<PAGE> 1
VANGUARD
STAR PORTFOLIO
Annual Report - December 31, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 2
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--more than 6,000 highly
motivated men and women--who form the cornerstone of our operations. As with any
cornerstone, we could not survive long--let alone prosper--without it. That's
why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also take
time to recognize the importance of the individual. Each calendar quarter, we
present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more than
300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving
you in the years ahead.
[PHOTO] [PHOTO]
JOHN J. BRENNAN JOHN C. BOGLE
Chairman President
CONTENTS
A Message To Our Shareholders .................................. 1
The Markets In Perspective .................................... 5
Performance Summary ............................................ 7
Portfolio Profile ............................................. 8
Financial Statements .......................................... 10
Report Of Independent Accountants ............................. 16
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
Vanguard STAR Portfolio flourished during 1997, providing a total return of
+21.2% amid a continuing surge by the U.S. stock market and solid results from
the bond and money markets. STAR's policy of holding a balanced portfolio of
Vanguard funds, with 62.5% of assets in stock funds, 25% in bond funds, and
12.5% in a money market fund, limited our participation in the continuing bull
market in stocks. In all, the final result was our third best since starting
twelve full years ago-trailing only the +28.6% advance in 1995 and the +24.2%
gain in 1991.
As shown in the table at right, STAR's total return (capital change plus
reinvested dividends) far exceeded the average return of a comparable portfolio
made up of mutual funds weighted in accordance with our asset-allocation
guidelines. Yet we fell short of a composite of unmanaged market indexes that
represent the asset classes in which we invest: for stocks, the Standard &
Poor's 500 Composite Stock Price Index; for bonds, the Lehman Brothers Aggregate
Bond Index; and for cash reserves, the Salomon Brothers Three-Month U.S.
Treasury Bill Index.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1997
- ---------------------------------------------------------
<S> <C>
Vanguard STAR Portfolio +21.2%
- ---------------------------------------------------------
Composite Fund Average* +17.9%
- ---------------------------------------------------------
STAR Composite Index* +23.6%
- ---------------------------------------------------------
S&P 500 Index +33.4%
Lehman Aggregate Bond Index + 9.7
Salomon Three-Month Treasury Index + 5.3
- ---------------------------------------------------------
</TABLE>
*The STAR Composite Index is weighted 62.5% S&P 500 Index, 25% Lehman Aggregate
Bond Index, and 12.5% Salomon Three-Month Treasury Index. The Composite Fund
Average is similarly weighted using the average general equity mutual fund,
average fixed-income fund, and average money market fund, respectively.
Our return is based on an increase in net asset value from $15.86 per
share on December 31, 1996, to $17.38 per share on December 31, 1997, with the
latter figure adjusted for dividends totaling $0.59 per share paid from net
investment income and distributions totaling $1.20 per share paid from net
realized capital gains. At year-end, our annualized yield was 3.4%.
THE FINANCIAL MARKETS IN BRIEF
The historic bull market in U.S. stocks that began in August 1982 continued in
impressive fashion during 1997. The economy, employment, and corporate earnings
all grew solidly, and consumer confidence strengthened. Yet interest rates
declined and inflation decelerated. In short, the domestic economic news
couldn't have been better. The sole dark cloud--severe turmoil in Asian
economies and currencies--only briefly darkened Wall Street's mood. After a
sharp decline in October--the S&P 500 Index tumbled -7% on October 27
alone--stocks resumed their climb, and the Index produced an astounding +33.4%
return for the year.
Long-term interest rates rose through the first quarter of 1997 on
expectations that the economy's robust growth would cause inflation to
accelerate. The yield on the benchmark 30-year U.S. Treasury bond peaked at
7.17% in mid-April, but drifted lower throughout the year as inflation news got
better, not worse. The 30-year Treasury's yield ended the year at 5.92%, 72
basis points below its level of 6.64% at the end of 1996. Mortgage-backed
securities, such as GNMA obligations, which carry a yield premium because of the
risk that homeowners will refinance mortgages when interest rates fall,
generally performed well but lost ground late in the year as concern mounted
that prepayments would rise. Overall during 1997, the Lehman Aggregate Bond
Index, a good benchmark for the U.S. bond market, rose +9.7%.
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Short-term interest rates bottomed out in June and began an irregular
climb that was apparently due to sales of short-term Treasuries by foreign
central banks and investors. The total return for the year on the Salomon
Three-Month Treasury Bill Index was 5.25%. At year-end 1997, the yield on
three-month U.S. Treasury bills was 5.35%, up just a bit from 5.17% when the
year began. The spread between yields on three-month T-bills and 30-year
Treasury bonds was a very slim 0.57 percentage point on December 31, 1997. Such
a "flattening" of the yield curve has more often than not been a precursor of a
slowdown in the economy.
1997 PERFORMANCE OVERVIEW
For the Vanguard Funds held by STAR, returns generally followed the market
segments in which they invest. Some of STAR's underlying funds performed
exceptionally well. Vanguard/Windsor II, STAR's largest holding, earned +32.4%
for the year--well above the +30.0% advance of the value component of the S&P
500 Index. Our other value holding, Vanguard/Windsor Fund, after getting caught
in the fourth-quarter market downdraft, fell a disappointing 11 percentage
points short of the S&P 500.
Among the growth-oriented funds held by STAR, the lavish +36.8% return of
Vanguard/PRIMECAP Fund outdistanced not only the S&P 500 Index but also the
+36.5% gain of the Index's growth component. Vanguard/Morgan Growth Fund and
Vanguard U.S. Growth Portfolio also turned in generous returns; but Vanguard
Explorer Fund, like most small-capitalization funds, sharply lagged the overall
market.
STAR's bond funds, the GNMA and Long-Term Corporate Portfolios of
Vanguard Fixed Income Securities Fund, provided excellent relative returns of
+9.5% and +13.8%, respectively. While these gains may seem paltry next to the
outsized advance by stocks, they were well in excess of those turned in by
comparable GNMA and long-term bond mutual funds. As it does regularly, Vanguard
Money Market Reserves-Prime Portfolio outpaced the average money market mutual
fund. The accompanying table summarizes the twelve-month performance of the
Vanguard Funds held by STAR.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
TOTAL RETURNS
PERCENT OF YEAR ENDED
VANGUARD PORTFOLIO STAR ASSETS DECEMBER 31, 1997
- ------------------------------------------------------------------
<S> <C> <C>
STOCK FUNDS
Windsor II 27.6% +32.4%
Windsor 14.9 +22.0
Explorer 5.1 +14.6
Morgan Growth 5.1 +30.8
PRIMECAP 5.1 +36.8
U.S. Growth 5.0 +25.9
- ------------------------------------------------------------------
BOND FUNDS
GNMA 12.4% + 9.5%
Long-Term Corporate 12.4 +13.8
- ------------------------------------------------------------------
MONEY MARKET FUND
Prime 12.4% + 5.4%
- ------------------------------------------------------------------
COMBINED 100.0% +21.2%
- ------------------------------------------------------------------
</TABLE>
On balance, the reduction in 1995 and 1996 of Windsor II's weighting from
42% of STAR's net assets to less than 30% worked against us in 1997, but we
remain confident that the added diversification in equity holdings and the
modest increase in exposure to growth-oriented funds are appropriate. We added
two investment advisers during the year to the multiadviser format of Explorer
Fund, which we believe will give us the opportunity to enhance that Fund's
long-term performance relative to its benchmarks. Morgan Growth Fund, after a
review of its returns under our multiadviser structure, will drop Husic Capital
Management as an adviser by early February 1998. The assets that Husic had
managed will be reallocated to two of the Fund's existing advisers, Vanguard
Core Management Group and Franklin Portfolio Associates, both of which have done
exemplary jobs for us.
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<PAGE> 5
LONG-TERM PERFORMANCE OVERVIEW
Over the past decade, the STAR Portfolio has performed extremely well, both in
terms of its absolute return--an average of +14.1% per year--and in relation to
competing mutual funds. We have also held our own relative to our benchmark
composite index.
The table below presents the returns earned by STAR and our key
comparative standards since December 31, 1987, and shows how an initial
investment of $10,000 in each would have grown over the decade, assuming
reinvestment of income dividends and capital gains distributions. We stayed
ahead of our balanced composite fund average by 1.7 percentage points a year, an
edge that amounted over the decade to $5,320, or more than half of the initial
$10,000 investment. This advantage derives largely from our bias toward value
stocks, the skilled portfolio management of our underlying Vanguard Funds, and
our trademark low costs.
Of course, STAR bears no direct operating expenses, but STAR shareholders
incur their share of the costs of operating the underlying Vanguard funds. Those
funds had an average weighted expense ratio (operating expenses as a percentage
of average net assets) of 0.36% during 1997. This was less than one-third of the
1.26% average expense ratio for the funds in the composite fund average. In all,
this 90-basis-point advantage accounts for fully one-half of our decade-long
margin over our peers. Clearly, cost matters.
Even Vanguard can't claim a cost advantage over the composite market
index, which exists only on paper and is subject to none of the administrative,
operating, and investment management expenses that actual mutual funds incur.
STAR's imputed annual expense ratio more than accounts for our -0.2% average
annual shortfall against the STAR Composite Index during the past decade.
Finally, we note that while the Index provides a fair comparative standard for
STAR, it does not precisely reflect the policies followed by STAR and our
actively managed counterparts. Even so, we will continue to strive to top this
formidable standard. As should be expected for a balanced portfolio at a time
when stocks markedly outperformed bonds and money market investments, we also
lagged, by a greater margin, the all-stock S&P 500 Index. By way of background,
the table at right also presents the ten-year return of this Index.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED DECEMBER 31, 1997
---------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ---------------------------------------------------------------
<S> <C> <C>
Vanguard STAR Portfolio +14.1% $37,449
- ---------------------------------------------------------------
Composite Fund Average +12.4% $32,129
- ---------------------------------------------------------------
STAR Composite Index +14.3% $38,121
- ---------------------------------------------------------------
S&P 500 Index +18.1% $52,567
- ---------------------------------------------------------------
</TABLE>
We stress that the returns earned by STAR and its comparative benchmarks
during the past decade were unusually high. They encompass a ten-year period
without a single severe downturn in the U.S. stock market and during which bond
prices rose because of a general decline in interest rates. But there will
surely be individual down years ahead, and we caution that returns from the STAR
Portfolio, and from the stock and bond markets in general, will almost certainly
be less generous over the next decade than during the one just past.
IN SUMMARY
While investors have every reason to be grateful for the recent bounty of the
financial markets, they also have reason to regard the future with some caution.
Lengthy bull markets can breed complacency and cause investors to discount the
risks inherent in investing in the financial markets. Make no mistake--the
markets will from time to time demonstrate these risks.
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<PAGE> 6
However, the greatest risk is failure to invest in the first place. We
believe that the stock market's risks can be partially offset by holding a
balanced portfolio that includes not only stock funds, but also bond funds and
money market funds. Indeed, this strategy is the idea behind our STAR Portfolio.
Investors who maintain such portfolios allocated in accordance with their time
horizon, financial situation, and tolerance for market volatility should be well
prepared to "stay the course" toward their investment objectives, no matter what
the future has in store.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
January 20, 1998
4
<PAGE> 7
THE MARKETS IN PERSPECTIVE
Year Ended December 31, 1997
U.S. EQUITY MARKETS
Despite some year-end rockiness, 1997 again provided U.S. equity investors with
exceptional returns, as illustrated by the 33.4% advance of the S&P 500 Index.
Investors' mettle was tested several times, however, and most severely by the
upheavals that devastated a number of Asian markets in the fourth quarter.
Beginning in late October, the U.S. market grew increasingly volatile, a direct
result of investors' struggle to understand the nature and implications of
Asia's economic turmoil. By the end of the year, it appeared that a new
consensus was emerging, grounded in two basic beliefs: (1) that the collapse of
currencies in the Far East would help keep inflation tame in the United States
and (2) that slower growth in Asia would most likely lead to weaker corporate
profits over the next several years.
As the dust continued to settle, many investors sought havens traditional
in periods of high uncertainty: large-capitalization issues and particularly the
"defensive" sectors of the stock market, such as utilities, consumer staples,
and health care. The closing weeks of 1997 saw a broad advance in these "safe"
sectors, with utilities gaining 20.1% and consumer staples 10.4% in the last
quarter. By contrast, more economically sensitive sectors were thrashed in the
wake of the Asian crisis, with technology issues falling 12.3% and producer
durables down 9.0% over the three months. After posting strong results in the
third quarter, small-company stocks also suffered in the fourth, falling 3.3%.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1997
----------------------------------
1 YEAR 3 YEARS 5 YEARS
- --------------------------------------------------------------------------------
EQUITY
<S> <C> <C> <C>
S&P 500 Index 33.4% 31.2% 20.3%
Russell 2000 Index 22.4 22.3 16.4
MSCI EAFE Index 2.1 6.6 11.7
- --------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 9.7% 10.4% 7.5%
Lehman 10-Year Municipal Bond Index 9.2 10.2 7.6
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.3 5.4 4.7
- --------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.7% 2.5% 2.6%
- --------------------------------------------------------------------------------
</TABLE>
The year-end excitement did not detract from 1997's overall record as a
stellar year for U.S. stock investors. The best-performing sector was financial
services, which rose 46.9%. This sector benefited from a number of factors,
including the strength of the economy, the vibrant financial markets, and merger
activity. By contrast, the commodity-oriented materials & processing sector
posted a gain of "only" 12.3%--in itself more than a percentage point above the
long-term average return from common stocks. Small-cap stocks also fared well
overall, as illustrated by the 22.4% increase of the Russell 2000 Index.
Small-company technology issues were the most glaring exception, mustering a
gain in 1997 of just 1.1%.
U.S. FIXED-INCOME MARKETS
In a year characterized by exceptionally low inflation, interest rates fell,
providing investors with very attractive total returns. The Lehman Aggregate
Bond Index, for example,
5
<PAGE> 8
posted a total return of 9.7% for 1997, comprising 7.2% in income return and
2.5% in capital appreciation. The decline in rates can be attributed largely to
better-than-expected reports about the inflation rate. Early in the year,
economists were projecting a 2.9% increase in the Consumer Price Index (CPI)
during 1997. In March, the Federal Reserve grew sufficiently concerned to boost
interest rates by 0.25% in an effort to temper economic growth and thereby ward
off inflation. By year-end, however, the worries seemed to have been
unnecessary, as the actual CPI increase was a mere 1.7%--its smallest increase
since 1986.
The bond market gradually gathered strength during the year as investors
grew more confident that four seemingly strange bedfellows--strong economic
growth, reasonable inflation, low unemployment, and stable wage growth--would
continue to coexist peacefully. In the fourth quarter, the market also was
bolstered by the "flight to quality" among investors concerned about Asia's
problems. Overall, the longest-maturity issues benefited most from the decline
in interest rates. The yield on the 30-year U.S. Treasury bond closed the year
at 5.92%, compared with 6.64% on December 31, 1996. Falling rates flattened the
yield curve considerably: Only 0.57% separated the yield on Treasury bills from
that on the 30-year issue, down from a spread of 1.47% at the end of 1996.
The best-performing sector in 1997 was long-term Treasuries, as
illustrated by the 15.1% return of the Lehman Long U.S. Treasury Index.
Investors in lower-quality securities also fared well, with the Lehman High
Yield Bond Index generating a 12.8% gain. The strength of the economy, together
with the lack of inflationary pressure, created an ideal environment for junk
bonds.
INTERNATIONAL EQUITY MARKETS
Arguably, investors' greatest disappointments were in international
markets--and, of course, Asian markets in particular. During the year, the
Morgan Stanley Capital International (MSCI) Pacific Index declined by 25.7% in
U.S. dollar terms; the Index fell 20.7% in the fourth quarter alone. Among
individual markets, the fiscal year saw sharp declines (in U.S. dollar terms) in
Japan, down 23.6% (including a 19.7% drop in the fourth quarter); Thailand, down
76.8%; and Malaysia, down 68.1%. The general slump in Asian markets began in
midsummer with currency devaluations by a number of countries.
By contrast, the European markets continued to provide U.S. investors
with solid returns, although they, too, stumbled in late October and
subsequently recovered. The MSCI Europe Index posted a gain of 23.7% for the 12
months. The robust character of the European markets reflected strong corporate
earnings and optimism that the European Monetary Union would provide a solid
framework for future fiscal responsibility and economic growth.
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<PAGE> 9
PERFORMANCE SUMMARY
STAR Portfolio
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the Portfolio. Note, too, that
both share price and return can fluctuate widely, so an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: MARCH 29, 1985-DECEMBER 31, 1997
- -----------------------------------------------------------
STAR PORTFOLIO COMPOSITE*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -----------------------------------------------------------
<S> <C> <C> <C> <C>
1985 14.5% 0.5% 15.0% 15.1%
1986 5.5 8.4 13.9 12.6
1987 -5.5 7.2 1.7 3.1
1988 11.7 7.3 19.0 11.8
1989 11.8 7.0 18.8 18.0
1990 -9.6 6.0 -3.6 -1.6
1991 18.1 6.1 24.2 26.9
1992 6.3 4.2 10.5 8.0
1993 7.1 3.8 10.9 10.6
1994 -4.1 3.9 -0.2 -1.2
1995 23.7 4.9 28.6 23.3
1996 12.0 4.1 16.1 13.6
1997 17.3 3.9 21.2 17.9
</TABLE>
* 62.5% average general equity fund, 25% average fixed-income fund, and 12.5%
average money market fund. See Financial Highlights table on page 14 for
dividend and capital gains information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: DECEMBER 31, 1987-DECEMBER 31, 1997
- -------------------------------------------------------------------
STAR
STAR COMPOSITE COMPOSITE S&P 500
PORTFOLIO FUND AVERAGE INDEX INDEX
- -------------------------------------------------------------------
<S> <C> <C> <C> <C>
1987 12 10000 10000 10000 10000
1988 03 10770 10598 10470 10569
1988 06 11423 11012 10955 11273
1988 09 11727 11034 11059 11312
1988 12 11904 11183 11317 11661
1989 03 12557 11705 11883 12488
1989 06 13434 12436 12809 13590
1989 09 14214 13202 13731 15045
1989 12 14141 13192 14073 15356
1990 03 13801 12986 13820 14894
1990 06 14188 13599 14532 15831
1990 09 12669 12284 13329 13655
1990 12 13630 12980 14274 14879
1991 03 15306 14542 15683 17040
1991 06 15294 14574 15757 17001
1991 09 16078 15461 16537 17910
1991 12 16925 16496 17653 19412
1992 03 16980 16498 17341 18922
1992 06 17516 16384 17744 19282
1992 09 18043 16851 18306 19890
1992 12 18703 17809 18909 20891
1993 03 19574 18372 19638 21803
1993 06 19826 18650 19848 21910
1993 09 20609 19391 20318 22476
1993 12 20739 19703 20635 22997
1994 03 20105 19205 20021 22125
1994 06 20317 18842 20049 22218
1994 09 20790 19609 20720 23304
1994 12 20695 19470 20775 23300
1995 03 22222 20566 22331 25569
1995 06 23919 21974 24037 28010
1995 09 25523 23322 25387 30236
1995 12 26622 24006 26656 32056
1996 03 27560 24818 27467 33777
1996 06 28235 25631 28318 35293
1996 09 29099 26245 29057 36384
1996 12 30911 27282 30837 39416
1997 03 31125 26972 31375 40473
1997 06 34263 29804 35089 47539
1997 09 36912 32271 37105 51099
1997 12 37449 32129 38121 52567
- -------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
--------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
STAR Portfolio 21.15% 14.90% 14.12% $37,449
Composite Fund Average* 17.92 12.55 12.38 32,129
STAR Composite Index** 23.62 15.05 14.32 38,121
S&P 500 Index 33.36 20.27 18.05 52,567
- -----------------------------------------------------------------------------------------------------
</TABLE>
* 62.5% average general equity fund, 25% average fixed-income fund, and 12.5%
average money market fund.
** 62.5% S&P 500 Index, 25% Lehman Aggregate Bond Index, and 12.5% Salomon
Three-Month Treasury Index.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
STAR Portfolio 3/29/1985 21.15% 14.90% 8.99% 5.13% 14.12%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE> 10
PORTFOLIO PROFILE
STAR Portfolio
This Profile presents key characteristics of the Portfolio as of December 31,
1997, including its allocations to various asset classes and to underlying
Vanguard Funds. Key elements of this Profile are defined on page 9.
<TABLE>
<CAPTION>
FINANCIAL ATTRIBUTES
- ----------------------------------------------------------
<S> <C>
Yield 3.4%
Expense Ratio 0%
Average Weighted Expense Ratio* 0.36%
</TABLE>
*For underlying portfolios.
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY ASSET CLASS
- ------------------------------------------
<S> <C>
STOCKS 63%
BONDS 25%
CASH 12%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ----------------------------------------------------------
STAR S&P 500
- ----------------------------------------------------------
<S> <C> <C>
R-Squared 0.91 1.00
Beta 0.58 1.00
- ----------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION TO FUNDS
- -------------------------------------------------------
<S> <C>
Vanguard/Windsor II 27.6%
Vanguard/Windsor Fund 14.9
Vanguard Explorer Fund 5.1
Vanguard/Morgan Growth Fund 5.1
Vanguard/PRIMECAP Fund 5.1
Vanguard U.S. Growth Portfolio 5.0
Vanguard Fixed Income Securities Fund-
GNMA Portfolio 12.4
Long-Term Corporate Portfolio 12.4
Vanguard Money Market Reserves-
Prime Portfolio-Investor Shares 12.4
- -------------------------------------------------------
Total 100.0%
</TABLE>
[GRAPH]
[GRAPH]
8
<PAGE> 11
AVERAGE WEIGHTED EXPENSE RATIO. Portfolios that invest in other Vanguard funds
incur no direct expenses, but do bear their share of the operating,
administrative, and advisory expenses of the underlying funds. The average
weighted expense ratio is the average of these expense ratios, weighted in
proportion to the amount of the portfolio represented by each underlying fund.
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a portfolio with a
beta of 1.20 would have seen its share price rise or fall by 12% when the
overall market rose or fell by 10%.
CASH RESERVES. The percentage of the Portfolio's net assets invested in money
market fund shares or in "cash equivalents"--highly liquid, short-term,
interest-bearing instruments.
EQUITY INVESTMENT FOCUS. This grid indicates the focus of a portfolio's equity
holdings in terms of two attributes: market capitalization (large, medium, or
small) and relative valuation (growth, value, or a blend).
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FIXED-INCOME INVESTMENT FOCUS. This grid indicates the focus of a portfolio's
fixed-income holdings in terms of two attributes: average maturity (short,
medium, or long) and average credit quality (high, medium, or low).
PORTFOLIO ALLOCATION BY ASSET CLASS. This chart shows the proportions of a
portfolio's holdings allocated to different types of asset.
PORTFOLIO ALLOCATION TO FUNDS. This table shows the distribution of a
portfolio's assets in underlying Vanguard funds.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based on
income earned by the portfolio over the past 30 days and is annualized, or
projected forward for the coming year.
9
<PAGE> 12
FINANCIAL STATEMENTS
December 31, 1997
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Portfolio's investments in shares
of each Vanguard fund, along with the value of each investment on the last day
of the reporting period. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the Portfolio's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the
Portfolio to arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the Portfolio's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Portfolio had available to distribute to shareholders as income
dividends or capital gains as of the statement date. Any Accumulated Net
Realized Losses, and any cumulative excess of distributions over net income or
net realized gains, will appear as negative balances. Unrealized Appreciation
(Depreciation) is the difference between the market value of the Portfolio's
investments and their cost, and reflects the gains (losses) that would be
realized if the Portfolio were to sell all of its investments at their
statement-date values.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
STAR PORTFOLIO SHARES (000)
- ------------------------------------------------------------------------------------------------------------------------
INVESTMENT COMPANIES (100.2%)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
STOCK FUNDS (63.0%)
Vanguard/Windsor II 71,055,143 $2,033,598
Vanguard/Windsor Fund 64,873,690 1,101,555
Vanguard Explorer Fund 6,832,387 377,831
Vanguard/Morgan Growth Fund 21,297,464 373,558
Vanguard/PRIMECAP Fund 9,437,736 373,451
Vanguard U.S. Growth Portfolio 12,925,823 370,971
-----------
4,630,964
-----------
BOND FUNDS (24.8%)
Vanguard Fixed Income Securities Fund-GNMA Portfolio 87,600,853 913,677
Vanguard Fixed Income Securities Fund-Long-Term Corporate Portfolio 98,378,277 910,983
-----------
1,824,660
-----------
MONEY MARKET FUND (12.4%)
Vanguard Money Market Reserves-Prime Portfolio-Investor Shares 911,733,409 911,733
-----------
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT COMPANIES
(COST $5,758,223) 7,367,357
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- ------------------------------------------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government Obligations in a Pooled Cash Account
6.54%, 1/2/1998
(COST $4,132) $4,132 4,132
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.2%)
(COST $5,762,355) 7,371,489
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
(000)
- --------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.2%)
- --------------------------------------------------------------------------------------------------------------------------
<S> <C>
Other Assets $ 21,625
Liabilities (37,735)
------------
(16,110)
- --------------------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------------------------------------------------
Applicable to 423,326,382 shares of beneficial interest
(unlimited authorization--no par value) $7,355,379
==========================================================================================================================
NET ASSET VALUE PER SHARE $17.38
==========================================================================================================================
*See Note A in Notes to Financial Statements.
- --------------------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------------------------------------------------
Paid in Capital $5,747,708 $13.58
Overdistributed Net Investment Income (87) --
Overdistributed Net Realized Gains (1,376) --
Unrealized Appreciation--Note D 1,609,134 3.80
- --------------------------------------------------------------------------------------------------------------------------
NET ASSETS $7,355,379 $17.38
==========================================================================================================================
</TABLE>
11
<PAGE> 14
STATEMENT OF OPERATIONS
This Statement shows the Portfolio's Income Distributions Received from the
other Vanguard funds in which it invests. This Statement also shows any Capital
Gain Distributions Received from the other funds' realized net gains, Net Gain
(Loss) realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
STAR PORTFOLIO
YEAR ENDED DECEMBER 31, 1997
(000)
- ------------------------------------------------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
<S> <C>
Income Distributions Received $ 229,432
Interest 46
- ------------------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME--Note B 229,478
- ------------------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN
Capital Gain Distributions Received 410,724
Investment Securities Sold 53,774
- ------------------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN 464,498
- ------------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 571,126
- ------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,265,102
========================================================================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Portfolio's total net assets changed during the two
most recent reporting periods. The Operations section summarizes information
detailed in the Statement of Operations. The amounts shown as Distributions to
shareholders from the Portfolio's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
Portfolio, either by purchasing shares or by reinvesting distributions, as well
as the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
STAR PORTFOLIO
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996
(000) (000)
- ------------------------------------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS
OPERATIONS
<S> <C> <C>
Net Investment Income $ 229,478 $ 197,636
Realized Net Gain 464,498 336,819
Change in Unrealized Appreciation (Depreciation) 571,126 273,268
----------------------------------
Net Increase in Net Assets Resulting from Operations 1,265,102 807,723
----------------------------------
DISTRIBUTIONS
Net Investment Income (226,950) (199,884)
Realized Capital Gain (466,547) (335,282)
----------------------------------
Total Distributions (693,497) (535,166)
----------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 954,494 801,072
Issued in Lieu of Cash Distributions 678,488 525,118
Redeemed (712,635) (577,160)
----------------------------------
Net Increase from Capital Share Transactions 920,347 749,030
- ------------------------------------------------------------------------------------------------------------------------
Total Increase 1,491,952 1,021,587
- ------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 5,863,427 4,841,840
----------------------------------
End of Year $7,355,379 $5,863,427
========================================================================================================================
(1)Shares Issued (Redeemed)
Issued 55,184 50,780
Issued in Lieu of Cash Distributions 39,523 33,115
Redeemed (41,066) (36,430)
----------------------------------
Net Increase in Shares Outstanding 53,641 47,465
========================================================================================================================
</TABLE>
13
<PAGE> 16
FINANCIAL HIGHLIGHTS
This table summarizes the Portfolio's investment results and distributions to
shareholders on a per-share basis. The table also presents the Portfolio's Total
Return and shows net investment income and expenses as percentages of average
net assets. The expense ratio is zero because the Portfolio pays no direct
expenses; the Portfolio's share of the expenses of the other funds in which it
invests reduces the income received from them. The data in the table will help
you assess: the variability of the Portfolio's net income and total returns from
year to year; the relative contributions of net income and capital gains to the
Portfolio's total return; the extent to which the Portfolio tends to distribute
capital gains; and the portion of capital gains distributions representing the
"pass-through" of capital gains distributions received from other Vanguard
funds. The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in the
Portfolio for one year.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
STAR PORTFOLIO
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $15.86 $15.03 $12.61 $13.41 $12.89
- -------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .60 .58 .590 .53 .47
Capital Gain Distributions Received 1.06 .63 .435 .26 .36
Net Realized and Unrealized Gain (Loss) on Investments 1.65 1.19 2.550 (.82) .56
-----------------------------------------------------------
Total from Investment Operations 3.31 2.40 3.575 (.03) 1.39
-----------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.59) (.59) (.590) (.52) (.47)
Distributions from Realized Capital Gains (1.20) (.98) (.565) (.25) (.40)
-----------------------------------------------------------
Total Distributions (1.79) (1.57) (1.155) (.77) (.87)
- -------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $17.38 $15.86 $15.03 $12.61 $13.41
=========================================================================================================================
TOTAL RETURN 21.15% 16.11% 28.64% -0.21% 10.88%
=========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $7,355 $5,863 $ 4,842 $ 3,766 $ 3,628
Ratio of Expenses to Average Net Assets--Note B 0% 0% 0% 0% 0%
Ratio of Net Investment Income to Average Net Assets 3.46% 3.71% 4.12% 4.01% 3.67%
Portfolio Turnover Rate 15% 18% 13% 9% 3%
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 17
NOTES TO FINANCIAL STATEMENTS
Vanguard STAR Portfolio is registered under the Investment Company Act of 1940
as an open-end investment company, or mutual fund. The Portfolio follows a
balanced investment strategy by investing in selected Vanguard funds. The
Portfolio invests 60% to 70% of its net assets in U.S. stock funds
(predominantly large-capitalization value stock funds), 20% to 30% in bond
funds, and about 10% in a money market fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Portfolio consistently follows such
policies in preparing its financial statements.
1. VALUATION: Investments are valued at the net asset value of each
Vanguard fund determined as of the close of the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date. Temporary cash
investments are valued at cost, which approximates market value.
2. FEDERAL INCOME TAXES: The Portfolio intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
4. REPURCHASE AGREEMENTS: The Portfolio, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
5. OTHER: Income and capital gain distributions received are recorded on
the ex-dividend date. Security transactions are accounted for on the date
securities are bought or sold. Costs used to determine realized gains (losses)
on the sale of investment securities are those of the specific securities sold.
B. Under a special service agreement, The Vanguard Group furnishes corporate
management, administrative, marketing, and distribution services to the
Portfolio. The special service agreement provides that Vanguard will reimburse
the Portfolio's expenses to the extent of savings in administrative and
marketing costs realized by Vanguard in the operation of the Portfolio.
Accordingly, all expenses incurred by the Portfolio during the year ended
December 31, 1997, were reimbursed by Vanguard. The Portfolio's Trustees and
officers are also Directors and officers of Vanguard and the funds in which the
Portfolio invests.
C. During the year ended December 31, 1997, the Portfolio purchased
$1,542,574,000 of investment securities and sold $850,563,000 of investment
securities other than money market fund and temporary cash investments.
D. At December 31, 1997, unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $1,609,134,000,
consisting entirely of unrealized gains on securities that had risen in value
since their purchase.
15
<PAGE> 18
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Trustees of
Vanguard STAR Portfolio
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard STAR Portfolio (the "Portfolio") at December 31, 1997, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for each
of the five years in the period then ended, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Portfolio's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at December 31, 1997 by
correspondence with the custodian and the application of alternative auditing
procedures where securities purchased had not been settled, provide a reasonable
basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 6, 1998
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD STAR PORTFOLIO
This information for the fiscal year ended December 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $338,369,000 as capital gain dividends (from net
long-term capital gains), which was distributed in December 1997. Of the
$338,369,000 capital gain dividends, the Portfolio designates $161,026,000 as a
20% rate gain distribution.
For corporate shareholders, 17.6% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
16
<PAGE> 19
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Chairman of the Board and Director of The Vanguard Group, Inc., and of each of
the investment companies in The Vanguard Group.
JOHN J. BRENNAN
President, Chief Executive Officer, and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley
College.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern New England Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and
NACCO Industries.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell Company is
the owner of trademarks and copyrights relating to the Russell Indexes.
"Wilshire 4500" and "Wilshire 5000" are trademarks of Wilshire Associates.
<PAGE> 20
VANGUARD FAMILY OF FUNDS
STOCK FUNDS
Convertible Securities Fund
Equity Income Fund
Explorer Fund
Growth and Income Portfolio
Horizon Fund
Aggressive Growth Portfolio
Capital Opportunity Portfolio
Global Equity Portfolio
Index Trust
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Small Capitalization Stock
Portfolio
Total Stock Market Portfolio
Value Portfolio
Institutional Index Fund
International Equity Index Fund
Emerging Markets Portfolio
European Portfolio
Pacific Portfolio
International Growth Portfolio
International Value Portfolio
Morgan Growth Fund
PRIMECAP Fund
Selected Value Portfolio
Specialized Portfolios
Energy Portfolio
Gold & Precious Metals
Portfolio
Health Care Portfolio
REIT Index Portfolio
Utilities Income Portfolio
Tax-Managed Fund
Capital Appreciation
Portfolio
Growth and Income Portfolio
Total International Portfolio
Trustees' Equity Fund
U.S. Portfolio
U.S. Growth Portfolio
Windsor Fund
Windsor II
BALANCED FUNDS
Asset Allocation Fund
Balanced Index Fund
Horizon Fund
Global Asset Allocation
Portfolio
LifeStrategy Portfolios
Conservative Growth
Portfolio
Growth Portfolio
Income Portfolio
Moderate Growth Portfolio
STAR Portfolio
Tax-Managed Fund
Balanced Portfolio
Wellesley Income Fund
Wellington Fund
BOND FUNDS
Admiral Funds
Intermediate-Term U.S.
Treasury Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term U.S. Treasury
Portfolio
Bond Index Fund
Intermediate-Term Bond
Portfolio
Long-Term Bond Portfolio
Short-Term Bond Portfolio
Total Bond Market Portfolio
Fixed Income Securities Fund
GNMA Portfolio
High Yield Corporate Portfolio
Intermediate-Term Corporate
Portfolio
Intermediate-Term U.S.
Treasury Portfolio
Long-Term Corporate
Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term Corporate
Portfolio
Short-Term Federal Portfolio
Short-Term U.S. Treasury
Portfolio
Municipal Bond Fund
High-Yield Portfolio
Insured Long-Term Portfolio
Intermediate-Term Portfolio
Limited-Term Portfolio
Long-Term Portfolio
Short-Term Portfolio
Preferred Stock Fund
State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
MONEY MARKET FUNDS
Admiral Funds
U.S. Treasury Money Market
Portfolio
Money Market Reserves
Federal Portfolio
Prime Portfolio
Municipal Bond Fund
Money Market Portfolio
Treasury Money Market Portfolio
State Tax-Free Funds
(CA, NJ, NY, OH, PA)
Q560-12/1997
(C) 1998 Vanguard Marketing
Corporation, Distributor
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
www.vanguard.com
[email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
<PAGE> 21
VANGUARD
LIFESTRATEGY
PORTFOLIOS
Annual Report -- December 31, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 22
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--more than 6,000 highly motivated
men and women--who form the cornerstone of our operations. As with any
cornerstone, we could not survive long--let alone prosper--without it. That's
why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also take
time to recognize the importance of the individual. Each calendar quarter, we
present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more
than 300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving
you in the years ahead.
[PHOTO] [PHOTO]
John C. Bogle John J. Brennan
Chairman President
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
A MESSAGE TO OUR SHAREHOLDERS . . . . . . . . . . . . . . . . . . . 1
THE MARKETS IN PERSPECTIVE . . . . . . . . . . . . . . . . . . . . 6
PERFORMANCE SUMMARIES . . . . . . . . . . . . . . . . . . . . . . . 8
PORTFOLIO PROFILES . . . . . . . . . . . . . . . . . . . . . . . . 12
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . 17
REPORT OF INDEPENDENT ACCOUNTANTS . . . . . . . . . . . . . . . . . 30
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 23
FELLOW SHAREHOLDER,
Another dramatic advance by the U.S. stock market and solid performance by
bonds led to excellent results for the four Vanguard LifeStrategy Portfolios
during 1997. Returns ranged from +14.2% for the Income Portfolio (holding about
80% of its assets in bonds and cash reserves) to +22.3% for the Growth
Portfolio (with about 80% of its assets in common stocks).
The adjacent table shows the total return (capital change plus reinvested
dividends) of each Portfolio for the twelve months ended December 31. Also
shown are the results of the composite indexes that serve as benchmarks for the
Portfolios. These composites are constructed from unmanaged indexes in
proportions that match the target asset-class weightings of the respective
Portfolios. Three Portfolios exceeded their targets and the fourth, our Growth
Portfolio, matched its benchmark.
<TABLE>
<CAPTION>
- -----------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1997
- -----------------------------------------------------
<S> <C>
LIFESTRATEGY INCOME +14.2%
Income Composite Index* +13.0
- -----------------------------------------------------
LIFESTRATEGY CONSERVATIVE GROWTH +16.8%
Conservative Growth Composite Index* +15.8
- -----------------------------------------------------
LIFESTRATEGY MODERATE GROWTH +19.8%
Moderate Growth Composite Index* +19.5
- -----------------------------------------------------
LIFESTRATEGY GROWTH +22.3%
Growth Composite Index* +22.3
- -----------------------------------------------------
</TABLE>
* Total returns for the composite indexes are derived by applying the
Portfolio's target allocation to the results of the following benchmarks: for
U.S.stocks, the Wilshire 5000 Equity Index; for international stocks, the
Morgan Stanley Capital International Total International Index; for bonds,
the Lehman Brothers Aggregate Bond Index; and for cash reserves, the Salomon
Brothers Three-Month U.S. Treasury Bill Index.
Detailed per-share figures, including net asset values at the beginning
and end of the period, income dividends, and capital gains distributions, are
presented along with each Portfolio's yield as of December 31, 1997, in the
table on page 5. As you know, the LifeStrategy Portfolios are "funds of funds,"
which invest in up to five underlying Vanguard Funds; the value of each
Portfolio's year-end holdings in those Funds is listed in the Financial
Statements beginning on page 17.
THE FINANCIAL MARKETS IN BRIEF
The historic bull market in U.S. stocks that began in August 1982 continued in
impressive fashion during 1997. The economy, employment, and corporate earnings
all grew solidly, and consumer confidence strengthened. Yet interest rates
declined and inflation decelerated. In short, the domestic economic news
couldn't have been better. The sole dark cloud--severe turmoil in Asian
economies and currencies--only briefly darkened the stock market's mood. After
a sharp decline in October--the Wilshire 5000 Index tumbled -6.6% on October 27
alone--stocks resumed their climb. The Index, an excellent measure of the
entire U.S. stock market, produced an astounding +31.3% return for the year.
The large-capitalization-dominated Standard & Poor's 500 Composite Stock Price
Index returned even more, a gain of +33.4%.
Long-term interest rates rose through the first quarter of 1997 on
expectations that the economy's robust growth would cause inflation to
accelerate. The yield on the benchmark 30-year U.S. Treasury bond peaked at
7.17% in mid-April, but drifted lower throughout the year as inflation news got
better, not worse. The 30-year Treasury's yield
1
<PAGE> 24
ended the year at 5.92%, 72 basis points below its level of 6.64% at the end of
1996. Overall during 1997, the Lehman Aggregate Bond Index, a good benchmark
for the U.S. bond market, rose +9.7%.
Short-term interest rates bottomed out in June and began an irregular
climb that was apparently due to sales of short-term Treasuries by foreign
central banks and investors. At year-end, the yield on three-month U.S.
Treasury bills was 5.35%, up just a bit from 5.17% when 1997 began. The spread
between yields on three-month T-bills and 30-year Treasury bonds was a very
slim 0.57 percentage point on December 31. Such a "flattening" of the yield
curve has more often than not been a precursor of a slowdown in the economy.
The year started favorably for international stocks, but faltered as a
series of currency crises began during the summer in Thailand, then spread to
Indonesia, Malaysia, the Philippines, and South Korea. The MSCI Europe,
Australasia, Far East Index, a widely used barometer of international stock
market activity, ended the year up +13.9% in local currency terms, reduced to
+2.1% for U.S. investors as the dollar continued to strengthen abroad. Gains in
European stocks, which were up +23.7% overall in dollar terms, stood in stark
contrast to negative returns (also in dollar terms) of -16.4% in emerging
markets and -25.7% in the Pacific region. With emerging markets added to the
EAFE Index, in proportion to their respective total market value, or
capitalization, the MSCI Total International Index provided a return of -0.8%
during 1997.
1997 PERFORMANCE OVERVIEW
The LifeStrategy Portfolios benefited from the U.S. stock market's
extraordinary performance in proportion to their target equity allocations. We
earned a return of +31.0% on our holdings of Vanguard Index Trust-Total Stock
Market Portfolio, which makes up 5%, 20%, 35%, and 50%, respectively, of the
Income, Conservative Growth, Moderate Growth, and Growth Portfolios. The Total
Stock Market Portfolio's benchmark is the Wilshire 5000 Index. The LifeStrategy
Portfolios also are exposed to U.S. stocks through their stake--an allocation
of 25% each--in Vanguard Asset Allocation Fund, which may invest in any
combination of stocks, long-term bonds, and cash reserves. The Asset
Allocation Fund's equity portion is invested in the stocks that make up the S&P
500 Index.
The blend of each LifeStrategy Portfolio's investments depends, therefore,
on two factors: its own target allocation and the stock/bond allocations of the
Asset Allocation Fund. The target allocations, as shown in the following table,
assume a 60% stock/40% bond position in the Asset Allocation Fund. However, the
adviser of the Asset Allocation Fund can change its allocation periodically,
which in turn may produce slight variations in the actual asset proportions of
the LifeStrategy Portfolios. In 1997, these variations benefited LifeStrategy
shareholders as the Asset Allocation Fund provided a +27.3% return, 1.3
percentage points above what would have been earned by a portfolio with a fixed
allocation of 60% to the S&P 500 Index and 40% to long-term U.S. Treasury
bonds.
During the year, the Asset Allocation Fund's investment mix ran as high as
70% stocks, adding to our returns. By year-end, however, the stock portion had
been reduced to 60% (with 30% bonds and 10% cash reserves). The following table
shows the target and actual allocations of each LifeStrategy Portfolio at
year-end.
2
<PAGE> 25
<TABLE>
<CAPTION>
TARGET AND ACTUAL ASSET ALLOCATIONS (DECEMBER 31, 1997)
- ---------------------------------------------------------------------------------------
STOCKS* BONDS RESERVES
------------------------------------------------------------
LIFESTRATEGY PORTFOLIOS TARGET ACTUAL TARGET ACTUAL TARGET ACTUAL
- -------------------------------------------- ----------------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Income 20% 20% 60% 57% 20% 23%
Conservative Growth 40 40 40 38 20 22
Moderate Growth 60 60 40 38 0 2
Growth 80 80 20 18 0 2
- ---------------------------------------------------------------------------------------
</TABLE>
* International stock positions for the Income, Conservative Growth, Moderate
Growth, and Growth Portfolios equal, respectively, 0%, 5%, 10%, and 15% of
assets.
For three LifeStrategy Portfolios--Conservative Growth, Moderate Growth,
and Growth--the stock allocations shown in the table include international
equity exposure through investments of 5%, 10%, and 15% of assets,
respectively, in Vanguard Total International Portfolio. This international
component came a cropper in 1997, as the Total International Portfolio had a
return of -0.8%. While the returns from international equities have been very
disappointing in recent years, especially in comparison to the booming U.S.
stock market, we believe that a modest commitment to international stocks
continues to make sense for the additional diversification they provide. We
expect this component eventually to make a more positive contribution to our
returns.
The fixed-income components of the LifeStrategy Portfolios are Vanguard
Bond Index Fund-Total Bond Market Portfolio and Vanguard Fixed Income
Securities Fund-Short-Term Corporate Portfolio, which earned +9.4% and +6.9%,
respectively, in 1997. While these returns may seem paltry next to the outsized
returns on stocks, they reflect our conservative mandate and closely parallel
their segments of the bond market.
Our LifeStrategy Portfolios also benefited from the low expense ratios
(operating costs as a percentage of average net assets) of the underlying funds
in which they invest. As you know, the Portfolios incur no direct expenses,
instead bearing their share of the expenses of the underlying Funds. These
expenses, which averaged approximately 0.29% of average assets in 1997, are by
far the lowest among competing mutual funds. The expense ratio for the average
of mutual funds that make up our composite benchmarks is about 1.27%.
Low costs, combined with the value added through active management of the
Asset Allocation Fund during the year, produced a significant advantage for
each Portfolio versus its comparable mutual fund benchmark, as illustrated in
the adjacent table.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
TOTAL RETURNS
YEAR ENDED DECEMBER 31, 1997
-------------------------------------
VANGUARD MUTUAL FUND
LIFESTRATEGY PORTFOLIOS PORTFOLIO BENCHMARK* DIFFERENCE
- ----------------------------------------------------------------
<S> <C> <C> <C>
Income +14.2% +11.0% +3.2%
Conservative Growth +16.8 +13.1 +3.7
Moderate Growth +19.8 +16.0 +3.8
Growth +22.3 +18.1 +4.2
- ----------------------------------------------------------------
</TABLE>
* Each benchmark is a blended composite that weights the returns of the average
comparable mutual fund for each asset class in proportion with the target
weighting of the appropriate LifeStrategy Portfolio.
3
<PAGE> 26
LIFETIME PERFORMANCE OVERVIEW
In slightly more than three years of existence, the Vanguard LifeStrategy
Portfolios have performed extremely well, in terms of both their absolute
returns and their returns relative to competing mutual funds and our benchmark
composite indexes.
The following table presents the returns earned by our Portfolios since
their inception on September 30, 1994, and shows how an initial investment of
$10,000 in each Portfolio would have grown, assuming reinvestment of income
dividends and capital gains distributions. It presents the same information for
our key comparative standards: the composite mutual fund benchmarks and
composite indexes appropriate to each LifeStrategy Portfolio. As the table
shows, we have earned +3.0% to +3.4% more per year than the average competing
fund. That advantage already has added up significantly. For example, an
investment of $10,000 in the Growth Portfolio on September 30, 1994, would
have grown to $18,218, compared with $16,617 for the average competitor.
<TABLE>
<CAPTION>
- -------------------------------------------------------------
TOTAL RETURNS
SEP. 30, 1994 TO DEC. 31, 1997
--------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- -------------------------------------------------------------
<S> <C> <C>
LIFESTRATEGY INCOME +13.6% $15,153
Mutual Fund Benchmark +10.4 13,814
Income Composite Index +12.1 14,506
- -------------------------------------------------------------
LIFESTRATEGY CONSERVATIVE
GROWTH +15.6% $16,044
Mutual Fund Benchmark +12.4 14,608
Conservative Growth
Composite Index +14.4 15,498
- -------------------------------------------------------------
LIFESTRATEGY MODERATE
GROWTH +18.0% $17,150
Mutual Fund Benchmark +15.0 15,754
Moderate Growth
Composite Index +17.6 16,964
- -------------------------------------------------------------
LIFESTRATEGY GROWTH +20.3% $18,218
Mutual Fund Benchmark +16.9 16,617
Growth Composite Index +20.0 18,077
- -------------------------------------------------------------
</TABLE>
An important portion of the incremental return we earn is derived from our
low--indeed peerless--expense ratios. We have operated our Portfolios at an
effective annual cost of 0.28% or 0.29% of average net assets. Our mutual fund
benchmarks operate at a cost of 1.27%. Result: a contribution equal to
one-third of our 3 percentage point margin. As mutual fund investors must come
to realize, cost matters.
As pleased as we are with the performance of the Portfolios, we caution
that their returns are far higher than can be expected over the long haul. The
Portfolios were, in retrospect, created at an ideal moment. The U.S. stock
market has produced remarkable returns since our inception--the Wilshire 5000
Index has earned an annualized return of +26.6% during the 3 1/4 years since our
start, while the bond market, as measured by the Lehman Aggregate Bond Index,
has returned a very respectable +9.7% annually. These returns far exceeded
long-term historical norms of +11.0% for stocks and +5.2% for bonds. Meanwhile,
inflation during the Portfolios' existence has run at a very low annual rate of
2.4%.
In this unbelievably favorable environment, the heavier a fund's exposure
to stocks, the more it earned. This is what one expects over the long term,
because higher returns have historically been the tradeoff for the greater
risks associated with stocks. However, we note that those investors relatively
new to mutual funds have yet to experience a serious or prolonged slump in
stock prices. While we are not predicting such a downturn, we emphasize that
stock prices can decline suddenly and steeply, just as they can make impressive
gains.
4
<PAGE> 27
IN SUMMARY
While investors have every reason to be grateful for the recent bounty of the
financial markets, they also have reason to regard the future with some
caution. Lengthy bull markets can breed complacency and cause investors to
discount the risks inherent in investing. Make no mistake--the markets will
from time to time demonstrate these risks.
The greatest risk, however, is failure to invest in the first place. We
believe that market risks can be partially offset by holding a balanced
portfolio that includes not only stock funds, but also bond funds and money
market funds. Indeed, this strategy is the foundation of each of our
LifeStrategy Portfolios. Investors who maintain such portfolios allocated in
accordance with their time horizon, financial situation, and tolerance for
market volatility should be well prepared to "stay the course" toward their
investment objectives, no matter what the future has in store.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
January 19, 1998
<TABLE>
<CAPTION>
PORTFOLIO STATISTICS
- ---------------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE 12 MONTHS
DECEMBER 31, --------------------------
------------------------ INCOME CAPITAL GAINS SEC
LIFESTRATEGY PORTFOLIO 1996 1997 DIVIDENDS DISTRIBUTIONS YIELD*
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income $11.55 $12.43 $0.63 $0.10 5.44%
Conservative Growth 12.14 13.40 0.56 0.19 4.44
Moderate Growth 12.97 14.81 0.49 0.215 3.51
Growth 13.68 16.04 0.38 0.29 2.47
- ---------------------------------------------------------------------------------------
</TABLE>
*30-day advertised yield net of expenses at month-end.
5
<PAGE> 28
THE MARKETS IN PERSPECTIVE
Year Ended December 31, 1997
U.S. EQUITY MARKETS
Despite some year-end rockiness, 1997 again provided U.S. equity investors with
exceptional returns, as illustrated by the 33.4% advance of the S&P 500 Index.
Investors' mettle was tested several times, however, and most severely by the
upheavals that devastated a number of Asian markets in the fourth quarter.
Beginning in late October, the U.S. market grew increasingly volatile, a direct
result of investors' struggle to understand the nature and implications of
Asia's economic turmoil. By the end of the year, it appeared that a new
consensus was emerging, grounded in two basic beliefs: (1) that the collapse of
currencies in the Far East would help keep inflation tame in the United States
and (2) that slower growth in Asia would most likely lead to weaker corporate
profits over the next several years.
As the dust continued to settle, many investors sought havens traditional
in periods of high uncertainty: large-capitalization issues and particularly
the "defensive" sectors of the stock market, such as utilities, consumer
staples, and health care. The closing weeks of 1997 saw a broad advance in
these "safe" sectors, with utilities gaining 20.1% and consumer staples 10.4%
in the last quarter. By contrast, more economically sensitive sectors were
thrashed in the wake of the Asian crisis, with technology issues falling 12.3%
and producer durables down 9.0% over the three months. After posting strong
results in the third quarter, small-company stocks also suffered in the fourth,
falling 3.3%.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1997
-------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 33.4% 31.2% 20.3%
Russell 2000 Index 22.4 22.3 16.4
MSCI EAFE Index 2.1 6.6 11.7
- ------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 9.7% 10.4% 7.5%
Lehman 10-Year Municipal Bond Index 9.2 10.2 7.6
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.3 5.4 4.7
- ------------------------------------------------------------------
OTHER
Consumer Price Index 1.7% 2.5% 2.6%
- ------------------------------------------------------------------
</TABLE>
The year-end excitement did not detract from 1997's overall record as a
stellar year for U.S. stock investors. The best-performing sector was financial
services, which rose 46.9%. This sector benefited from a number of factors,
including the strength of the economy, the vibrant financial markets, and
merger activity. By contrast, the commodity-oriented materials & processing
sector posted a gain of "only" 12.3%--in itself more than a percentage point
above the long-term average return from common stocks. Small-cap stocks also
fared well overall, as illustrated by the 22.4% increase of the Russell 2000
Index. Small-company technology issues were the most glaring exception,
mustering a gain in 1997 of just 1.1%.
U.S. FIXED-INCOME MARKETS
In a year characterized by exceptionally low inflation, interest rates fell,
providing investors with very attractive total returns. The Lehman Aggregate
Bond Index, for example,
6
<PAGE> 29
posted a total return of 9.7% for 1997, comprising 7.2% in income return and
2.5% in capital appreciation. The decline in rates can be attributed largely to
better-than-expected reports about the inflation rate. Early in the year,
economists were projecting a 2.9% increase in the Consumer Price Index (CPI)
during 1997. In March, the Federal Reserve grew sufficiently concerned to boost
interest rates by 0.25% in an effort to temper economic growth and thereby ward
off inflation. By year-end, however, the worries seemed to have been
unnecessary, as the actual CPI increase was a mere 1.7%--its smallest increase
since 1986.
The bond market gradually gathered strength during the year as investors
grew more confident that four seemingly strange bedfellows--strong economic
growth, reasonable inflation, low unemployment, and stable wage growth--would
continue to coexist peacefully. In the fourth quarter, the market also was
bolstered by the "flight to quality" among investors concerned about Asia's
problems. Overall, the longest-maturity issues benefited most from the decline
in interest rates. The yield on the 30-year U.S. Treasury bond closed the year
at 5.92%, compared with 6.64% on December 31, 1996. Falling rates flattened the
yield curve considerably: Only 0.57% separated the yield on Treasury bills from
that on the 30-year issue, down from a spread of 1.47% at the end of 1996.
The best-performing sector in 1997 was long-term Treasuries, as
illustrated by the 15.1% return of the Lehman Long U.S. Treasury Index.
Investors in lower-quality securities also fared well, with the Lehman High
Yield Bond Index generating a 12.8% gain. The strength of the economy, together
with the lack of inflationary pressure, created an ideal environment for junk
bonds.
INTERNATIONAL EQUITY MARKETS
Arguably, investors' greatest disappointments were in international
markets--and, of course, Asian markets in particular. During the year, the
Morgan Stanley Capital International (MSCI) Pacific Index declined by 25.7% in
U.S. dollar terms; the Index fell 20.7% in the fourth quarter alone. Among
individual markets, the fiscal year saw sharp declines (in U.S. dollar terms)
in Japan, down 23.6% (including a 19.7% drop in the fourth quarter); Thailand,
down 76.8%; and Malaysia, down 68.1%. The general slump in Asian markets began
in midsummer with currency devaluations by a number of countries.
By contrast, the European markets continued to provide U.S. investors with
solid returns, although they, too, stumbled in late October and subsequently
recovered. The MSCI Europe Index posted a gain of 23.7% for the 12 months. The
robust character of the European markets reflected strong corporate earnings
and optimism that the European Monetary Union would provide a solid framework
for future fiscal responsibility and economic growth.
7
<PAGE> 30
PERFORMANCE SUMMARY
Income Portfolio
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Portfolio. Note, too,
that both share price and return can fluctuate widely, so an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- --------------------------------------------------------------
INCOME PORTFOLIO MUTUAL FUND
BENCHMARK*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -------------------------------------------
<S> <C> <C> <C> <C>
1994 -1.2% 1.4% 0.2% -0.2%
1995 17.7 5.3 23.0 16.0
1996 1.9 5.7 7.6 7.5
1997 8.5 5.7 14.2 11.0
- -------------------------------------------
</TABLE>
* 60% average fixed-income fund, 20% average general equity fund, and 20%
average money market fund. See Financial Highlights table on page 25 for
dividend and capital gains information since the Portfolio's inception.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- -------------------------------------------------------------------------------
INCOME MUTUAL FUND INCOME LEHMAN AGGREGATE
PORTFOLIO BENCHMARK COMPSITE INDEX BOND INDEX
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Sep 30, 94 10000 10000 10000 10000
1994 12 10020 9984 10034 10038
1995 03 10618 10393 10545 10544
1995 06 11354 10910 11157 11186
1995 09 11780 11249 11522 11405
1995 12 12324 11583 11960 11891
1996 03 12323 11676 11996 11681
1996 06 12476 11857 12174 11747
1996 09 12739 12098 12414 11965
1996 12 13266 12447 12843 12324
1997 03 13276 12412 12851 12255
1997 06 14088 13063 13591 12704
1997 09 14700 13649 14167 13126
1997 12 15153 13814 14506 13514
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
-------------------------------- FINAL VALUE OF A
1 YEAR SINCE INCEPTION $10,000 INVESTMENT
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Income Portfolio 14.23% 13.63% $15,153
Mutual Fund Benchmark* 10.98 10.45 13,814
Income Composite Index** 12.95 12.12 14,506
Lehman Aggregate Bond Index 9.65 9.70 13,514
- ----------------------------------------------------------------------------------
</TABLE>
* 60% average fixed-income fund, 20% average general equity fund, and 20%
average money market fund.
** 60% Lehman Aggregate Bond Index, 20% Wilshire 5000 Index, and 20% Salomon
Three-Month Treasury Index.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- -------------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION ------------------------
DATE 1 YEAR CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income Portfolio 9/30/1994 14.23% 8.03% 5.60% 13.63%
- -------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 31
PERFORMANCE SUMMARY
Conservative Growth Portfolio
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Portfolio. Note, too,
that both share price and return can fluctuate widely, so an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- --------------------------------------------------------------
CONSERVATIVE GROWTH PORTFOLIO MUTUAL FUND
BENCHMARK*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -------------------------------------------------
<S> <C> <C> <C> <C>
1994 -1.3% 1.4% 0.1% -0.5%
1995 19.3 5.0 24.3 18.0
1996 5.6 4.8 10.4 10.0
1997 12.0 4.8 16.8 13.1
- -------------------------------------------------
</TABLE>
* 40% average fixed-income fund, 35% average general equity fund, 20% average
money market fund, and 5% average international fund.
See Financial Highlights table on page 26 for dividend and capital gains
information since the Portfolio's inception.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------------------
CONSERVATIVE MUTUAL FUND CONSERVATIVE GROWTH LEHMAN AGGREGATE WILSHIRE
GROWTH PORTFOLIO BENCHMARK COMPOSITE INDEX BOND INDEX 500 INDEX
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Sep 30, 94 10000 10000 10000 10000 10000
1994 12 10010 9949 10011 10038 9923
1995 03 10618 10373 10566 10544 10819
1995 06 11371 10944 11202 11186 11829
1995 09 11897 11416 11702 11405 12910
1995 12 12447 11738 12158 11891 13540
1996 03 12617 11977 12358 11681 14300
1996 06 12854 12256 12621 11747 14930
1996 09 13137 12503 12878 11965 15353
1996 12 13736 12913 13389 12324 16412
1997 03 13768 12853 13417 12255 16505
1997 06 14942 13805 14513 12704 19293
1997 09 15680 14587 15242 13126 21188
1997 12 16044 14608 15498 13514 21560
- -----------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
---------------------------------- FINAL VALUE OF A
1 YEAR SINCE INCEPTION $10,000 INVESTMENT
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Conservative Growth Portfolio 16.81% 15.65% $16,044
Mutual Fund Benchmark* 13.13 12.36 14,608
Conservative Growth Composite Index** 15.75 14.42 15,498
Lehman Aggregate Bond Index 9.65 9.70 13,514
Wilshire 5000 Index 31.35 26.65 21,560
- ------------------------------------------------------------------------------------------
</TABLE>
* 40% average fixed-income fund, 35% average general equity fund, 20% average
money market fund, and 5% average international fund.
** 40% Lehman Aggregate Bond Index, 35% Wilshire 5000 Index, 20% Salomon
Three-Month Treasury Index, and 5% MSCI Total International Index.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION -------------------------
DATE 1 YEAR CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Conservative Growth Portfolio 9/30/1994 16.81% 10.73% 4.92% 15.65%
- --------------------------------------------------------------------------------------
</TABLE>
9
<PAGE> 32
PERFORMANCE SUMMARY
Moderate Growth Portfolio
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Portfolio. Note, too, that
both share price and return can fluctuate widely, so an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- --------------------------------------------------------------
MODERATE GROWTH PORTFOLIO MUTUAL FUND
BENCHMARK*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ---------------------------------------------------
<S> <C> <C> <C> <C>
1994 -2.1% 1.4% -0.7% -1.1%
1995 24.1 3.8 27.9 22.1
1996 9.0 3.7 12.7 12.5
1997 15.9 3.9 19.8 16.0
- ---------------------------------------------------
</TABLE>
* 50% average general equity fund, 40% average fixed-income fund, and 10%
average international fund.
See Financial Highlights table on page 26 for dividend and capital gains
information since the Portfolio's inception.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------------------------
MODERATE GROWTH MUTUAL FUND MODERATE GROWTH LEHMAN AGGREGATE WILSHIRE
PORTFOLIO BENCHMARK COMPOSITE INDEX BOND INDEX 500 INDEX
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Sep 30, 94 10000 10000 10000 10000 10000
1994 12 9930 9886 9969 10038 9923
1995 03 10605 10378 10640 10544 10819
1995 06 11441 11079 11405 11186 11829
1995 09 12123 11705 12063 11405 12910
1995 12 12705 12069 12614 11891 13540
1996 03 12999 12414 12914 11681 14300
1996 06 13315 12786 13254 11747 14930
1996 09 13612 13060 13544 11965 15353
1996 12 14320 13579 14197 12324 16412
1997 03 14331 13453 14194 12255 16505
1997 06 15942 14802 15772 12704 19293
1997 09 16870 15872 16749 13126 21188
1997 12 17150 15754 16964 13514 21560
- -----------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
---------------------------------- FINAL VALUE OF A
1 YEAR SINCE INCEPTION $10,000 INVESTMENT
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Moderate Growth Portfolio 19.77% 18.04% $17,150
Mutual Fund Benchmark* 16.02 15.00 15,754
Moderate Growth Composite Index** 19.49 17.65 16,964
Lehman Aggregate Bond Index 9.65 9.70 13,514
Wilshire 5000 Index 31.35 26.65 21,560
- ------------------------------------------------------------------------------------------
</TABLE>
* 50% average general equity fund, 40% average fixed-income fund, and 10%
average international fund.
** 50% Wilshire 5000 Index, 40% Lehman Aggregate Bond Index, and 10% MSCI
Total International Index.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION -------------------------
DATE 1 YEAR CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Moderate Growth Portfolio 9/30/1994 19.77% 14.08% 3.96% 18.04%
- --------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 33
PERFORMANCE SUMMARY
Growth Portfolio
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Portfolio. Note, too,
that both share price and return can fluctuate widely, so an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- --------------------------------------------------------------
GROWTH PORTFOLIO MUTUAL FUND
BENCHMARK*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -------------------------------------------
<S> <C> <C> <C> <C>
1994 -1.5% 1.4% -0.1% -1.5%
1995 26.0 3.2 29.2 24.1
1996 12.5 2.9 15.4 15.1
1997 19.4 2.9 22.3 18.1
- -------------------------------------------
</TABLE>
* 65% average general equity fund, 20% average fixed-income fund, and 15%
average international fund.
See Financial Highlights table on page 27 for dividend and capital gains
information since the Portfolio's inception.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: SEPTEMBER 30, 1994-DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------
MUTUAL FUND GROWTH WILSHIRE
GROWTH PORTFOLIO BENCHMARK COMPOSITE INDEX 500 INDEX
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Sep 30, 94 10000 10000 10000 10000
1994 12 9990 9850 9944 9923
1995 03 10684 10356 10658 10819
1995 06 11539 11111 11447 11829
1995 09 12311 11874 12245 12910
1995 12 12911 12224 12814 13540
1996 03 13381 12725 13295 14300
1996 06 13789 13205 13729 14930
1996 09 14105 13481 14033 15353
1996 12 14901 14068 14782 16412
1997 03 14922 13910 14798 16505
1997 06 16970 15612 16812 19293
1997 09 18067 16923 17979 21188
1997 12 18218 16617 18077 21560
- ---------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
--------------------------------- FINAL VALUE OF A
1 YEAR SINCE INCEPTION $10,000 INVESTMENT
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Growth Portfolio 22.26% 20.26% $18,218
Mutual Fund Benchmark* 18.12 16.90 16,617
Growth Composite Index** 22.29 19.97 18,077
Wilshire 5000 Index 31.35 26.65 21,560
- -----------------------------------------------------------------------------------
</TABLE>
* 65% average general equity fund, 20% average fixed-income fund, and 15%
average international fund.
** 65% Wilshire 5000 Index, 20% Lehman Aggregate Bond Index, and 15% MSCI
Total International Index.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- -------------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION ------------------------
DATE 1 YEAR CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Growth Portfolio 9/30/1994 22.26% 17.03% 3.23% 20.26%
- -------------------------------------------------------------------------------------
</TABLE>
11
<PAGE> 34
PORTFOLIO PROFILE
Income Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
December 31, 1997, including its allocations to various asset classes and to
underlying Vanguard portfolios. Key elements of this Profile are defined on
page 13.
<TABLE>
<CAPTION>
FINANCIAL ATTRIBUTES
- -----------------------------------------
<S> <C>
Yield 5.4%
Expense Ratio 0%
Average Weighted Expense Ratio* 0.28%
</TABLE>
*For underlying portfolios.
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY ASSET CLASS
- -----------------------------------------
<S> <C>
BONDS 57%
SHORT-TERM
RESERVES 23%
STOCKS 20%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -----------------------------------------
INCOME
PORTFOLIO S&P 500
- -----------------------------------------
<S> <C> <C>
R-Squared 0.66 1.00
Beta 0.34 1.00
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION TO FUNDS
- --------------------------------------------------
<S> <C>
Vanguard Asset Allocation Fund 25.2%
Vanguard Bond Index Fund-Total Bond
Market Portfolio-Investor Shares 49.7
Vanguard Fixed Income Securities
Fund-Short-Term Corporate Portfolio 20.0
Vanguard Index Trust-Total Stock
Market Portfolio-Investor Shares 5.1
- --------------------------------------------------
Total 100.0%
</TABLE>
EQUITY INVESTMENT FOCUS
- -----------------------------------------
[GRAPH]
FIXED-INCOME INVESTMENT FOCUS
- -----------------------------------------
[GRAPH]
12
<PAGE> 35
AVERAGE WEIGHTED EXPENSE RATIO. Portfolios that invest in other Vanguard mutual
funds incur no direct expenses, but do bear their share of the operating,
administrative, and advisory expenses of the underlying funds. The average
weighted expense ratio is the average of these expense ratios, weighted in
proportion to the amount of the portfolio represented by each underlying fund.
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a portfolio with
a beta of 1.20 would have seen its share price rise or fall by 12% when the
overall market rose or fell by 10%.
EQUITY INVESTMENT FOCUS. This grid indicates the focus of a portfolio's equity
holdings in terms of two attributes: market capitalization (large, medium, or
small) and relative valuation (growth, value, or a blend).
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FIXED-INCOME INVESTMENT FOCUS. This grid indicates the focus of a portfolio's
fixed-income holdings in terms of two attributes: average maturity (short,
medium, or long) and average credit quality (high, medium, or low).
PORTFOLIO ALLOCATION BY ASSET CLASS. This chart shows the proportions of a
portfolio's holdings allocated to different types of asset.
PORTFOLIO ALLOCATION TO FUNDS. This table shows the distribution of a
portfolio's investments in underlying Vanguard funds.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
SHORT-TERM RESERVES. The percentage of a portfolio's net assets invested in
short-term bond fund shares or in "cash equivalents"--highly liquid,
short-term, interest-bearing instruments.
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based
on income earned by the portfolio over the past 30 days and is annualized, or
projected forward for the coming year.
13
<PAGE> 36
PORTFOLIO PROFILE
Conservative Growth Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
December 31, 1997, including its allocations to various asset classes and to
underlying Vanguard portfolios. Key elements of this Profile are defined on
page 13.
<TABLE>
<CAPTION>
FINANCIAL ATTRIBUTES
- -----------------------------------------
<S> <C>
Yield 4.4%
Expense Ratio 0%
Average Weighted Expense Ratio* 0.29%
</TABLE>
*For underlying portfolios.
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY ASSET CLASS
- -----------------------------------------
<S> <C>
STOCKS 40%
BONDS 38%
SHORT-TERM
RESERVES 22%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -----------------------------------------
CONSERVATIVE
GROWTH PORTFOLIO S&P 500
- -----------------------------------------
<S> <C> <C>
R-Squared 0.89 1.00
Beta 0.48 1.00
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION TO FUNDS
- -----------------------------------------------------
<S> <C>
Vanguard Asset Allocation Fund 24.9%
Vanguard Bond Index Fund-Total Bond
Market Portfolio-Investor Shares 30.0
Vanguard Fixed Income Securities
Fund-Short-Term Corporate Portfolio 19.9
Vanguard Index Trust-Total Stock
Market Portfolio-Investor Shares 20.2
Vanguard Total International Portfolio 5.0
- -----------------------------------------------------
Total 100.0%
</TABLE>
EQUITY INVESTMENT FOCUS
- -----------------------------------------
[GRPAH]
FIXED-INCOME INVESTMENT FOCUS
- -----------------------------------------
[GRAPH]
14
<PAGE> 37
PORTFOLIO PROFILE
Moderate Growth Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
December 31, 1997, including its allocations to various asset classes and to
underlying Vanguard portfolios. Key elements of this Profile are defined on
page 13.
<TABLE>
<CAPTION>
FINANCIAL ATTRIBUTES
- -----------------------------------------
<S> <C>
Yield 3.5%
Expense Ratio 0%
Average Weighted Expense Ratio* 0.29%
</TABLE>
*For underlying portfolios.
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY ASSET CLASS
- -----------------------------------------
<S> <C>
STOCKS 60%
BONDS 38%
SHORT-TERM
RESERVES 2%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -----------------------------------------
MODERATE
GROWTH PORTFOLIO S&P 500
- -----------------------------------------
<S> <C> <C>
R-Squared 0.95 1.00
Beta 0.63 1.00
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION TO FUNDS
- -----------------------------------------------------
<S> <C>
Vanguard Asset Allocation Fund 25.0%
Vanguard Bond Index Fund-Total Bond
Market Portfolio-Investor Shares 30.1
Vanguard Index Trust-Total Stock
Market Portfolio-Investor Shares 34.9
Vanguard Total International Portfolio 10.0
- -----------------------------------------------------
Total 100.0%
</TABLE>
EQUITY INVESTMENT FOCUS
- -----------------------------------------
[GRAPH]
FIXED-INCOME INVESTMENT FOCUS
- -----------------------------------------
[GRAPH]
15
<PAGE> 38
PORTFOLIO PROFILE
- --------------------------------------------------------------------------------
Growth Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
December 31, 1997, including its allocations to various asset classes and to
underlying Vanguard portfolios. Key elements of this Profile are defined on
page 13.
<TABLE>
<CAPTION>
FINANCIAL ATTRIBUTES
- -----------------------------------------
<S> <C>
Yield 2.5%
Expense Ratio 0%
Average Weighted Expense Ratio* 0.29%
</TABLE>
*For underlying portfolios.
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY ASSET CLASS
- -----------------------------------------
<S> <C>
STOCKS 80%
BONDS 18%
SHORT-TERM
RESERVES 2%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -----------------------------------------
GROWTH
PORTFOLIO S&P 500
- -----------------------------------------
<S> <C> <C>
R-Squared 0.95 1.00
Beta 0.77 1.00
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION TO FUNDS
- ----------------------------------------------------
<S> <C>
Vanguard Asset Allocation Fund 25.0%
Vanguard Bond Index Fund-Total Bond
Market Portfolio-Investor Shares 10.1
Vanguard Index Trust-Total Stock
Market Portfolio-Investor Shares 49.9
Vanguard Total International Portfolio 15.0
- ----------------------------------------------------
Total 100.0%
</TABLE>
EQUITY INVESTMENT FOCUS
- -----------------------------------------
[GRAPH]
FIXED-INCOME INVESTMENT FOCUS
- -----------------------------------------
[GRAPH]
16
<PAGE> 39
FINANCIAL STATEMENTS
December 31, 1997
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Portfolio's investments in
shares of each Vanguard fund, along with the value of each investment on the
last day of the reporting period. Other assets are added to, and liabilities
are subtracted from, the value of Total Investments to calculate the
Portfolio's Net Assets. Finally, Net Assets are divided by the outstanding
shares of the Portfolio to arrive at its share price, or Net Asset Value (NAV)
Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the Portfolio's net assets on both a dollar and per-share
basis. Because all income and any realized gains must be distributed to
shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Portfolio had available to distribute to shareholders as income
dividends or capital gains as of the statement date. Any Accumulated Net
Realized Losses, and any cumulative excess of distributions over net income or
net realized gains, will appear as negative balances. Unrealized Appreciation
(Depreciation) is the difference between the market value of the Portfolio's
investments and their cost, and reflects the gains (losses) that would be
realized if the Portfolio were to sell all of its investments at their
statement-date values.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
INCOME PORTFOLIO SHARES (000)
- -----------------------------------------------------------------------------------------------------------------
NVESTMENT COMPANIES (99.4%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
STOCK FUND (5.1%)
Vanguard Index Trust-Total Stock Market Portfolio-Investor Shares 544,701 $ 12,332
----------
BALANCED FUND (25.1%)
Vanguard Asset Allocation Fund 2,903,984 61,129
----------
BOND FUNDS (69.2%)
Vanguard Bond Index Fund-Total Bond Market Portfolio-Investor Shares 11,939,517 120,470
Vanguard Fixed Income Securities Fund-Short-Term Corporate Portfolio-Investor Shares 4,480,446 48,433
----------
168,903
----------
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT COMPANIES
(COST $225,076) 242,364
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- -----------------------------------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (0.3%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government Obligations in a Pooled Cash Account
6.54%, 1/2/1998
(COST $832) $832 832
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.7%)
(COST $225,908) 243,196
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE> 40
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
INCOME PORTFOLIO (000)
- -----------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.3%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C>
Other Assets $ 2,767
Liabilities (2,025)
----------
742
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------------------------------------------------------
Applicable to 19,620,603 shares of beneficial interest
(unlimited authorization--no par value) $243,938
=================================================================================================================
NET ASSET VALUE PER SHARE $12.43
=================================================================================================================
*See Note A in Notes to Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $226,714 $11.56
Undistributed Net Investment Income 52 --
Overdistributed Net Realized Gains (116) (.01)
Unrealized Appreciation--Note D 17,288 .88
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS $243,938 $12.43
=================================================================================================================
</TABLE>
18
<PAGE> 41
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
CONSERVATIVE GROWTH PORTFOLIO SHARES (000)
- -----------------------------------------------------------------------------------------------------------------
INVESTMENT COMPANIES (99.7%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
STOCK FUNDS (25.1%)
Vanguard Index Trust-Total Stock Market Portfolio-Investor Shares 7,133,466 $161,501
Vanguard Total International Portfolio 4,079,026 40,260
----------
201,761
----------
BALANCED FUND (24.8%)
Vanguard Asset Allocation Fund 9,464,071 199,219
----------
BOND FUNDS (49.8%)
Vanguard Bond Index Fund-Total Bond Market Portfolio-Investor Shares 23,801,289 240,155
Vanguard Fixed Income Securities Fund-Short-Term Corporate Portfolio-Investor Shares 14,759,186 159,547
----------
399,702
----------
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT COMPANIES
(COST $714,512) 800,682
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- -----------------------------------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (0.2%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government Obligations in a Pooled Cash Account
6.54%, 1/2/1998
(COST $1,357) $1,357 1,357
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.9%)
(COST $715,869) 802,039
- -----------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.1%)
- -----------------------------------------------------------------------------------------------------------------
Other Assets 8,680
Liabilities (7,770)
----------
910
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------------------------------------------------------
Applicable to 59,938,647 shares of beneficial interest
(unlimited authorization--no par value) $802,949
=================================================================================================================
NET ASSET VALUE PER SHARE $13.40
=================================================================================================================
*See Note A in Notes to Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $716,738 $11.96
Undistributed Net Investment Income 155 --
Overdistributed Net Realized Gains (114) --
Unrealized Appreciation--Note 86,170 1.44
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS $802,949 $13.40
=================================================================================================================
</TABLE>
19
<PAGE> 42
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
MODERATE GROWTH PORTFOLIO SHARES (000)
- -----------------------------------------------------------------------------------------------------------------
INVESTMENT COMPANIES (99.9%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
STOCK FUNDS (44.9%)
Vanguard Index Trust-Total Stock Market Portfolio-Investor Shares 20,954,559 $ 474,411
Vanguard Total International Portfolio 13,694,180 135,162
----------
609,573
----------
BALANCED FUND (24.9%)
Vanguard Asset Allocation Fund 16,085,134 338,592
----------
BOND FUND (30.1%)
Vanguard Bond Index Fund-Total Bond Market Portfolio-Investor Shares 40,522,654 408,874
----------
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT COMPANIES
(COST $1,171,750) 1,357,039
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- -----------------------------------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (0.1%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government Obligations in a Pooled Cash Account
6.54%, 1/2/1998
(COST $984) $984 984
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.0%)
(COST $1,172,734) 1,358,023
- -----------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES
- -----------------------------------------------------------------------------------------------------------------
Other Assets 18,868
Liabilities (18,882)
----------
(14)
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------------------------------------------------------
Applicable to 91,708,360 shares of beneficial interest
(unlimited authorization--no par value) $1,358,009
=================================================================================================================
NET ASSET VALUE PER SHARE $14.81
=================================================================================================================
*See Note A in Notes to Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $1,173,123 $12.79
Overdistributed Net Investment Income (162) --
Overdistributed Net Realized Gains (241) --
Unrealized Appreciation--Note D 185,289 2.02
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS $1,358,009 $14.81
=================================================================================================================
</TABLE>
20
<PAGE> 43
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
MARKET
VALUE*
GROWTH PORTFOLIO SHARES (000)
- -----------------------------------------------------------------------------------------------------------------
INVESTMENT COMPANIES (99.9%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
STOCK FUNDS (64.9%)
Vanguard Index Trust-Total Stock Market Portfolio-Investor Shares 26,124,077 $ 591,449
Vanguard Total International Portfolio 17,927,165 176,941
----------
768,390
----------
BALANCED FUND (25.0%)
Vanguard Asset Allocation Fund 14,037,258 295,484
----------
BOND FUND (10.0%)
Vanguard Bond Index Fund-Total Bond Market Portfolio-Investor Shares 11,787,887 118,940
----------
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT COMPANIES
(COST $991,097) 1,182,814
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- -----------------------------------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (0.2%)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government Obligations in a Pooled Cash Account
6.54%, 1/2/1998
(COST $2,044) $2,044 2,044
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.1%)
(COST $993,141) 1,184,858
- -----------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.1%)
- -----------------------------------------------------------------------------------------------------------------
Other Assets 12,748
Liabilities (13,889)
----------
(1,141)
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------------------------------------------------------
Applicable to 73,810,750 shares of beneficial interest
(unlimited authorization--no par value) $1,183,717
=================================================================================================================
NET ASSET VALUE PER SHARE $16.04
=================================================================================================================
*See Note A in Notes to Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $ 992,177 $13.44
Overdistributed Net Investment Income (63) --
Overdistributed Net Realized Gains (114) --
Unrealized Appreciation--Note D 191,717 2.60
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS $1,183,717 $16.04
=================================================================================================================
</TABLE>
21
<PAGE> 44
STATEMENT OF OPERATIONS
This Statement shows each Portfolio's Income Distributions Received from the
other Vanguard funds in which it invests. This Statement also shows any Capital
Gain Distributions Received from the other funds' realized net gains, Net Gain
(Loss) realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
CONSERVATIVE MODERATE
INCOME GROWTH GROWTH GROWTH
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
---------------------------------------------------
YEAR ENDED DECEMBER 31, 1997
---------------------------------------------------
(000) (000) (000) (000)
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INVESTMENT INCOME
INCOME
Income Distributions Received $10,523 $28,898 $ 40,526 $ 25,556
Interest 18 59 109 92
- ----------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME--Note B 10,541 28,957 40,635 25,648
- ----------------------------------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Capital Gain Distributions Received 2,815 10,671 20,534 19,998
Investment Securities Sold (939) 464 (1,469) 380
- ----------------------------------------------------------------------------------------------------------
REALIZED NET GAIN 1,876 11,135 19,065 20,378
- ----------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
(DEPRECIATION) OF INVESTMENT SECURITIES 12,899 56,446 133,867 129,235
- ----------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS $25,316 $96,538 $193,567 $175,261
==========================================================================================================
</TABLE>
22
<PAGE> 45
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how each Portfolio's total net assets changed during the
two most recent reporting periods. The Operations section summarizes
information detailed in the Statement of Operations. The amounts shown as
Distributions to shareholders from the Portfolio's net income and capital gains
may not match the amounts shown in the Operations section, because
distributions are determined on a tax basis and may be made in a period
different from the one in which the income was earned or the gains were
realized on the financial statements. The Capital Share Transactions section
shows the amount shareholders invested in the Portfolio, either by purchasing
shares or by reinvesting distributions, as well as the amounts redeemed. The
corresponding numbers of Shares Issued and Redeemed are shown at the end of the
Statement.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
INCOME CONSERVATIVE GROWTH
PORTFOLIO PORTFOLIO
---------------------- ---------------------
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1997 1996 1997 1996
(000) (000) (000) (000)
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 10,541 $ 7,881 $ 28,957 $ 16,809
Realized Net Gain 1,876 2,615 11,135 7,187
Change in Unrealized Appreciation
(Depreciation) 12,899 110 56,446 12,584
-------------------------------------------------
Net Increase in Net Assets
Resulting from Operations 25,316 10,606 96,538 36,580
-------------------------------------------------
DISTRIBUTIONS
Net Investment Income (10,467) (7,907) (28,823) (16,731)
Realized Capital Gain (1,902) (2,654) (10,984) (7,326)
-------------------------------------------------
Total Distributions (12,369) (10,561) (39,807) (24,057)
-------------------------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 130,219 90,016 382,488 297,016
Issued in Lieu of Cash Distributions 10,467 9,108 37,567 22,450
Redeemed (61,177) (68,426) (136,332) (88,762)
-------------------------------------------------
Net Increase from Capital
Share Transactions 79,509 30,698 283,723 230,704
- ------------------------------------------------------------------------------------------------------
Total Increase 92,456 30,743 340,454 243,227
- ------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 151,482 120,739 462,495 219,268
-------------------------------------------------
End of Year $243,938 $151,482 $802,949 $462,495
======================================================================================================
(1)Shares Issued (Redeemed)
Issued 10,739 7,797 29,511 24,891
Issued in Lieu of Cash Distributions 859 790 2,855 1,858
Redeemed (5,091) (5,937) (10,535) (7,409)
-------------------------------------------------
Net Increase in Shares Outstanding 6,507 2,650 21,831 19,340
======================================================================================================
</TABLE>
23
<PAGE> 46
STATEMENT OF CHANGES IN NET ASSETS (continued)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
MODERATE GROWTH
GROWTH PORTFOLIO PORTFOLIO
-------------------------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1997 1996 1997 1996
(000) (000) (000) (000)
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 40,635 $ 19,999 $ 25,648 $ 13,739
Realized Net Gain 19,065 11,128 20,378 10,306
Change in Unrealized Appreciation
(Depreciation) 133,867 31,082 129,235 40,378
-------------------------------------------------
Net Increase in Net Assets
Resulting from Operations 193,567 62,209 175,261 64,423
-------------------------------------------------
DISTRIBUTIONS
Net Investment Income (40,797) (19,971) (25,360) (14,036)
Realized Capital Gain (18,847) (11,572) (20,474) (10,183)
-------------------------------------------------
Total Distributions (59,644) (31,543) (45,834) (24,219)
-------------------------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 535,843 651,410 516,946 420,869
Issued in Lieu of Cash Distributions 55,672 28,857 45,132 23,804
Redeemed (193,147) (119,901) (136,459) (73,627)
-------------------------------------------------
Net Increase from Capital
Share Transactions 398,368 560,366 425,619 371,046
- ------------------------------------------------------------------------------------------------------
Total Increase 532,291 591,032 555,046 411,250
- ------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 825,718 234,686 628,671 217,421
-------------------------------------------------
End of Year $1,358,009 $825,718 $1,183,717 $628,671
======================================================================================================
(1)Shares Issued (Redeemed)
Issued 37,852 51,569 33,989 32,215
Issued in Lieu of Cash Distributions 3,820 2,225 2,860 1,737
Redeemed (13,628) (9,501) (9,004) (5,575)
-------------------------------------------------
Net Increase in Shares Outstanding 28,044 44,293 27,845 28,377
======================================================================================================
</TABLE>
24
<PAGE> 47
FINANCIAL HIGHLIGHTS
This table summarizes each Portfolio's investment results and distributions to
shareholders on a per-share basis. The table also presents the Portfolio's
Total Return and shows net investment income and expenses as percentages of
average net assets. The expense ratio is zero because the Portfolio pays no
direct expenses; its share of the expenses of the other funds in which it
invests indirectly reduces the income received from them. The data in the table
will help you assess: the variability of the Portfolio's net income and total
returns from year to year; the relative contributions of net income and capital
gains to the Portfolio's total return; the extent to which the Portfolio tends
to distribute capital gains; and the portion of capital gains distributions
representing the "pass-through" of capital gains distributions received from
other Vanguard funds. The table also shows the Portfolio Turnover Rate, a
measure of trading activity. A turnover rate of 100% means that the average
security is held in the Portfolio for one year.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
INCOME PORTFOLIO
YEAR ENDED DECEMBER 31,
-------------------------------- SEPT. 30* TO
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 1997 1996 1995 DEC. 31, 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $11.55 $11.54 $ 9.88 $10.00
- -------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .63 .64 .49 .14
Capital Gain Distributions Received .15 .19 .09 --
Net Realized and Unrealized Gain (Loss) on Investments .83 .03 1.66 (.12)
-----------------------------------------------
Total from Investment Operations 1.61 .86 2.24 .02
-----------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.63) (.64) (.49) (.14)
Distributions from Realized Capital Gains (.10) (.21) (.09) --
-----------------------------------------------
Total Distributions (.73) (.85) (.58) (.14)
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $12.43 $11.55 $11.54 $ 9.88
===================================================================================================================
TOTAL RETURN 14.23% 7.65% 22.99% 0.20%
===================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $244 $151 $121 $11
Ratio of Expenses to Average Net Assets--Note B 0% 0% 0% 0%
Ratio of Net Investment Income to Average Net Assets 5.54% 5.66% 5.76% 7.31%**
Portfolio Turnover Rate 6% 22% 4% 1%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
*Commencement of operations.
**Annualized.
25
<PAGE> 48
FINANCIAL HIGHLIGHTS (continued)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
CONSERVATIVE GROWTH PORTFOLIO
YEAR ENDED DECEMBER 31,
-------------------------------- SEPT. 30* TO
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 1997 1996 1995 DEC. 31, 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $12.14 $11.68 $9.89 $10.03
- -------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .56 .53 .47 .14
Capital Gain Distributions Received .18 .20 .11 .01
Net Realized and Unrealized Gain (Loss) on Investments 1.27 .46 1.80 (.14)
-----------------------------------------------
Total from Investment Operations 2.01 1.19 2.38 .01
-----------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.56) (.53) (.47) (.14)
Distributions from Realized Capital Gains (.19) (.20) (.12) (.01)
-----------------------------------------------
Total Distributions (.75) (.73) (.59) (.15)
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $13.40 $12.14 $11.68 $ 9.89
===================================================================================================================
TOTAL RETURN 16.81% 10.36% 24.35% 0.10%
===================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $803 $462 $219 $41
Ratio of Expenses to Average Net Assets--Note B 0% 0% 0% 0%
Ratio of Net Investment Income to Average Net Assets 4.61% 4.86% 5.14% 7.07%**
Portfolio Turnover Rate 1% 2% 1% 0%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
*Commencement of operations.
**Annualized.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
MODERATE GROWTH PORTFOLIO
YEAR ENDED DECEMBER 31,
-------------------------------- SEPT. 30* TO
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 1997 1996 1995 DEC. 31, 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $12.97 $12.11 $9.86 $10.08
- -------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .490 .44 .36 .14
Capital Gain Distributions Received .236 .22 .13 .01
Net Realized and Unrealized Gain (Loss) on Investments 1.819 .87 2.25 (.22)
-----------------------------------------------
Total from Investment Operations 2.545 1.53 2.74 (.07)
-----------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.490) (.44) (.36) (.14)
Distributions from Realized Capital Gains (.215) (.23) (.13) (.01)
-----------------------------------------------
Total Distributions (.705) (.67) (.49) (.15)
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $14.81 $12.97 $12.11 $ 9.86
===================================================================================================================
TOTAL RETURN 19.77% 12.71% 27.94% -0.70%
===================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $1,358 $826 $235 $35
Ratio of Expenses to Average Net Assets--Note B 0% 0% 0% 0%
Ratio of Net Investment Income to Average Net Assets 3.72% 3.98% 4.42% 7.10%**
Portfolio Turnover Rate 2% 3% 1% 0%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
*Commencement of operations.
**Annualized.
26
<PAGE> 49
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
GROWTH PORTFOLIO
YEAR ENDED DECEMBER 31,
-------------------------------- SEPT. 30* TO
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 1997 1996 1995 DEC. 31, 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $13.68 $12.36 $9.93 $10.10
- -------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .39 .34 .32 .13
Capital Gain Distributions Received .28 .24 .14 .02
Net Realized and Unrealized Gain (Loss) on Investments 2.36 1.32 2.43 (.16)
-----------------------------------------------
Total from Investment Operations 3.03 1.90 2.89 (.01)
-----------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.38) (.35) (.31) (.14)
Distributions from Realized Capital Gains (.29) (.23) (.15) (.02)
-----------------------------------------------
Total Distributions (.67) (.58) (.46) (.16)
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $16.04 $13.68 $12.36 $ 9.93
===================================================================================================================
TOTAL RETURN 22.26% 15.41% 29.24% -0.10%
===================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $1,184 $629 $217 $38
Ratio of Expenses to Average Net Assets--Note B 0% 0% 0% 0%
Ratio of Net Investment Income to Average Net Assets 2.84% 3.18% 3.67% 7.06%**
Portfolio Turnover Rate 1% 0% 1% 1%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
*Commencement of operations.
**Annualized.
27
<PAGE> 50
NOTES TO FINANCIAL STATEMENTS
Vanguard LifeStrategy Portfolios comprises the Income, Conservative Growth,
Moderate Growth, and Growth Portfolios of Vanguard STAR Fund. Each Portfolio is
registered under the Investment Company Act of 1940 as an open-end investment
company, or mutual fund. Each Portfolio follows a balanced investment strategy
by investing in selected Vanguard funds to achieve its targeted allocation of
assets to U.S. stocks, international stocks, bonds, and short-term reserves.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Portfolios consistently follow such
policies in preparing their financial statements.
1. VALUATION: Investments are valued at the net asset value of each
Vanguard fund determined as of the close of the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date. Temporary cash
investments are valued at cost, which approximates market value.
2. FEDERAL INCOME TAXES: Each Portfolio intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
4. REPURCHASE AGREEMENTS: Each Portfolio, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
5. OTHER: Income and capital gain distributions received are recorded on
the ex-dividend date. Security transactions are accounted for on the date
securities are bought or sold. Costs used to determine realized gains (losses)
on the sale of investment securities are those of the specific securities sold.
B. Under a special service agreement, The Vanguard Group furnishes corporate
management, administrative, marketing, and distribution services to the
Portfolios. The special service agreement provides that Vanguard will reimburse
the Portfolios' expenses to the extent of savings in administrative and
marketing costs realized by Vanguard in the operation of the Portfolios.
Accordingly, all expenses incurred by the Portfolios during the year ended
December 31, 1997, were reimbursed by Vanguard. The Portfolios' Trustees and
officers are also Directors and officers of Vanguard and the funds in which the
Portfolios invest.
C. During the year ended December 31, 1997, purchases and sales of investment
securities were:
<TABLE>
<CAPTION>
--------------------------------------------------------------------
(000)
--------------------------
PORTFOLIO PURCHASES SALES
--------------------------------------------------------------------
<S> <C> <C>
Income $ 90,231 $11,364
Conservative Growth 289,516 7,114
Moderate Growth 423,521 24,045
Growth 430,232 5,142
--------------------------------------------------------------------
</TABLE>
28
<PAGE> 51
D. At December 31, 1997, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was:
<TABLE>
<CAPTION>
--------------------------------------------------------------------
(000)
--------------------------------------------
NET
APPRECIATED DEPRECIATED UNREALIZED
PORTFOLIO SECURITIES SECURITIES APPRECIATION
--------------------------------------------------------------------
<S> <C> <C> <C>
Income $ 17,288 -- $ 17,288
Conservative Growth 87,491 $(1,321) 86,170
Moderate Growth 189,736 (4,447) 185,289
Growth 198,534 (6,817) 191,717
--------------------------------------------------------------------
</TABLE>
29
<PAGE> 52
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Trustees of
Vanguard STAR Fund
In our opinion, the accompanying statements of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Income, Conservative Growth, Moderate Growth and Growth Portfolios (separate
portfolios of Vanguard STAR Fund, hereafter referred to as the "Fund") at
December 31, 1997, the results of each of their operations for the year then
ended, the changes in each of their net assets for each of the two years in the
period then ended and the financial highlights for each of the periods
indicated, in conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits, which included confirmation of
securities at December 31, 1997 by correspondence with the custodian and the
application of alternative auditing procedures where securities purchased had
not been settled, provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 6, 1998
30
<PAGE> 53
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD LIFESTRATEGY PORTFOLIOS
This information for the fiscal year ended December 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Income, Conservative Growth, Moderate Growth, and Growth Portfolios
designate $651,000, $6,620,000, $10,569,000, and $12,237,000, respectively,
as capital gain dividends (from net long-term capital gains), which were
distributed in December 1997. Of these capital gain dividends, $651,000,
$3,529,000, $6,997,000, and $7,011,000, respectively, are designated as 20%
rate gain distributions.
For corporate shareholders, the percentage of investment income
(dividend income plus short-term gains, if any) that qualifies for the
dividends-received deduction is as follows:
<TABLE>
<S> <C>
-----------------------------------------------
Income Portfolio 4.3%
Conservative Growth Portfolio 9.1%
Moderate Growth Portfolio 15.4%
Growth Portfolio 25.0%
-----------------------------------------------
</TABLE>
31
<PAGE> 54
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Chairman of the Board and Director of The Vanguard Group, Inc., and of each of
the investment companies in The Vanguard Group.
JOHN J. BRENNAN
President, Chief Executive Officer, and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley
College.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern New England Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and
NACCO Industries.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell Company
is the owner of trademarks and copyrights relating to the Russell Indexes.
"Wilshire 4500" and "Wilshire 5000" are trademarks of Wilshire Associates.
<PAGE> 55
VANGUARD FAMILY OF FUNDS
STOCK FUNDS
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(CA, NJ, NY, OH, PA)
Q880-12/1997
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[THE VANGUARD GROUP LOGO]
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