<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-1A
REGISTRATION STATEMENT (NO. 2-54886) UNDER
THE SECURITIES ACT OF 1933
Pre-Effective Amendment No. /X/
Post-Effective Amendment No. 35 /X/
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
Amendment No. 39 /X/
VANGUARD PREFERRED
STOCK FUND
(Exact Name of Registrant as Specified in Charter)
P.O. Box 2600,
Valley Forge, PA 19482
(Address of Principal Executive Office)
Registrant's Telephone Number (610) 669-1000
Raymond J. Klapinsky, Esquire
P.O. Box 876
Valley Forge, PA 19482
It is proposed that this filing become effective on January 23, 1998,
pursuant to paragraph (b) of Rule 485.
Approximate Date of Proposed Public Offering: As soon as practicable after
this Registration Statement becomes effective.
We have elected to register an indefinite number of shares pursuant to
Rule 24f-2 under the Investment Company Act of 1940. We filed our Rule 24f-2
Notice for the fiscal year ended October 31, 1997 on January 29, 1998.
<PAGE>
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A Member of The Vanguard Group
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PROSPECTUS -- January 23, 1998
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NEW ACCOUNT INFORMATION: Investor Information Department -- 1-800-662-7447
(SHIP)
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SHAREHOLDER ACCOUNT SERVICES: Client Services Department -- 1-800-662-2739
(CREW)
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INVESTMENT Vanguard Preferred Stock Fund (the "Fund") is an open-end
OBJECTIVE AND diversified investment company that seeks to provide the
POLICIES maximum dividend income which qualifies for the 70%
corporate dividends received deduction under federal tax
law. The Fund invests primarily in the preferred stocks of
domestic corporations. There is no assurance that the Fund
will achieve its stated objective. Shares of the Fund are
neither insured nor guaranteed by any agency of the U.S.
Government, including the FDIC.
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OPENING AN To open a regular (non-retirement) account, please
ACCOUNT complete and return the Account Registration Form. If you
need assistance in completing this Form, please call the
Investor Information Department. To open an Individual
Retirement Account (IRA), please use a Vanguard IRA
Adoption Agreement. To obtain a copy of this form, call
1-800-662-7447, Monday through Friday, from 8:00 a.m. to
9:00 p.m. and Saturday, from 9:00 a.m. to 4:00 p.m.
(Eastern time). The minimum initial investment is $3,000
or $1,000 for Uniform Gifts/Transfers to Minors Act
accounts. The Fund is offered on a no-load basis (i.e.,
there are no sales commissions or 12b-1 fees). However,
the Fund incurs expenses for investment advisory,
management, administrative and distribution services.
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ABOUT THIS This Prospectus is designed to set forth concisely the
PROSPECTUS information you should know about the Fund before you
invest. It should be retained for future reference. A
"Statement of Additional Information" containing
additional information about the Fund has been filed with
the Securities and Exchange Commission. This Statement is
dated January 23, 1998, and has been incorporated by
reference into this Prospectus. A copy may be obtained,
without charge, by writing to the Fund, by calling the
Investor Information Department at 1-800-662-7447 or
visiting the Securities and Exchange Commission's website
(www.sec.gov).
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page Page Page
<S> <C> <C> <C> <C> <C>
Fund Expenses ............... 2 Investment Limitations ...... 7 SHAREHOLDER GUIDE
Financial Highlights ......... 2 Management of the Fund ...... 9 Opening an Account and
Yield and Total Return ...... 3 Investment Adviser ............ 9 Purchasing Shares .......... 15
FUND INFORMATION Performance Record ............ 10 When Your Account Will Be
Investment Objective ......... 4 Dividends, Capital Gains and Credited ................... 18
Investment Policies ......... 4 Taxes ..................... 11 Selling Your Shares .......... 18
Investment Risks ............ 4 The Share Price of the Fund ... 13 Exchanging Your Shares ....... 21
Who Should Invest ............ 5 General Information ......... 14 Important Information About
Implementation of Policies ... 6 Telephone Transactions .... 23
Transferring Registration ... 23
Statements and Reports ...... 24
Other Vanguard Services ...... 24
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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<PAGE>
FUND EXPENSES The following table illustrates all expenses and
fees that you would incur as a shareholder of the Fund.
The expenses and fees set forth in the table are for the
1997 fiscal year.
Shareholder Transaction Expenses
------------------------------------------------------------
Sales Load Imposed on Purchases .................. None
Sales Load Imposed on Reinvested Dividends ...... None
Redemption Fees ................................. None
Exchange Fees .................................... None
Annual Fund Operating Expenses
-----------------------------------------------------------
Management & Administrative Expenses ...... 0.20%
Investment Advisory Fees .................. 0.13
12b-1 Fees ................................. None
Other Expenses
Distribution Costs ........................ 0.03%
Miscellaneous Expenses .................. 0.01
-----
Total Other Expenses ..................... 0.04
----
Total Operating Expenses ............... 0.37%
====
The purpose of this table is to assist you in
understanding the various costs and expenses that you
would bear directly or indirectly as an investor in the
Fund.
The following example illustrates the expenses that you
would incur on a $1,000 investment over various periods,
assuming (1) a 5% annual rate of return and (2) a redemption
at the end of each period. As noted in the table above,
the Fund charges no redemption fees of any kind.
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$4 $12 $21 $ 47
This example should not be considered a representation of
past or future expenses or performance. Actual expenses
may be higher or lower than those shown.
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FINANCIAL The following financial highlights for a share outstanding
HIGHLIGHTS throughout each period, insofar as they relate to each of
the five years in the period ended October 31, 1997, have
been derived from financial statements which were audited
by Price Waterhouse LLP, independent accountants, whose
report thereon was unqualified. This information should be
read in conjunction with the Fund's financial statements
and notes thereto which, together with the remaining
portions of the Fund's 1997 Annual Report to Shareholders,
are incorporated by reference in the Statement of
Additional Information and in this Prospectus, and which
appear, along with the report of Price Waterhouse LLP, in
the Fund's 1997 Annual Report to Shareholders. For a more
complete discussion of the Fund's performance, please see
the Fund's 1997 Annual Report to Shareholders, which may
be obtained without charge by writing to the Fund or by
calling our Investor Information Department at
1-800-662-7447.
2
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year Ended October 31,
---------------------------------------------------------------
1997 1996 1995 1994 1993
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<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Year .............................. $ 9.67 $ 9.61 $ 8.35 $ 9.99 $ 9.32
------ ------ ------ ------ ------
Investment Operations
Net Investment Income ............ .63 .69 .660 .660 .690
Net Realized and Unrealized Gain
(Loss) on
Investments ..................... .53 .04 1.250 (1.460) .685
------ ------ ------ ------ ------
Total from Investment
Operations ..................... 1.16 .73 1.910 (.800) 1.375
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Distributions
Dividends from Net
Investment Income ............... (.66) (.67) (.650) (.700) (.705)
Distributions from Realized Capital
Gains ........................... -- -- -- (.140) --
----- ------ ------ ------ ------
Total Distributions ............... (.66) (.67) (.650) (.840) (.705)
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Net Asset Value, End of Year ...... $10.17 $ 9.67 $ 9.61 $ 8.35 $ 9.99
=======================================================================================================
Total Return ........................ 12.44% 8.04% 23.79% (8.45)% 15.56%
=======================================================================================================
Ratios/Supplemental Data
Net Assets, End of Year
(Millions) ........................ $320 $286 $308 $305 $392
Ratio of Total Expenses to Average
Net Assets ........................ 0.37% 0.39% 0.52% 0.51% 0.53%
Ratio of Net Investment Income to
Average Net Assets ............... 6.41% 7.23% 7.43% 7.27% 6.77%
Portfolio Turnover Rate ............ 34% 31% 20% 27% 45%
Average Commission Rate Paid ...... $.0600 $ .0600 N/A N/A N/A
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</TABLE>
(RESTUBBED TABLE)
<TABLE>
<CAPTION>
Fiscal Year Ended October 31,
------------------------------------------------------------------
1992 1991 1990 1989 1988
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Year .............................. $ 9.06 $ 8.22 $ 8.62 $ 7.94 $ 8.02
------ ------ ------ ------ ------
Investment Operations
Net Investment Income ............ .749 .765 .695 .691 .765
Net Realized and Unrealized Gain
(Loss) on
Investments ..................... .236 .855 (.350) .514 .170
------ ------ ------ ------ ------
Total from Investment
Operations ..................... .985 1.620 .345 1.205 .935
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Distributions
Dividends from Net
Investment Income ............... (.725) (.780) (.745) (.525) (.895)
Distributions from Realized Capital
Gains ........................... -- -- -- -- (.120)
------ ------ ------ ------ ------
Total Distributions ............... (.725) (.780) (.745) (.525) (1.015)
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Net Asset Value, End of Year ...... $ 9.32 $ 9.06 $ 8.22 $ 8.62 $ 7.94
=======================================================================================================
Total Return ........................ 11.34% 20.83% 4.28% 15.82% 12.37%
=======================================================================================================
Ratios/Supplemental Data
Net Assets, End of Year
(Millions) ........................ $187 $90 $54 $64 $78
Ratio of Total Expenses to Average
Net Assets ........................ 0.58% 0.63% 0.65% 0.67% 0.66%
Ratio of Net Investment Income to
Average Net Assets ............... 7.43% 7.96% 8.69% 9.11% 9.40%
Portfolio Turnover Rate ............ 33% 18% 15% 42% 52%
Average Commission Rate Paid ...... N/A N/A N/A N/A N/A
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</TABLE>
<PAGE>
YIELD AND From time to time the Fund advertises its yield and total
TOTAL RETURN return. Both yield and total return figures are based on
historical earnings and are not intended to indicate
future performance. The "total return" of the Fund refers
to the average annual compounded rates of return over
one-, five- and ten-year periods or over the life of the
Fund (as stated in the advertisement) that would equate an
initial amount invested at the beginning of a stated
period to the ending redeemable value of the investment,
assuming the reinvestment of all dividend and capital gains
distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day
yield" of the Fund is calculated by dividing the net
investment income per share earned during a 30-day period
by the net asset value per share on the last day of the
period. Net investment income includes interest and
dividend income earned on the Fund's securities; it is net
of all expenses and all recurring and nonrecurring charges
that have been applied to all shareholder accounts. The
yield calculation assumes that the net investment income
earned over 30 days is compounded monthly for six months
and then annualized. Methods used to calculate advertised
yields are standardized for all stock and bond mutual
funds. However, these methods differ from the accounting
methods used by the Fund to maintain its books and
records, and so the advertised 30-day yield may not fully
reflect the income paid to an investor's account or the
yield reported in the Fund's reports to shareholders.
Additionally the Fund may compare its performance to that
of the Merrill Lynch Perpetual Preferred Index.
3
<PAGE>
INVESTMENT The Fund is an open-end diversified investment company.
OBJECTIVE The objective of the Fund is to provide the maximum
dividend income which qualifies for the corporate
The Fund seeks to dividends received deduction (currently 70%) under federal
provide qualified tax law by investing primarily in the preferred stocks of
dividend income domestic corporations. There is no assurance that the Fund
will achieve its stated objective.
The investment objective of the Fund is not fundamental
and so may be changed by the Board of Trustees without
shareholder approval.
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INVESTMENT Under normal circumstances, the Fund will invest more than
POLICIES 75% of its total assets in preferred stocks of domestic
corporations (including domestic subsidiaries of foreign
The Fund invests companies) which have been rated Baa or better by Moody's
in preferred stock Investors Service, Inc. or BBB or better by Standard &
Poor's Corporation. The remainder of the Fund's assets may
be invested in (i) similarly rated fixed-income
securities, including convertible preferred stocks and
bonds, and money market instruments, and (ii) preferred
stocks with lower ratings. The Fund will not sell any of
the securities that it holds solely on account of such
securities having been downgraded. Except for the
qualified dividend income exclusion previously described,
the Fund is managed without regard to tax ramifications.
The Fund may also invest in U.S. dollar denominated
preferred stocks and debt securities issued by foreign
corporations, foreign governments, their agencies and
instrumentalities and supranational entities.
No investments will be made in common stocks. In the case
of convertible securities, the conversion privilege may be
exercised, but the common stocks received will be sold.
The Fund will not ordinarily invest in non-rated preferred
stocks, but reserves the right to do so should market
conditions dictate that it be in the best interests of the
Fund and its shareholders. The Fund will not purchase
warrants or rights directly and will not in any event hold
rights or warrants to an extent greater than 5% of its
total assets. See "Implementation of Policies" for other
investment practices of the Fund.
The Fund is responsible for voting the shares of all
securities it holds.
These policies are not fundamental and so may be changed
by the Board of Trustees without shareholder approval.
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INVESTMENT As a mutual fund investing primarily in perpetual
RISKS preferred stocks, the Fund is subject to interest rate
risk--i.e., the possibility that the market value of
The Fund is subject preferred stocks will vary inversely with interest rates.
to interest rate, When interest rates rise, the value of preferred stocks
credit and will fall; when interest rates fall, the value of
manager risks preferred stocks will rise.
Perpetual preferred stocks are similar in many ways to
corporate fixed-income securities; they provide investors
with a fixed stream of income that is generated from
corporate earnings. However, perpetual preferred stocks,
unlike corporate bonds, do not have a stated maturity
date. Because they lack a fixed maturity date, the prices
of preferred stocks are extremely sensitive to changes in
interest
4
<PAGE>
rates. Investors should anticipate that the fluctuations
in market value of preferred stocks will generally exceed
those of long-term government or corporate bonds (those
with maturities of 15 to 30 years).
As an illustration of interest rate risk, the table below
depicts the effect of a one and two percentage point
change in interest rates on long-term bonds:
Percent Change in the Price of a Par Bond Yielding 5.5%
1 Percentage Point 1 Percentage Point
Increase in Decrease in
Interest Rates Interest Rates
------------------ ---------------------
-11.1% +13.1%
2 Percentage Point 2 Percentage Point
Increase in Decrease in
Interest Rates Interest Rates
------------------ ---------------------
-20.5% +28.6%
This table is intended to provide you with guidelines for
determining the degree of interest rate risk you may be
willing to assume. The price changes shown should not be
taken as representative of the Fund's current or future
change in share price.
In addition to interest rate risk, the Fund is also
subject to a limited degree to credit risk--i.e., the
likelihood that the issuing corporation will be unable to
make the dividend payments due on its preferred stock.
Credit risk in the Fund will be minimized by investing
chiefly in investment grade preferred stocks, and by
diversifying preferred stock investments among many
companies and industries.
The investment adviser manages the Fund according to the
traditional methods of "active" investment management,
which involve the buying and selling of securities based
upon economic, financial and market analysis and
investment judgment. Manager risk refers to the
possibility that the Fund's investment adviser may fail to
execute the Fund's investment strategy effectively. As a
result, an investor in the Fund may lose money.
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WHO SHOULD The Fund is intended for investors who are seeking income
INVEST from their investments and who can tolerate substantial
price risks in pursuit of their income objectives. The
Investors seeking Fund is suited to investors who are willing to hold their
income which investments over a long time horizon in anticipation of
qualifies for the the income that preferred stocks may provide. Because the
dividends received Fund invests in preferred stocks, investors should be able
deduction to tolerate sharp, sometimes substantial fluctuations in
the value of their investment due to changes in interest
rates.
By minimizing nonqualifying investment income (i.e.,
realized interest income and net realized short-term
capital gains), the Fund is especially suitable for
corporations seeking to benefit from the corporate
dividends received deduction,
5
<PAGE>
which is currently 70%. Because of the tax considerations
involved, the Fund may not be as suitable an investment
for individuals, who, unlike corporations, are not
permitted to exclude qualified dividends received from
their taxable income.
Because of the risks associated with stock investments,
the Fund is intended to be a long-term investment vehicle
and is not designed to provide investors with a means of
speculating on short-term stock market movements.
Investors who en-gage in excessive account activity
generate additional costs which are borne by all of the
Fund's shareholders. In order to minimize such costs, the
Fund has adopted the following policies. The Fund reserves
the right to reject any purchase request (including
exchange purchases from other Vanguard portfolios) that is
reasonably deemed to be disruptive to efficient portfolio
management, either because of the timing of the investment
or previous excessive trading by the investor.
Additionally, the Fund has adopted exchange privilege
limitations as described in the section "Exchange
Privilege Limitations." Finally, the Fund reserves the
right to suspend the offering of its shares.
Given its objectives and risks, the Fund is not intended as
a complete investment program. Most investors should
maintain diversified holdings of securities with different
risk characteristics--including common stocks, bonds and
money market instruments.
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IMPLEMENTATION In addition to investing in preferred stocks, the Fund
OF POLICIES follows a number of additional investment policies.
The Fund may Although it normally seeks to remain substantially
invest in short- invested in preferred stocks, the Fund may invest
term fixed income temporarily in certain short-term fixed income securities.
securities Such securities may be used to invest uncommitted cash
balances or to maintain liquidity to meet shareholder
redemptions. Under normal circumstances, the Fund will
invest no more than 35% of its assets in short-term fixed
income securities. However, the Fund reserves the right to
invest 100% of its assets in such securities for temporary
defensive purposes. These short-term fixed income
securities include: obligations of the United States
Government and its agencies or instrumentalities;
commercial paper, bank certificates of deposit, and
bankers' acceptances; and repurchase agreements
collateralized by these securities.
The Fund may lend The Fund may lend its investment securities on a
its securities short-term or a long-term basis to qualified institutional
investors for the purpose of realizing additional income.
Loans of securities by the Fund will be collateralized by
cash, letters of credit, or securities issued or
guaranteed by the U.S. Government or its agencies. The
collateral will equal at least 100% of the current market
value of the loaned securities.
The Fund may The Fund may borrow money, subject to the limits set forth
borrow money on page 8, for temporary or emergency purposes, including
the meeting of redemption requests which might otherwise
require the untimely disposition of securities.
6
<PAGE>
Portfolio turnover Although it generally seeks to invest for the long term,
is not expected to the Fund retains the right to sell securities irrespective
exceed 100% of how long they have been held. It is anticipated that
the Fund's annual turnover rate will not exceed 100%. A
turnover rate of 100% would occur, for example, if all of
the securities of the Fund were replaced within one year.
Derivative Derivatives are instruments whose values are linked to or
Investing derived from an underlying security or index. The most
common and conventional types of derivative securities are
futures and options.
The Fund may The Fund may invest in futures contracts and options, but
invest in only to a limited extent. Specifically, the Fund may enter
derivative into futures contracts provided that notmore than 5% of its
securities assets are required as a futures contract deposit; in
addition, the Fund may enter into futures contracts and
options transactions only to the extent that obligations
under such contracts or transactions represent not more
than 20% of the Fund's assets.
Futures contracts and options may be used to pursue
several widely accepted management strategies: to maintain
cash reserves while simulating full investment, to
facilitate trading, to reduce transaction costs, or to
seek higher investment returns when a specific futures
contract is priced more attractively than other futures
contracts or the underlying security or index.
The Fund may use futures contracts for bona fide "hedging"
purposes. In executing a hedge, a manager sells, for
example, stock index futures to protect against a decline
in the stock market. As such, if the market drops, the
value of the futures position will rise, thereby
offsetting the decline in value of the Fund's stock
holdings.
The Fund may The Fund may also invest modestly in a fairly conservative
invest in CMOs class of collateralized mortgage obligations (CMOs) which
feature a high degree of cash flow predictability and
moderate vulnerability to mortgage prepayment risk. To
reduce credit risk, the Fund purchases these less risky
classes of collateralized mortgage obligations issued only
by agencies of the U.S. Government or privately-issued
collateralized mortgage obligations that carry
high-quality investment-grade ratings.
Futures contracts The primary risks associated with the use of futures
and options pose contracts and options are: (i) imperfect correlation
certain risks between the change in market value of the stocks or bonds
held by the Fund and the prices of futures contracts and
options; and (ii) possible lack of a liquid secondary
market for a futures contract and the resulting inability
to close a futures position prior to its maturity date.
The risk of imperfect correlation will be minimized by
investing in those contracts whose price fluctuations are
expected to resemble those of the Fund's underlying
securities. The risk that the Fund will be unable to close
out a futures position will be minimized by entering into
such transactions on a national exchange with an active
and liquid secondary market.
7
<PAGE>
The Fund may own The Fund may own restricted securities to a limited
restricted extent. Restricted securities are securities which are not
securities freely marketable or which are subject to restrictions
upon sale under the Securities Act of 1933. The Portfolio
may invest up to 15% of its net assets in illiquid
securities which include certain restricted Securities.
The Fund's Board of Trustees may from time to determine
certain restricted Securities known as Rule 144A Securities
to be liquid. Such securities will not be subject to the
15% limitation described above.
The Fund may The Fund may hold securities of foreign issuers, but all
invest in such securities must be in denominated in U.S. dollars.
securities of Securities of foreign issuers may trade in U.S. or foreign
foreign issuers securities markets. Securities of foreign issuers may
involve investment risks that are different from those of
domestic issuers. Such risks include the effect of foreign
economic policies and conditions, future political and
economic developments, and the possible imposition of
exchange controls or other foreign governmental
restrictions on foreign debt issuers. There may also be
less publicly available information about a foreign issuer
than a domestic issuer of securities. Foreign issuers are
generally not subject to the uniform accounting, auditing
and financial reporting standards that apply to domestic
issuers. Also, foreign debt markets may be characterized by
lower liquidity, greater price volatility and higher
transaction costs. Additionally, it may be difficult to
obtain or enforce a legal judgment in a foreign court.
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INVESTMENT The Fund has adopted certain fundamental limitations on
LIMITATIONS some of its investment policies. Some of these limitations
are that the Fund may not:
The Fund has (a) With respect to 75% of the value of its total assets,
adopted certain purchase the securities of any issuer (except
fundamental obligations of the United States Government and its
limitations instrumentalities) if, as a result, the Fund would
hold more than 10% of the outstanding voting
securities of the issuer, or more than 5% of the value
of the Fund's total assets would be invested in the
securities of such issuer;
(b) Invest more than 25% of its assets in any one
industry, with the exception of the electric and/or
gas industries; and
(c) Borrow money, except from banks (or through reverse
repurchase agreements) for temporary or emergency (not
leveraging) purposes, and then not in an amount
exceeding 15% of the value of the Fund's net assets
(including the amount borrowed and the value of any
outstanding reverse repurchase agreements) at the time
the borrowing is made. Whenever borrowings exceed 5%
of the value of the Fund's net assets, the Fund will
not make any additional investments.
A complete list of applicable investment limitations can
be found in the Statement of Additional Information; these
are fundamental and may be changed only by approval of a
majority of the Fund's shareholders.
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8
<PAGE>
MANAGEMENT OF The Fund is a member of The Vanguard Group of Investment
THE FUND Companies, a family of more than 30 investment companies
with more than 95 distinct investment portfolios and total
Vanguard assets in excess of $310 billion. Through their
administers and jointly-owned subsidiary, The Vanguard Group, Inc.
distributes the ("Vanguard"), the Fund and the other funds in the Group
Fund obtain at cost virtually all of their corporate
management, administrative, shareholder accounting and
distribution services. Vanguard also provides investment
advisory services on an at-cost basis to certain Vanguard
funds. As a result of Vanguard's unique corporate
structure, the Vanguard funds have costs substantially
lower than those of most competing mutual funds. In 1996,
the average expense ratio (annual costs including advisory
fees divided by total net assets) for the Vanguard funds
amounted to approximately .29% compared to an average of
1.22% for the mutual fund industry (data provided by Lipper
Analytical Services).
The Officers of the Fund manage its day-to-day operations
and are responsible to the Fund's Board of Trustees. The
Trustees set broad policies for the Fund and choose its
Officers. A list of the Trustees and Officers of the Fund
and a statement of their present positions and principal
occupations during the past five years can be found in the
Statement of Additional Information.
Vanguard employs a supporting staff of management and
administrative personnel needed to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings and equipment. Each
fund pays its share of Vanguard's total expenses, which
are allocated among the funds under methods approved by
the Board of Trustees (Directors) of each fund. In
addition, each fund bears its own direct expenses, such as
legal, auditing and custodian fees.
Vanguard also provides distribution and marketing services
to the Vanguard funds. The funds are available on a no-load
basis (i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears its share of the Group's
distribution costs.
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INVESTMENT The Fund has entered into an investment advisory agreement
ADVISER with Wellington Management Company, LLP ("WMC"), 75 State
Street, Boston, MA 02109, under which WMC manages the
Wellington investment and reinvestment of the Fund's assets and
Management continuously reviews, supervises and administers the
Company, LLP Fund's investment program. WMC discharges its
manages the Fund's responsibilities subject to the control of the Fund's
investments Officers and Trustees.
WMC is a professional investment advisory firm which
globally provides services to investment companies, other
institutions and individuals. Among the clients of WMC are
more than 10 investment companies of The Vanguard Group.
As of October 31, 1997, WMC held investment management
authority with respect to more than $169 billion of
assets. WMC and its predecessor organizations have
provided investment advisory services to investment
companies since 1933 and to investment counseling clients
since 1960.
9
<PAGE>
Earl E. McEvoy, Senior Vice President of WMC, serves as
portfolio manager of the Fund, a position he has held
since October 1982. Mr. McEvoy also manages the Long-Term
Corporate and High Yield Corporate Portfolios of Vanguard
Fixed Income Securities Fund, as well as the High Yield
Bond Portfolio of the Vanguard Variable Insurance Fund and
the bond components of Vanguard/Wellesley Income Fund and
the Utilities Income Portfolio of the Vanguard Specialized
Portfolios. Mr. McEvoy has been associated with Wellington
Management Company for 20 years. Mr. McEvoy is supported
by research and other investment services provided by the
professional staff of WMC.
The Fund pays WMC an advisory fee at the end of each
fiscal quarter, calculated by applying a quarterly rate,
based on the following annual percentage rates, to the
Fund's average month-end net assets for the quarter:
Net Assets Rate
---------- ----
First $200 million .150%
Next $200 million .100%
Assets in excess of $400 million .075%
During the fiscal year which ended on October 31, 1997,
the total advisory fees paid by the Fund to WMC
represented an annual effective rate of .13 of 1% of the
Fund's total average net assets. This fee was paid under a
previous fee schedule that provided for a higher rate of
fees.
The adviser is authorized to choose brokers or dealers to
handle the purchase and sale of the Fund's securities, and
is directed to get the best available price and most
favorable execution from these brokers with respect to all
transactions. At times, the adviser may choose brokers who
charge higher commissions in the interests of obtaining
better execution of a transaction. If more than one broker
can obtain the best available price and favorable
execution of a transaction, then the adviser is authorized
to choose a broker who, in addition to executing the
transaction, will provide research services to the adviser
or the Fund. However, the adviser will not pay higher
commissions specifically for the purpose of obtaining
research services. The Fund may direct the adviser to use
a particular broker for certain transactions in exchange
for commission rebates or research services provided to
the Fund.
The Fund's Board of Trustees may, without the approval of
shareholders, provide for: (a) the employment of a new
investment adviser pursuant to the terms of a new advisory
agreement, either as a replacement for an existing adviser
or as an additional adviser; (b) a change in the terms of
an advisory agreement; and (c) the continued employment of
an existing adviser on the same advisory contract terms
where a contract has been assigned because of a change in
control of the adviser. Any such change will only be made
upon not less than 30 days' prior written notice to
shareholders of the Fund which shall include substantially
the information concerning the adviser that would have
normally been included in a proxy statement.
- --------------------------------------------------------------------------------
10
<PAGE>
PERFORMANCE The table below provides investment results for the Fund
RECORD for several periods over the Fund's lifetime. The results
represent the Fund's "total return" investment
performance, which assumes the reinvestment of all capital
gains and income dividends for the indicated periods. Also
included is comparative information on the unmanaged
Merrill Lynch Perpetual Preferred Index, a measure of the
investment performance of preferred stocks. The table does
not make any allowance for federal, state or local income
taxes, which shareholders must pay on a current basis.
The results shown should not be considered a
representation of the total return from an investment made
in the Fund today. This information is provided to help
investors better understand the Fund and may not provide a
basis for comparison with other investments or mutual
funds which use a different method to calculate
performance.
Average Annual Return for
Vanguard Preferred Stock Fund
Merrill Lynch
Fiscal Years Vanguard Preferred Perpetual Preferred
Ended 10/31/97 Stock Fund Index**
-------------- ---------- -------
1 Year +12.4% + 9.4%
3 Years +14.6 +11.5
5 Years + 9.7 + 7.8
10 Years +11.3 + 9.7
Lifetime* +10.1 + 9.4
*December 3, 1975, to October 31, 1997.
**Standard & Poor's Preferred Stock Index through March 1989;
Merrill Lynch Perpetual Preferred Index through January
1997; Merrill Lynch Perpetual Preferred DRD-Eligible Index
thereafter.
- --------------------------------------------------------------------------------
DIVIDENDS, CAPITAL The Fund expects to pay dividends quarterly from ordinary
GAINS AND TAXES income. Net capital gains distributions, if any, will be
made annually.
The Fund pays In addition, in order to satisfy certain distribution
quarterly requirements of the Tax Reform Act of 1986, the Fund may
dividends declare special year-end dividend and capital gains
distributions during December. Such distributions, if
received by shareholders by January 31, are deemed to have
been paid by the Fund and received by shareholders on
December 31 of the prior year.
Dividend and capital gains distributions may be
automatically reinvested or received in cash. See
"Choosing a Distribution Option" for a description of
these methods.
The Fund intends to continue to qualify for taxation as a
"regulated investment company" under the Internal Revenue
Code so that it will not be subject to federal income tax
to the extent its income is distributed to shareholders.
Dividends paid by the Fund from net investment income,
whether received in cash or reinvested in additional
shares, will be taxable to shareholders as ordinary
income.
11
<PAGE>
Dividends will For corporate investors, if the Fund qualifies for
qualify for the taxation as a regulated invest ment company and satisfies
dividends received certain requirements, a portion of the dividends paid by
deduction the Fund will be eligible, whether received in cash or
reinvested in additional shares, for the corporate
dividends received deduction, which is currently 70%.
After such a deduction, the qualifying portion of the
Fund's dividends would be subject to a maximum federal tax
rate of 10.2%, in contrast to the current maximum federal
corporate tax rate of 34%.
In keeping with the policies and objectives of the Fund,
the Fund will seek to maximize dividend income which
qualifies for the corporate dividends received deduction.
In fiscal year 1997, all of the Fund's dividend
distributions qualified for the dividends received
deduction.
In order to qualify for the corporate dividends received
deduction, corporate shareholders must satisfy certain
holding period requirements for the Fund's shares.
Specifically, the deduction is only permitted when the
Fund's shares have been held for more than 45 days. The
holding period requirements apply to each block of Fund
shares acquired, including each block of shares received
in payment of the Fund's quarterly dividends. Corporate
investors are advised to consult with their tax advisers
on their eligibility for the dividends received deduction.
Distributions paid by the Fund from long-term capital
gains, whether received in cash or reinvested in
additional shares, are taxable to shareholders, as
long-term capital gains, regardless of the length of time
the shareholder has owned the shares. Long-term gains may
be taxed at different rates depending on how long the Fund
held the securities. Capital gains distributions result
when the Fund realizes net capital gains on sales of
portfolio securities. For the Fund, realized capital gains
are not expected to be a significant or predictable part
of investment return.
Keep in mind that if you purchase shares shortly before
the record date of a dividend or capital gains
distribution, you will pay the full price for the shares
and then receive some portion of the price back as a
taxable dividend or capital gains distribution.
The Fund notifies shareholders annually as to the tax
status of distributions paid by the Fund. Except for
qualification for the corporate dividends received
deduction, the Fund is managed without regard to tax
ramifications.
A capital gain or A sale of shares of the Fund is a taxable event and may
loss may be result in a capital gain or loss. A capital gain or loss
realized upon may be realized from an ordinary redemption of shares or
exchange or an exchange of shares between two mutual funds (or two
redemption portfolios of a mutual fund). Dividend distributions,
capital gains distributions, and capital gains or losses
from redemptions and exchanges may be subject to state and
local taxes.
12
<PAGE>
The Fund is required to withhold 31% of taxable dividends,
capital gains distributions, and redemptions paid to
shareholders who have not complied with IRS taxpayer
identification regulations. You may avoid this withholding
requirement by certifying on your Account Registration
Form your proper Social Security or employer
identification number and by certifying that you are not
subject to backup withholding.
The Fund is organized as a Pennsylvania business trust
and, in the opinion of counsel, is not liable for any
income or franchise tax in the Commonwealth of
Pennsylvania. The Fund will be subject to Pennsylvania
county personal property tax in the county which is the
site of its principal office. Shareholders who are
residents of Pennsylvania will be exempt from county
personal property taxes, except for shareholders who are
residents of the City and School District of Pittsburgh.
The tax discussion set forth above is included for general
information only. Prospective investors should consult
their own tax advisers concerning the tax consequences of
an investment in the Fund.
- --------------------------------------------------------------------------------
THE SHARE PRICE The Fund's share price, or "net asset value" per share, is
OF THE FUND calculated by dividing the total assets of the Fund, less
all liabilities, by the total number of shares
outstanding. The net asset value is determined as of the
close of the New York Stock Exchange (generally 4:00 p.m.
Eastern time) on each day that the exchange is open for
trading.
Fund securities for which market quotations are readily
available (including those securities listed on national
securities exchanges, as well as those quoted on the
NASDAQ Stock Market) will be valued at the last quoted
sales price on the day the valuation is made. Such
securities which are not traded on the valuation date are
valued at the mean of the bid and ask prices. Price
information on exchange-listed securities is taken from
the exchange where the security is primarily traded. Any
foreign securities are valued at the latest quoted sales
price available before the time when assets are valued.
Securities may be valued on the basis of prices provided
by a pricing service when such prices are believed to
reflect the fair market value of such securities.
Short-term instruments (those with remaining maturities of
60 days or less) may be valued at cost, plus or minus any
amortized discount or premium, which approximates market
value.
Bonds and other fixed income securities may be valued on
the basis of prices provided by a pricing service when such
prices are believed to reflect the fair market value of
such securities. The prices provided by a pricing service
may be determined without regard to bid or last sale
prices of each security, but take into account
institutional-size transactions in similar groups of
securities as well as any developments related to specific
securities.
13
<PAGE>
Other assets and securities for which no quotations are
readily available or which are restricted as to sale (or
resale) are valued by such methods as the Board of
Directors deems in good faith to reflect fair value.
The share price for the Fund can be found daily in the
mutual fund listings of most major newspapers under the
heading of Vanguard Funds.
- --------------------------------------------------------------------------------
GENERAL The Fund is a Pennsylvania business trust and is
INFORMATION authorized to issue an unlimited number of shares of
beneficial interest, without par value. Annual meetings of
shareholders will not be held except as required by the
Investment Company Act of 1940 and other applicable law.
An annual meeting will be held to vote on the removal of a
Trustee or Trustees of the Fund if requested in writing by
the holders of not less than 10% of the outstanding shares
of the Fund.
The shares of the Fund are fully paid and non-assessable;
have no preference as to conversion, exchange, dividends,
retirement or other features; and have no pre-emptive
rights. The shares of the Fund have non-cumulative voting
rights, meaning that the holders of more than 50% of the
shares voting for the election of Trustees can elect 100%
of the Trustees if they so choose.
All securities and cash are held by State Street Bank and
Trust Company, Boston, MA. CoreStates Bank, N.A., holds
daily cash balances that are used by the Fund to invest in
repurchase agreements or securities acquired in these
transactions. The Vanguard Group, Inc., Valley Forge, PA,
serves as the Fund's Transfer and Dividend Disbursing
Agent. Price Waterhouse LLP, serves as independent
accountants for the Fund and will audit its financial
statements annually. The Fund is not involved in any
litigation.
- -------------------------------------------------------------------------------
14
<PAGE>
SHAREHOLDER GUIDE
OPENING AN You may open a regular (non-retirement) account, either by
ACCOUNT AND mail or wire. Simply complete and return an Account
PURCHASING Registration Form and any required legal documentation,
SHARES indicating the amount you wish to invest. Your purchase
must be equal to or greater than the $3,000 minimum
initial investment requirement ($1,000 for Uniform
Gifts/Transfers to Minors Act accounts). If you wish to
open a Vanguard Individual Retirement Account, you must
open the account by mail (IRAs may not be opened by wire)
using a Vanguard IRA Adoption Agreement. Your purchase
must be equal to or greater than $1,000, but no more than
$2,000 if you are making a regular IRA contribution.
(Rollover IRA contributions may be made in greater
amounts.) If you need assistance with the forms or have
any questions about this Fund, please call our Investor
Information Department at 1-800-662-7447. Note: For other
types of account registrations (e.g., corporations,
associations, other organizations, trusts or powers of
attorney), please call us to determine which additional
forms you may need.
The Fund's shares are purchased at the next-determined net
asset value after your investment has been received. The
Fund is offered on a no-load basis (i.e., there are no
sales commissions or 12b-1 fees).
Purchase 1) Because of the risks associated with stock investments,
Restrictions the Fund is intended to be a long-term investment
vehicle and is not designed to provide investors with a
means of speculating on short-term stock market
movements. Consequently, the Fund reserves the right to
reject any specific purchase (and exchange purchase)
request. The Fund also reserves the right to suspend
the offering of shares for a period of time.
2) Vanguard will not accept third-party checks to purchase
shares of the Fund. Please be sure your purchase check
is made payable to The Vanguard Group.
Additional Subsequent investments to regular accounts may be made by
Investments mail ($100 minimum), wire ($1,000 minimum), exchange from
another Vanguard Fund account, or Vanguard Fund Express.
Subsequent investments to Individual Retirement Accounts
may be made by mail ($100 minimum) or exchange from
another Vanguard Fund IRA account. In some instances,
contributions may be made by wire or Vanguard Fund
Express. Please call us for more information on these
options.
------------------------------------------------------------
15
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
Purchasing By Mail Please include the amount of your Additional investments should
Complete and sign the initial investment on the registration include the Invest-by-Mail remittance
enclosed Account form, make your check payable form attached to your Fund
Registration Form to The Vanguard Group-38 confirmation statements. Please
and mail to: make your check payable to The
Vanguard Group-38, write your
Vanguard Financial Center account number on your check
P.O. Box 2600 and, using the return envelope
Valley Forge, PA 19482-2600 provided, mail to the address indicated
on the Invest-by-Mail Form.
For express or Vanguard Financial Center All written requests should be
registered mail, 455 Devon Park Drive mailed to one of the addresses indicated
send to: Wayne, PA 19087 for new accounts. Do not
send registered or express
mail to the post office box address.
---------------------------------------------------------------------------------------------------
Purchasing By Wire CORESTATES BANK, N.A.
Money should be ABA 031000011
wired to: CORESTATES NO. 0101 9897
ATTN VANGUARD
Before Wiring
Please contact VANGUARD PREFERRED STOCK FUND
Client Services ACCOUNT NUMBER
(1-800-662-2739) ACCOUNT REGISTRATION
</TABLE>
To assure proper receipt, please be sure your bank
includes the name of the Fund selected, the account number
Vanguard has assigned to you and the eight-digit
CoreStates number. If you are opening a new account,
please complete the Account Registration Form and mail it
to the "New Account" address above after completing your
wire arrangement. Note: Federal Funds wire purchase orders
will be accepted only when the Fund and Custodian Bank are
open for business.
- --------------------------------------------------------------------------------
Purchasing By You may open an account or purchase additional shares by
Exchange (from a making an exchange from an existing Vanguard Fund account.
Vanguard Account However, the Fund reserves the right to refuse any
exchange purchase request. Call our Client Services
Department at 1-800-662-2739. The new account will have
the same registration as the existing account.
- --------------------------------------------------------------------------------
Purchasing By Fund The Fund Express Special Purchase option lets you move
Express money from your bank account to your Vanguard account at
your request. Or if you choose the Automatic Investment
Special Purchase option, money will be moved from your bank account to your
and Automatic Vanguard account on the schedule (monthly, bimonthly
Investment [i.e., every other month],
16
<PAGE>
quarterly, semiannually or annually) you select. To
establish these Fund Express options, please provide the
appropriate information on the Account Registration Form.
We will send you a confirmation of your Fund Express
service; please wait two weeks before using the service.
- --------------------------------------------------------------------------------
CHOOSING A You must select one of three distribution options:
DISTRIBUTION
OPTION 1. Automatic Reinvestment Option--Both dividend and
capital gains distributions will be reinvested in
additional Fund shares. This option will be selected
for you automatically unless you specify one of the
other options.
2. Cash Dividend Option--Your dividends will be paid in
cash and your capital gains will be reinvested in
additional Fund shares.
3. All Cash Option--Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client Services
Department (1-800-662-2739).
If a shareholder has chosen to receive dividend and/or
capital gains distributions in cash, and the postal or
other delivery service is unable to deliver checks to the
shareholder's address of record, we will change the
distribution option so that all dividends and other
distributions are automatically reinvested in additional
shares. We will not pay interest on uncashed distribution
checks.
In addition, an option to invest your cash dividend and/or
capital gains distributions in another Vanguard Fund
account is available. Please call our Client Services
Department (1-800-662-2739) for information. You may also
elect Vanguard Dividend Express which allows you to
transfer your cash dividend and/or capital gains
distributions automatically to your bank account. Please
see "Other Vanguard Services" for more information.
- --------------------------------------------------------------------------------
TAX CAUTION Under Federal tax laws, the Fund is required to distribute
net capital gains and dividend income to Fund
Investors should shareholders. These distributions are made to all
ask about the shareholders who own Fund shares as of the distribution's
timing of capital record date, regardless of how long the shares have been
gain and dividend owned. Purchasing shares just prior to the record date
distributions could have a significant impact on your tax liability for
befor investing the year. For example, if you purchase shares immediately
prior to the record date of a sizable capital gain or
income dividend distribution, you will be assessed taxes
on the amount of the capital gain and/or dividend
distribution later paid even though you owned the Fund
shares for just a short period of time. (Taxes are due on
the distributions even if the dividend or gain is
reinvested in additional Fund shares.) While the total
value of your investment will be the same after the
distribution--the amount of the distribution will offset
the drop in the net asset value of the shares--you should
be aware of the tax implications the timing of your
purchase may have.
Prospective investors should, therefore, inquire about
potential distributions before investing. The Fund's
annual capital gains distribution normally occurs in
17
<PAGE>
December, while income dividends are generally paid
quarterly in March, June, September and December. In
addition, the Fund may occasionally be required to make
supplemental dividend or capital gains distributions at
some other time during the year. For additional
information on distributions and taxes, see the section
titled "Dividends, Capital Gains, and Taxes."
- --------------------------------------------------------------------------------
IMPORTANT The easiest way to establish optional Vanguard services on
ACCOUNT your account is to select the options you desire when you
INFORMATION complete your Account Registration Form.
Establishing If you wish to add shareholder options later, you may need
Optional Services to provide Vanguard with additional information and a
signature guarantee. Please call our Client Services
Department (1-800-662-2739) for further assistance.
Signature For our mutual protection, we may require a signature
Guarantees guarantee on certain written transaction requests. A
signature guarantee verifies the authenticity of your
signature and may be obtained from banks, brokers and any
other guarantors that Vanguard deems acceptable. A
signature guarantee cannot be provided by a notary public.
Certificates Share certificates will be issued upon request. If a
certificate is lost, you may incur an expense to replace
it.
Broker/Dealer If you purchase shares in Vanguard Funds through a
Purchases registered broker-dealer or investment adviser, the
broker-dealer or adviser may charge a service fee.
Cancelling Trades The Fund will not cancel any trade (e.g., a purchase,
exchange or redemption) believed to be authentic, received
in writing or by telephone, once the trade request has
been received.
Electronic You may receive a prospectus for the Fund or any of the
Prospectus Vanguard Funds in an electronic format through Vanguard's
Delivery website at www.vanguard.com. For additional information
please see "Other Vanguard Services -- Computer Access."
- --------------------------------------------------------------------------------
WHEN YOUR The trade date is the date on which your account is
ACCOUNT WILL BE credited. If your purchase is made by check, Federal Funds
CREDITED wire, or exchange, and is received by the close of trading
on the New York Stock Exchange (generally 4:00 p.m.
Eastern time), your trade date is the day of receipt. If
your purchase is received after the close of the Exchange,
your trade date is the next business day. Your shares are
purchased at the net asset value determined on your trade
date.
In order to prevent lengthy processing delays caused by
the clearing of foreign checks, Vanguard will only accept
a foreign check which has been drawn in U.S. dollars and
has been issued by a foreign bank with a U.S.
correspondent bank. The name of the U.S. correspondent
bank must be printed on the face of the foreign check.
- --------------------------------------------------------------------------------
SELLING YOUR You may withdraw any portion of the funds in your account
SHARES by redeeming shares at any time. (Please see "Important
Redemption Information.") You generally may
18
<PAGE>
initiate a redemption request by writing or by
telephone. Your redemption proceeds are normally mailed
within two business days after the receipt of the request
in Good Order. No interest will accrue on amounts
represented by uncashed redemption checks.
------------------------------------------------------------
Selling By Mail Requests should be mailed to Vanguard Financial Center,
Vanguard Preferred Stock Fund, P.O. Box 1120, Valley
Forge, PA 19482-1120. (For express or registered mail,
send your request to Vanguard Financial Center, Vanguard
Preferred Stock Fund, 455 Devon Park Drive, Wayne, PA
19087-1815.)
The redemption price of shares will be the Fund's net asset
value next determined after Vanguard has received all
required documents in Good Order.
------------------------------------------------------------
Definition of Good Order means that the request includes the following:
Good Order
1. The account number and Fund name.
2. The amount of the transaction (specified in dollars or
shares).
3. Signatures of all owners exactly as they are registered
on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that may be
required in the case of estates, corporations, trusts,
and certain other accounts.
6. Any certificates that you hold for the account.
If you have questions about this definition as it pertains
to your request, please call our Client Services Department
at 1-800-662-2739.
------------------------------------------------------------
Selling By To sell shares by telephone, you or your pre-authorized
Telephone representative may call our Client Services Department at
1-800-662-2739. The proceeds will be sent to you by mail
or by wire. In addition to the details below, please see
"Important Information About Telephone Transactions."
By Mail: Telephone mail redemption is automatically
established on your account unless you indicate otherwise
on your Account Registration Form. You may redeem any
amount by calling Vanguard. The proceeds will be paid to
the registered shareholders. Please Note: As a protection
against fraud, your telephone mail redemption privilege
will be suspended for 15 calendar days following any
expedited address change to your account. An expedited
address change is one that is made by telephone or in
writing without the signatures of all account owners.
By Wire: Telephone wire redemption must be specifically
elected for your account. The best time to elect telephone
wire redemption is at the time you complete your Account
Registration Form. If you do not presently have telephone
wire redemption and wish to establish it, please contact
our Client Services Department.
19
<PAGE>
With the wire redemption option, you may withdraw a
minimum of $1,000 and have the amount wired directly to
your bank account. Wire redemptions less than $5,000 are
subject to a $5 charge deducted by Vanguard. There is no
Vanguard charge for wire redemptions of $5,000 or more.
However, your bank may assess a separate fee to accept
incoming wires.
A request to change the bank associated with your wire
redemption option must be received in writing, signed by
each registered shareholder, and accompanied by a voided
check or preprinted deposit slip. A signature guarantee is
required if your bank registration is not identical to
your Vanguard Fund account registration.
------------------------------------------------------------
Selling By Fund If you select the Fund Express Automatic Withdrawal
Express option, money will be automatically moved from your
Vanguard Fund account to your bank account according to
Automatic the schedule you have selected. The Special Redemption
Withdrawal & option lets you move money from your Vanguard account to
Special Redemption your bank account on an "as needed" basis. To establish
these Fund Express options, please provide the appropriate
information on the Account Registration Form. We will send
you a confirmation of your Fund Express service; please
wait two weeks before using the service.
------------------------------------------------------------
Selling By You may sell shares of the Fund by making an exchange to
Exchange another Vanguard Fund account. Please see "Exchanging Your
Shares" for details.
Important Shares purchased by check or Fund Express may be redeemed
Redemption at any time. How ever, your redemption proceeds will not
Information be paid until payment for the purchase is collected, which
may take up to ten calendar days.
------------------------------------------------------------
Delivery of Redemption requests received by telephone prior to the
Redemption close of trading on the New York Stock Exchange (generally
Proceeds 4:00 p.m. Eastern time) are processed on the day of
receipt and the redemption proceeds are normally sent on
the following business day.
Redemption requests received by telephone after the close
of the Exchange are processed on the business day
following receipt and the proceeds are normally sent on
the second business day following receipt.
Redemption proceeds must be sent to you within seven days
of receipt of your request in Good Order, except as
described above in "Important Redemption Information."
If you experience difficulty in making a telephone
redemption during periods of drastic economic or market
changes, your redemption request may be made by regular or
express mail. It will be implemented at the net asset
value next determined after your request has been received
by Vanguard in Good Order. The Fund reserves the right to
revise or terminate the telephone redemption privilege at
any time.
20
<PAGE>
The Fund may suspend the redemption right or postpone
payment at times when the New York Stock Exchange is
closed or under any emergency circumstances as determined
by the United States Securities and Exchange Commission.
If the Board of Trustees determines that it would be
detrimental to the best interests of the Fund's remaining
shareholders to make payment in cash, the Fund may pay
redemption proceeds in whole or in part by a distribution
in kind of readily marketable securities.
------------------------------------------------------------
Vanguard's Average If you make a redemption from a qualifying account,
Cost Statement Vanguard will send you an Average Cost Statement which
provides you with the cost and tax basis of the shares you
redeemed. Please see "Statements and Reports" for
additional information.
------------------------------------------------------------
Low Balance Fee Due to the relatively high cost of maintaining smaller
and Minimum accounts, the Fund will automatically deduct a $10 annual
Account Balance fee in either June or December from non-retirement
Requirement accounts with balances falling below $2,500 ($500 for
Uniform Gifts/Transfers to Minors Act accounts). The fee
generally will be waived for investors whose aggregate
Vanguard assets exceed $50,000.
In addition, the Fund reserves the right to liquidate any
non-retirement account that is below the minimum initial
investment amount of $3,000. If at any time your total
investment does not have a value of at least $3,000, you
may be notified that your account is below the Fund's
minimum account balance requirement. You would then be
allowed 60 days to make an additional investment before
the account is liquidated. Proceeds would be promptly paid
to the registered shareholder.
Vanguard will not liquidate your account if it has fallen
below $3,000 solely as a result of declining markets
(i.e., a decline in a Fund's net asset value).
- --------------------------------------------------------------------------------
EXCHANGING YOUR Should your investment goals change, you may exchange
SHARES shares of Vanguard Preferred Stock Fund for those of other
available Vanguard Funds.
Exchanging By When exchanging shares by telephone, please have ready
Telephone your Fund name, account number, Social Security or
employer identification number listed on the account and
Call Client the exact name and address in which the account is
Services registered. Only the registered shareholder may complete
(1-800-622-2739) such an exchange. Requests for telephone exchanges
received prior to the close of trading on the New York
Stock Exchange (generally 4:00 p.m. Eastern time) are
processed at the close of business that same day.
Requests received after the close of the Exchange are
processed the next business day. Telephone exchanges are
not accepted into or from non-retirement investments in
Vanguard Index Trust, Vanguard Balanced Index Fund,
Vanguard International Equity Index Fund, Vanguard REIT
Index Portfolio, Vanguard Total International Portfolio,
and Vanguard Growth and Income Portfolio (formerly known
as Vanguard Quantitative Portfolios). If you
21
<PAGE>
experience difficulty in making a telephone exchange, your
exchange request may be made by regular or express mail,
and it will be implemented at the closing net asset value
on the date received by Vanguard provided the request is
received in Good Order.
------------------------------------------------------------
Exchanging By Mail Please be sure to include on your exchange request the name
and account number of your current Fund, the name of the
Fund you wish to exchange into, the amount you wish to
exchange, and the signatures of all registered account
holders. Send your request to Vanguard Financial Center,
Vanguard Preferred Stock Fund, P.O. Box 1120, Valley Forge,
PA 19482-1120. (For express or registered mail, send your
request to Vanguard Financial Center, Vanguard Preferred
Stock Fund, 455 Devon Park Drive, Wayne, PA 19087-1815.)
------------------------------------------------------------
Exchanging Online You may use your personal computer to exchange shares of
most Vanguard funds by accessing Vanguard's website
(www.vanguard.com). To establish this service on your
account, you must first register through our website. We
will then send to you by mail an account access password
that will enable you to make online exchanges.
The Vanguard funds that you cannot purchase or sell through
online exchange are Vanguard Index Trust, Vanguard Balanced
Index Fund, Vanguard International Equity Index Fund,
Vanguard REIT Index Portfolio, Vanguard Total International
Portfolio, and Vanguard Growth and Income Portfolio
(formerly known as Vanguard Quantitative Portfolios). These
funds do permit online exchanges within Vanguard IRAs and
other Vanguard retirement accounts.
------------------------------------------------------------
Important Before you make an exchange, you should consider the
Exchange following:
Information
o Please read the Fund's prospectus before making an
exchange. For a copy and for answers to any questions
you may have, call our Investor Information Department
(1-800-662-7447).
o An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on
the transaction.
o Exchanges by telephone are accepted only if the
registrations and the taxpayer identification numbers of
the two accounts are identical.
o In order to exchange into an account with a different
registration (including a different name, address, or
taxpayer identification number), you must obtain the
guaranteed signatures of all current account owners on
your written instructions.
o The shares to be exchanged must be on deposit and not
held in certificate form.
o New accounts are not currently accepted in
Vanguard/Windsor Fund.
o The redemption price of shares redeemed by exchange is
the net asset value next determined after Vanguard has
received any required documents in Good Order.
22
<PAGE>
Every effort will be made to maintain the exchange
privilege. However, the Fund reserves the right to revise
or terminate the exchange privilege and limit the amount
of or reject any exchange, as deemed necessary, at any
time.
- --------------------------------------------------------------------------------
EXCHANGE The Fund's exchange privilege is not intended to afford
PRIVILEGE shareholders a way to speculate on short-term movements in
LIMITATIONS the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive
exchange activity.
Exchange activity generally will not be deemed excessive if
limited to two substantive exchange redemptions (at least
30 days apart) from the Fund during any twelve month
period. Notwithstanding these limitations, the Fund
reserves the right to reject any purchase request
(including exchange purchases from other Vanguard
portfolios) that is reasonably deemed to be disruptive to
efficient portfolio management.
- --------------------------------------------------------------------------------
IMPORTANT The ability to initiate redemptions (except wire or Fund
INFORMATION Express redemptions) and exchanges by telephone is
ABOUT TELEPHONE automatically established on your account unless you
TRANSACTIONS request in writing that telephone transactions on your
account not be permitted. The ability to initiate wire
redemptions by telephone will be established on your
account only if you specifically elect this option in
writing.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions,
Vanguard adheres to the following security procedures:
1. Security Check. To request a transaction by telephone,
the caller must know (i) the name of the Portfolio;
(ii) the 10-digit account number; (iii) the exact name
and address used in the registration; and (iv) the
Social Security or employer identification number
listed on the account.
2. Payment Policy. The proceeds of any telephone
redemption by mail will be made payable to the
registered shareowner and mailed to the address of
record, only. In the case of a telephone redemption by
wire, the wire transfer will be made only in accordance
with the shareowner's prior written instructions.
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by
telephone, provided that reasonable security procedures
have been followed. Vanguard believes that the security
procedures described above are reasonable, and that if such
procedures are followed, you will bear the risk of any
losses resulting from unauthorized or fraudulent telephone
transactions on your account.
- --------------------------------------------------------------------------------
TRANSFERRING You may transfer the registration of any of your Fund
REGISTRATION shares to another person by completing a transfer form and
sending it to: Vanguard Financial Center, P.O. Box 1110,
Valley Forge, PA 19482-1110. The request must be in Good
Order. Before mailing your request, please call our Client
Services Department (1-800-662-2739) for full
instructions.
- --------------------------------------------------------------------------------
23
<PAGE>
STATEMENTS AND Vanguard will send you a confirmation statement each time
REPORTS you initiate a trans action in your account (except for
checkwriting redemptions from Vanguard money market
accounts). You will also receive a comprehensive account
statement at the end of each calendar quarter. The
fourth-quarter statement will be a year-end statement,
listing all transaction activity for the entire calendar
year.
Vanguard's Average Cost Statement provides you with the
average cost of shares redeemed from your account during
the calendar year, using the average cost single category
method. This service is available for most taxable
accounts opened since January 1, 1986. In general,
investors who redeemed shares from a qualifying Vanguard
account may expect to receive their Average Cost Statement
along with their Portfolio Summary Statement. Please call
our Client Services Department (1-800-662-2739) for
information.
Financial reports on the Fund will be mailed to you
semi-annually, according to the Fund's fiscal year-end.
- --------------------------------------------------------------------------------
OTHER VANGUARD For more information about any of these services, please
SERVICES call our Investor Information Department at 1-800-662-7447.
Vanguard Direct With Vanguard's Direct Deposit Service, most U.S.
Deposit Service Government checks (including Social Security and military
pension checks) and private payroll checks may be
automatically deposited into your Vanguard Fund account.
Separate brochures and forms are available for direct
deposit of U.S. Government and private payroll checks.
Vanguard Automatic Vanguard's Automatic Exchange Service allows you to move
Exchange Service money automatically among your Vanguard Fund accounts. For
instance, the service can be used to "dollar cost average"
from a money market portfolio into a stock or bond fund or
to contribute to an IRA or other retirement plan. Please
contact our Client Services Department at 1-800-662-2739
for additional information.
Vanguard Fund Vanguard's Fund Express allows you to transfer money
Express between your Fund account and your account at a bank,
savings and loan association, or a credit union that is a
member of the Automated Clearing House (ACH) system. You
may elect this service on the Account Registration Form or
call our Investor Information Department (1-800-662-7447)
for a Fund Express application.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition,
some services of Fund Express cannot be used with specific
Vanguard Funds. For more information, please refer to the
Vanguard Fund Express brochure.
Vanguard Dividend Vanguard's Dividend Express allows you to transfer your
Express dividend and/or capital gains distributions automatically
from your Fund account, one business day after the Fund's
payable date, to your account at a bank, savings and loan
association,
24
<PAGE>
or a credit union that is a member of the Automated
Clearing House (ACH) system. You may elect this service on
the Account Registration Form or call our Investor
Information Department (1-800-662-7447) for a Vanguard
Dividend Express application.
Vanguard Vanguard's Tele-Account is a convenient, automated service
Tele-Account(R) that provides share price, price change and yield
quotations on Vanguard Funds through any Touch-ToneTM
telephone. This service also lets you obtain information
about your account balance, your last transaction, and
your most recent dividend or capital gains distribution.
In addition, you may make investment exchanges of Vanguard
Fund shares and redemptions by check using Tele-Account.
To contact Vanguard's Tele-Account service, dial
1-800-ON-BOARD (1-800-662-6273). A brochure offering
detailed operating instructions is available from our
Investor Information Department (1-800-662-7447).
Computer Access
Vanguard Online Use your personal computer to learn more about Vanguard
www.vanguard.com funds and services; keep in touch with your Vanguard
accounts; map out a long-term investment strategy;
initiate certain transactions; and ask questions, make
suggestions, and send messages to Vanguard.
Our education-oriented website provides timely news and
information about Vanguard funds and services; an online
"university" that offers a variety of mutual fund classes;
and easy-to-use, interactive tools to help you create your
own investment and retirement strategies.
- --------------------------------------------------------------------------------
25
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<PAGE>
[LOGO]
VANGUARD
PREFERRED Vanguard
STOCK FUND Preferred
- ------------- Stock Fund
The Vanguard Group
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
P R O S P E C T U S
JANUARY 23, 1998
Investor Information
Department:
1-800-662-7447 (SHIP)
Client Services
Department:
1-800-662-2739 (CREW)
Tele-Account for
24-Hour Access:
1-800-662-6273 (ON-BOARD)
Telecommunications
Service for the
Hearing Impaired
1-800-662-2738
Transfer Agent:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
A Member of
TheVanguardGroup
P038
<PAGE>
PART B
VANGUARD PREFERRED STOCK FUND
STATEMENT OF ADDITIONAL INFORMATION
January 23, 1998
This Statement is not a prospectus, but should be read in conjunction
with the Fund's current Prospectus (dated January 23, 1998). To obtain the
Prospectus please call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS
Page
----
Investment Objective and Policies ..................... 1
Yield and Total Return ................................. 7
Purchase of Shares .................................... 7
Redemption of Shares ................................. 7
Investment Limitations ................................. 8
Management of the Fund ................................. 10
Investment Advisory Services ........................... 12
Portfolio Transactions ................................. 14
General Information .................................... 16
Financial Statements ................................. 17
Performance Measures ................................. 17
Appendix--Description of Preferred Stock Ratings ...... 19
INVESTMENT OBJECTIVE AND POLICIES
The following policies supplement the Fund's investment objective and
policies set forth in the Prospectus.
Repurchase Agreements
The Fund may invest in repurchase agreements with commercial banks,
brokers or dealers either for defensive purposes due to market conditions or
to generate income from its excess cash balances. A repurchase agreement is an
agreement under which the Fund acquires a money market instrument (generally a
security issued by the U.S. Government or an agency thereof, a banker's
acceptance or a certificate of deposit) from a commercial bank, broker or
dealer, subject to resale to the seller at an agreed upon price and date
(normally, the next business day). A repurchase agreement may be considered a
loan collateralized by securities. The resale price reflects an agreed upon
interest rate effective for the period the instrument is held by the Fund and
is unrelated to the interest rate on the underlying instrument. In these
transactions, the securities acquired by the Fund (including accrued interest
earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by a custodian bank until repurchased. In
addition, the
B-1
<PAGE>
Fund's Board of Trustees will monitor the Fund's repurchase agreement
transactions generally and will establish guidelines and standards for review
by the investment adviser of the creditworthiness of any bank, broker or
dealer party to a repurchase agreement with the Fund. No more than an
aggregate of 15% of the Fund's assets, at the time of investment, will be
invested in repurchase agreements having maturities longer than seven days and
securities subject to legal or contractual restrictions on resale or for which
there are no readily available market quotations. See "Illiquid Securities"
below.
The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Fund may incur a loss upon disposition of the security. If the other party to
the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Fund not within the
control of the Fund and therefore the realization by the Fund on such
collateral may be automatically stayed. Finally, it is possible that the Fund
may not be able to substantiate its interest in the underlying security and
may be deemed an unsecured creditor of the other party to the agreement. While
the Fund's management acknowledges these risks, it is expected that they can
be controlled through careful monitoring procedures.
Illiquid Securities
The Fund may not invest more than 15% of its net assets in illiquid
securities. Illiquid securities are securities that may not be sold or
disposed of in the ordinary course of business within seven business days at
approximately the value at which they are being carried on a Fund's books. An
illiquid security includes repurchase agreements which have a maturity of
longer than seven days, securities which are illiquid by virtue of the absence
of a readily available market, and demand instruments with a demand notice
exceeding seven days. Illiquid securities may include securities that are not
registered under the Securities Act of 1933 (the "1933 Act"), however,
unregistered securities that can be sold to "qualified institutional buyers"
in accordance with Rule 144A under the 1933 Act will not be considered
illiquid so long as it is determined by the Fund's adviser that an adequate
trading market exists for the security.
Foreign Investments
As indicated in the Prospectus, the Fund may include foreign securities
to a certain extent. Investors should recognize that investing in foreign
companies involves certain special considerations which are not typically
associated with investment in U.S. companies.
Country Risk. As foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards and practices
comparable to those applicable to domestic companies, there may be less
publicly available information about certain foreign companies than about
domestic companies. Securities of some foreign companies are generally less
liquid and more volatile than securities of comparable domestic companies.
There is generally less government supervision and regulation of stock
exchanges, brokers and listed companies than in the U.S. In addition, with
respect to certain foreign countries, there is the possibility of
expropriation or confiscatory taxation, political or social instability, or
diplomatic developments which could affect U.S. investments in those
countries.
Although the Fund will endeavor to achieve most favorable execution costs
in its portfolio transactions in foreign securities, fixed commissions on many
foreign stock exchanges are generally higher than negotiated commissions on
U.S. exchanges. In addition, it is expected that the expenses for custodial
arrangements of the Fund's foreign securities will be somewhat greater than
the expenses for the custodian arrangement for handling U.S. securities of
equal value.
B-2
<PAGE>
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will
reduce the income the Fund receives from its foreign investments.
Futures Contracts and Options
The Fund may enter into futures contracts, options, and options on
futures contracts for the purpose of remaining fully invested and reducing
transaction costs. Futures contracts provide for the future sale by one party
and purchase by another party of a specified amount of a specific security at
a specified future time and at a specified price. Futures contracts which are
standardized as to maturity date and underlying financial instrument are
traded on national futures exchanges. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC"), a U.S. Government Agency. Assets committed to futures
contracts will be segregated at the Fund's custodian bank to the extent
required by law.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold" or "selling" a
contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is bought
or sold.
Futures traders are required to make a good faith margin deposit in cash
or government securities with a broker or custodian to initiate and maintain
open positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be
changed. Brokers may establish deposit requirements which are higher than the
exchange minimums. Futures contracts are customarily purchased and sold on
margin that may range upward from less than 5% of the value of the contract
being traded.
The Fund may invest in futures contracts and options
Although it has no present intention to do so, the Fund may utilize
equity futures contracts and options to a limited extent. Specifically, the
Fund may enter into futures contracts provided that not more than 5% of its
assets are required as a futures contract deposit; in addition, the Fund may
enter into futures contracts and options transactions only to the extent that
obligations under such contracts or transactions represent not more than 20%
of the Fund's assets.
Futures contracts and options may be used for several reasons: to
maintain cash reserves while simulating full investment, to facilitate
trading, to reduce transactions costs, or to seek higher investment returns
when a futures contract is priced more attractively than the underlying equity
security or index. Although futures contracts and options may be used as
leveraged instruments, the Fund will not use futures contracts or options
transactions to leverage its assets.
For example, in order to remain fully invested in stocks, while
maintaining liquidity to meet potential shareholder redemptions, the Fund may
invest a portion of its assets in a stock index futures contract. Because
futures contracts only require a small initial margin deposit, the Fund would
then be able to maintain a cash reserve to meet potential redemptions, while
at the same time remaining fully invested. Also, because the transaction costs
of futures contracts and options may be lower than the costs of investing in
stocks directly, it is expected that the use of futures contracts and options
may reduce the Fund's total transaction costs.
B-3
<PAGE>
Futures contracts and options pose certain risks
The primary risks associated with the use of futures contracts and
options are: (i) imperfect correlation between the change in market value of
the stocks held by the Fund and the prices of futures and options; and (ii)
possible lack of a liquid secondary market for a futures contract and the
resulting inability to close a futures position prior to its maturity date.
The risk of imperfect correlation will be minimized by investing only in those
contracts whose price fluctuations are expected to resemble those of the
Fund's underlying securities. The risk that the Fund will be unable to close
out a futures position will be minimized by entering into such transactions on
a national exchange with an active and liquid secondary market.
After a futures contract position is opened, the value of the contract is
marked to the market daily. If the futures contract price changes to the
extent that the margin on deposit does not satisfy margin requirements,
payment of additional "variation" margin will be required. Conversely, change
in the contract value may reduce the required margin, resulting in a repayment
of excess margin to the contract holder. Variation margin payments are made to
and from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either
"hedgers" or "speculators." Hedgers use the futures markets primarily to
offset unfavorable changes in the value of securities otherwise held for
investment purposes or expected to be acquired by them. Speculators are less
inclined to own the securities underlying the futures contracts which they
trade, and use futures contracts with the expectation of realizing profits
from fluctuations in the value of the underlying securities. The Fund intends
to use futures contracts only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions except to the
extent that the aggregate initial margins and premiums required to establish
any non-hedging positions do not exceed five percent of the value of the
Fund's portfolio. The Fund will only sell futures contracts to protect
securities it owns against price declines or purchase contracts to protect
against an increase in the price of securities it intends to purchase. As
evidence of this hedging interest, the Fund expects that approximately 75% of
its futures contract purchases will be "completed;" that is, equivalent
amounts of related securities will have been purchased or are being purchased
by the Fund upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Fund's exposure to market fluctuations, the use
of futures contracts may be a more effective means of hedging this exposure.
While the Fund will incur commission expenses in both opening and closing out
futures positions, these costs are lower than transaction costs incurred in
the purchase and sale of the underlying securities.
Restrictions on the Use of Futures Contracts
The Fund will not enter into futures contract transactions to the extent
that, immediately thereafter, the sum of its initial margin deposits on open
contracts exceeds 5% of the market value of the Fund's total assets. In
addition, the Fund will not enter into futures contracts to the extent that
its outstanding obligations to purchase securities under these contracts would
exceed 20% of the Fund's total assets.
Risk Factors in Futures Transactions
Positions in futures contracts may be closed out only on an Exchange
which provides a secondary market for such futures. However, there can be no
assurance that a liquid secondary market will exist for any
B-4
<PAGE>
particular futures contract at any specific time. Thus, it may not be possible
to close a futures position. In the event of adverse price movements, the Fund
would continue to be required to make daily cash payments to maintain its
required margin. In such situations, if the Fund has insufficient cash, it may
have to sell portfolio securities to meet daily margin requirements at a time
when it may be disadvantageous to do so. In addition, the Fund may be required
to make delivery of the instruments underlying interest rate futures contracts
it holds. The inability to close options and futures positions also could have
an adverse impact on the Fund's ability to effectively hedge. It is also
possible that the Fund could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a futures contract or
related option. Additionally, investments in futures contracts and options
involve the risk that the investment advisers will incorrectly predict stock
market and interest rate trends.
The Fund will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the
time of purchase, 10% of the value of the futures contract is deposited as
margin, a subsequent 10% decrease in the value of the futures contract would
result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit if the contract
were closed out. Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the contract. However, because the
futures strategies of the Fund are engaged in only for hedging purposes, the
Adviser does not believe that the Fund is subject to the risks of loss
frequently associated with futures transactions. The Fund would presumably
have sustained comparable losses if, instead of the futures contract, it had
invested in the underlying financial instrument and sold it after the decline.
Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is
also possible that the Fund could both lose money on futures contracts and
also experience a decline in value of its portfolio securities. There is also
the risk of loss by the Fund of margin deposits in the event of bankruptcy of
a broker with whom the Fund has an open position in a futures contract or
related option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have
occasionally moved to the daily limit for several consecutive trading days
with little or no trading, thereby preventing prompt liquidation of future
positions and subjecting some futures traders to substantial losses.
Federal Tax Treatment of Futures Contracts
The Fund is required for Federal income tax purposes to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts held as of the end of the year as well as those actually
B-5
<PAGE>
realized during the year. In most cases, any gain or loss recognized with
respect to a futures contract is considered to be 60% long-term capital gain
or loss and 40% short-term capital gain or loss, without regard to the holding
period of the contract. Furthermore, sales of futures contracts which are
intended to hedge against a change in the value of securities held by the Fund
may affect the holding period of such securities and, consequently, the nature
of the gain or loss on such securities upon disposition. The Fund may be
required to defer the recognition of losses on futures contracts to the extent
of any unrecognized gains on related positions held by the Fund.
In order for the Fund to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, and gains from the sale of
securities or foreign currencies, or other income derived with respect to its
business of investing in such securities or currencies. It is anticipated that
any net gain realized from the closing out of futures contracts will be
considered gain from the sale of securities and therefore be qualifying income
for purposes of the 90% requirement.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including
unrealized gains at the end of the Fund's fiscal year) on futures
transactions. Such distributions will be combined with distributions of
capital gains realized on the Fund's other investments and shareholders will
be advised on the nature of the payments.
Lending of Securities
The Fund may lend its portfolio securities on a short-term or a long-
term basis to qualified institutional investors who need to borrow securities
in order to complete certain transactions, such as covering short sales,
avoiding failures to deliver securities or completing arbitrage operations. By
lending its portfolio securities, the Fund attempts to increase its income
through the receipt of interest on the loan. Any gain or loss in the market
price of the securities loaned that might occur during the term of the loan
would be for the account of the Fund. The Fund may lend its portfolio
securities to qualified brokers, dealers, banks or other financial
institutions, so long as the terms and the structure of such loans are not
inconsistent with the Investment Company Act of 1940, or the Rules and
Regulations or interpretations of the Securities and Exchange Commission (the
"Commission") thereunder, which currently require that (a) the borrower pledge
and maintain with the Fund collateral consisting of cash, an irrevocable
letter of credit, or securities issued or guaranteed by the United States
Government having a value at all times not less than 100% of the value of the
securities loaned, (b) the borrower add to such collateral whenever the price
of the securities loaned rises (i.e., the borrower "marks to the market" on a
daily basis), (c) the loan be made subject to termination by the Fund at any
time, and (d) the Fund receive reasonable interest on the loan (which may
include the Fund's investing any cash collateral in interest bearing
short-term investments), any distributions on the loaned securities and any
increase in their market value. The Fund will accept only cash as collateral
for its loaned securities and will not lend portfolio securities if, as a
result, the aggregate of such loans exceeds 10% of the value of the Fund's
total assets. Loan arrangements made by the Fund will comply with all other
applicable regulatory requirements, including the rules of the New York Stock
Exchange, which rules presently require the borrower, after notice, to
redeliver the securities within the normal settlement time of three business
days. All relevant facts and circumstances, including the credit worthiness of
the broker, dealer or institution, will be considered in making decisions with
respect to the lending of securities, subject to review by the Fund's Board of
Trustees. Since income derived from lending portfolio securities is not
qualifying income for the purpose of the 70% intercorporate dividends received
deduction under Federal tax laws, the Fund will limit such activity in
accordance with its objective of maximizing dividend income which qualifies
for the dividends deduction.
B-6
<PAGE>
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's Trustees (Directors).
YIELD AND TOTAL RETURN
The yield of the Fund for the 30-day period ended October 31, 1997 was
+5.99%.
The average annual total return of the Fund for the one-, five- and
ten-year periods ending October 31, 1997 was +12.44%, +9.73% and +11.25%,
respectively. Total return is computed by finding the average compounded rates
of return over the one-, five- and ten-year periods set forth above that would
equate an initial amount invested at the beginning of the periods to the
ending redeemable value of the investment.
PURCHASE OF SHARES
The purchase price of shares of the Fund is the net asset value next
determined after the order is received. The net asset value is calculated as
of the close of the New York Stock Exchange on each day the Exchange is open
for business. An order received prior to the close of the Exchange will be
executed at the price computed on the date of receipt; and an order received
after the close of the Exchange will be executed at the price computed on the
next day the Exchange is open.
The Fund reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund, and (iii) to
reduce or waive the minimum investment for or any other restrictions on
initial and subsequent investments for certain fiduciary accounts such as
employee benefit plans or under circumstances where certain economies can be
achieved in sales of the Fund's shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange is closed or
trading on the Exchange is restricted as determined by the Securities and
Exchange Commission (the "Commission"), (ii) during any period when an
emergency exists as defined by the rules of the Commission as a result of
which it is not reasonably practicable for the Fund to dispose of securities
owned by it or fairly determine the value of its assets, and (iii) for such
other periods as the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during
any 90-day period to the lesser of $250,000 or 1% of the net assets of the
Fund at the beginning of such period. Such commitment is irrevocable without
the prior approval
B-7
<PAGE>
of the Commission. Redemptions in excess of the above limits may be paid, in
whole or in part, in investment securities or in cash, as the Trustees may deem
advisable; however, payment will be made wholly in cash unless the Trustees
believe that economic or market conditions exist which would make such a
practice detrimental to the best interests of the Fund. If redemptions are paid
in investment securities, such securities will be valued as set forth in the
Prospectus under "The Share Price of the Fund" and a redeeming shareholder would
normally incur brokerage expenses if he converted these securities to cash.
No charge is made by the Fund for redemptions, except for wire
withdrawals in amounts less than $5,000 which are subject to a $5.00 charge
which will be deducted from the withdrawal payment. Any redemption may be more
or less than the shareholder's cost depending on the market value of the
Fund's portfolio securities.
Signature Guarantees -- To protect your account, the Fund and Vanguard
from fraud, signature guarantees are required for certain redemptions.
Signature guarantees enable the Fund to verify the identity of the person who
has authorized a redemption from your account. Signature guarantees are
required in connection with: (1) all redemptions, regardless of the amount
involved, when the proceeds are to be paid to someone other than the
registered owner(s) and/or registered address; and (2) share transfer
requests. These requirements are not applicable to redemptions in Vanguard's
prototype retirement plans except in connection with: (1) distributions made
when the proceeds are to be paid to someone other than the plan participant;
(2) certain authorizations to effect exchanges by telephone; and (3) when
proceeds are to be wired. These requirements may be waived by the Fund in
certain instances.
Signature guarantees may be obtained from a bank, broker or any other
guarantor institution that Vanguard deems acceptable. Notaries public are not
acceptable guarantors.
The signature guarantees must appear either: (1) on the written request
for redemption; (2) on a separate instrument for assignment ("stock power")
which should specify the total number of shares to be redeemed; or (3) on all
stock certificates tendered for redemption and, if shares held by the Fund are
also being redeemed, on the letter or stock power.
INVESTMENT LIMITATIONS
The Fund is subject to the following limitations which may not be changed
without the approval of at least a majority of the outstanding voting
securities of the Fund. The Fund will not:
(1) Borrow money, except that the Fund may borrow from banks (or through
reverse repurchase agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of redemption requests which
might otherwise require the untimely disposition of securities, in an
amount not exceeding 15% of the value of the Fund's net assets (including
the amount borrowed and the value of any outstanding reverse repurchase
agreements) at the time the borrowing is made. Whenever borrowings exceed
5% of the value of the Fund's net assets, the Fund will not make any
additional investments;
(2) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if, as a result, the Fund would hold
more than 10% of the outstanding voting securities of the issuer, or more
than 5% of the value of the Fund's total assets would be invested in the
securities of such issuer;
(3) Invest in companies for the purpose of exercising control;
B-8
<PAGE>
(4) Invest in securities of other investment companies, except as they
may be acquired as a part of a merger, consolidation or acquisition of
assets or otherwise to the extent permitted by Section 12 of the 1940 Act.
The Fund will invest only in investment companies which have investment
objectives and investment policies consistent with those of the Fund;
(5) Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed to
be an underwriter under the Securities Act of 1933, as amended, in
disposing of portfolio securities;
(6) Purchase or otherwise acquire any security (including the Fund's
investment in The Vanguard Group, Inc.) if, as a result, more than 15% of
its net assets would be invested in securities that are illiquid;
(7) Purchase or sell real estate although it may purchase and sell
securities of companies which deal in real estate or interests therein;
(8) Purchase or sell commodities or commodity contracts, except that the
Fund may invest in stock futures contracts, stock options and options on
stock futures contracts to the extent that not more than 5% of its assets
are required as deposit to secure obligations under such contracts and not
more than 20% of the Funds assets are invested in futures contracts and
options at any time;
(9) Write, or invest in, put, call, straddle, or spread option contracts
(except as described above in investment limitation No. 8) or invest in
interests in oil, gas, or other mineral exploration or development
programs;
(10) Purchase securities on margin or sell any securities short (except
as described above in investment limitation No. 8);
(11) Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements) which are either publicly
distributed or customarily purchased by institutional investors, and (ii)
as provided under "Lending of Securities" (page 4); and
(12) With the exception of the electric and/or gas industries in which
it may invest a majority of its assets, concentrate its investments in
any other particular industry, by investing more than 25% of the value of
its total assets taken at market value in securities of issuers all of
which conduct their principal business activities in the same industry.
These limitations are considered at the time investment securities are
purchased. Notwithstanding these limitations the Fund may own all or any
portion of the securities of, or make loans to, or contribute to the costs or
other financial requirements of any company which will be wholly owned by the
Fund and one or more other investment companies and is primarily engaged in
the business of providing, at-cost, management, administrative or related
services to the Fund and other investment companies. See "The Vanguard Group"
on page 11.
B-9
<PAGE>
MANAGEMENT OF THE FUND
Officers and Trustees
The Fund's Officers, under the supervision of the Board of Trustees,
manage the day-to-day operations of the Fund. The Trustees set broad policies
for the Fund and choose its Officers. Following is a list of the Trustees and
Officers of the Fund and a brief statement of their present positions and
principal occupations during the past 5 years. As of January 1, 1998, the
Trustees and Officers of the Fund owned less than 1% of the Fund's outstanding
shares. The mailing address of the Trustees and Officers of the Fund is Post
Office Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, (DOB: 5/8/1929) Chairman and Trustee*
Chairman and Director of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group; Director of The Mead Corporation, General
Accident Insurance, and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, (DOB: 7/29/1954) President, Chief Executive Officer and
Trustee*
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, (DOB: 9/28/1935) Trustee
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 Corporation.
BARBARA BARNES HAUPTFUHRER, (DOB: 10/11/1928) Trustee
Director of The Great Atlantic and Pacific Tea Company, IKON Office
Solutions, Inc., Raytheon Company, Knight-Ridder, Inc., Massachusetts
Mutual Life Insurance Co., and Ladies Professional Golf Association; and
Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY, (DOB: 5/7/1931) Trustee
President Emeritus of The Brookings Institution; Director of American Express
Bank, Ltd., The St. Paul Companies, Inc. and National Steel Corporation.
BURTON G. MALKIEL, (DOB: 8/28/1932) Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co., and Southern New England
Telecommunications Company.
<PAGE>
ALFRED M. RANKIN, JR., (DOB: 10/8/1941) Trustee
Chairman, President and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, Inc.; Director of The BFGoodrich Company and
The Standard Products Company.
JOHN C. SAWHILL, (DOB: 6/12/1936) Trustee
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 Company, Procter & Gamble
Company, and NACCO Industries.
JAMES O. WELCH, JR., (DOB: 5/13/1931) Trustee
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director
of RJR Nabisco; Director of TECO Energy, Inc. and Kmart Corporation.
J. LAWRENCE WILSON, (DOB: 3/2/1936) Trustee
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company, and The Mead Corporation; and Trustee of
Vanderbilt University.
RAYMOND J. KLAPINSKY, (DOB: 12/7/1938) Secretary*
Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of
each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, (DOB: 3/22/1937) Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment companies
in The Vanguard Group.
KAREN E. WEST, (DOB: 9/13/1946) Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ---------------
*Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
B-10
<PAGE>
The Vanguard Group
Vanguard Preferred Stock Fund is a member of The Vanguard Group of
Investment Companies. Through their jointly-owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other Funds in the Group obtain
at-cost virtually all of their corporate management, administrative and
distribution services. Vanguard also provides investment advisory services on
an at-cost basis to a number of the Vanguard Funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment.
Each Fund pays its share of Vanguard's total expenses which are allocated
among the Funds under methods approved by the Board of Trustees (Directors) of
each Fund. In addition, each Fund bears its own direct expenses, such as
legal, auditing and custodian fees.
The Vanguard Group adheres to a Code of Ethics established pursuant to
Rule 17j-1 under the Investment Company Act of 1940. The Code is designed to
prevent unlawful practices in connection with the purchase or sale of
securities by persons associated with Vanguard. Under Vanguard's Code of
Ethics certain Officers and employees of Vanguard who are considered access
persons are permitted to engage in personal securities transactions. However,
such transactions are subject to procedures and guidelines substantially
similar to those recommended by the mutual fund industry and approved by the
U.S. Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds has invested are adjusted from time to time in
order to maintain the proportionate relationship between each Fund's relative
net assets and its contribution to Vanguard's capital. The Funds' Service
Agreement provides as follows: (1) each Vanguard Fund may invest a maximum of
.40% of its current net assets in Vanguard, and (2) there are no restrictions
on the maximum aggregate cash investment that the Vanguard Funds may make in
Vanguard. At October 31, 1997, the Fund had contributed capital of $21,000 to
Vanguard, representing 0.1% of Vanguard's capitalization.
Management
Corporate management and administrative services include: (1) executive
staff; (2) accounting and financial; (3) legal and regulatory; (4) shareholder
account maintenance; (5) monitoring and control of custodian relationships;
(6) shareholder reporting; and (7) review and evaluation of advisory and other
services provided to the Funds by third parties. During the fiscal year ended
October 31, 1997, the Fund's share of Vanguard's actual net costs of operation
relating to management and administrative services (including transfer agency)
totaled approximately $591,000.
Distribution
Vanguard provides all distribution and marketing activities for the Funds
in the Group. Vanguard Marketing Corporation, a wholly-owned subsidiary of The
Vanguard Group, Inc., acts as Sales Agent for shares of the Funds, in
connection with any sales made directly to investors in the states of Florida,
Missouri, New York, Ohio, Texas and such other states as it may be required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more
B-11
<PAGE>
new investment companies which will become members of the Group. The Directors
and Officers of Vanguard determine the amount to be spent annually on
distribution activities, the manner and amount to be spent on each Fund, and
whether to organize new investment companies.
One half of the distribution expenses of a marketing and promotional
nature is allocated among the Funds based upon their relative net assets. The
remaining one half of these expenses is allocated among the Funds based upon
each Fund's sales for the preceding 24 months relative to the total sales of
the Funds as a Group, provided, however, that no Fund's aggregate quarterly
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of the average distribution expense rate for the
Group, and that no Fund shall incur annual distribution expenses in excess of
.20 of 1% of its average month-end net assets. During the fiscal year ended
October 31, 1997, the Fund paid approximately $67,000 of the Group's
distribution and marketing expenses, which represented an effective annual
rate of .03 of 1% of the Fund's average net assets.
Investment Advisory Services
Vanguard provides investment advisory services to Vanguard Money Market
Reserves, Vanguard Treasury Fund, Vanguard Bond Index Fund, Vanguard Index
Trust, Vanguard Admiral Funds, Vanguard Balanced Index Fund, Vanguard
International Equity Index Fund, Vanguard Institutional Index Fund, Vanguard
Tax-Managed Fund, Aggressive Growth Portfolio of Vanguard Horizon Fund,
Vanguard REIT Index Portfolio, the Total International Portfolio of Vanguard
STAR Fund, Vanguard Municipal Bond Fund; several Portfolios of Vanguard Fixed
Income Securities Fund, several Portfolios of Vanguard Variable Insurance
Fund, Vanguard California Tax-Free Fund, Vanguard Florida Insured Tax-Free
Fund, Vanguard New Jersey Tax-Free Fund, Vanguard Ohio Tax-Free Fund, Vanguard
New York Tax-Free Fund, Vanguard Pennsylvania Tax-Free Fund, a portion of
Vanguard/Windsor II, a portion of Vanguard/Morgan Growth Fund, a portion of
Vanguard Explorer Fund as well as several indexed separate accounts. These
services are provided on an at-cost basis from a money management staff
employed directly by Vanguard. The compensation and other expenses of this
staff are paid by the Funds utilizing these services.
Remuneration of Trustees and Officers
The Fund pays each Trustee who is not also an Officer an annual fee plus
travel and other expenses incurred in attending Board meetings. The Fund's
Officers and employees are paid by Vanguard which, in turn, is reimbursed by
the Fund, and each other Fund in the Group, for its proportionate share of
Officers' and employees' salaries and retirement benefits. The Fund's
proportionate share of remuneration paid by Vanguard (and reimbursed by the
Fund) during the 1997 fiscal year to all Officers of the Fund, as a group, was
approximately $7,154.
Upon retirement, Trustees who are not Officers are paid an annual fee
based upon the number of years of service on the Board. The fee is equal to
$1,000 for each year of service on the Board up to a maximum of fifteen years.
Under its retirement plan, Vanguard contributes annually an amount equal to
10% of each eligible Officer's annual compensation plus 5.7% of that part of
the eligible Officer's compensation during the year, if any, that exceeds the
Social Security Taxable Wage Base then in effect. Under its thrift plan, all
eligible Officers are permitted to make pre-tax contributions in an amount
equal to 4% of total compensation which are matched by Vanguard on a 100%
basis. The Fund's proportionate share of retirement contributions made by
Vanguard under its retirement and thrift plans on behalf of all eligible
Officers of the Fund, as a group, during the 1997 fiscal year was
approximately $150.
B-12
<PAGE>
The following table provides detailed information with respect to the
amounts paid or accrued for the Trustees, and the Officers of the Fund, for
the fiscal year ended October 31, 1997.
VANGUARD PREFERRED STOCK FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
Aggregate Pension or Retirement Estimated Total Compensation
Compensation Benefits Accrued As Annual Benefits From All Vanguard Funds
Names of Trustees From Fund Part of Fund Expenses Upon Retirement Paid to Trustees(2)
- ----------------- --------- --------------------- --------------- -------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) ............... -- -- -- --
John J. Brennan(1) ............ -- -- -- --
Barbara Barnes Hauptfuhrer...... $ 84 $ 12 $ 15,000 $ 70,000
Robert E. Cawthorn ............ $ 84 $ 10 $ 13,000 $ 70,000
Bruce K. MacLaury ............ $ 88 $ 12 $ 12,000 $ 65,000
Burton G. Malkiel ............ $ 85 $ 8 $ 15,000 $ 70,000
Alfred M. Rankin, Jr. ......... $ 84 $ 6 $ 15,000 $ 70,000
John C. Sawhill ............... $ 84 $ 8 $ 15,000 $ 70,000
James O. Welch, Jr. ............ $ 84 $ 9 $ 15,000 $ 70,000
J. Lawrence Wilson ............ $ 84 $ 7 $ 15,000 $ 70,000
</TABLE>
(1) As "Interested Trustees," Messrs. Bogle and Brennan receive no compensation
for their service.
(2) The amounts reported in this column reflect the total compensation paid to
each Trustee for their service as Director or Trustee of 35 Vanguard Funds
(34 in the case of Mr. Malkiel; 28 in the case of Mr. MacLaury).
B-13
<PAGE>
INVESTMENT ADVISORY SERVICES
The Fund employs Wellington Management Company, LLP (the "Adviser") under
an investment advisory agreement dated August 1, 1996 to manage the investment
and reinvestment of the assets of the Fund and to continuously review,
supervise and administer the Fund's investment program. The Adviser discharges
its responsibilities subject to the control of the Officers and Trustees of
the Fund.
The Fund pays the Adviser an advisory fee at the end of each fiscal
quarter, calculated by applying a quarterly rate, based on the following
annual percentage rates, to the Fund's average month-end net assets for the
quarter:
Net Assets Rate
---------- ----
First $200 million............................................... .150%
Next $200 million ............................................... .100%
Assets in excess of $400 million ................................ .075%
During the fiscal years ended October 31, 1995, 1996 and 1997, the Fund
paid advisory fees of $706,669, $394,000, and $406,000 respectively. In 1995,
and through July 31, 1996, fees were paid under an advisory agreement that
provided for a higher rate of fees.
The present agreement continues until July 31, 1998 and is renewable
thereafter, for successive one-year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Trustees, including the
affirmative votes of a majority of the Trustees who are not parties to the
contract or "interested persons" (as defined in the Investment Company Act of
1940) of any such party, cast in person at a meeting called for the purpose of
considering such approval.
The Fund's Board of Trustees may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of a
new advisory agreement, either as a replacement for an existing adviser or
as an additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same advisory
contract terms where a contract has been assigned because of a change in
control of the adviser.
Any such change will only be made upon not less than 30 days' prior
written notice to shareholders, which shall include the information concerning
the adviser that would have normally been included in a proxy statement.
Description of the Adviser
Wellington Management Company LLP, 75 State Street, Boston, MA 02109, is a
Massachusetts limited liability partnership, of which the following persons are
managing partners: Robert W. Doran, Duncan M. McFarland and John R. Ryan.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the Adviser (with the
approval of the Fund's Board of Trustees) to select the brokers or dealers
that will execute the purchases and sales of portfolio securities for
B-14
<PAGE>
the Fund and directs the Adviser to use its best efforts to obtain the best
available price and most favorable execution as to all transactions for the
Fund. The Adviser has undertaken to execute each investment transaction at a
price and commission which provides the most favorable total cost or proceeds
reasonably obtainable under the circumstances.
In placing portfolio transactions, the Adviser will use its best judgment
to choose the broker most capable of providing the brokerage services
necessary to obtain best available price and most favorable execution. The
full range and quality of brokerage services available will be considered in
making these determinations. In those instances where it is reasonably
determined that more than one broker can offer the brokerage services needed
to obtain the best available price and most favorable execution, consideration
may be given to those brokers which supply investment research and statistical
information and provide other services in addition to execution services to
the Fund and/or the Adviser. The Adviser considers such information useful in
the performance of its obligations under the agreement but is unable to
determine the amount by which such services may reduce its expenses.
The investment advisory agreement also incorporates the concepts of
Section 28(e) of the Securities Exchange Act of 1934 by providing that,
subject to the approval of the Fund's Board of Trustees, the Adviser may cause
the Fund to pay a broker-dealer which furnishes brokerage and research
services a higher commission than that which might be charged by another
broker-dealer for effecting the same transaction; provided that such
commission is deemed reasonable in terms of either that particular transaction
or the overall responsibilities of the Adviser to the Fund and the other Funds
in the Group.
Currently, it is the Fund's policy that the Adviser may at times pay
higher commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be in the best interest of the Fund. Some
brokers or dealers who may receive such higher commissions in recognition of
brokerage services related to execution of securities transactions are also
providers of research information to the Adviser and/or the Fund. However, the
Adviser has informed the Fund that it will not pay higher commission rates
specifically for the purpose of obtaining research services.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified broker-dealers who
recommend the Fund to other clients, or who act as agent in the purchase of
the Fund's shares for their clients, and may, when a number of brokers and
dealers can provide comparable best price and execution on a particular
transaction, consider the sale of Fund shares by a broker or dealer in
selecting among qualified broker-dealers.
During the fiscal years ended October 31, 1995, 1996 and 1997 the Fund
paid $509, $7,554 and $516 in brokerage commissions, respectively.
Some securities considered for investment by the Fund may also be
appropriate for other Funds and/or clients served by the Adviser. If purchase
or sale of securities consistent with the investment policies of the Fund and
one or more of these other Funds or clients served by the Adviser are
considered at or about the same time, transactions in such securities will be
allocated among the several Funds and clients in a manner deemed equitable by
the Adviser.
B-15
<PAGE>
GENERAL INFORMATION
Description of Shares and Voting Rights
The Fund was originally organized as a Maryland corporation in 1975. On
November 12, 1984 the Fund was reorganized into a Pennsylvania business trust
which was created solely for that purpose. The Declaration of Trust permits
the Trustees to issue an unlimited number of shares of beneficial interest,
without par value.
The shares of the Fund are fully paid and non-assessable, except as set
forth under "Shareholder and Trustee Liability," and have no preference as to
conversion, exchange, dividends, retirement or other features. The shares have
no pre-emptive rights. The shares have non-cumulative voting rights, which
means that the holders of more than 50% of the shares voting for the election
of Trustees can elect 100% of the Trustees if they choose to do so. A
shareholder is entitled to one vote for each full share held (and a fractional
vote for each fractional share held), then standing in his name on the books
of the Fund. On any matter submitted to a vote of shareholders, all shares of
the Fund then issued and outstanding and entitled to vote, irrespective of the
class, shall be voted in the aggregate and not by class: except (i) when
required by the Investment Company Act of 1940, shares shall be voted by
individual class; and (ii) when the matter does not affect any interest of a
particular class, then only shareholders of the affected class or classes
shall be entitled to vote thereon.
The Fund will continue without limitation of time, provided however that:
1)Subject to the majority vote of the holders of shares of the Fund
outstanding, the Trustees may sell or convert the assets of the Fund to
another investment company in exchange for shares of such investment
company, and distribute such shares, ratably among the shareholders of
the Fund; and
2)Subject to the majority vote of shares of the Fund outstanding, the
Trustees may sell and convert into money the assets of the Fund and
distribute such assets ratably among the shareholders of the Fund.
Upon completion of the distribution of the remaining proceeds or the
remaining assets of the Fund as provided in paragraphs 1) and 2) above, the
Fund shall terminate and the Trustees shall be discharged of any and all
further liabilities and duties hereunder and the right, title and interest of
all parties shall be cancelled and discharged.
Shareholder and Trustee Liability
Under Pennsylvania law, shareholders of a trust may, under certain
circumstances, be held personally liable as partners for the obligations of
the Trust. Therefore, the Declaration of Trust contains an express disclaimer
of shareholder liability for acts or obligations of the Fund and requires that
notice of such disclaimer be given in each agreement, obligation, or
instrument entered into or executed by the Fund or the Trustees. The
Declaration of Trust provides for indemnification out of the Fund property of
any shareholder held personally liable for the obligations of the Fund. The
Declaration of Trust also provides that the Fund shall, upon request, assume
the defense of any claim made against any shareholder for any act or
obligation of the Fund and satisfy any judgment thereon. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund itself would be unable to meet its
obligations. The Trustees and officers of the Fund believe that, in view of
the above, the risk of personal liability to shareholders is remote.
B-16
<PAGE>
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he
would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of his
office.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended October 31, 1997,
including the financial highlights for each of the five fiscal years in the
period ended October 31, 1997, appearing in the Vanguard Preferred Stock Fund
1997 Annual Report to Shareholders, and the report thereon of Price Waterhouse
LLP, independent accountants, also appearing therein, are incorporated by
reference in this Statement of Additional Information. The Fund's 1997 Annual
Report to Shareholders is enclosed with this Statement of Additional
Information. For a more complete discussion of the Fund's performance, please
see the Fund's 1997 Annual Report to Shareholders, which may be obtained
without charge.
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc.
or any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of The Vanguard Group, including
Vanguard Preferred Stock Fund, may, from time to time, use one or more of the
following unmanaged indices for comparative performance purposes.
Standard and Poor's 500 Composite Stock Price Index--is a well diversified list
of 500 companies representing the U.S. Stock Market.
Standard & Poor's MidCap 400 Index--is composed of 400 medium sized domestic
stocks.
Standard & Poor's/BARRA 600 Value Index--contains stocks for the S&P SmallCap
600 Index which have a lower than average price-to-book ratio.
Standard & Poor's/BARRA 600 Growth Index--contains stocks of the S&P SmallCap
600 Index which have a higher than average price-to-book ratio.
Russell 1000 Value Index--consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the lowest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000.
Wilshire 5000 Equity Index--consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
Wilshire 4500 Equity Index--consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard and Poor's 500 Index.
Morgan Stanley Capital International EAFE Index--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Austrailia, Asia and the Far East.
B-17
<PAGE>
Goldman Sachs 100 Convertible Bond Index--currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
Salomon Brothers GNMA Index--includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National
Mortgage Association.
Salomon Brothers High-Grade Corporate Bond Index--consists of publicly issued,
non-convertible corporate bonds rated AA or AAA. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years
or greater.
Lehman Brothers Aggregate Bond Index--is a market weighted index that contains
over 4,000 individually priced U.S. Treasury, agency, corporate, and mortgage
pass-through securities corporate rated BBB-- or better. The Index has a
market value of over $4 trillion.
Lehman Brothers Mutual Fund Short (1-5) Government/Corporate Index--is a
market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate investment grade bonds rated BBB-- or better
with maturities between 1 and 5 years. The index has a market value of over
$1.6 trillion.
Lehman Brothers Mutual Fund Intermediate (5-10) Government/Corporate Index--is
a market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate securities rated BBB-- or better with
maturities between 5 and 10 years. The index has a market value of over $700
billion.
Lehman Brothers Mutual Fund Long (10+) Government/Corporate Index--is a market
weighted index that contains over 1,900 individually priced U.S. Treasury,
agency, and corporate securities rated BBB-- or better with maturities greater
than 10 years. The index has a market value of over $900 billion.
Lehman Long-Term Treasury Bond Index--is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
Merrill Lynch Corporate & Government Bond Index--consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index--all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
Lehman Brothers Long-Term Corporate Bond Index--is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Bond Index--is a yield index on current coupon high grade
general obligation municipal bonds.
Standard & Poor's Preferred Index--is a yield index based upon the average
yield of four high grade, noncallable preferred stock issues.
NASDAQ Industrial Index--is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
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Composite Index--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
Composite Index--65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
Composite Index--65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index, 12.5% Standard & Poor's Utilities Index and 12.5% Standard & Poor's
Telephone Index).
Lehman Long-Term Corporate AA or Better Bond Index--consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
APPENDIX -- DESCRIPTION OF PREFERRED STOCK RATINGS
Excerpts from Moody's Investors Service, Inc. description of its four
highest preferred stock ratings: aaa -- considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least
risk of dividend impairment within the universe of preferred stocks; aa --
considered a high-grade preferred stock. This rating indicates that there is
reasonable assurance that earnings and asset protection will remain relatively
well maintained in the foreseeable future; a -- considered to be an
upper-medium grade preferred stock. While risks are judged to be somewhat
greater than in the aaa and aa classifications, earning and asset protection
are, nevertheless, expected to be maintained at adequate levels; baa --
considered to be lower-medium grade, neither highly protected nor poorly
secured. Earnings and asset protection appear adequate at present but may be
questionable over any great length of time.
Excerpts from Standard & Poor's Corporation description of its four
highest preferred stock ratings:
Quality ratings are expressed by symbols like those rating bonds. They
are independent of Standard & Poor's bond ratings, however, in the sense that
they are not necessarily graduated downward from the rankings accorded the
issuing company's debt. They represent a considered judgment of the relative
security of dividends, and -- what is thereby implied -- the prospective yield
stability of the stock. The four highest ratings are AAA -- Prime; AA -- High
Grade; A -- Sound; BBB -- Medium Grade.
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