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VANGUARD
GROWTH AND INCOME
PORTFOLIO
Annual Report - December 31, 1997
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[THE VANGUARDGROUP LOGO]
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[PHOTO]
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.
John C. Bogle John J. Brennan
Chairman President
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CONTENTS
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A MESSAGE TO OUR SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . 1
THE MARKETS IN PERSPECTIVE . . . . . . . . . . . . . . . . . . . . . . . . . . 4
REPORT FROM THE ADVISER . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
PORTFOLIO PROFILE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
PERFORMANCE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
REPORT OF INDEPENDENT ACCOUNTANTS . . . . . . . . . . . . . . . . . . . . . . . 19
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
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FELLOW SHAREHOLDER,
Vanguard Growth and Income Portfolio provided a stellar return of +35.6%
in 1997 as the U.S. stock market turned in another astonishing performance,
capping a three-year run during which market averages more than doubled.
The Portfolio (formerly designated Vanguard Quantitative Portfolios) not
only smartly outpaced the average value mutual fund but also topped the
unmanaged Standard & Poor's 500 Composite Stock Price Index. The adjacent table
presents the twelve-month total return (capital change plus reinvested
dividends) of the Portfolio and its two comparative standards. Our return is
based on an increase in net asset value from $22.23 per share on December 31,
1996, to $26.19 per share on December 31, 1997, with the latter figure adjusted
for dividends of $0.42 per share paid from net investment income and
distributions totaling $3.18 per share paid from net realized capital gains.
<TABLE>
<CAPTION>
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TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1997
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<S> <C>
Vanguard Growth and
Income Portfolio* +35.6%
- ------------------------------------------------------------
Average Value Fund +27.7%
- ------------------------------------------------------------
S&P 500 Index +33.4%
- ------------------------------------------------------------
</TABLE>
*Vanguard Quantitative Portfolios prior to April 30, 1997.
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 a +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.
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 1997, the yield on three-month U.S.
Treasury bills was 5.35%, up 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 the precursor of a slowdown in the economy.
1997 PERFORMANCE OVERVIEW
Your Portfolio's +35.6% return during 1997 was the second highest in its
eleven-year history, trailing only the +35.9% gain in 1995. More important,
because our adviser's mandate is to exceed the returns on the S&P 500 Index
while paralleling its risk
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characteristics, the Portfolio surpassed that goal by +2.2 percentage points.
We achieved a far more substantial margin of +7.9 percentage points over our
average competitor--more than a 28% enhancement.
The adviser's excellent stock selection, using its computer-driven
quantitative techniques, enhanced returns in several sectors. Our selection of
financial-services stocks, the market's best sector for the year with a +46.9%
return, provided the Portfolio with a +54.7% return. The Portfolio also
benefited from its heavier concentration in this sector (19.0% of assets on
average during the year, versus 16.5% for the S&P 500 Index). In technology
stocks, the Portfolio gained +38.3%, compared with the +28.4% return from the
sector for the Index. Lagging returns among our health care (+29.2%) and
consumer staples (+25.9%) selections proved our major negatives, partially
offset by solid selections in consumer services and even in the oil sector, a
market laggard.
The Portfolio got a boost versus its competitors from the stock market's
bias toward large-capitalization stocks. The S&P 500 Index, which is dominated
by large-cap stocks, outdistanced by more than 6 percentage points the +27.2%
return on the Russell 2800 Index, a good barometer of mid-cap stocks. This
worked to our advantage in 1997, when the Portfolio held but 20% of its assets
in mid- and small-cap stocks, while the average large value fund held a 30%
position--half again as much in these less-robust equities.
LONG-TERM PERFORMANCE OVERVIEW
The table below compares the Portfolio's record over the decade ended December
31, 1997, with those of the average value fund and the S&P 500 Index. It also
shows how much a hypothetical $10,000 investment made in each on December 31,
1987, would have grown, assuming the reinvestment of all income dividends and
capital gains distributions. As the table shows, we have earned an average of
+2.8% more per year than the average value fund. That advantage adds up
dramatically over a decade. An investment of $10,000 in the Portfolio on
December 31, 1987, would have grown to $53,807 over ten years, compared with
$42,405 for our average competitor. The additional $11,402 wealth created over
the decade is 114% of the entire initial stake.
<TABLE>
<CAPTION>
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TOTAL RETURNS
10 YEARS ENDED DECEMBER 31, 1997
------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
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<S> <C> <C>
Vanguard Growth and
Income Portfolio +18.3% $53,807
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Average Value Fund +15.5% $42,405
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S&P 500 Index +18.1% $52,567
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</TABLE>
It is a pleasure to report that we also have outperformed the S&P 500 Index
over the decade, though by a small margin. The Index, as you know, is a tough
competitor for all actively managed mutual funds because it exists only on
paper and has none of the operating and transaction costs that all mutual funds
bear to one degree or another. To be sure, index mutual funds are indeed
available, but even the lowest-cost ones tend to lag the Index by about the
0.20% expense ratios (operating costs as a percentage of average net assets)
that they incur. Thus we would have eked out a margin of about 0.40% per year
over such a fund.
In respect to cost, the Portfolio has a significant advantage over
competing mutual funds; our annual expense ratio of 0.36% is nearly a full
percentage point below the 1.23% expense ratio of the average value fund. We
fully expect this advantage of nearly
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1% to persist, regardless of the direction of the financial markets. As mutual
fund investors are slowly learning, costs matter.
We stress that the long-term returns shown in the table were unusually
high. They encompass a ten-year period without a single severe downturn in the
U.S. stock market. But there will surely be individual down years ahead, and we
caution that returns from the Growth and Income Portfolio, and from the U.S.
stock market in general, will almost certainly be less generous over the next
decade than during the one just past.
IN SUMMARY
Returns from the U.S. stock market over the past three calendar years--indeed
over the past 15 years--have no precedent in American financial history. While
investors have every reason to be grateful for the 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 stocks. Make no mistake--the market will from time to
time demonstrate these risks.
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 also includes bond funds and money market funds.
Investors who maintain such portfolios--allocated in accordance with their time
horizon, financial situation, and tolerance for market volatility--are 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 13, 1998
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<PAGE> 6
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%.
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<CAPTION>
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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,
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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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REPORT FROM THE ADVISER
We are pleased to report on our investment results for the year ended December
31, 1997. The Portfolio's return of 35.6% exceeded those of the unmanaged S&P
500 Index and the average value (growth and income) mutual fund. Indeed, your
Portfolio's return in 1997 surpassed those earned by more than 90% of the funds
in Morningstar's growth and income fund category, a record we have achieved in
each of the four periods presented in the table at right.
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<CAPTION>
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RANK OF VANGUARD GROWTH AND INCOME PORTFOLIO
AMONG GROWTH AND INCOME FUNDS
THROUGH DECEMBER 31, 1997
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<S> <C>
Last 10 years 7th out of 133
Last 5 years 16th out of 251
Last 3 years 19th out of 410
Last 1 year 25th out of 610
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</TABLE>
Source: Morningstar, Inc.
Large-capitalization stocks were the market's clear leaders both in the
fourth quarter of 1997 and for the full year. The largest 25 stocks in the S&P
500 Index earned a total return of 4.1% during the fourth quarter, while the
entire Index returned 2.9%. For the full year, the largest 25 stocks
outperformed the entire Index by more than 5 percentage points. Most actively
managed stock portfolios have trouble matching the Index when its largest
components are so heavily influencing its gains. By the same token, when the
largest components of the Index are laggards, managed portfolios typically
perform better than the Index.
Despite the dominance of the very largest stocks, with the implied
challenge for a managed fund such as your Portfolio, we were able to outperform
the Index in 1997 because of our analytical approach to selecting stocks.
We build and maintain the Portfolio by making a series of analytical
measurements on a large universe of securities. In attempting to identify those
stocks that are undervalued, we use three basic types of measures:
- Fundamental momentum measures. These analytical yardsticks are employed
to identify companies whose business and near-term business prospects are
relatively strong.
- Relative value measures. These quantify the attractiveness of a stock's
price in relation to such financial measures as book value, sales, or earnings.
- Future cash flow. These analytical measures identify likely favorable
payoffs in terms of future earnings and dividends for an investment made today.
Vanguard Growth and Income Portfolio uses these measures of value in
developing investment strategies. Applying a variety of yardsticks to security
selection will, we believe, help us to deliver consistent results. The
long-term performance comparisons above lend credence to our view. Each method
of determining value contributed to our strong results during 1997, helping us
to surpass both our average peer and the unmanaged Index.
We emphasize a point that we try to make in every shareholder report: We
are long-term investors. We do not expect to be near the top of a list of
equity funds for every short-term period of comparison. We are, of course,
happy when this is the case; however, our goal is to be at the top of these
lists over the long term.
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Our investors should have a long-range perspective and a desire for exposure to
the stock market. We expect to be fully invested in equities as a matter of
investment policy. Our goal is to provide superior equity returns over extended
periods.
Our outlook is positive. We have demonstrated an ability to outperform
most active managers in a period that has been difficult for active management.
In periods when active managers generally outperform indexing, we believe that
we will outperform to a meaningful degree both our peers and indexing
alternatives.
We believe that our past success illustrates the effectiveness of the
Franklin game plan, which is to seek to win while avoiding periods of major
underperformance versus our benchmark. Our goal with your assets is to be
consistently above average. We believe that consistency builds strong long-term
performance, and that it will continue to make Vanguard Growth and Income
Portfolio an attractive option for equity investors.
John Nagorniak
Franklin Portfolio Associates
January 12, 1998
INVESTMENT PHILOSOPHY
The Portfolio reflects a belief that superior long-term investment results can
be achieved by using quantitative methods to select stocks that, in the
aggregate, have risk characteristics similar to the S&P 500 Index but that are
currently undervalued by the market.
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PORTFOLIO PROFILE
Growth and Income Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
December 31, 1997, compared where appropriate to an unmanaged index. Key
elements of this Profile are defined on page 9.
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<CAPTION>
PORTFOLIO CHARACTERISTICS
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GROWTH AND INCOME S&P 500
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<S> <C> <C>
Number of Stocks 116 500
Median Market Cap $23.0B $34.1B
Price/Earnings Ratio 19.7x 21.9x
Price/Book Ratio 3.4x 4.1x
Yield 1.6% 1.6%
Return on Equity 18.8% 20.4%
Earnings Growth Rate 15.9% 17.6%
Foreign Holdings 2.9% 1.9%
Turnover Rate 66% --
Expense Ratio 0.36% --
Cash Reserves 0.7% --
</TABLE>
INVESTMENT FOCUS
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[GRAPH]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
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GROWTH AND INCOME S&P 500
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<S> <C> <C>
R-Squared 0.96 1.00
Beta 1.04 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
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<S> <C>
American International Group, Inc. 3.5%
Merck & Co., Inc. 3.3
Ford Motor Co. 3.1
Dayton-Hudson Corp. 2.8
Bell Atlantic Corp. 2.7
Morgan Stanley, Dean Witter,
Discover and Co. 2.6
Dow Chemical Co. 2.6
Compaq Computer Corp. 2.5
AirTouch Communications, Inc. 2.4
Tyco International Ltd. 2.4
- -----------------------------------------
Top Ten 27.9%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
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DECEMBER 31, 1996 DECEMBER 31, 1997
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GROWTH AND INCOME GROWTH AND INCOME S&P 500
---------------------------------------------
<S> <C> <C> <C>
AUTO & TRANSPORTATION 4.2% 5.4% 3.5%
CONSUMER DISCRETIONARY 14.1 11.8 9.8
CONSUMER STAPLES 7.3 6.0 11.5
FINANCIAL SERVICES 16.3 20.8 17.7
HEALTH CARE 11.5 10.3 11.4
INTEGRATED OILS 6.7 5.9 7.2
OTHER ENERGY 3.6 3.3 1.4
MATERIALS & PROCESSING 8.9 8.2 5.8
PRODUCER DURABLES 7.4 4.7 4.0
TECHNOLOGY 5.9 9.7 11.2
UTILITIES 9.1 10.9 10.6
OTHER 5.0 3.0 5.9
- -------------------------------------------------------------------------------------
</TABLE>
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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 a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a portfolio.
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.
FOREIGN HOLDINGS. The percentage of a portfolio's net assets represented by
stocks or American Depositary Receipts of companies based outside the United
States.
INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of the stocks in a portfolio. Half the stocks in the portfolio
have higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a portfolio, the weighted average P/E of the
stocks it holds. P/E is an indicator of market expectations about corporate
prospects; the higher the P/E, the greater the expectations for a company's
future growth.
R-SQUARED. A measure of how much of a 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.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a portfolio, the weighted average return
on equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that
come from each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a portfolio has
invested in its ten largest holdings. (The average for stock mutual funds is
about 30%.) As this percentage rises, a portfolio's returns are likely to be
more volatile because they are more dependent on the fortunes of a few
companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a 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 over the past 30 days and is annualized, or projected forward
for the coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
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PERFORMANCE SUMMARY
Growth and 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: DECEMBER 10, 1986-DECEMBER 31, 1997
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GROWTH AND INCOME PORTFOLIO S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ------------------------------------------
<S> <C> <C> <C> <C>
1986 -3.1% 0.0% -3.1% -3.3%
1987 1.8 2.2 4.0 5.3
1988 13.1 3.7 16.8 16.6
1989 27.6 4.4 32.0 31.7
1990 -5.7 3.3 -2.4 -3.1
1991 26.4 3.9 30.3 30.5
1992 4.2 2.8 7.0 7.6
1993 11.4 2.4 13.8 10.1
1994 -3.1 2.5 -0.6 1.3
1995 33.1 2.8 35.9 37.6
1996 20.9 2.2 23.1 23.0
1997 33.5 2.1 35.6 33.4
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</TABLE>
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: DECEMBER 31, 1987-DECEMBER 31, 1997
- ------------------------------------------------------------
Growth and Income Average Value S&P 500
Portfolio Fund Index
<S> <C> <C> <C> <C>
1987 12 10000 10000 10000
1988 03 10655 10678 10569
1988 06 11408 11255 11273
1988 09 11408 11285 11312
1988 12 11680 11506 11661
1989 03 12544 12192 12488
1989 06 13619 13063 13590
1989 09 15095 14193 15045
1989 12 15417 14179 15356
1990 03 15025 13795 14894
1990 06 15843 14454 15831
1990 09 13683 12655 13655
1990 12 15041 13542 14879
1991 03 17202 15422 17040
1991 06 17032 15335 17001
1991 09 17988 16359 17910
1991 12 19597 17450 19412
1992 03 19104 17333 18922
1992 06 19152 17309 19282
1992 09 19632 17962 19890
1992 12 20970 18955 20891
1993 03 22269 19738 21803
1993 06 22660 19838 21910
1993 09 23478 20744 22476
1993 12 23869 21081 22997
1994 03 22884 20342 22125
1994 06 22732 20219 22218
1994 09 23753 21346 23304
1994 12 23723 20917 23300
1995 03 25904 22541 25569
1995 06 28344 24323 28010
1995 09 30865 26396 30236
1995 12 32247 27470 32056
1996 03 34149 28862 33777
1996 06 35334 29772 35293
1996 09 36328 30999 36384
1996 12 39684 33214 39416
1997 03 40405 33425 40473
1997 06 47224 38298 47539
1997 09 52892 42206 51099
1997 12 53807 42405 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>
Growth and Income Portfolio 35.59% 20.74% 18.33% $53,807
Average Value Fund 27.67 17.47 15.54 42,405
S&P 500 Index 33.36 20.27 18.05 52,567
- ---------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------
10 YEARS
INCEPTION --------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GROWTH AND INCOME PORTFOLIO 12/10/1986 35.59% 20.74% 15.31% 3.02% 18.33%
- ---------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
FINANCIAL STATEMENTS
December 31, 1997
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Portfolio's holdings, including
each security's market value on the last day of the reporting period.
Securities are grouped and subtotaled by asset type (common stocks, preferred
stocks, bonds, etc.) and by industry sector. Other assets are added to, and
liabilities are subtracted from, the value of Total Investments to calculate
the 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
GROWTH AND VALUE*
INCOME PORTFOLIO SHARES (000)
- ----------------------------------------------------------------------------
COMMON STOCKS (96.2%)(1)
- ----------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (5.2%)
- Federal Express Corp. 439,200 $ 26,819
Ford Motor Co. 1,377,000 67,043
- Halter Marine Group, Inc. 20,253 585
Union Pacific Corp. 228,000 14,236
- Yellow Corp. 78,200 1,960
------------
110,643
------------
CONSUMER DISCRETIONARY (11.3%)
- AccuStaff, Inc. 94,000 2,162
Alberto-Culver Co. Class B 145,600 4,668
Browning-Ferris Industries, Inc. 220,000 8,140
- Costco Cos., Inc. 145,900 6,502
Dayton-Hudson Corp. 879,300 59,353
Deluxe Corp. 202,500 6,986
The Walt Disney Co. 266,600 26,410
Gannett Co., Inc. 414,300 25,609
Home Depot, Inc. 616,900 36,320
Knight-Ridder, Inc. 58,000 3,016
- Robert Half International, Inc. 18,150 726
- Ryan's Family Steak Houses, Inc. 317,300 2,717
TJX Cos., Inc. 250,200 8,601
Tribune Co. 237,400 14,778
Wal-Mart Stores, Inc. 438,200 17,282
Whirlpool Corp. 351,800 19,349
------------
242,619
------------
CONSUMER STAPLES (5.8%)
The Coca-Cola Co. 288,200 19,201
ConAgra, Inc. 167,900 5,509
Adolph Coors Co. Class B 199,600 6,612
Interstate Bakeries Corp. 141,800 5,300
Philip Morris Cos., Inc. 567,300 25,706
Procter & Gamble Co. 141,968 11,331
The Quaker Oats Co. 566,500 29,883
SuperValu Inc. 480,100 20,104
------------
123,646
------------
FINANCIAL SERVICES (20.0%)
Aegon NV ARS 62,208 5,575
H.F. Ahmanson & Co. 289,500 19,378
Allstate Corp. 70,800 6,434
American International
Group, Inc. 690,075 75,046
Automatic Data Processing, Inc. 133,300 8,181
BankAmerica Corp. 612,400 44,705
Bankers Trust New York Corp. 135,000 15,179
Citicorp 57,800 7,308
Conseco Inc. 283,500 12,882
The Dun & Bradstreet Corp. 201,700 6,240
First Union Corp. 116,000 5,945
Green Tree Financial Corp. 519,300 13,599
The Hartford Financial
Services Group Inc. 131,700 12,322
Jefferson-Pilot Corp. 119,000 9,267
Merrill Lynch & Co., Inc. 190,900 13,924
J.P. Morgan & Co., Inc. 383,000 43,231
Morgan Stanley, Dean Witter,
Discover and Co. 954,855 56,456
NationsBank Corp. 337,400 20,518
Torchmark Corp. 61,200 2,574
Travelers Group Inc. 933,300 50,282
------------
429,046
------------
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
MARKET
GROWTH AND VALUE*
INCOME PORTFOLIO SHARES (000)
- ----------------------------------------------------------------------------
<S> <C> <C>
HEALTH CARE (10.0%)
Abbott Laboratories 303,240 $ 19,881
- ALZA Corp. 311,600 9,913
American Home Products Corp. 159,800 12,225
- Beverly Enterprises, Inc. 288,300 3,748
Cardinal Health, Inc. 426,400 32,033
- HEALTHSOUTH Corp. 358,000 9,934
Johnson & Johnson 538,800 35,493
Merck & Co., Inc. 663,900 70,539
- PharMerica, Inc. 131,205 1,361
United Healthcare Corp. 198,900 9,883
- Wellpoint Health Networks Inc.
Class A 192,200 8,120
------------
213,130
------------
INTEGRATED OILS (5.6%)
Ashland, Inc. 140,300 7,532
Atlantic Richfield Co. 178,900 14,334
Exxon Corp. 544,800 33,335
Mobil Corp. 193,200 13,947
Pennzoil Co. 286,200 19,122
Phillips Petroleum Co. 75,900 3,691
Royal Dutch Petroleum Co. ADR 275,600 14,934
Sun Co., Inc. 336,400 14,150
------------
121,045
------------
OTHER ENERGY (3.2%)
Baker Hughes, Inc. 231,800 10,112
Burlington Resources, Inc. 150,900 6,762
Helmerich & Payne, Inc. 78,300 5,315
Schlumberger Ltd. 567,000 45,644
------------
67,833
------------
MATERIALS & PROCESSING (7.9%)
Archer-Daniels-Midland Co. 484,764 10,513
Avery Dennison Corp. 241,800 10,821
Centex Corp. 268,700 16,911
Crown Cork & Seal Co., Inc. 112,100 5,619
Dow Chemical Co. 538,200 54,627
Moore Corp. Ltd. 586,700 8,874
Nucor Corp. 314,000 15,170
Phelps Dodge Corp. 71,200 4,432
Praxair, Inc. 342,200 15,399
USX-U.S. Steel Group, Inc. 581,100 18,159
Union Camp Corp. 170,900 9,175
------------
169,700
------------
PRODUCER DURABLES (4.5%)
Caterpillar, Inc. 604,400 29,351
Dover Corp. 95,800 3,461
Ingersoll-Rand Co. 690,650 27,971
Lockheed Martin Corp. 69,478 6,844
Parker Hannifin Corp. 269,400 12,359
Raychem Corp. 244,600 10,533
Snap-On Inc. 131,100 5,719
------------
96,238
------------
TECHNOLOGY (9.4%)
- Bay Networks, Inc. 149,700 3,827
Compaq Computer Corp. 959,550 54,155
General Dynamics Corp. 173,900 15,031
Hewlett-Packard Co. 219,000 13,687
Intel Corp. 184,900 12,978
Lucent Technologies, Inc. 351,431 28,071
- Microsoft Corp. 287,600 37,154
- National Semiconductor Corp. 34,600 897
- Oracle Corp. 382,350 8,507
- Silicon Graphics, Inc. 519,200 6,458
- Sun Microsystems, Inc. 143,300 5,714
- Tech Data Corp. 264,400 10,279
Texas Instruments, Inc. 86,800 3,906
------------
200,664
------------
UTILITIES (10.4%)
- AirTouch Communications, Inc. 1,255,900 52,198
ALLTEL Corp. 160,600 6,595
American Electric Power
Co., Inc. 131,900 6,809
Ameritech Corp. 43,400 3,494
Bell Atlantic Corp. 625,700 56,939
Carolina Power & Light Co. 81,400 3,454
Houston Industries, Inc. 835,800 22,305
Northern States Power Co. 240,800 14,027
PP&L Resources Inc. 640,500 15,332
PacifiCorp 520,300 14,211
Public Service Enterprise
Group, Inc. 889,900 28,199
------------
223,563
------------
OTHER (2.9%)
Cooper Industries, Inc. 214,800 10,525
Tyco International Ltd. 1,140,700 51,402
------------
61,927
------------
- ----------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,563,571) 2,060,054
- ----------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- ----------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (5.1%)
- ----------------------------------------------------------------------------
<S> <C> <C>
U.S. TREASURY BILL
(2) 5.07%, 3/19/1998 $ 2,900 2,869
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.54%, 1/2/1998 106,989 106,989
- ----------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $109,858) 109,858
- ----------------------------------------------------------------------------
TOTAL INVESTMENTS (101.3%)
(COST $1,673,429) 2,169,912
- ----------------------------------------------------------------------------
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
MARKET
VALUE*
(000)
- ----------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-1.3%)
- ----------------------------------------------------------------------------
<S> <C>
Other Assets--Note C $ 40,252
Liabilities (68,355)
------------
(28,103)
- ----------------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------------
Applicable to 81,788,476 outstanding
$.001 par value shares
(authorized 1,000,000,000 shares) $2,141,809
============================================================================
NET ASSET VALUE PER SHARE $26.19
============================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
- Non-Income-Producing Security.
(1)The combined market value of common stocks and S&P 500 Index futures
contracts represents 99.3% of net assets.
(2)Security segregated as initial margin for open futures contracts.
ADR--American Depositary Receipt.
ARS--American Registered Share.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $1,593,408 $19.48
Undistributed Net
Investment Income 87 --
Accumulated Net Realized Gains 51,244 .63
Unrealized Appreciation--Note E
Investment Securities 496,483 6.07
Futures Contracts 587 .01
- ----------------------------------------------------------------------------
NET ASSETS $2,141,809 $26.19
============================================================================
</TABLE>
13
<PAGE> 16
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Portfolio
during the reporting period, and details the operating expenses charged to the
Portfolio. These expenses directly reduce the amount of investment income
available to pay to shareholders as dividends. This Statement also shows any
Net Gain (Loss) realized on the sale of investments, and the increase or
decrease in the Unrealized Appreciation (Depreciation) on investments during
the period. If the Portfolio invested in futures contracts during the period,
the results of these investments are shown separately.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
GROWTH AND INCOME PORTFOLIO
YEAR ENDED DECEMBER 31, 1997
(000)
- -------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 30,728
Interest 4,727
----------
Total Income 35,455
----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 2,231
Performance Adjustment (244)
The Vanguard Group--Note C
Management and Administrative 3,537
Marketing and Distribution 381
Taxes (other than income taxes) 124
Custodian Fees 12
Auditing Fees 9
Shareholders' Reports 57
Annual Meeting and Proxy Costs 18
Directors' Fees and Expenses 4
----------
Total Expenses 6,129
Expenses Paid Indirectly--Note C (131)
----------
Net Expenses 5,998
- -------------------------------------------------------------------------------------
NET INVESTMENT INCOME 29,457
- -------------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 213,983
Futures Contracts 13,285
- -------------------------------------------------------------------------------------
REALIZED NET GAIN 227,268
- -------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 234,161
Futures Contracts 17
- -------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 234,178
- -------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $490,903
=====================================================================================
</TABLE>
14
<PAGE> 17
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>
- -------------------------------------------------------------------------------------------------
GROWTH AND INCOME PORTFOLIO
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996
(000) (000)
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 29,457 $ 21,806
Realized Net Gain 227,268 132,043
Change in Unrealized Appreciation (Depreciation) 234,178 77,181
--------------------------------
Net Increase in Net Assets Resulting from Operations 490,903 231,030
--------------------------------
DISTRIBUTIONS
Net Investment Income (29,804) (21,371)
Realized Capital Gain (226,698) (96,032)
--------------------------------
Total Distributions (256,502) (117,403)
--------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 825,200 352,761
Issued in Lieu of Cash Distributions 245,739 112,927
Redeemed (448,946) (203,347)
--------------------------------
Net Increase from Capital Share Transactions 621,993 262,341
- -------------------------------------------------------------------------------------------------
Total Increase 856,394 375,968
- -------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 1,285,415 909,447
--------------------------------
End of Year $2,141,809 $1,285,415
=================================================================================================
(1)Shares Issued (Redeemed)
Issued 31,457 16,557
Issued in Lieu of Cash Distributions 9,936 5,223
Redeemed (17,430) (9,549)
--------------------------------
Net Increase in Shares Outstanding 23,963 12,231
=================================================================================================
</TABLE>
15
<PAGE> 18
FINANCIAL HIGHLIGHTS
This table summarizes the Portfolio's investment results and distributions to
shareholders on a per-share basis. It also presents the Portfolio's Total
Return and shows net investment income and expenses as percentages of average
net assets. These data will help you assess: the variability of the 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; how much it costs
to operate the Portfolio; and the extent to which the Portfolio tends to
distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Portfolio for one year. Finally, the table lists the Portfolio's Average
Commission Rate Paid, a disclosure required by the Securities and Exchange
Commission beginning in 1996. This rate is calculated by dividing total
commissions paid on portfolio securities by the total number of shares
purchased and sold on which commissions were charged.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
GROWTH AND INCOME 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 $22.23 $19.95 $15.56 $16.45 $16.30
- -----------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .41 .41 .41 .40 .40
Net Realized and Unrealized Gain (Loss) on Investments 7.15 4.09 5.14 (.50) 1.83
-----------------------------------------------------
Total from Investment Operations 7.56 4.50 5.55 (.10) 2.23
-----------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.42) (.40) (.42) (.39) (.39)
Distributions from Realized Capital Gains (3.18) (1.82) (.74) (.40) (1.69)
-----------------------------------------------------
Total Distributions (3.60) (2.22) (1.16) (.79) (2.08)
- -----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $26.19 $22.23 $19.95 $15.56 $16.45
=================================================================================================================
TOTAL RETURN 35.59% 23.06% 35.93% -0.61% 13.83%
=================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $2,142 $1,285 $909 $596 $531
Ratio of Total Expenses to Average Net Assets 0.36% 0.38% 0.47% 0.48% 0.50%
Ratio of Net Investment Income to Average Net Assets 1.74% 1.97% 2.25% 2.50% 2.22%
Portfolio Turnover Rate 66% 75% 59% 71% 85%
Average Commission Rate Paid $.0388 $.0333 N/A N/A N/A
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 19
NOTES TO FINANCIAL STATEMENTS
Vanguard Growth and Income Portfolio (formerly Vanguard Quantitative
Portfolios) is registered under the Investment Company Act of 1940 as a
diversified open-end investment company, or mutual 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. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such
securities not traded on the valuation date are valued at the mean of the
latest quoted bid and asked prices. Securities not listed on an exchange are
valued at the latest quoted bid prices. Bonds, and temporary cash investments
acquired more than 60 days to maturity, are valued using the latest bid prices
or using valuations based on a matrix system (which considers such factors as
security prices, yields, maturities, and ratings), both as furnished by
independent pricing services. Other temporary cash investments are valued at
amortized 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. 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.
4. FUTURES: The Portfolio uses S&P 500 Index futures contracts to a limited
extent, with the objectives of maintaining full exposure to the stock market
while maintaining liquidity. The Portfolio may purchase or sell futures
contracts to achieve a desired level of investment, whether to accommodate
portfolio turnover or cash flows from capital share transactions. The primary
risks associated with the use of futures contracts are imperfect correlation
between changes in market values of stocks held by the Portfolio and the prices
of futures contracts, and the possibility of an illiquid market.
Futures contracts are valued at their quoted daily settlement prices. The
aggregate principal amounts of the contracts are not recorded in the financial
statements. Fluctuations in the value of the contracts are recorded in the
Statement of Net Assets as an asset (liability) and in the Statement of
Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized futures gains (losses).
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Franklin Portfolio Associates provides investment advisory services to the
Portfolio for a fee calculated at an annual percentage rate of average net
assets. The basic fee is subject to quarterly adjustments based on performance
relative to the S&P 500 Index. For the year ended December 31, 1997, the
advisory fee represented an effective annual basic rate of 0.13% of the
Portfolio's average net assets before a decrease of $244,000 (0.01%) based on
performance.
17
<PAGE> 20
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Portfolio under methods approved by the Board of Directors. At December
31, 1997, the Portfolio had contributed capital of $138,000 to Vanguard
(included in Other Assets), representing 0.6% of Vanguard's capitalization. The
Portfolio's Directors and officers are also Directors and officers of Vanguard.
Vanguard has asked the Portfolio's investment adviser to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the Portfolio part of the commissions generated.
Such rebates are used solely to reduce the Portfolio's administrative expenses.
For the year ended December 31, 1997, these arrangements reduced the
Portfolio's expenses by $131,000 (0.01% of average net assets).
D. During the year ended December 31, 1997, the Portfolio purchased
$1,443,991,000 of investment securities and sold $1,058,763,000 of investment
securities, other than U.S. government securities and temporary cash
investments.
E. At December 31, 1997, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $496,483,000,
consisting of unrealized gains of $522,701,000 on securities that had risen in
value since their purchase and $26,218,000 in unrealized losses on securities
that had fallen in value since their purchase.
At December 31, 1997, the aggregate settlement value of open futures
contracts expiring in March 1998 and the related unrealized appreciation were:
<TABLE>
<CAPTION>
---------------------------------------------------------------------
(000)
-------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION
---------------------------------------------------------------------
<S> <C> <C> <C>
S&P 500 Index 270 $66,089 $587
---------------------------------------------------------------------
</TABLE>
18
<PAGE> 21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard Growth and Income 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 Growth and Income Portfolio (formerly Vanguard Quantitative
Portfolios, hereafter referred to as 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
19
<PAGE> 22
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD GROWTH AND INCOME
PORTFOLIO
This information for the fiscal year ended December 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $143,763,000 as capital gains dividends (from net
long-term capital gains), of which $93,832,000 was distributed to shareholders
in December 1997 and $49,931,000 will be distributed in March 1998. Of the
$143,763,000 capital gain dividends, the Portfolio designates $95,905,000 as a
20% rate gain distribution.
For corporate shareholders, 26.4% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
20
<PAGE> 23
[PHOTO]
DIRECTORS 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> 24
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