<PAGE> 1
[PHOTO]
VANGUARD
PREFERRED STOCK
FUND
Annual Report
October 31, 1996
THE VANGUARD GROUP: LINKING TRADITION AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our course
toward the twenty-first century. Our Report cover reflects that blending of
tradition and innovation, of past, present, and future. The montage includes a
bronze medallion with a likeness of our namesake, HMS Vanguard (Lord Nelson's
flagship at The Battle of the Nile); a clock built circa 1816 in Scotland,
featuring a portrait of Nelson (who is also shown, accepting a surrender, in a
detail from a nineteenth-century engraving); and several views of our recently
completed campus, which is steeped in nautical imagery--from our buildings named
after Nelson's warships (Victory, Majestic, and Goliath are three shown), to our
artwork and ornamental compass rose.
<PAGE> 2
[PHOTO]
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our shareholder
communications. During the past year, we raised the standard once again by
rewriting and reformatting our Fund prospectuses. They are designed to ensure
that prospective investors fully understand, before they make an investment,
each Fund's investment strategies, risks, and costs. In that spirit, we have
redesigned our Annual Reports to shareholders, which provide a comprehensive
discussion and analysis of the year's results in the context of each Fund's
investment objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding objective was to
maintain the character of the previous Reports, while adding information to
assist shareholders in understanding the investment characteristics of their
Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide a candid
assessment of the Fund's performance relative to an appropriate unmanaged market
benchmark and a peer group of mutual funds with similar investment policies. It
also reviews the principal factors contributing to--and detracting from--the
returns earned by the Fund. To help you evaluate your Fund's current-year
performance, the Message includes a discussion of the Fund's long-term
investment results, as well as a look ahead to the prospects for the coming
year. A recap of the financial markets, which had been included as part of the
Chairman's letter, now appears in The Markets In Perspective. This overview
covers the world's financial markets, putting the results of the Fund's strategy
in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to evaluate their
mutual fund holdings, and our new Portfolio Profile furnishes shareholders with
comprehensive data on key characteristics--sector diversification, volatility,
top-ten holdings, among others--that ultimately define how a Fund is likely to
perform in various market environments. For this information to be used
effectively, we include a brief description of the profiled characteristics. The
Report From The Adviser (for our traditionally managed Funds) now covers
specific topics that we have defined as being the important ones for the adviser
to address--and we do our best to ensure that this Report is written in the same
simple and candid manner that characterizes all Vanguard communications.
Finally, each Adviser's Report will include an inset reminder of the adviser's
basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results and a
thorough portfolio review. We welcome any comments that you might have at any
time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Portfolio
Profile
8
Financial
Statements
10
Report Of
Independent
Accountants
16
Trustees And
Officers
INSIDE BACK COVER
<PAGE> 3
[PHOTO]
John C. Bogle
[PHOTO]
John J. Brennan
FELLOW SHAREHOLDER,
The twelve months ended October 31--the 1996 fiscal year for Vanguard
Preferred Stock Fund--were marked by mixed signals in the financial markets,
with the economy continuing to grow strongly even as inflation remained in
check. In this environment, our Fund earned a solid total return of +8.0%,
nicely ahead of the returns achieved by its primary competitive standards. The
table below compares the twelve-month total return (capital change plus
reinvested dividends) of the Fund with those of the unmanaged Merrill Lynch
Perpetual Preferred Index (a broad measure of the preferred-stock market) and
the average fixed-income mutual fund.
The Fund's return is based on an increase in its net asset value from
$9.61 per share on October 31, 1995, to $9.67 per share on October 31, 1996,
adjusted for the reinvestment of quarterly dividends totaling $.67 per share
from net investment income. As expected, 100% of our income dividends qualified
for the 70% intercorporate dividends-received deduction (DRD). The Fund's yield
is 7.2%.
<TABLE>
<CAPTION>
- ------------------------------------------------------------
TOTAL RETURN
FISCAL YEAR ENDED
OCTOBER 31, 1996
- ------------------------------------------------------------
<S> <C>
Vanguard Preferred Stock Fund +8.0%
- ------------------------------------------------------------
Average Fixed Income Fund +5.9%
- ------------------------------------------------------------
Merrill Lynch Perpetual
Preferred Index +7.4%
- ------------------------------------------------------------
</TABLE>
FISCAL 1996 PERFORMANCE OVERVIEW
During the twelve months ended October 31, the stock market flourished in an
ideal environment of moderate economic growth, rising corporate profits, and
low inflation. In contrast, the bond market floundered: interest rates edged
lower as the fiscal year commenced, rose sharply through the beginning of
autumn, only to abruptly reverse course as the fiscal year came to a close. On
balance, rates ended the twelve-month period a shade higher than where they
began, reflected in slightly lower bond prices. For its part, the Fund more
than held its own during the year, posting a total return of +8.0% compared to
returns of +7.4% for the Merrill Lynch Perpetual Preferred Index and +5.9% for
the average fixed-income fund.
We should note that, while interest-rate fluctuations largely determine
the performance of fixed-income investments--including preferred stocks--the
past year has seen several additional influences in the preferred-stock market.
First, there have been some indications that the U.S. Treasury Department may
lower the DRD from 70% to 50%, a move that would reduce the prices of
DRD-eligible preferreds. Second, there has been a dearth of new preferred-stock
issuance, which has helped to offset the downward price pressures associated
with the potential reduction in the DRD. The Report From The Adviser, beginning
on page 5, elaborates on these and other market dynamics.
LONG-TERM PERFORMANCE OVERVIEW
Our Fund's results during the past year enhanced our long-term performance
advantage over our benchmarks. A $10,000 investment in the Fund ten years ago
would have grown
1
<PAGE> 4
to $23,085; the same $10,000 investment in the Perpetual Preferred Index would
have grown to $22,034, and in the average fixed-income fund to $20,742. Our
margin of $2,343 over our bond fund competitors is particularly satisfying,
since these funds represent options for Vanguard Preferred Stock Fund
shareholders.
As we have often noted, the average fixed-income fund is an imperfect
benchmark against which to measure our performance. Nonetheless, we are forced
to use this standard, because our Fund is one of a few "pure" preferred-stock
funds in the industry. As an investor in the Fund, you should recognize that a
portion of the advantage we have achieved relates to the lower overall credit
quality of preferred stocks relative to bonds; in particular, preferreds are
junior in status with regard to claims on both interest and principal. What's
more, with interest rates moving lower on balance during the past decade--and
prices of fixed-income securities moving commensurately higher--preferred
stocks benefited from their longer effective maturities.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
TOTAL RETURN*
10 YEARS ENDED OCTOBER 31, 1996
-------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- -------------------------------------------------------------------------
<S> <C> <C>
Vanguard Preferred Stock Fund +8.7% $23,085
- -------------------------------------------------------------------------
Average Fixed Income Fund +7.6% 20,742
- -------------------------------------------------------------------------
Merrill Lynch Perpetual
Preferred Index +8.2% 22,034
- -------------------------------------------------------------------------
</TABLE>
*Assumes reinvestment of all dividends and distributions, and excludes sales
charges, if any, on the other mutual funds.
That said, our margin over the average fixed income fund is actually
understated for corporate investors, since 100% of the interest income on bonds
is taxable at the regular corporate tax rate, while the dividends on preferreds
are eligible for the 70% DRD. In other words, our +8.7% return over the past
decade is reduced to an after-tax return of +7.9% for the corporate investor;
the +7.6% return for the average fixed-income fund over the same period is
reduced to an after-tax return of +4.6%. Based on an initial investment of
$10,000 by a corporate investor over the ten-year period, our cumulative
advantage after taxes amounts to $5,727--$21,434 for the Fund versus $15,707
for the typical competitor. This substantial excess after-tax return is there
for the taking by the corporate investor who is willing to accept the
incremental risks associated with preferred stocks.
IN SUMMARY
The U.S. stock market has been on the rise--with only a few brief
interludes--for nearly 15 years. What's more, the bond market has enjoyed
double-digit annualized returns during the same period, as interest rates have
been declining since their historic highs in the early 1980s. So, it seems
appropriate to step back and assess the outlook for the markets.
While no one can accurately predict what will happen over the next
decade--or even the next year--it seems unlikely that stocks and bonds will
enjoy a repeat of the exceptional returns of the past 15 years. Indeed, there
are sure to be some rough seas ahead. Nonetheless, we believe that investors
who maintain a balanced portfolio of stock funds, bond funds, and money market
funds will be rewarded. "Stay the course" has proved wise counsel in the past,
and we see no reason why it should not continue to be.
/s/ JOHN C BOGLE /s/ JOHN J. BRENNAN
Chairman of the Board President
November 15, 1996
2
<PAGE> 5
THE MARKETS IN PERSPECTIVE: FISCAL YEAR ENDED OCTOBER 31, 1996
[PHOTO]
U.S. EQUITY MARKETS
The past twelve months were truly rewarding for common-stock investors in the
United States, particularly those who emphasized larger companies. As noted in
the table, the Standard & Poor's 500 Composite Stock Price Index gained 24.1%
for the fiscal year, while the Russell 2000 Small Stock Index posted a 16.6%
advance. The strong absolute returns can be attributed primarily to solid
earnings growth, continued low inflation, and the expectation on the part of
investors that this environment will prevail over the near term.
Among larger-capitalization issues, the best performing sector was
financial, with a 39.0% advance. Leading this group were banks and brokerage
firms. Banks benefited from the relative stability of economic growth--which
could be expected to result in both growing demand for loans and low default
rates; brokerage firms continued to reap the benefits of positive equity
markets. Energy issues also posted very strong results (33.1%), reflecting the
pronounced increase in oil prices from $17.98 per barrel to $23.35 during the
past twelve months.
Technology issues probably exhibited the greatest disparity of any sector.
The best performers were generally larger companies with dominant positions in
their industries; many of these firms rose 30% or more compared to 16.9%, in
aggregate, for the technology holdings in the S&P 500 Index. By contrast,
technology was the worst-performing sector within the Russell 2000 Index, with
a scant 2.9% return over the fiscal year.
In sum, investors displayed a strong preference for companies with
"predictable" earnings streams. One unusual note: the price/earnings ratio of
the S&P 500 Index rose 17% (from 15.8 to 18.5) during the last twelve months,
despite a rise in interest rates. In general, the P/E ratio moves inversely
with interest rates.
<TABLE>
<CAPTION>
- -------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED OCTOBER 31, 1996
------------------------------
1 YEAR 3 YEARS 5 YEARS
- -------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 24.1% 17.7% 15.5%
Russell 2000 Index 16.6 11.2 14.8
MSCI-EAFE Index 10.8 6.9 8.0
- -------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 5.9% 5.6% 7.7%
Lehman 10-Year Municipal
Bond Index 5.0 5.2 7.7
Salomon 90-Day U.S.
Treasury Bills 5.3 5.0 4.4
- -------------------------------------------------------------
Other
Consumer Price Index 3.0% 2.8% 2.9%
- -------------------------------------------------------------
</TABLE>
U.S. FIXED-INCOME MARKETS
While U.S. stock investors relished their solid gains, bond investors were not
so fortunate. Interest rates, as reflected in the 30-year U.S. Treasury yield,
fell from 6.33% on October 31, 1995, to 5.95% two months later. At that time,
analysts anticipated an environment of slow economic growth and harbored almost
no concern about potential increases in inflation. Underscoring that view, the
Federal Reserve Board's Open Market Committee cut both the discount rate and
the Federal funds rate by 0.25% in late January.
3
<PAGE> 6
Economic data soon suggested a different scenario--one characterized by
accelerating economic activity. A range of indicators pointed toward more rapid
growth than anticipated, but none concerned the bond market as much as the
ongoing increases in employment. In many analysts' view, continued job growth
would probably lead to higher wage rates, which might not be offset by
improvements in productivity. The net result would be higher inflation, the
bane of bond investors. Such concerns caused the 30-year U.S. Treasury yield to
climb to 7.19% in early July. From that point forward, interest rates declined,
although in an erratic pattern, leaving the long-term Treasury yield at 6.64%
by the end of October.
Three categories of bonds did benefit their investors, at least on a
relative basis, over the past year: short-maturity portfolios, low-quality
issues, and municipals. Short-maturity investors saw a small increase in rates
(0.18% for the 3-year U.S. Treasury bond). Owners of junk bonds earned positive
returns as lower-quality, higher-yielding issues generally fare well during
periods of steady growth; a modest increase in inflation can be beneficial to
junk-bond issuers (the Lehman High Yield Bond Index gained 11.1%). Municipal
bonds, freed from investor worries over the proposed "flat tax," performed
exceptionally well and, to some extent, seemed immune to the inflation concerns
of the taxable market. In fact, the yield on the benchmark 30-year municipal
fell -0.05% during the twelve months, while the yield on the
comparable-maturity U.S. Treasury issue rose 0.31%.
INTERNATIONAL EQUITY MARKETS
Investments in non-U.S. equity markets fared quite well over the fiscal year,
with one major exception: Japan. For the past twelve months, the Morgan Stanley
Capital International-Europe, Australasia, Far East Index (which covers all
major markets outside North America) posted a total return of 10.8% in dollars,
after a 5.1% increase in the value of the U.S. dollar over foreign currencies.
Nearly all of this return was generated in the European markets, where the
dollar return was 17.9% compared to 3.5% for the Pacific Basin. Aside from
Japan (-0.7% in dollars) and Singapore (-3.1%), markets in the Pacific Basin
provided very strong returns, as evidenced by Hong Kong (28.0%) and Australia
(18.3%).
The variation in returns across and within regions can be attributed to
differing environments and expectations for growth and inflation. In Europe,
many governments focused on the deficit-spending guidelines mandated by the
Maastricht Treaty for the conversion to a common European currency unit (the
ECU). The Treaty stipulated that deficit spending not exceed defined
levels--with the idea that restraint would keep inflation to reasonable levels.
Over the past year, many governments reaffirmed their commitments to the ECU
and cut spending accordingly. Investors took this as an indication that
inflation would remain modest and economic growth tepid. The result was a
strong boost to high-quality growth stocks across Europe.
The Japanese market continues to suffer because the long-anticipated
economic recovery has yet to materialize in a meaningful way. Despite some
positive signs, such as improving corporate profits, the Japanese economy
continues to perform in a lack-luster fashion.
4
<PAGE> 7
REPORT FROM THE ADVISER
[PHOTO]
For the six- and twelve-month periods ended October 31, 1996, Vanguard
Preferred Stock Fund posted total returns of 7.4% and 8.0%, respectively. For
more details about Fund performance, please see the Message To Shareholders on
pages 1 and 2.
FISCAL YEAR IN REVIEW
In the six months since our last report to you, long-term interest rates fell
approximately 0.25%. However, rates closed the fiscal year higher than when it
began. Thirty-year U.S. Treasury bonds, which fell to below 6% at the end of
December 1995, are now approximately 0.75% higher. Thus, a majority of the
damage to the fixed-income markets--including preferred stocks--occurred in the
winter and spring, when the economy performed better than expected. We find it
remarkable that interest rates declined in the last six months of the fiscal
year, as the bond market had expected the Federal Reserve to raise short-term
rates on two separate occasions in the July-September period.
In the preferred-stock market, uncertainty stemming from the U.S.
Treasury Department's proposal to lower the intercorporate dividends-received
deduction (DRD) from 70% to 50% has not disappeared. This suggested change in
tax law could slice 7% to 8% off the price of a typical DRD-eligible perpetual
preferred. (The price of such an issue would have to fall that much to restore
the preferred's yield to the same after-tax equivalent that it has under
current law.) However, the lack of new preferred-stock issues has created a
shortage in supply that has overwhelmed the effects of anxiety about the
potential reduction of the DRD.
MARKET UPDATE
A majority of new preferred-stock issues are coming to market with "DRD
protection." The prospectus of such a security states that the issuer will
increase the dividend if the DRD is lowered so that the investor will lose no
income, on an after-tax basis. The preferred market is demanding this shield
because the Clinton administration is actively trying to reduce the DRD to
increase Federal revenues.
Also, several new preferreds issued by banks have structures different
from the norm. These irregular preferreds have, in addition to DRD protection,
a fixed-rate dividend for five years, after which the rate floats. Known as
"Fixed Rate Adjustable Preferreds," these issues are non-cumulative, a feature
that allows banks to credit the preferred toward regulatory capital
requirements. The risk to the buyer is that--unlike the issuer of a cumulative
preferred--the issuer of a non-cumulative preferred is under no obligation to
make up any dividends previously suspended or in arrears. (Investors in
INVESTMENT PHILOSOPHY
This Fund is managed in the interest of corporations able to use 70%
"intercorporate dividends-received" deduction under Federal tax law. The
adviser believes that the Fund can provide a relatively high and sustainable
level of income that qualifies for the deduction by investing primarily in
dividend paying, high quality, cumulative preferred stock. (Note: Individual
investors are unable to use this tax deduction and are, therefore, not
compensated for the interest-rate and credit risks inherent in the Fund.)
5
<PAGE> 8
Vanguard Preferred Stock Fund need not be overly concerned about this risk; our
investment guidelines require us to invest at least 75% of our assets in
cumulative preferred stocks.)
INVESTMENT GOALS AND STRATEGY
The investment goals and strategy of the Fund today are consistent with those
put in place when it was started in 1975. We purchase relatively high-quality
preferred stocks with the goal of having all of the Fund's dividends qualify
for the 70% intercorporate dividends-received deduction. We achieved total
qualification in fiscal 1996, as we have in all previous years, and expect to
do the same in fiscal 1997. Another Fund objective is to provide sustainable,
tax-advantaged income through our ownership of investment-grade preferreds.
The risk to Vanguard Preferred Stock Fund's net asset value from
changes in Federal tax law, such as the proposed reduction in the DRD, is
always present, yet it cannot be predicted. The risk to the Fund from rising
long-term interest rates is also a constant. However, we attempt to control
income risk and variability by investing in the securities of high-quality
companies. In our effort to maintain stability of income, we emphasize
securities with call protection and invest in a broadly diversified group of
companies. The Fund now owns preferred stock from 61 issuers.
Forty-four percent of Vanguard Preferred Stock Fund is concentrated in
the electric utility industry, representing 32 different issuers. We continue
to believe that the risks and rewards from investing approximately half of the
Fund's assets in the utility industry are favorably balanced. We also seek to
own high-quality issues from financial service companies, a category that is
becoming more readily available in the DRD-eligible preferred stock market.
Examples of such issuers are the Federal National Mortgage Association and
Federal Home Loan Mortgage Corporation. Your Fund's purchase of these
relatively new issues has helped increase the overall quality and
diversification of our holdings.
Earl E. McEvoy, Senior Vice President
Wellington Management Company, LLP
November 7, 1996
6
<PAGE> 9
PERFORMANCE SUMMARY: PREFERRED STOCK FUND
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Fund. Note, too, that
both share price and return can fluctuate widely so that an investment in the
Fund could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: 10/31/76-10/31/96
- -----------------------------------------------------------------------------------------------------
PREFERRED STOCK FUND MERRILL LYNCH PREFERRED STOCK FUND MERRILL LYNCH
FISCAL CAPITAL INCOME TOTAL INDEX* FISCAL CAPITAL INCOME TOTAL INDEX*
YEAR RETURN RETURN RETURN TOTAL RETURN YEAR RETURN RETURN RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1977 2.5% 8.7% 11.2% 10.5% 1987 -17.8% 7.2% -10.6% -3.8%
1978 -6.7 8.3 1.6 -2.2 1988 0.5 11.9 12.4 8.7
1979 -12.2 8.1 -4.1 -4.9 1989 8.6 7.2 15.8 14.5
1980 -9.1 10.3 1.2 -3.4 1990 -4.6 8.9 4.3 -3.1
1981 -10.9 11.4 0.5 -3.7 1991 10.2 10.6 20.8 28.8
1982 17.5 18.6 36.1 27.0 1992 2.9 8.4 11.3 13.5
1983 1.5 11.9 13.4 16.6 1993 7.2 8.4 15.6 10.4
1984 -6.9 12.5 5.6 5.3 1994 -15.2 6.7 -8.5 -5.0
1985 9.7 14.2 23.9 23.4 1995 15.1 8.7 23.8 18.0
1986 20.7 11.9 32.6 37.9 1996 0.6 7.4 8.0 7.4
- -----------------------------------------------------------------------------------------------------
</TABLE>
*S&P Preferred Index through March 1989; Merrill Lynch Perpetual Preferred
Index thereafter. See Financial Highlights table on page 14 for dividend and
capital gains information for the past five years.
CUMULATIVE PERFORMANCE: 10/31/86-10/31/96
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
MERRILL LYNCH
PREFERRED STOCK AVERAGE FIXED- PREFERRED
FUND INCOME FUND PERPETUAL INDEX MONTH
- ---------------------------------------------------------------------
<S> <C> <C> <C> <C>
1986 10000 10000 10000 10
10325 10343 10459 1
9602 10153 10195 4
9742 10211 10498 7
1987 8936 10103 9572 10
9651 10664 10063 1
9569 10716 9975 4
9611 10879 10055 7
1988 10041 11260 10429 10
10263 11360 10652 1
10334 11498 10662 4
11306 12193 11244 7
1989 11630 12231 11706 10
11491 12147 10992 1
11498 12074 10803 4
12246 12743 11596 7
1990 12128 12494 11342 10
12825 13014 12282 1
13501 13644 13323 4
13700 13958 13569 7
1991 14654 14683 14604 10
15369 15103 15307 1
15394 15286 15546 4
16229 16023 16234 7
1992 16316 16122 16581 10
16861 16659 16865 1
17575 17132 17520 4
18118 17574 17920 7
1993 18854 17979 18307 10
18939 18198 18686 1
17633 17408 17468 4
17772 17554 17719 7
1994 17261 17395 17393 10
17791 17619 18013 1
19193 18315 19099 4
20289 18982 19873 7
1995 21368 19524 20515 10
21910 20188 21161 1
21502 19780 21058 4
22086 20016 21372 7
1996 23085 20742 22034 10
- ---------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1996
------------------------------ FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Preferred Stock Fund 8.04% 9.52% 8.73% $23,085
Average Fixed-Income Fund 5.85 7.14 7.57 20,742
Merrill Lynch Perpetual
Preferred Index 7.40 8.57 8.22 22,034
- ---------------------------------------------------------------------------------
</TABLE>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED 9/30/96*
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
10 YEARS
INCEPTION -----------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Preferred Stock Fund 12/3/75 6.12% 8.90% 0.27% 8.53% 8.80%
- -----------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter as well as for the Fund's fiscal year end.
7
<PAGE> 10
PORTFOLIO PROFILE: PREFERRED STOCK FUND
OCTOBER 31, 1996
This Profile provides a snapshot of the Fund's characteristics, where
appropriate, compared to an unmanaged index. Key elements of this Profile are
defined on page 9.
PORTFOLIO CHARACTERISTICS
<TABLE>
<CAPTION>
- -----------------------------------------------
PREFERRED MERRILL LYNCH
STOCK INDEX*
- -----------------------------------------------
<S> <C> <C>
Number of Stocks 75 165
Yield 7.2% 7.0%
Average Coupon 7.2% 8.3%
Average Quality A2 A3
Turnover Rate 31% --
Expense Ratio 0.39% --
Cash Reserves 1.8% --
</TABLE>
*Merrill Lynch Perpetual Preferred Index.
<TABLE>
<CAPTION>
DISTRIBUTION BY COUPON (% OF PORTFOLIO)
- -----------------------------------------------
<S> <C>
Less than 4.0% 0.0%
4.0 to 5.0 2.5
5.0 to 6.0 2.1
6.0 to 7.0 29.3
7.0 to 8.0 52.4
8.0 to 9.0 13.2
9.0 to 10.0 0.5
Greater than 10.0 0.0
- -----------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY CREDIT QUALITY (% OF PORTFOLIO)
- -----------------------------------------------
<S> <C>
Aaa 2.6%
Aa 16.7
A 46.7
Baa 32.3
Ba --
B --
Not Rated 1.7
- -----------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- -----------------------------------------------
<S> <C>
J.P. Morgan & Co., Inc. 4.4%
Baltimore Gas & Electric Co. 3.8
Duke Power Co. 3.7
Morgan Stanley Group 3.6
Household International, Inc. 3.6
Ford Motor Co. 3.5
Federal Home Loan Mortgage Corp. 3.5
Florida Power & Light Co. 3.1
BankBoston Corp. 3.0
Pennsylvania Power & Light Co. 3.0
- -----------------------------------------------
Top Ten 35.2%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF PREFERRED STOCK)
- ---------------------------------------------------------------------------------------
OCTOBER 31, 1995 OCTOBER 31, 1996
-------------------------------------
PREFERRED STOCK PREFERRED STOCK
-------------------------------------
<S> <C> <C>
Basic Materials ........................... 0.0% 0.0%
Capital Goods & Construction .............. 0.0 0.0
Consumer Cyclical ......................... 2.3 6.3
Consumer Staples .......................... 0.0 0.0
Energy .................................... 0.4 0.5
Financial ................................. 42.1 44.8
Health Care ............................... 0.0 0.0
Technology ................................ 0.0 0.0
Transport & Services ...................... 0.0 0.0
Utilities ................................. 55.2 48.4
Miscellaneous ............................. 0.0 0.0
- --------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
[PHOTO]
AVERAGE COUPON. The average interest rate, expressed as a percentage of face
value, paid on the securities held by a portfolio.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
credit ratings assigned to a portfolio's securities holdings by credit-rating
agencies. Agencies assign credit ratings after an appraisal of an issuer's
ability to meet its obligations. Quality is graded on a scale, with Aaa
indicating the most creditworthy issuers.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
DISTRIBUTION BY COUPON. A breakdown of the securities in a portfolio according
to coupon rate, the interest rate that an issuer promises to pay, expressed as
an annual percentage of face value. Securities with unusually high coupon rates
may be subject to call risk, the possibility that securities in a portfolio
will be redeemed, or called, early by the issuer.
DISTRIBUTION BY CREDIT QUALITY. An indicator of the risk of default or other
credit problems on securities held by 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. In 1995 the average expense ratio was 1.00% for a
fixed-income fund.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified, and the less susceptible it is to a price decline
stemming from the problems of a particular company.
SECTOR DIVERSIFICATION. The percentage of preferred stocks from issuers in each
of the major industry classifications that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of a portfolio's total net assets in its
ten largest stocks. As this percentage rises, a portfolio's returns are likely
to be more volatile, since its return is more dependent on the fortunes of a
few companies.
TURNOVER RATE. Indicates trading activity during the past year. Portfolios with
high turnover rates incur higher transaction costs and are more likely to
realize and 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 a 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
[PHOTO]
FINANCIAL STATEMENTS
OCTOBER 31, 1996
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (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 Fund's Net Assets.
Finally, Net Assets are divided by the outstanding shares of the Fund to arrive
at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the Fund's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Fund had available to distribute to shareholders as income dividends
or capital gains as of the statement date. Any Accumulated Net Realized Losses,
and any cumulative excess of distributions over net income or net realized
gains, will appear as negative balances. Unrealized Appreciation (Depreciation)
is the difference between the market value of the Fund's investments and their
cost, and reflects the gains (losses) that would be realized if the Fund were
to sell all of its investments at their statement-date values.
<TABLE>
<CAPTION>
- ------------------------------------------------------------
MARKET
VALUE*
PREFERRED STOCK FUND SHARES (000)
- ------------------------------------------------------------
<S> <C> <C>
PREFERRED STOCKS (97.5%)
- ------------------------------------------------------------
CONSUMER CYCLICAL (6.2%)
Ford Motor Co. 8.25% 375,000 $ 10,125
General Motors Corp. 7.92% 23,300 606
McDonald's Corp. 7.72% 265,500 6,870
---------
17,601
---------
ENERGY (0.5%)
Phillips Gas Co. 9.32% 50,000 1,294
---------
FINANCIAL (43.7%)
BANKS (23.9%)
H.F. Ahmanson & Co. 8.40% 200,000 5,250
BankBoston Corp. 7.875% 280,000 7,315
BankBoston Corp. 8.60% 50,000 1,294
BankAmerica Corp. 7.875% 100,000 2,587
Bankers Trust New York 7.50% 150,000 3,788
Chase Manhattan Corp. 7.50% 150,000 3,825
Citicorp 7.75% 25,000 656
Citicorp 8.30% 275,000 7,253
First Maryland Bancorp 7.875% 200,000 5,150
Fleet Financial Group 6.75% 125,000 6,250
Mellon Bank Corp. 8.20% 200,000 5,150
J. P. Morgan & Co., Inc. 6.625% 250,000 12,563
NationsBank Corp. 8.75% 9,000 236
+ PNC Bank Corp. 6.05% 80,000 4,101
Republic New York Corp. 7.25% 86,000 2,225
+ Wells Fargo & Co. 6.59% 12,000 638
FINANCIAL SERVICES (17.3%)
Beneficial Corp. $4.30 77,550 4,750
+ Federal Home Loan
Mortgage Corp. 6.125% 200,000 10,025
+ Federal National
Mortgage Assn. 6.45% 125,800 6,479
Household International, Inc.
7.35% 400,000 10,200
MBNA Corp. 7.50% 250,000 6,406
Morgan Stanley Group 7.75% 200,000 10,400
TransAmerica Corp. 8.50% 48,700 1,278
INSURANCE (2.5%)
Aon Corp. 8.00% 175,000 4,484
W. R. Berkley Corp. 7.375% 100,000 2,538
---------
124,841
---------
UTILITIES (47.1%)
ELECTRICAL POWER (44.0%)
Alabama Power Co. 6.40% 200,000 4,825
Alabama Power Co. 7.60% 125,000 3,141
Arizona Public Service 7.25% 175,000 4,375
Baltimore Gas & Electric Co.
6.70% 39,700 4,099
Baltimore Gas & Electric Co.
6.99% 25,000 2,609
Baltimore Gas & Electric Co.
7.125% 40,000 4,291
Commonwealth Edison Co.
$7.24 50,000 4,500
Detroit Edison Co. 7.75% 75,000 1,894
Duke Power Co. 6.375% 97,900 2,374
Duke Power Co. 7.00% 50,000 5,364
Duke Power Co. 7.85% 25,000 2,750
Entergy Arkansas Inc. $1.96 60,000 1,500
Entergy Louisiana Inc. 4.16% 7,000 400
- ------------------------------------------------------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- ------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ------------------------------------------------------------
<S> <C> <C>
Entergy Louisiana Inc. 4.44% 6,000 $ 369
Entergy Louisiana Inc. 8.00% 30,000 758
Entergy Mississippi Inc. 8.36% 20,000 2,000
Florida Power & Light Co. 6.75% 10,000 1,034
Florida Power & Light Co. 6.98% 75,000 7,761
Georgia Power Co. $1.9875 6,000 152
Gulf Power Co. 5.44% 5,500 449
Idaho Power Co 7.07% 25,000 2,638
Illinois Power Co. 4.20% 6,850 197
Illinois Power Co. 4.26% 14,000 413
Illinois Power Co. 4.42% 12,900 409
Illinois Power Co. 7.75% 25,000 1,339
Mississippi Power 7.25% 100,000 2,475
Monongahela Power Co. 7.73% 50,000 5,263
Oklahoma Gas & Electric Co.
5.34% 5,700 459
Pacific Gas & Electric Co. 7.04% 150,000 3,750
PacifiCorp 7.92% 150,000 3,769
PECO Energy Co. 7.48% 50,000 5,187
Pennsylvania Power & Light Co.
6.75% 85,000 8,529
PSI Energy Inc. 7.44% 200,000 5,050
Public Service of Oklahoma 4.24% 4,300 285
San Diego Gas & Electric Co.
6.80% 140,000 3,584
Savannah Electric & Power Co.
6.64% 125,000 3,062
Sierra Pacific Power Co. 7.80% 200,000 5,345
Southern California Edison Co.
7.36% 150,000 3,731
Texas Utilities Electric Co. 7.50% 52,000 1,326
Texas Utilities Electric Co. 7.98% 45,000 4,783
Union Electric Co. $7.64 33,000 3,551
Virginia Electric & Power Co.
$6.98 45,000 4,746
West Penn Power Co. 4.20% 5,000 317
Wisconsin Public Service Co.
6.88% 10,000 1,034
NATURAL GAS (3.1%)
Atlanta Gas Light Co. 7.70% 100,000 2,563
Washington Natural Gas Co.
7.45% 240,000 6,210
---------
134,660
---------
- ------------------------------------------------------------
TOTAL PREFERRED STOCKS
(COST $272,309) 278,396
- ------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ------------------------------------------------------------
<S> <C>
U.S. GOVERNMENT OBLIGATION (0.7%)
- ------------------------------------------------------------
U. S. TREASURY BOND
7.25%, 5/15/16
(COST $2,069) $2,000 $ 2,116
- ------------------------------------------------------------
TEMPORARY CASH INVESTMENT (3.4%)
- ------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled Cash
Account
5.58%, 11/1/96
(Cost $9,775) 9,775 9,775
- ------------------------------------------------------------
TOTAL INVESTMENTS (101.6%)
(COST $284,153) 290,287
- ------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-1.6%)
- ------------------------------------------------------------
Other Assets--Note C 7,838
Liabilities (12,426)
- ------------------------------------------------------------
(4,588)
- ------------------------------------------------------------
NET ASSETS (100%)
- ------------------------------------------------------------
Applicable to 29,532,506 outstanding
shares of beneficial interest
(unlimited authorization--no par value) $285,699
============================================================
NET ASSET VALUE PER SHARE $9.67
============================================================
</TABLE>
*See Note A in Notes to Financial Statements.
+Non-Income Producing Security. New issue that has not paid a dividend as of
October 31, 1996.
<TABLE>
<CAPTION>
- ------------------------------------------------------------
AT OCTOBER 31, 1996, NET ASSETS CONSISTED OF:
- ------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ------------------------------------------------------------
<S> <C> <C>
Paid in Capital $ 279,854 $ 9.47
Undistributed Net
Investment Income 4,036.14
Accumulated Net
Realized Losses--Note D (4,325) (.15)
Unrealized Appreciation--
Note E 6,134.21
- ------------------------------------------------------------
NET ASSETS $285,699 $9.67
============================================================
</TABLE>
11
<PAGE> 14
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Fund during the
reporting period, and details the operating expenses charged to the Fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Preferred Stock Fund
YEAR ENDED OCTOBER 31, 1996
(000)
- -----------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $21,973
Interest 524
-----------
Total Income 22,497
-----------
EXPENSES
Investment Advisory Fee--Note B 394
The Vanguard Group--Note C
Management and Administrative 585
Marketing and Distribution 65
Taxes (other than income taxes) 39
Custodian Fees 14
Auditing Fees 9
Shareholders' Reports 30
Annual Meeting and Proxy Costs 5
Trustees' Fees and Expenses 1
-----------
Total Expenses 1,142
- -----------------------------------------------------------------------------------------
NET INVESTMENT INCOME 21,355
- -----------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 1,305
- -----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES (552)
- -----------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $22,108
=========================================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Fund's total net assets changed during the two
most recent reporting periods. The Operations section summarizes information
that is detailed in the Statement of Operations. The amounts shown as
Distributions to shareholders from the Fund's net income and capital gains may
not match the amounts shown in the Operations section, because distributions
are determined on a tax basis and may be made in a period different from the
one in which the income was earned or the gains were realized on the financial
statements. The Capital Share Transactions section shows the amount
shareholders invested in the Fund, either by purchasing shares or by
reinvesting distributions, as well as the amounts redeemed. The corresponding
numbers of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31,
----------------------
1996 1995
(000) (000)
- -----------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 21,355 $ 22,230
Realized Net Gain (Loss) 1,305 (3,927)
Change in Unrealized Appreciation (Depreciation) (552) 44,868
-------------------------
Net Increase in Net Assets Resulting from Operations 22,108 63,171
-------------------------
DISTRIBUTIONS
Net Investment Income (20,847) (21,652)
Realized Capital Gain -- --
-------------------------
Total Distributions (20,847) (21,652)
-------------------------
NET EQUALIZATION CHARGES--NOTE A (370) (631)
-------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 56,872 56,956
Issued in Lieu of Cash Distributions 15,200 15,335
Redeemed (95,268) (110,318)
-------------------------
Net Decrease from Capital Share Transactions (23,196) (38,027)
- -----------------------------------------------------------------------------------------
Total Increase (Decrease) (22,305) 2,861
- -----------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 308,004 305,143
-------------------------
End of Year $285,699 $308,004
=========================================================================================
(1)Shares Issued (Redeemed)
Issued 6,073 6,474
Issued in Lieu of Cash Distributions 1,634 1,745
Redeemed (10,239) (12,694)
-------------------------
Net Decrease in Shares Outstanding (2,532) (4,475)
=========================================================================================
</TABLE>
13
<PAGE> 16
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the
Fund; and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Fund for one year. Finally, the table lists the Fund's Average Commission
Rate Paid, a disclosure required by the SEC 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>
- -------------------------------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31,
--------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $9.61 $8.35 $9.99 $9.32 $9.06
- -------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .69 .66 .66 .690 .749
Net Realized and Unrealized Gain (Loss) on .04 1.25 (1.46) .685 .236
Investments ---------------------------------------------
Total from Investment Operations .73 1.91 (.80) 1.375 .985
---------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.67) (.65) (.70) (.705) (.725)
Distributions from Realized Capital Gains -- -- (.14) -- -
---------------------------------------------
Total Distributions (.67) (.65) (.84) (.705) (.725)
- -------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $9.67 $9.61 $8.35 $9.99 $9.32
=======================================================================================================
TOTAL RETURN 8.04% 23.79% -8.45% 15.56% 11.34%
=======================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $286 $308 $305 $392 $187
Ratio of Total Expenses to Average Net Assets 0.39% 0.52% 0.51% 0.53% 0.58%
Ratio of Net Investment Income to Average Net Assets 7.23% 7.43% 7.27% 6.77% 7.43%
Portfolio Turnover Rate 31% 20% 27% 45% 33%
Average Commission Rate Paid $.0600 N/A N/A N/A N/A
- -------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 17
NOTES TO FINANCIAL STATEMENTS
Vanguard Preferred Stock Fund 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 with generally
accepted accounting principles for mutual funds. The Fund consistently follows
such policies in preparing its financial statements.
1. SECURITY VALUATION: Securities are valued at the latest quoted bid
prices. Temporary cash investments are valued at cost, which approximates
market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for Federal income taxes is required in the financial
statements.
3. EQUALIZATION: The Fund follows the accounting practice known as
"equalization," under which a portion of the price of capital shares issued and
redeemed, equivalent to undistributed net investment income per share on the
date of the transaction, is credited or charged to undistributed income. As a
result, undistributed income per share is unaffected by capital share
transactions.
4. REPURCHASE AGREEMENTS: The Fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. Government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
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. Under a contract that expires July 31, 1998, the Fund pays Wellington
Management Company, LLP an investment advisory fee calculated at an annual
percentage rate of average net assets. For the year ended October 31, 1996, the
advisory fee represented an effective annual rate of 0.13% of the Fund's
average net assets after giving effect to a fee waiver of $253,000 (0.09%) for
the period November 1, 1995, to July 31, 1996.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Fund under methods approved by the Board of Trustees. At October 31,
1996, the Fund had contributed capital of $27,000 to Vanguard (included in
Other Assets), representing 0.1% of Vanguard's capitalization. The Fund's
trustees and officers are also directors and officers of Vanguard.
D. During the year ended October 31, 1996, the Fund purchased $89,719,000 of
investment securities and sold $112,887,000 of investment securities, not
counting U.S. Government securities and temporary cash investments.
At October 31, 1996, the Fund had available realized capital losses of
$4,273,000 to offset future net capital gains of $345,000 through October 31,
2002, and $3,928,000 through October 31, 2003.
E. At October 31, 1996, net unrealized appreciation of investment securities
for financial reporting and Federal income tax purposes was $6,134,000,
consisting of unrealized gains of $7,117,000 on securities that had risen in
value since their purchase and $983,000 in unrealized losses on securities that
had fallen in value since their purchase.
15
<PAGE> 18
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Trustees of
Vanguard Preferred Stock Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Preferred Stock Fund (the "Fund") at October 31, 1996, and the results
of its operations, the changes in its net assets 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 October 31, 1996 by correspondence with the
custodian and brokers and the application of alternative auditing procedures
where confirmations from brokers were not received, provide a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
December 2, 1996
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
VANGUARD PREFERRED STOCK FUND
This information for the fiscal year ended October 31, 1996, is included
pursuant to provisions of the Internal Revenue Code.
For corporate shareholders, 100% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
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;
Director of Chris-Craft Industries, Inc.
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.;
Director of Sun Company, Inc. and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Co.,
Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and
Massa-chusetts Mutual Life Insurance Co.
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 Communications 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.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President 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
ROBERT A. DISTEFANO, Senior Vice President, Information Technology.
JAMES H. GATELY, Senior Vice President, Individual Investor Group.
IAN A. MACKINNON, Senior Vice President, Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and Chief Financial Officer.
[VANGUARD LOGO]
Please send your comments to us at:
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
[email protected] http://www.vanguard.com
This Report has been prepared for shareholders and may be distributed to others
only if preceded or accompanied by a current prospectus. All Funds in the
Vanguard Family are offered by prospectus only.
<PAGE> 20
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International
Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY,OH, PA)
Q380-10/96
[PHOTO]
