which consists of more than 30 investment companies.
Through their jointly-owned subsidiary, The Vanguard Group, Inc. ("Vanguard"),
the Vanguard Funds obtain at cost virtually all of their corporate management,
administrative and distribution services.
B-8
<PAGE> 102
Vanguard employs a supporting staff of management personnel needed to
provide the requisite services to the Funds and also furnishes the Funds with
necessary office space, furnishings and equipment. Each Fund pays its share of
Vanguard's net expenses which are allocated among the Funds under procedures
approved by the Directors (Trustees) of each Fund. In addition, each Fund bears
its own direct expenses such as legal, auditing and custodian fees.
The Officers of the Fund and the Vanguard Funds are also Officers and
employees of Vanguard. No Officer or employee is permitted to own any securities
of any external adviser for the Vanguard Funds.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines substantially similar to
those recommended by the mutual fund industry and approved by the U.S.
Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds have invested are adjusted from time to time in
order to maintain the proportionate relationship between each Fund's relative
net assets and its contribution to Vanguard's capital. At January 31, 1998 the
Fund had contributed capital of $515,000 to Vanguard representing 2.6% of its
capitalization. The Fund's Service Agreement provides as follows: (a) each
Vanguard Fund may invest up to .40% of its current assets in Vanguard, and (b)
there is no other limitation on the amount that each Vanguard Fund may
contribute to Vanguard's capitalization.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Vanguard Funds by third parties.
During the fiscal year ended January 31, 1998, the Fund's share of Vanguard's
actual net costs of operation relating to management and administrative services
(including transfer agency) totaled approximately $18,229,000.
DISTRIBUTION. Vanguard also provides all distribution and marketing
services for the Vanguard Funds. The principal distribution expenses are for
advertising, promotional materials and marketing personnel. Distribution
services may also include organizing and offering to the public, from time to
time, one or more new investment companies which will become members of the
Group. The Directors and Officers of Vanguard determine the amount to be spent
annually on distribution activities, the manner and amount to be spent on each
Fund, and whether to organize new investment companies. During the fiscal year
ended January 31, 1998, the Fund paid approximately $1,518,000 of the Group's
distribution and marketing expenses, which represented an effective annual rate
of .02 of 1% of the Fund's average net assets.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Vanguard Funds based upon their relative net assets. The
remaining one half of these expenses is allocated among the Vanguard Funds based
upon each Fund's sales for the preceding 24 months relative to the total sales
of the Funds as a Group. Provided, however, that no Fund's aggregate quarterly
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of the average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of 20/100 of
1% of its average month-end net assets.
INVESTMENT ADVISORY SERVICES. Vanguard provides Vanguard Money Market
Reserves, Vanguard Admiral Funds, Vanguard Municipal Bond Fund, the several
Portfolios of Vanguard Fixed Income Securities Fund, Vanguard Institutional
Index Fund, Vanguard Bond Index Fund, several Portfolios of Vanguard Variable
Insurance Fund, Vanguard Treasury Fund, Vanguard California Tax-Free Fund,
Vanguard Florida Insured Tax-Free Fund, Vanguard New Jersey Tax-Free Fund,
Vanguard New York Tax-Free Fund, Vanguard Ohio Tax-Free Fund, Vanguard
Pennsylvania Tax-Free Fund, Vanguard Treasury Fund, the Total International
Portfolio of Vanguard STAR Fund, Vanguard Balanced Index Fund, Vanguard Index
Trust, Vanguard Institutional Index Fund, Vanguard International Equity Index
Fund, Vanguard Tax-Managed Fund, the Aggressive Growth Portfolio of Vanguard
Horizon Fund, the REIT Index Portfolio of Vanguard Specialized Portfolios, a
portion of Vanguard/Windsor II, a portion of Vanguard/Explorer and a portion
ofVanguard/Morgan Growth Fund, as well as several indexed separate accounts with
investment advisory services. These services are provided on an at-
B-9
<PAGE> 103
cost basis from a money management staff employed directly by Vanguard. The
compensation and other expenses of this staff are paid by the Funds utilizing
these services.
DIRECTOR TRUSTEE COMPENSATION
The individuals in the table below serve as Directors/Trustees of all
Vanguard Funds, and each Fund pays a proportionate share of the
Directors'/Trustees' compensation. The Funds employ their officers on a shared
basis, as well. However, officers are compensated by The Vanguard Group, Inc.,
not the Funds.
INDEPENDENT DIRECTOR TRUSTEES. The Funds compensate their independent
Directors/Trustees -- that is, the ones who are not also officers of the
Fund -- in three ways:
- The independent Directors/Trustees receive an annual fee for their
service to the Funds, which is subject to reduction based on absences
from scheduled Board meetings.
- The independent Directors/Trustees are reimbursed for the travel and
other expenses that they incur in attending Board meetings.
- Upon retirement, the independent Directors/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 the Directors'/Trustees' death.
"INTERESTED" DIRECTORS TRUSTEES. The Funds' interested
Directors/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.
COMPENSATION TABLE. The following table provides compensation details for
each of the Directors. For the Fund, we list the amounts paid as compensation
and accrued as retirement benefits by the Fund for each Director. In addition,
the table shows the total amount of benefits that we expect each
Director/Trustee to receive from all Vanguard Funds upon retirement, and the
total amount of compensation paid to each Director/Trustee by all Vanguard
Funds. All information shown is for the fiscal year ended January 31, 1998:
VANGUARD SPECIALIZED PORTFOLIOS
COMPENSATION TABLE
<TABLE>
<CAPTION>
PENSION OR RETIREMENT TOTAL COMPENSATION
AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL FROM ALL
COMPENSATION AS PART OF BENEFITS VANGUARD FUNDS
NAMES OF DIRECTORS FROM FUND FUND EXPENSES UPON RETIREMENT PAID TO DIRECTORS(2)
------------------ ------------ --------------------- ---------------- --------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) None None None None
John J. Brennan(1) None None None None
Barbara Barnes Hauptfuhrer $1,912 $276 $15,000 $70,000
Robert E. Cawthorn $1,912 $230 $13,000 $70,000
Bruce K. MacLaury $2,083 $264 $12,000 $65,000
Burton G. Malkiel $1,924 $185 $15,000 $70,000
Alfred M. Rankin, Jr. $1,912 $145 $15,000 $70,000
John C. Sawhill $1,912 $172 $15,000 $70,000
James O. Welch, Jr. $1,912 $212 $15,000 $70,000
J. Lawrence Wilson $1,912 $153 $15,000 $70,000
</TABLE>
- ---------------
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no compensation
for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid to
each Director for his or her service as Director or Trustee of 35 Vanguard
Funds (34 in the case of Mr. Malkiel; 28 in the case of Mr. MacLaury).
DIRECTORS' RETIREMENT FEES A Retirement Plan for Directors has been
implemented to provide a fee to retired Directors equal to $1,000 per year of
service on the Board, up to 15 years of service. This fee will remain in place
subsequent to the Director's retirement for a period of 10 years or until a
retired Director's death.
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<PAGE> 104
INVESTMENT ADVISORY SERVICES
INVESTMENT ADVISORY AGREEMENT WITH WELLINGTON MANAGEMENT COMPANY, LLP The
Fund employs Wellington Management Company, LLP ("WMC") under an investment
advisory agreement dated as of May 1, 1996 to manage the investment and
reinvestment of the assets of the Fund's Energy, Health Care, and Utilities
Income Portfolios and to continuously review, supervise and administer each
Portfolio's investment program. WMC discharges its responsibilities subject to
the control of the officers and Directors of the Fund.
Under the investment advisory agreement, the three Portfolios are required
to pay the Adviser an aggregate fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on the following annual
percentage rates, to the aggregate average month-end net assets of the
Portfolios for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
---------- ----
<S> <C>
First $500 million.......................................... 0.150%
Next $500 million........................................... 0.125%
Next $1 billion............................................. 0.100%
Next $1 billion............................................. 0.075%
Over $3 billion............................................. 0.050%
</TABLE>
The advisory fee is based on the total assets of the Portfolios and is
allocated to each Portfolio based on the relative net assets of each. In
addition, once the advisory fee to WMC is calculated for the three Portfolios
under this schedule, the total fee will be reduced in order that the advisory
fee paid by the Utilities Income Portfolio does not exceed 0.08%. During the
years ended January 31, 1996, 1997, 1998 the Fund paid to WMC advisory fees
totaling $2,698,000, $3,343,000 and $4,409,000, respectively, which represented
an effective annual rate of .12 of 1%, .09 of 1% and .08 or 1%, respectively, of
the aggregate average net assets of the Energy, Health Care, and Utilities
Income Portfolios. Prior to May 1, 1996, these fees were paid pursuant to the
terms of a previous investment advisory agreement, which called for a higher
rate of fees.
DESCRIPTION OF WMC. WMC is a Massachusetts limited liability partnership,
of which the following persons are managing partners: Robert W. Doran, Duncan M.
McFarland, and John R. Ryan.
INVESTMENT ADVISORY AGREEMENT WITH M & G GROUP P.L.C. The Fund has also
entered into an investment advisory agreement with M & G Investment Management
Limited ("M & G"), dated December 1, 1996 to manage the assets of the Gold &
Precious Metals Portfolio. Under this agreement M & G manages the investment and
reinvestment of the assets of the Gold & Precious Metals Portfolio and
continuously renews, supervises and administers the Portfolio's investment
program. M & G will discharge its responsibilities subject to the control of the
officers and Directors of the Fund.
DESCRIPTION OF M & G. M & G is a wholly-owned subsidiary of the M & G
Group P.L.C. M & G Group P.L.C. is a public company whose shares are quoted on
the London Stock Exchange. The Esmee Fairbairn Charitable Trust owns 32% of
total shares outstanding. The remaining shares are held by individuals,
nominees, pension plans and M & G employees.
The Gold & Precious Metals Portfolio will pay M & G a fee at the end of
each fiscal quarter, calculated by applying a quarterly rate, based on the
following annual percentage rates, to the aggregate average month-end net assets
of the Portfolio for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
---------- ----
<S> <C>
First $100 million.......................................... 0.30%
Next $150 million........................................... 0.20%
Next $250 million........................................... 0.15%
Over $500 million........................................... 0.10%
</TABLE>
During the years ended January 31, 1996, 1997 and 1998, the Gold & Precious
Metals Portfolio paid advisory fees of $1,058,000, $1,054,000 and $826,000,
respectively, to M & G which represented an effective annual rate of .18 of 1%
after giving effect to a fee waiver of $364,000 (.06 of 1%), .18 of 1% after
giving effect to a fee waiver of $310,000 (.05 of 1%) and .20 of 1%,
respectively, of average net assets. These fees were paid pursuant to the terms
of a previous investment advisory agreement, which called for a higher rate of
fees.
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<PAGE> 105
THE VANGUARD GROUP furnishes investment advisory services to the REIT Index
Portfolio on an at-cost basis.
INVESTMENT ADVISORY SERVICES. Vanguard also provides investment advisory
services to Vanguard Municipal Bond Fund, Vanguard Admiral Funds, Vanguard
Balanced Index Fund, several Portfolios of Vanguard Variable Insurance Fund,
Vanguard Bond Index Fund, the Total International Portfolio of Vanguard STAR
Fund, Vanguard Index Trust, Vanguard Institutional Index Fund, Vanguard Money
Market Reserves, several Portfolios of Vanguard Fixed Income Securities Fund,
Vanguard Tax-Managed Fund, the Total International Portfolio of Vanguard STAR
Fund, Vanguard Treasury Fund, the Aggressive Growth Portfolio of Vanguard
Horizon Fund, the REIT Index Portfolio of Vanguard Specialized Portfolios,
Vanguard California Tax-Free Fund, Florida Insured Tax-Free Fund, New Jersey
Tax-Free Fund, New York Tax-Free Fund, Ohio Tax-Free Fund, Pennsylvania Tax-Free
Fund, a portion of the assets of Vanguard/Windsor II, a portion of
Vanguard/Explorer, a portion of Vanguard/Morgan Growth Fund and several indexed
separate accounts. These services are provided on an at-cost basis from money
management staff employed directly by Vanguard. The compensation and other
expenses of this staff are paid by the Funds utilizing these services.
The current agreements will continue until April 30, 1998, with respect to
WMC and November 30, 1998, with respect to M & G, and will be renewable
thereafter, for successive one-year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Directors, including the
affirmative votes of a majority of the Directors who are not parties to the
agreement or "interested persons" (as defined in the Investment Company Act of
1940) of any such party cast in person at a meeting called for the purpose of
considering such approval. In addition, the question of continuance of the
agreement may be presented to the shareholders of the Fund; in such event,
continuance shall be effected only if approved by the affirmative vote of a
majority of the outstanding voting securities of the Fund. If the holders of any
Portfolio fail to approve the agreement, WMC or M & G may continue to serve as
investment adviser to each Portfolio which approved the agreement, and to any
Portfolio which did not approve the agreement until new arrangements have been
made. The agreement is automatically terminated if assigned, and may be
terminated by any Portfolio without penalty, at any time, (1) either by vote of
the Board of Directors or by vote of the outstanding voting securities of the
Portfolio on sixty (60) days' written notice to WMC or M & G, or (2) by WMC or M
& G upon ninety (90) days' written notice to the Fund.
SECURITIES TRANSACTIONS
The investment advisory agreements with WMC and M & G authorize the
investment advisers (with the approval of the Fund's Board of Directors) to
select the brokers or dealers that will execute the purchases and sales of
securities for the Fund's Portfolio(s) and directs the investment adviser to use
its best efforts to obtain the best available price and most favorable execution
with respect to all transactions for the Portfolio(s). Each investment 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, each investment adviser will use its
best judgment to choose the broker most capable of providing the brokerage
services necessary to obtain best available price and most favorable execution.
The full range and quality of brokerage services available will be considered in
making these determinations. In those instances where it is reasonably
determined that more than one broker can offer the brokerage services needed to
obtain the best available price and most favorable execution, consideration may
be given to those brokers which supply investment research and statistical
information, and provide other services in addition to execution services to the
Fund and/or the investment adviser. Each investment adviser considers the
investment services it receives 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 agreements also incorporate the concepts of Section
28(e) of the Securities Exchange Act of 1934 by providing that, subject to the
approval of the Fund's Board of Directors, each investment 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 investment adviser to the Fund and the other Funds in
the Group.
B-12
<PAGE> 106
Currently, it is the Fund's policy that each investment 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. An investment 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 higher commissions in recognition
of brokerage services related to execution of securities transactions are also
providers of research information to the investment adviser and/or the Fund.
However, the investment advisers have informed the Fund that they 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 made through such
firms. However, the Fund may place portfolio orders with qualified
broker-dealers who recommend the sale of shares of the Fund 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.
The total brokerage commissions paid by the Fund's Portfolios during the
fiscal years ended January 31, 1996, 1997 and 1998 totaled $3,080,278,
$4,807,083 and $4,904,144, respectively.
Some securities considered for investment by one Portfolio may also be
appropriate for the other Portfolios and the other Funds and/or clients served
by the investment advisers. If purchase or sale of securities consistent with
the investment policies of a Portfolio, the other Portfolios and/or one or more
of these other Funds or clients are considered at or about the same time,
transactions in such securities will be allocated among the Portfolios and the
several Funds and clients in a manner deemed equitable by the respective
investment 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 Fund's Board of
Directors.
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund or any Portfolio,
and (iii) to reduce or waive the minimum investment for or any other
restrictions on initial and subsequent investments for certain fiduciary
accounts such as employee benefit plans or under circumstances where certain
economies can be achieved in sales of the Fund's shares.
STOCK CERTIFICATES. Your purchase will be made in full and fractional
shares of a Portfolio calculated to three decimal places. Shares are normally
held on deposit for shareholders by the Fund, which will send to shareholders a
statement of shares owned at the time of each transaction. This saves the
shareholders the trouble of safekeeping the certificates, and saves the Fund the
cost of issuing certificates. Except in the case of the Utilities Income
Portfolio and the Vanguard REIT Index Portfolio, share certificates are
available at any time upon written request at no additional cost to
shareholders. No certificates will be issued for the Utilities Income Portfolio
or for the Vanguard REIT Index Portfolio, or for any fractional shares of the
Fund's other Portfolios.
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
Portfolio's net asset value calculated at the close of trading that
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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
Portfolio'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 New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods as
the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% or the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part, in investment securities or in cash, as the Directors
may deem advisable; however, payment will be made wholly in cash unless the
Directors believe that economic or market conditions exist which would make a
practice detrimental to the best interests of the Fund. If redemptions are paid
in investment securities, such securities will be valued as set forth in the
Prospectus under "The Share Price of Each Portfolio" and a redeeming shareholder
would normally incur brokerage expenses if he converted these securities to
cash.
SHARE PRICE OF EACH PORTFOLIO
Each Portfolio's share price, or "net asset value" per share, is calculated
by dividing the total assets of the Portfolio, 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 (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 acquired 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 Portfolio
is valued. If events which materially affect the value of a Portfolio'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 Directors deems in good faith to reflect fair value.
In determining the Portfolio'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
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<PAGE> 108
quotations are not available, the rate of exchange will be determined in
accordance with policies established in good faith by the Board of Directors.
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 Directors deems in good faith to reflect fair value.
The share price for each Portfolio can be found daily in the mutual fund
listings of most major newspapers under the heading of Vanguard Funds Group.
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 Specialized Portfolios, Inc., may, from time to time, use one or more
of the following unmanaged indices for comparative performance purposes.
STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX -- is a well diversified
list of 500 companies representing the U.S. Stock Market.
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.
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.
LEHMAN GNMA INDEX -- includes pools of mortgages originated by private lenders
and guaranteed by the mortgage pools of the Government National Mortgage
Association.
MORGAN STANLEY REIT INDEX -- consist of approximately 125 stocks of equity Real
Estate Investment Trusts (REITs). REITs in the index meet size and liquidity
criteria specified by Morgan Stanley. The index had a market value of $115
billion as of January, 1998.
LEHMAN LONG-TERM TREASURY BOND INDEX -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND INDEX -- consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
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<PAGE> 109
LEHMAN CORPORATE (Baa) Bond Index -- all publicly offered fixed-rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
LEHMAN BROTHERS LONG-TERM CORPORATE BOND INDEX -- is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 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 -- 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).
COMPOSITE INDEX -- 40% S&P Utilities Index, 40% S&P Telephone Index, and 20%
Lehman Utility Bond Index.
LEHMAN LONG-TERM CORPORATE AA OR BETTER BOND INDEX -- consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar denominated,
SEC-registered corporate debt rated AA or AAA.
RUSSELL 2000 STOCK INDEX -- consists of the smallest 2,000 stocks within the
Russell 3000; a widely-used benchmark for small capitalization common stocks.
LEHMAN BROTHERS AGGREGATE BOND INDEX -- is a market weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass-through
securities corporate rated BBB- or better. The Index has a market value of over
$4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX -- is a
market weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities
between 1 and 5 years. The index has a market value of over $1.6 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX -- is
a market weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities between 5 and 10
years. The index has a market value of over $700 billion.
LEHMAN BROTHERS LONG (10+) GOVERNMENT/CORPORATE INDEX -- is a market weighted
index that contains individually priced U.S. Treasury, agency, and corporate
securities rated Baa- or better with maturities greater than 10 years. The index
has a market value of over $900 billion.
LIPPER BALANCED FUND AVERAGE -- an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of
average non-government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE -- the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company.
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<PAGE> 110
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.)
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.
Advertisements which refer to the use of the fund as a potential investment
for Individual Retirement Accounts may quote a total return based upon
compounding of dividends on which it is presumed no Federal income tax applies.
In assessing such comparisons of yields, an investor should keep in mind
that the composition of the investments in the reported averages is not
identical to the Fund's Portfolio and that the items included in the
calculations of such averages may not be identical to the formula used by the
Fund to calculate its yield. In addition there can be no assurance that the Fund
will continue its performance as compared to such other averages.
YIELD AND TOTAL RETURN
The yield* of each Portfolio of the Fund for the 30-day period ended
January 31, 1998 was as follows:
<TABLE>
<S> <C>
Energy Portfolio..................................... 1.42%
Gold & Precious Metals Portfolio..................... N/A
Health Care Portfolio................................ 1.21%
Utilities Income Portfolio........................... 3.92%
Vanguard REIT Index Portfolio........................ 4.37%
</TABLE>
- -------------------------------
*Yield is calculated daily.
The average annual total return of each Portfolio of the Fund for the one-,
five- and ten-year periods ended January 31, 1998 was as follows:
<TABLE>
<CAPTION>
YEAR ENDED FIVE YEARS ENDED TEN YEARS ENDED
JANUARY 31, 1998 JANUARY 31, 1998 JANUARY 31, 1998
---------------- ---------------- ----------------
<S> <C> <C> <C>
Energy Portfolio........................ 3.80% 16.74% 14.60%
Gold & Precious Metals Portfolio........ - 29.85% 2.59% 0.25%
Health Care Portfolio................... 27.37% 24.36% 22.07%
Utilities Income Portfolio.............. 23.17% 12.69% 13.69%*
Vanguard REIT Index Portfolio........... 17.08% 27.87% --
</TABLE>
--------------------
*Since inception, inception for Vanguard REIT Index Portfolio, May 13,
1996; Inception for Utilities Income Portfolio, May 15, 1992.
Total return is computed by finding the average compounded rate of return
over the one-year period set forth above that would equate an initial amount
invested at the beginning of the period to the ending redeemable value of the
investment.
FINANCIAL STATEMENTS
The Fund's financial statements as of and for the year ended January 31,
1998 appearing in the Vanguard Specialized Portfolios Annual Report to
Shareholders, and the report thereon of Price Waterhouse LLP, independent
accountants, also appearing therein, are incorporated by reference in this
Statement of Additional Information. The Fund's 1998 Annual Report to
Shareholders is enclosed with this Statement of Additional Information.
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