<PAGE> 1
VANGUARD
PREFERRED STOCK
FUND
ANNUAL
REPORT
OCTOBER 31, 1998
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 2
AT VANGUARD, WE BELIEVE THAT TRADITION MATTERS
Our 8,000 crew members embrace the traditional values on which our success is
built, including integrity, hard work, thrift, teamwork, and fair dealing on
behalf of our clients.
This year, our report cover pays homage to three anniversaries, each of great
significance to The Vanguard Group:
- - The 200th anniversary of the Battle of the Nile, which commenced on August
1, 1798. HMS Vanguard, the victorious British flagship at the Nile, is our
namesake. And its motto-- "Leading the way"--serves as a guiding principle
for our company.
- - The 100th birthday, on July 23, of Walter L. Morgan, founder of Wellington
Fund, the oldest member of what became The Vanguard Group. Mr. Morgan was
friend and mentor to Vanguard founder John C. Bogle, and helped to shape the
standards and business principles that Mr. Bogle laid down for Vanguard at
its beginning nearly 25 years ago: a stress on balanced, diversified
investments; insistence on fair dealing and candor with clients; and a focus
on long-term investing. To our great regret, Mr. Morgan died on September 2.
- - The 70th anniversary, on December 28, of the incorporation of Vanguard
Wellington Fund. It was the nation's first balanced mutual fund, and is one
of only a handful of funds created in the 1920s that are still in operation.
Although Vanguard constantly tackles new challenges, adopts new technology, and
develops new services, we treasure the traditions and values that set us apart
in a crowded, competitive industry. And we salute our shareholders, whose
support and trust we strive to earn each and every day.
[VANGUARD ART]
CONTENTS
A MESSAGE TO
OUR SHAREHOLDERS
1
THE MARKETS IN
PERSPECTIVE
4
REPORT FROM
THE ADVISER
6
FUND PROFILE
8
PERFORMANCE SUMMARY
10
FINANCIAL STATEMENTS
11
REPORT OF
INDEPENDENT ACCOUNTANTS
18
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
[PHOTO] [PHOTO]
John J. Brennan John C. Bogle
Chairman & Ceo Senior Chairman
In a favorable environment featuring lower long-term interest rates, Vanguard
Preferred Stock Fund earned a solid return of +8.0% during the fiscal year ended
October 31, 1998. As the table below shows, our return for the twelve-month
period was comfortably ahead of returns for both the average fixed-income fund
and our unmanaged benchmark, the Merrill Lynch DRD-Eligible Preferred Stock
Index.
<TABLE>
<CAPTION>
- -----------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
OCTOBER 31, 1998
- -----------------------------------------------
<S> <C>
Vanguard Preferred Stock Fund +8.0%
- -----------------------------------------------
Average Fixed-Income Fund +5.9%
- -----------------------------------------------
Merrill Lynch DRD-Eligible
Preferred Stock Index +6.4%
- -----------------------------------------------
</TABLE>
Our fund's return is based on an increase in net asset value from $10.17 per
share on October 31, 1997, to $10.36 per share on October 31, 1998, with the
ending net asset value adjusted for the reinvestment of dividends totaling $0.61
per share paid from net investment income. As we expected, 100% of our income
dividends qualified under federal tax law for the 70% intercorporate
dividends-received deduction (DRD). The fund's yield at fiscal year-end was
5.4%.
FINANCIAL MARKETS IN REVIEW
Wide and abrupt shifts in investor sentiment buffeted financial markets during
the fiscal year that ended October 31. There was plenty to worry about,
including the Asian financial crisis, Russia's debt default, and the $3.6
billion bailout of a U.S. hedge fund. Nonetheless, the U.S. economy grew by more
than 3% during the period. This expansion was fueled by strong consumer spending
encouraged by a strong job market (unemployment as low as 4.3%) and rising wages
(up 4%). Inflation also stayed in check: Consumer prices rose just 1.5%.
The interest rate decline during the year elevated prices for bonds and
provided support for stock prices. A classic "flight to quality" amid turmoil in
global bond and stock markets helped drive U.S. Treasury bond yields to historic
lows during the period. The yield on the benchmark 30-year U.S. Treasury bond
began the year at 6.15%, fell to a 31-year low of 4.72% on October 5, then
rebounded in the final weeks of the fiscal year to end at 5.16%. Yields on
3-month Treasury bills declined on balance during the year by 88 basis points
(0.88 percentage point) to 4.32% on October 31. For fixed-income securities, of
course, lower yields translate into higher prices. Long-term Treasury bonds, as
measured by the Lehman Brothers Long U.S. Treasury Bond Index, returned +16.3%.
Gains were considerably smaller for corporate bonds (+9.7% for the Lehman Long
Corporate AA or Better Bond Index), which did not benefit from the flight to
quality that boosted Treasury prices.
FISCAL 1998 PERFORMANCE OVERVIEW
The Preferred Stock Fund's +8.0% return during fiscal 1998 was considerably
better than the +5.9% return on the average fixed-income mutual fund. We hasten
to point out that this category is not a perfect fit for preferred stock funds
on two accounts. First, the credit quality of preferred stocks is generally
lower than for bonds, by far the most predominant
1
<PAGE> 4
fixed-income security, so one would expect higher yields on preferreds. Second,
since many preferred securities are "perpetual"--meaning that, unlike bonds,
they have no stated maturity date--preferred stocks have very long average
maturities. Therefore, the share prices of preferred stock funds typically are
more sensitive than those of other fixed-income funds to changes in interest
rates. In periods of declining rates, preferred stocks generally outshine the
typical fixed-income fund. When interest rates rise, the reverse is true.
Investing, of course, always involves trade-offs between potential risks and
rewards. In return for accepting the risk of increased price volatility,
corporations eligible for the 70% DRD earn very attractive levels of after-tax
income from preferred stocks.
Your fund's return also exceeded that of our index benchmark--which
comprises DRD-eligible preferred stocks--by a substantial 1.6 percentage points.
We tip our hats to Wellington Management Company, our investment adviser, for an
excellent job in managing the fund. Beating the index is a noteworthy
achievement in that it exists only on paper and incurs no operating or
transaction costs, which any mutual fund must bear. On that score, however,
Vanguard Preferred Stock Fund has a wide edge over competing funds. Our expense
ratio in fiscal 1998 was a slender 0.36% of average net assets, which is about
65% below the 1.04% expense ratio charged by the average fixed-income fund.
LONG-TERM PERFORMANCE OVERVIEW
A single year is too short a period for a meaningful judgment of any mutual
fund, so we believe investors are well served by examining a fund's long-term
record. In the case of Vanguard Preferred Stock Fund, the long-term record is
excellent, both on an absolute basis and relative to our performance benchmarks.
Our average total return during the decade ended October 31 was +10.8% per year,
placing 3 percentage points ahead of the average fixed-income fund and 1.4
percentage points ahead of our index benchmark. (The benchmark has changed over
the years to reflect changes in the market for preferred stocks.)
The cumulative impact of these annual return differences is impressive. As
shown in the table below, a $10,000 investment in the Preferred Stock Fund made
a decade ago would have grown to $27,916, assuming that all income dividends and
capital gains distributions had been reinvested. That is $6,775 more than the
$21,141 that would have accumulated in the average fixed-income fund during the
decade, a difference equal to nearly 68% of the initial sum invested. A $10,000
investment in the index benchmark--which, as noted, reflects no operating
expenses--would have grown to $24,488, lagging the result for our fund by
$3,428.
As we pointed out, our wide margin over other fixed-income funds is partly
due to the extra boost that preferred stocks receive from declining interest
rates, a trend of the past decade. Our investment adviser's fine record of
security selection also is a factor in our strong long-term record. And we
reiterate the importance of our low costs, which give our adviser a nice
tailwind, year after year, in the attempt to provide superior returns.
<TABLE>
<CAPTION>
- --------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED OCTOBER 31, 1998
---------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- --------------------------------------------------------------
<S> <C> <C>
Vanguard Preferred Stock Fund +10.8% $27,916
- --------------------------------------------------------------
Average Fixed-Income Fund + 7.8% $21,141
- --------------------------------------------------------------
Merrill Lynch DRD-Eligible
Preferred Stock Index* + 9.4% $24,488
- --------------------------------------------------------------
</TABLE>
* S&P Preferred Index through March 1989; Merrill Lynch Perpetual Preferred
Index through January 1997; Merrill Lynch DRD-Eligible Preferred Stock Index
thereafter.
We emphasize that future returns are very likely to be lower than those of
the past decade simply because, at the present
2
<PAGE> 5
level of interest rates, the income return from fixed-income securities
purchased today will be lower than on those purchased a decade ago. As to the
capital component of return--the effect of up or down movements in security
prices--no one knows what the future will bring. However, with yields low and
prices high by historical standards, it would take extreme optimism to expect
large price gains to continue. That said, we note that the yields currently
provided by preferred stocks and other fixed-income securities are significantly
higher than recent levels of inflation.
IN SUMMARY
The past fiscal year was a good one for the fund and for most fixed-income
investors. But we repeat our customary caution that the risk of price
fluctuations goes with the territory when investing in preferred stocks. We
believe that a time-tested method for managing the risks of investing is to
build a balanced investment program that includes bond funds, stock funds, and
money market funds in proportions suitable to your financial goals. Once such a
plan is in place, our advice is to stick with it.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
November 17, 1998
3
<PAGE> 6
THE MARKETS IN PERSPECTIVE
YEAR ENDED OCTOBER 31, 1998 [ARTWORK]
U.S. financial markets encountered strong turbulence yet produced solid overall
gains during the fiscal year ended October 31. The S&P 500 Index gained 22.0%,
overcoming a sharp six-week setback in July and August. Bond prices rose as
interest rates declined over the course of the year. Overseas, returns varied
widely, with big gains on European bourses and sharp losses in Pacific and most
emerging stock markets.
U.S. STOCK MARKETS
Large-capitalization stocks--especially large growth stocks--overwhelmingly led
the market during the year. While the S&P 500 Index, which is dominated by
large-cap stocks, was rising 22.0%, the rest of the market was down 3.4%, more
than 25 percentage points behind the S&P. Results were even worse--a negative
return of 11.8%--for small-cap stocks, as represented by the Russell 2000 Index.
The Wilshire 5000 Equity Index, a measure of the entire U.S. market, gained
14.9%.
Even large-cap investors endured sharp fluctuations during the year. After
vaulting to a record high on July 17, the S&P 500 fell by 19.2% during the
following six weeks, just shy of the 20% mark generally considered the
"boundary" between a bear market and a mere "correction." However, declines were
certifiably bearish for most smaller stocks. The Russell 2000 Index fell more
than 30% from its peak in April before recovering somewhat during the final two
months of the fiscal year.
The July-August tumble in stock prices reflected a number of factors that
collectively raised the anxiety level for many investors. Among these factors
were deteriorating corporate earnings reports and forecasts, Russia's default on
its debts, and a murkier global economic picture. Asia's economic
troubles--which surfaced in mid-1997--persisted and began to look like a
significant threat to continued expansions in the U.S. and European economies.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED OCTOBER 31, 1998
--------------------------------
1 YEAR 3 YEARS 5 YEARS
- ----------------------------------------------------------------------
<S> <C> <C> <C>
STOCKS
S&P 500 Index 22.0% 26.0% 21.3%
Russell 2000 Index -11.8 10.0 9.4
MSCI EAFE Index 10.0 8.5 7.1
- ----------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 9.3% 8.0% 7.0%
Lehman 10-Year Municipal Bond Index 8.3 7.3 6.5
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 5.2 5.2 5.1
- ----------------------------------------------------------------------
OTHER
Consumer Price Index 1.5% 2.2% 2.4%
- ----------------------------------------------------------------------
</TABLE>
But after steadying during September, stock prices bounced back strongly in
October. Although many of the risk factors remained--for example, securities
analysts continued to trim their estimates of corporate earnings--stock prices
got a lift from falling interest rates, which dropped to levels last seen in the
1960s. (Low inflation and low interest rates help stock prices by raising the
estimated value of future dividends and earnings.)
Three forces clearly shaped the performance of industry sectors within the
overall market. They could be summarized as faith (the buoyant confidence of
consumers), fear (related to the effects of financial troubles abroad), and
fortresses (companies somewhat protected from competition). U.S. consumers
played the role of Atlas during fiscal 1998,
4
<PAGE> 7
propping up the economic world with their strong spending. Feeling flush because
of plentiful jobs (the nation's unemployment rate was as low as 4.3%) and rising
wages, consumers spent a record proportion of their income. Not surprisingly,
then, two big gainers among sectors of the S&P 500 Index were consumer staples
(+26%) and consumer discretionary firms, such as retailers (+23%).
Fear was a factor in the lagging returns from industry groups that were
perceived by investors to be vulnerable to slowing global growth, falling
commodity prices, and heightened price competition from foreign suppliers. Among
these were exploration and services firms in the "other energy" category (-34%);
chemical, metals, and other materials & processing firms (-3%); and makers of
producer durables such as airplanes and machinery (-0.3%). Conversely, the
utilities sector was the year's top performer (+45%) in part because utilities
are seen as relatively insulated from foreign competition or economic troubles.
Fortresses are companies perceived as relatively safe from competitors because
of patented products, brands, or services. Such companies dominated the
health-care (+41%) and technology (+37%) groups.
U.S. BOND MARKETS
Interest rates declined during the fiscal year, especially for U.S. Treasury
securities, which benefited from greater aversion to risk among investors and
from a slight decrease in supply, thanks to a $70 billion federal budget
surplus. The Federal Reserve Board twice trimmed short-term rates by 0.25
percentage point, first on September 29 and then on October 15. Inflation, the
bane of bond investors, was remarkably tame--consumer prices were up just 1.5%
for the 12 months ended October 31. In this friendly environment, yields on
long-term Treasury bonds fell by roughly 1 to 1.25 percentage points, with the
30-year Treasury bond ending the fiscal year at 5.16%. Lower rates mean higher
prices for bonds, and the Lehman Brothers Long U.S. Treasury Bond Index earned a
return of 16.3%, an astounding margin of nearly 15 percentage points over the
inflation rate.
High-quality corporate bonds and mortgage-backed securities did not rise in
price as far as Treasury securities. Mortgage bonds tend to lag Treasuries
during periods of falling rates because increased refinancing activity by
homeowners results in prepayments of principal to holders of mortgage-backed
securities. The Lehman Aggregate Bond Index, which comprises high-quality
corporate and mortgage-backed bonds, as well as Treasuries, and has an
intermediate-term average maturity, earned 9.3%. Yields on long-term municipal
bonds declined only modestly during the fiscal year, and by October 31 were only
slightly lower than yields on comparable Treasury securities, even though
interest on municipals is exempt from federal income tax.
INTERNATIONAL STOCK MARKETS
Europe's stock markets outshone even the S&P 500 Index, but big declines swept
the markets of Asia and Latin America. As a group, European stocks earned 23.4%
for U.S. investors, reflecting local returns of about 21% and a gain of about 2%
from a slight strengthening of several currencies against the dollar. Reasons
for Europe's bull market included continuing economic growth; increased
corporate restructuring and merger activity; and optimism about the long-term
impact of the euro, a common currency due to be adopted in 1999 by 11 nations.
In Japan, the stock market declined 14.3% in U.S.-dollar terms, reflecting a
severe recession and a shaky banking system. Declines elsewhere in the Pacific
region ranged from about 1% in Hong Kong to more than 60% in Indonesia and
Malaysia. Losses were steep in non-Asian emerging markets, too. Notable declines
in our own hemisphere occurred in Mexico (-20%), Venezuela (-64%), Brazil
(-30%), and Chile (-38%).
5
<PAGE> 8
REPORT FROM THE ADVISER [ARTWORK]
For the 6- and 12-month periods ended October 31, 1998, Vanguard Preferred Stock
Fund posted total returns of 2.9% and 8.0%, respectively.
AN OVERVIEW OF THE PERIOD
When the fiscal year began, yields on long-term U.S. Treasury bonds stood at
6.15% and short-term Treasury rates at 5.20%. Twelve months later, both
long-term and short-term interest rates are lower by roughly 100 basis points (1
percentage point). Falling interest rates, of course, boost the prices for
fixed-income securities in general and for preferred stocks in particular. The
strength in preferred-stock prices also can be attributed in part to a shortage
of new issues during the fund's fiscal year.
Another positive factor was the absence of any serious proposal within
government to lower the intercorporate dividends-received deduction (DRD). Such
proposals had repeatedly cropped up in previous years, but we know of no current
efforts to reduce the DRD from today's level of 70%.
MARKET UPDATE
Amid the lowest interest rates in 30 years, companies have been making tender
offers and calling for redemption of their older issues of preferred stock. Many
of the issues thus retired have not been replaced by similar ones at lower rates
because preferred stock remains a relatively expensive financing vehicle for
companies seeking capital. This trend causes concern about the supply of new
merchandise, although the decline in rates has motivated some companies to issue
preferreds.
As rates fell in the first half of fiscal 1998, Wall Street dealers took
advantage of the strong market conditions to strengthen their own balance sheets
by issuing equity capital in the form of preferred stock. Preferred-stock
valuations retreated somewhat--along with prices of other corporate debt--after
the Russian government's default on its debts prompted many investors to seek
the safety of virtually risk-free U.S. Treasuries. Risk premiums, or the spread
between yields on Treasuries and other fixed-income securities, widened across
all global capital markets. Preferreds were no exception. The current after-tax
yield spread for A-rated perpetual utility preferreds versus 30-year Treasury
bonds is 158 basis points, up from 114 basis points six months ago. This spread
is still below the ten-year average of 213 basis points. In comparison with
municipal bonds, preferreds have averaged 79 basis points of extra after-tax
yield over the last ten years, although this spread has narrowed and preferreds
currently offer only an extra 13 basis points in after-tax yield versus
municipals.
6
<PAGE> 9
With the federal budget in surplus (to the tune of $70 billion in fiscal
1998), the U.S. government's need for new sources of revenue is less urgent, and
the threat of a DRD reduction is therefore diminished. Even so, market
participants are still demanding that new issues of DRD-eligible preferred stock
have protection against such a reduction. The prospectus of a "DRD-protected
issue" states that the dividend will increase if the DRD is lowered to ensure
that the investor is left whole on an after-tax basis with respect to income. We
view this protection as necessary insurance against tax law changes that could
severely hurt prices for preferred stocks. However, the protection typically
expires 18 months after a preferred security is issued.
INVESTMENT GOALS AND STRATEGY
The fund's investment goals and strategy are consistent with those put in place
at its inception in 1975. We purchase relatively high-quality preferred stocks
with the goal of qualifying all of the fund's dividends for the 70%
intercorporate DRD. We achieved total qualification in fiscal 1998, as we have
in all previous years, and we will attempt to do so again in fiscal 1999.
Another objective of the fund is to provide sustainable, tax-advantaged income
by holding high-quality, investment-grade preferreds with call protection.
Stability of income should also be strengthened by broad diversification. As of
October 31, the fund owned preferreds from 48 issuers.
As noted, we attempt to mitigate somewhat the risk to the fund's net asset
value by purchasing DRD-protected securities. However, the risk to the fund from
rising long-term interest rates--which would cause market values of preferred
stocks to decline--is a constant, especially with interest rates at the current
low absolute levels. Preferreds, most of which have no stated maturity date,
perform very poorly when rates are rising. We do not now expect rates to rise to
any great extent. However, because they have fallen so dramatically over the
last year, a small uptick should not be a surprise.
At the fiscal year-end, the fund's credit-quality breakdown (using ratings
by Moody's Investors Service) was: cash and Treasuries, 4%; aa, 25%; a, 57%;
baa, 14%. High-quality financial-services issuers are our largest sector,
accounting for about 51% of assets. About 42% of the fund's holdings are
concentrated in the electric utility industry, representing 27 different
issuers. Our weighting in electric utility securities is up 4% from six months
ago.
Earl E. McEvoy, Senior Vice President
Wellington Management Company, LLP
November 12, 1998
INVESTMENT PHILOSOPHY
This fund is managed in the interest of corporations able to use the 70%
"intercorporate dividends-received" deduction under federal tax law. The adviser
believes that the fund can provide a relatively high and sustainable level of
income that qualifies for the deduction by investing primarily in
dividend-paying, high-quality, preferred stocks. (Note: Individual investors are
unable to use this tax deduction and are, therefore, not compensated for the
interest-rate and credit risks inherent in the fund.)
7
<PAGE> 10
FUND PROFILE
PREFERRED STOCK FUND
This Profile provides a snapshot of the fund's characteristics as of October 31,
1998, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- -------------------------------------------
PREFERRED MERRILL LYNCH
STOCK INDEX*
- -------------------------------------------
<S> <C> <C>
Number of Stocks 65 50
Yield 5.4% 5.0%
Average Coupon 6.4% 7.2%
Average Quality a1 a2
Turnover Rate 39% --
Expense Ratio 0.36% --
Cash Reserves 0.8% --
</TABLE>
* Merrill Lynch DRD-Eligible Preferred Stock Index.
<TABLE>
<CAPTION>
DISTRIBUTION BY CREDIT QUALITY (% OF PORTFOLIO)
- ---------------------------------------------------------
<S> <C>
Treasury/Agency 3.1%
aaa 0.0
aa 24.8
a 55.9
baa 13.5
ba 0.0
b 0.0
Not Rated 2.7
- ---------------------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY COUPON (% OF PORTFOLIO)
- -------------------------------------------------
<S> <C>
Less than 4.0% 0.2%
4.0 to 5.0 6.0
5.0 to 6.0 22.4
6.0 to 7.0 48.9
7.0 to 8.0 22.5
8.0 to 9.0 0.0
9.0 to 10.0 0.0
Greater than 10.0 0.0
- --------------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ------------------------------------------------------
<S> <C>
Federal Home Loan Mortgage Corp. 6.1%
Alabama Power Co. 4.8
Citigroup, Inc. 4.6
J. P. Morgan & Co., Inc. 4.2
Republic New York Corp. 4.2
Baltimore Gas & Electric Co. 4.1
Fleet Financial Group 4.0
ABN-AMRO North America 3.7
Heller Financial, Inc. 3.5
Florida Power & Light Co. 3.4
- ------------------------------------------------------
Top Ten 42.6%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF PREFERRED STOCKS)
- ----------------------------------------------------------------------------
OCTOBER 31, 1997 OCTOBER 31, 1998
------------------------------------------------
PREFERRED STOCK PREFERRED STOCK
------------------------------------------------
<S> <C> <C>
Auto & Transportation .... 4.5% 0.0%
Consumer Discretionary ... 0.0 0.0
Consumer Staples ......... 0.0 3.5
Financial Services ....... 50.7 52.7
Health Care .............. 0.0 0.0
Integrated Oils .......... 0.0 0.0
Other Energy ............. 0.0 0.0
Materials & Processing ... 0.2 0.2
Producer Durables ........ 0.0 0.0
Technology ............... 0.1 0.4
Utilities ................ 44.5 43.2
- ----------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
AVERAGE COUPON. The average interest rate paid on the securities held by a fund.
It is expressed as a percentage of face value.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
ratings assigned to a fund's securities holdings by credit-rating agencies. The
agencies make their judgment after appraising an issuer's ability to meet its
obligations. Quality is graded on a scale, with "aaa" indicating the most
creditworthy issuers.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities.
DISTRIBUTION BY COUPON. A breakdown of the securities in a fund according to
coupon rate-- the interest rate that an issuer promises to pay, expressed as an
annual percentage of face value. Securities with unusually high coupon rates may
be subject to call risk, the possibility that they will be redeemed (or
"called") early by the issuer.
DISTRIBUTION BY CREDIT QUALITY. This breakdown of a fund's securities by credit
rating can help in gauging the risk that returns could be affected by defaults
or other credit problems.
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is, and the less susceptible to a price decline stemming
from the problems of a particular company.
SECTOR DIVERSIFICATION. The percentage of preferred stocks from issuers in each
of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a fund has invested in
its ten largest holdings. (The average for stock mutual funds is about 30%.) As
this percentage rises, a fund's returns are likely to be more volatile because
they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year. Funds
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is the rate of return an investor would receive if
the securities were held to their maturity dates.
9
<PAGE> 12
PERFORMANCE SUMMARY
PREFERRED STOCK FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely, so an investment in the fund could
lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: OCTOBER 31, 1978-OCTOBER 31, 1998
- ----------------------------------------------------------------------
PREFERRED STOCK FUND MERRILL LYNCH
INDEX*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ----------------------------------------------------------------------
<S> <C> <C> <C> <C>
1979 -12.2% 8.1% -4.1% -4.9%
1980 -9.1 10.3 1.2 -3.4
1981 -10.9 11.4 0.5 -3.7
1982 17.5 18.6 36.1 27.0
1983 1.5 11.9 13.4 16.6
1984 -6.9 12.5 5.6 5.3
1985 9.7 14.2 23.9 23.4
1986 20.7 11.9 32.6 37.9
1987 -17.8 7.2 -10.6 -3.8
1988 0.5 11.9 12.4 8.7
1989 8.6 7.2 15.8 12.3
1990 -4.6 8.9 4.3 -3.1
1991 10.2 10.6 20.8 28.8
1992 2.9 8.4 11.3 13.5
1993 7.2 8.4 15.6 10.4
1994 -15.2 6.7 -8.5 -4.9
1995 15.1 8.7 23.8 17.9
1996 0.6 7.4 8.0 7.4
1997 5.2 7.2 12.4 8.8
1998 1.9 6.1 8.0 6.4
- ----------------------------------------------------------------------
</TABLE>
* S&P Preferred Index through March 1989; Merrill Lynch Perpetual Preferred
Index through January 1997; Merrill Lynch DRD-Eligible Preferred Stock Index
thereafter.
See Financial Highlights table on page 15 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMMULATIVE PERFORMANCE: OCTOBER 31, 1988-OCTOBER 31, 1998
- ----------------------------------------------------------
Preferred Average Merrill Lynch DRD-
Stock Fixed-Income Eligible Preferred
Fund Fund Stock Index*
<S> <C> <C> <C>
1988 10 10000 10000 10000
1989 01 10221 10089 10217
1989 04 10291 10211 10227
1989 07 11260 10829 10786
1989 10 11582 10862 11228
1990 01 11444 10787 10543
1990 04 11451 10723 10362
1990 07 12195 11317 11124
1990 10 12078 11096 10879
1991 01 12772 11558 11782
1991 04 13445 12117 12780
1991 07 13643 12396 13015
1991 10 14594 13040 14008
1992 01 15306 13413 14683
1992 04 15331 13576 14912
1992 07 16162 14230 15572
1992 10 16249 14318 15905
1993 01 16791 14795 16177
1993 04 17503 15215 16805
1993 07 18044 15608 17189
1993 10 18777 15967 17560
1994 01 18861 16161 17924
1994 04 17561 15460 16755
1994 07 17699 15590 17015
1994 10 17190 15448 16701
1995 01 17718 15647 17297
1995 04 19114 16265 18340
1995 07 20205 16857 19082
1995 10 21280 17340 19699
1996 01 21820 17929 20319
1996 04 21413 17567 20220
1996 07 21995 17776 20522
1996 10 22990 18389 21156
1997 01 23467 18656 21614
1997 04 23978 18755 22047
1997 07 25344 19604 22622
1997 10 25849 19940 23010
1998 01 26846 20442 23717
1998 04 27132 20636 23830
1998 07 27787 20946 24390
1998 10 27916 21141 24488
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1998
-------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Preferred Stock Fund 8.00% 8.25% 10.81% $27,916
Average Fixed-Income Fund 5.87 5.75 7.77 21,141
Merrill Lynch DRD-Eligible Preferred Stock Index* 6.42 6.88 9.37 24,488
- ------------------------------------------------------------------------------------------------------
</TABLE>
*S&P Preferred Index through March 1989; Merrill Lynch Perpetual Preferred Index
through January 1997; Merrill Lynch DRD-Eligible Preferred Stock Index
thereafter.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1998*
- --------------------------------------------------------------------------------------------
10 YEARS
INCEPTION ---------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Preferred Stock Fund 12/3/1975 10.77% 8.76% 3.15% 7.99% 11.14%
- --------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
10
<PAGE> 13
FINANCIAL STATEMENTS
OCTOBER 31, 1998 [ARTWORK]
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (preferred stocks, bonds, etc.) and by
industry sector. Other assets are added to, and liabilities are subtracted from,
the value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital (money invested by
shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date. Any Accumulated Net Realized Losses, and any cumulative
excess of distributions over net income or net realized gains, will appear as
negative balances. Unrealized Appreciation (Depreciation) is the difference
between the market value of the fund's investments and their cost, and reflects
the gains (losses) that would be realized if the fund were to sell all of its
investments at their statement-date values.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
MARKET
VALUE*
PREFERRED STOCK FUND SHARES (000)
- --------------------------------------------------------------------------------
PREFERRED STOCKS (96.1%)
- --------------------------------------------------------------------------------
<S> <C> <C>
CONSUMER STAPLES (3.4%)
- -(1)Ocean Spray Cranberries, Inc.
6.25% 125,000 $ 12,531
Stokely-Van Camp Corp. 5.00% 25,070 429
----------
12,960
----------
FINANCIAL SERVICES (50.6%)
BANKS--NEW YORK CITY (11.6%)
The Chase Manhattan Corp. 4.96% 250,000 12,500
J. P. Morgan & Co., Inc. 6.625% 290,000 15,950
Republic New York Corp. 5.715% 310,000 15,849
BANKS--OUTSIDE NEW YORK CITY (13.4%)
(1)ABN-AMRO North America
6.59% 13,000 14,045
Comerica, Inc. 6.84% 150,000 7,912
Fleet Financial Group 6.75% 231,000 12,474
Fleet Financial Group 7.25% 100,000 2,606
(1)LaSalle National Bank 6.46% 2,000 2,111
PNC Bank Corp. 6.05% 125,000 6,508
Wells Fargo & Co. 6.59% 100,000 5,217
DIVERSIFIED FINANCIAL SERVICES (7.0%)
Citigroup, Inc. 6.365% 330,000 17,655
Household International Inc.
5.00% 43,480 2,022
Household International Inc.
$4.30 82,950 6,841
FINANCIAL--MISCELLANEOUS (13.7%)
Federal Home Loan Mortgage
Corp. 5.00% 375,000 18,586
- - Federal Home Loan Mortgage
Corp. 5.10% 10,500 529
Federal Home Loan Mortgage
Corp. 6.14% 80,000 4,250
Federal National Mortgage
Assn. 6.45% 165,800 8,777
Heller Financial, Inc. 6.687% 125,000 13,464
MBNA Corp. 7.50%250,000 6,375
INSURANCE--PROPERTY--CASUALTY (2.1%)
(1)Hillbrook Insurance Co. 5.90% 75 8,187
SECURITIES BROKERS & SERVICES (2.8%)
Morgan Stanley Dean Witter Co.
7.75% 200,000 10,612
----------
192,470
----------
MATERIALS & PROCESSING (0.2%)
E.I. du Pont de Nemours & Co.
3.50% 12,300 878
----------
TECHNOLOGY (0.4%)
International Business Machines
Corp. 7.50% 57,500 1,570
----------
UTILITIES--ELECTRIC (41.5%)
Alabama Power Co. 5.20% 730,000 18,341
Baltimore Gas & Electric Co.
6.70% 39,700 4,505
Baltimore Gas & Electric Co.
6.97% 10,900 1,270
Baltimore Gas & Electric Co.
6.99% 35,000 4,129
Baltimore Gas & Electric Co.
7.125% 52,000 5,857
Duke Energy Corp. 7.00% 3,362 381
Duke Energy Corp. 7.04% 1,558 179
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
MARKET
VALUE*
PREFERRED STOCK FUND SHARES (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
Duke Energy Corp. 7.85% 20,544 $ 2,345
Duquesne Light Co. 4.10% 5,060 193
Duquesne Light Co. 4.15% 5,030 196
Entergy Louisiana Inc. 4.16% 7,000 469
Entergy Louisiana Inc. 4.44% 6,000 427
Entergy Mississippi Inc. 4.92% 10,000 938
Florida Power & Light Co. 6.75% 10,000 1,110
Florida Power & Light Co. 6.98% 105,000 11,710
Idaho Power Co. 7.07% 25,000 2,773
Illinois Power Co. 7.75% 28,400 1,538
Indianapolis Power & Light 5.65% 75,000 8,016
Monongahela Power Co. 7.73% 50,000 5,819
PECO Energy Co. $7.48 50,000 5,518
PP&L Resources, Inc. 6.75% 85,000 9,350
PSI Energy Inc. 6.875% 40,000 4,530
Pacific Gas & Electric Co. 4.36% 11,800 233
Pacific Gas & Electric Co. 5.00% 39,800 930
Pacific Gas & Electric Co. 7.04% 210,000 6,038
PacifiCorp 7.48% 75,000 8,737
Puget Sound Energy 7.45% 240,000 6,960
San Diego Gas & Electric Co.
$1.70 140,000 3,791
Sierra Pacific Power Co. 7.80% 200,000 5,589
South Carolina Electric &
Gas Co. 6.52% 115,000 12,765
Southern California Edison Co.
4.24% 14,200 288
Southern California Edison Co.
6.45% 5,000 530
Texas Utilities Electric Co. $1.875 112,800 3,081
Texas Utilities Electric Co. $4.76 3,786 332
Texas Utilities Electric Co. $7.98 45,000 5,237
Union Electric Co. $7.64 34,000 3,818
Virginia Electric & Power Co.
$6.98 60,000 6,700
West Penn Power Co. 4.20% 5,000 370
Wisconsin Power & Light Co.
6.20% 18,500 2,077
Wisconsin Public Service Corp.
6.88% 10,000 1,095
----------
158,165
----------
- --------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(COST $346,381) 366,043
- --------------------------------------------------------------------------------
<CAPTION>
- --------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
U.S. GOVERNMENT OBLIGATION (3.1%)
- --------------------------------------------------------------------------------
U.S. Treasury Note
5.75%, 8/15/2003
(COST $11,399) $11,000 $ 11,655
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (1.5%)
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.41%, 11/2/1998
(COST $5,798) 5,798 5,798
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.7%)
(COST $363,578) 383,496
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.7%)
- --------------------------------------------------------------------------------
Other Assets--Note C 5,272
Liabilities (8,014)
----------
(2,742)
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 36,754,090 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $380,754
================================================================================
NET ASSET VALUE PER SHARE $10.36
================================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- - Non-Income-Producing Security. New issue that has not paid a dividend as of
October 31, 1998.
(1) Security exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be sold in transactions exempt from
registration, normally to qualified institutional buyers. At October 31,
1998, the aggregate value of these securities was $36,874,000, representing
9.7% of net assets.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AT OCTOBER 31, 1998, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $355,973 $ 9.69
Undistributed Net
Investment Income 428 .01
Accumulated Net Realized Gains 4,435 .12
Unrealized Appreciation--
Note E 19,918 .54
- --------------------------------------------------------------------------------
NET ASSETS $380,754 $10.36
================================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31, 1998
(000)
- -------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $20,161
Interest 945
-----------
Total Income 21,106
-----------
EXPENSES
Investment Advisory Fee--Note B 458
The Vanguard Group--Note C
Management and Administrative 678
Marketing and Distribution 85
Custodian Fees 6
Auditing Fees 10
Shareholders' Reports 22
Annual Meeting and Proxy Costs 3
Trustees' Fees and Expenses 1
-----------
Total Expenses 1,263
- -------------------------------------------------------------------------------------
NET INVESTMENT INCOME 19,843
- -------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 6,265
- -------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 53
- -------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $26,161
=====================================================================================
</TABLE>
13
<PAGE> 16
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two
most recent reporting periods. The Operations section summarizes information
detailed in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined
on a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in
the fund, either by purchasing shares or by reinvesting distributions, as well
as the amounts redeemed. The corresponding numbers of Shares Issued and
Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31,
--------------------------
1998 1997
(000) (000)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 19,843 $ 19,485
Realized Net Gain 6,265 2,495
Change in Unrealized Appreciation (Depreciation) 53 13,731
--------------------------
Net Increase in Net Assets Resulting from Operations 26,161 35,711
--------------------------
DISTRIBUTIONS
Net Investment Income (20,808) (20,291)
Realized Capital Gain -- --
--------------------------
Total Distributions (20,808) (20,291)
--------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 130,539 86,381
Issued in Lieu of Cash Distributions 15,646 14,827
Redeemed (90,903) (82,208)
--------------------------
Net Increase from Capital Share Transactions 55,282 19,000
- ---------------------------------------------------------------------------------------------------
Total Increase 60,635 34,420
- ---------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 320,119 285,699
--------------------------
End of Year $380,754 $320,119
===================================================================================================
(1)Shares Issued (Redeemed)
Issued 12,503 8,822
Issued in Lieu of Cash Distributions 1,509 1,514
Redeemed (8,731) (8,395)
--------------------------
Net Increase in Shares Outstanding 5,281 1,941
===================================================================================================
</TABLE>
14
<PAGE> 17
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the
fund; and the extent to which the fund tends to distribute capital gains. The
table also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
PREFERRED STOCK FUND
YEAR ENDED OCTOBER 31,
-----------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $10.17 $ 9.67 $9.61 $8.35 $9.99
- -----------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .58 .63 .69 .66 .66
Net Realized and Unrealized Gain (Loss) on Investments .22 .53 .04 1.25 (1.46)
-----------------------------------------------
Total from Investment Operations .80 1.16 .73 1.91 (.80)
-----------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.61) (.66) (.67) (.65) (.70)
Distributions from Realized Capital Gains -- -- -- -- (.14)
-----------------------------------------------
Total Distributions (.61) (.66) (.67) (.65) (.84)
- -----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $10.36 $10.17 $9.67 $9.61 $8.35
===========================================================================================================
TOTAL RETURN 8.00% 12.44% 8.04% 23.79% -8.45%
===========================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $381 $320 $286 $308 $305
Ratio of Total Expenses to Average Net Assets 0.36% 0.37% 0.39% 0.52% 0.51%
Ratio of Net Investment Income to Average Net Assets 5.60% 6.41% 7.23% 7.43% 7.27%
Portfolio Turnover Rate 39% 34% 31% 20% 27%
===========================================================================================================
</TABLE>
15
<PAGE> 18
NOTES TO FINANCIAL STATEMENTS
Vanguard Preferred Stock Fund is registered under the Investment Company Act of
1940 as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid
and asked prices. Prices are taken from the primary market in which each
security trades. Bonds are valued using the latest bid prices or using
valuations based on a matrix system (which considers such factors as security
prices, yields, maturities, and ratings), both as furnished by independent
pricing services. Temporary cash investments are valued at cost, which
approximates market value. Securities for which market quotations are not
readily available are valued by methods deemed by the Board of Trustees to
represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Wellington Management Company, LLP provides investment advisory services to
the fund for a fee calculated at an annual percentage rate of average net
assets. For the year ended October 31, 1998, the advisory fee represented an
effective annual rate of 0.13% of the fund's average net assets.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At October 31, 1998, the fund had contributed capital of $77,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net
assets and 0.1% of Vanguard's capitalization. The fund's Trustees and officers
are also Directors and officers of Vanguard.
D. During the year ended October 31, 1998, the fund purchased $155,072,000 of
investment securities and sold $102,856,000 of investment securities, other
than U.S. government securities and temporary cash investments. Purchases and
sales of U.S. government securities were $36,864,000 and $34,008,000,
respectively.
The fund used a capital loss carryforward of $1,778,000 to offset taxable
capital gains realized during the year ended October 31, 1998, reducing the
amount of capital gains that would otherwise be available to distribute to
shareholders.
16
<PAGE> 19
E. At October 31, 1998, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $19,918,000,
consisting of unrealized gains of $20,206,000 on securities that had risen in
value since their purchase and $288,000 in unrealized losses on securities that
had fallen in value since their purchase.
17
<PAGE> 20
REPORT OF INDEPENDENT
ACCOUNTANTS [ARTWORK]
To the Shareholders and
Board of Trustees of
Vanguard Preferred Stock Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Preferred Stock Fund (the "Fund") at October 31, 1998, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for each
of the five years in the period then ended, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at October 31, 1998 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
November 30, 1998
18
<PAGE> 21
SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR VANGUARD PREFERRED STOCK FUND
This information for the fiscal year ended October 31, 1998, is included
pursuant to provisions of the Internal Revenue Code.
For corporate shareholders, 100% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
19
<PAGE> 22
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director/Trustee of The Vanguard
Group, Inc., and each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman, Chief Executive Officer, and Director/Trustee of The Vanguard Group,
Inc., and each of the investment companies in The Vanguard Group.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley
College.
JOANN HEFFERNAN HEISEN
Vice President, Chief Information Officer, and a member of the Executive
Committee of Johnson & Johnson; Director of Johnson & Johnson-Merck Consumer
Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and
Dyslexic, The Medical Center at Princeton, and Women's Research and Education
Institute.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress
& Co., The Jeffrey Co., and Southern New England Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co.,
NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM McNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"STANDARD & POOR'S(R)," "S&P(R)," "S&P 500(R)," "STANDARD & POOR'S 500," AND
"500" ARE TRADEMARKS OF THE MCGRAW-HILL COMPANIES, INC. FRANK RUSSELL
COMPANY IS THE OWNER OF TRADEMARKS AND COPYRIGHTS RELATING TO THE
RUSSELL INDEXES. "WILSHIRE 4500" AND "WILSHIRE 5000" ARE
TRADEMARKS OF WILSHIRE ASSOCIATES.
<PAGE> 23
VANGUARD
MILESTONES
[PHOTO]
The Vanguard Group is
named for HMS Vanguard,
Admiral Horatio Nelson's flagship
at the Battle of the Nile on
August 1, 1798. Our founder,
John C. Bogle, chose the name
after reading Nelson's inspiring
tribute to his fleet: "Nothing could
withstand the squadron . . .
with the judgment of the captains,
together with their valour, and that
of the officers and men of every
description, it was absolutely irresistible."
[PHOTO]
Walter L. Morgan, founder of
Wellington Fund, the nation's
first balanced mutual fund
and forerunner of today's family
of some 100 Vanguard funds,
celebrated his 100th birthday on
July 23, 1998. Mr. Morgan,
a true investment pioneer, died
six weeks later on September 2.
[PHOTO]
Wellington Fund,
The Vanguard Group's oldest fund,
was incorporated by Mr. Morgan
70 years ago, on December 28, 1928.
The fund was named after
the Duke of Wellington,
whose forces defeated
Napoleon Bonaparte at the
Battle of Waterloo in 1815.
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
www.vanguard.com
[email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
Q380-12/15/1998
(C) 1998 Vanguard Marketing
Corporation, Distributor.
All rights reserved.
