<PAGE> 1
VANGUARD
NEW JERSEY
TAX-FREE FUND
ANNUAL REPORT 1994
THE VANGUARD VOYAGE . . . STAYING THE COURSE
<PAGE> 2
THE VANGUARD VOYAGE . . . STAYING THE COURSE
WE ARE PRESENTLY OBSERVING TWO MILESTONES IN OUR HISTORY: (1) THE 20TH
ANNIVERSARY OF THE VANGUARD GROUP; AND (2) THE 65TH ANNIVERSARY YEAR OF
WELLINGTON FUND, THE OLDEST MUTUAL FUND ASSOCIATED WITH VANGUARD. WE CELEBRATE
THESE TWO EVENTS SINCE THEY HAVE INDELIBLY ALTERED THE MUTUAL FUND INDUSTRY--IN
OUR VIEW, FOR THE BETTER.
Wellington Fund--a pioneer in the mutual fund industry--began operations on
June 30, 1929. Its first fifteen years were a struggle for survival in an
industry that was shaken to its roots by the Great Crash of 1929-1933. From an
initial base of $100,000, Wellington's assets had grown to but $27 million by
the end of World War II. The Vanguard Group was founded on September 24, 1974.
Soon thereafter, we assumed responsibility for the management of Wellington
Fund and ten associated funds, with assets aggregating $1.4 billion.
The years that followed the founding of The Vanguard Group were marked
by exceptional growth. Today, Wellington Fund, with assets of nearly $9
billion, remains one of the largest mutual funds in the nation. And Vanguard,
now managing 85 mutual fund portfolios, is entrusted with assets of $134
billion, and ranks as the second largest fund complex in the world.
Our durability in an era of change--and our longevity in an era of
challenge--didn't "just happen." What brought us to where we are today is what
we were when we began. Put another way, we set our original investment course
based on sound principles, and our corporate course based on a single focus:
serving solely the interests of our Fund shareholders.
FOUNDING INVESTMENT PRINCIPLES
The founding investment principles of Wellington Fund were, above all,
conservative. The Fund provided a broadly diversified portfolio at a time when
holding individual securities was the conventional strategy. It incurred no
debt in an era of high leverage that would soon come back to haunt less
cautious investors. And it was a "balanced" fund--in fact, Wellington is
America's oldest balanced fund--with holdings from each of the three basic
financial asset classes: cash reserves, bonds, and common stocks. In short,
Wellington Fund was a staid investment in an era of stock speculation that was
to become, almost within moments, an era of conservatism.
For Vanguard, these investment principles endure. "Balance" is still
our watchword, because the three basic financial asset classes have
different--and usually countervailing--investment characteristics. When it
began, Wellington Fund provided a balanced program in a single investment; in
1994, such a balance is often achieved by a combination of Vanguard money
market, bond, and stock funds.
"Conservatism," too, remains our standard. Over the years, we have
tried to maintain the discipline to eschew offering funds that lack sound
financial principles, often based on marketplace fads that could not--and did
not--endure. Our conservatism applies not only to the funds we offer, but to
the instruments in which they invest. For example, we have steered clear of
exotic derivative securities with unpredictable investment characteristics. Too
many fund managers have been taken in by these highly risky instruments, and
their shareholders have paid a heavy price--except in cases where the manager
has "made the fund whole," when to do otherwise would have shocked investors
and impaired their confidence in the fund complex.
Speculation, it seems, comes and goes, albeit in different guises. But
the investment principles to which we have adhered since Wellington Fund began
in 1929 remain firm:
* We offer Funds with sound and durable investment objectives, designed
for long-term investors.
(please turn to inside back cover)
VANGUARD NEW JERSEY TAX-FREE FUND OFFERS TWO PORTFOLIOS THAT SEEK TO PROVIDE A
HIGH LEVEL OF INCOME THAT IS EXEMPT FROM FEDERAL AS WELL AS NEW JERSEY STATE
PERSONAL INCOME TAXES. THE INSURED LONG-TERM PORTFOLIO INVESTS PRIMARILY IN
INSURED LONG-TERM MUNICIPAL BONDS. THE MONEY MARKET PORTFOLIO SEEKS TO MAINTAIN
A CONSTANT NET ASSET VALUE OF $1.00 PER SHARE ALONG WITH REASONABLE CURRENT
INCOME.
<PAGE> 3
CHAIRMAN'S LETTER
DEAR SHAREHOLDER:
The 1994 fiscal year for Vanguard State Tax-Free Fund, which ended on November
30, 1994, was the most difficult year for bonds since the Fund's inception
some eight years ago, in April 1986. A persistent rise in long-term interest
rates during the twelve-month period sharply reduced the prices of long-term
tax-exempt bonds, and the net asset values of our Insured Long-Term Portfolios
declined accordingly. Rates also increased in the short-term arena, to the
substantial benefit of our Money Market Portfolios, which saw sharply higher
income yields during the year.
In each of our Money Market Portfolios and our Insured Long-Term
Portfolios, our returns exceeded the results of competitive funds with similar
objectives. The detailed fiscal year results for each of our State Tax-Free
Portfolios, including per share net asset values, dividends and capital gains
distributions for the year, as well as current yields, are presented in a table
at the conclusion of this letter.
Over the past twelve months, the STATE MONEY MARKET PORTFOLIOS
provided total returns in the area of +2.6%. As expected, net asset values
remained at $1.00 per share. Yields at the end of the fiscal year were
generally about 50% higher than they were at the beginning of the year, as
shown in the following table:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
Total Return Seven-Day Annualized Yield
--------------- --------------------------------
Money Market 12 Months Ended Nov. 30, Nov. 30,
Portfolio Nov. 30, 1994 1993 1994 Increase
- ---------------------------------------------------------------
<S> <C> <C> <C> <C>
CALIFORNIA +2.6% 2.32% 3.44% +1.12%
PENNSYLVANIA +2.6 2.25 3.51 +1.26
NEW JERSEY +2.5 2.23 3.34 +1.11
OHIO +2.6 2.36 3.47 +1.11
- ---------------------------------------------------------------
</TABLE>
These yields, of course, reflect income that is entirely exempt both from
Federal income taxes and from state and local taxes in the respective states. I
would reemphasize that in each case our yields exceed those available on
comparable state money market portfolios as a group. Indeed, our yield
advantage has persisted with remarkable regularity, year in and year out, such
that the longer-term returns of our Money Market Portfolios have nicely
exceeded the returns of their peer groups. Specifically, the New Jersey Money
Market Portfolio has earned an average annual total return of +4.2% since its
inception in February 1988, compared to +4.1% for the average New Jersey money
market fund.
The STATE INSURED LONG-TERM PORTFOLIOS suffered through a challenging
year of rising rates, resulting in negative total returns (capital change plus
income) ranging from -5.4% to -6.4%. The good news is that current yields are
considerably more generous than they were one year ago, having risen by an
average of 1.5 percentage points (150 basis points).
In contrast to a year ago, when declining interest rates resulted in a
solid positive capital contribution (in the area of 6%) to our Insured
Long-Term Portfolios' total returns, this year the contribution from capital
return has been decidedly negative. The table on the following page summarizes
the components of return for each of our State Insured Long-Term Portfolios
over the past twelve months. If there is a better example of the "two way
street" of interest rate sensitivity, I am not sure that I have seen it.
(continued)
[FIGURE 1]
1
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[FIGURE 2]
<TABLE>
<CAPTION>
Average Annual Total Returns--Periods Ended November 30, 1994
- ----------------------------------------------------------------------------
Since
1 Year 5 Years Inception*
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
VANGUARD NJ LONG-TERM PORTFOLIO -6.10% +6.50% +7.37%
AVERAGE NJ MUNICIPAL FUND -7.37 +6.07 +6.85
LEHMAN MUNICIPAL BOND INDEX -5.23 +6.58 +7.20
</TABLE>
* Inception, February 3, 1988. Performance begins on January 31, 1988, to show
competitive data.
Note: Past performance is not predictive of future performance.
<TABLE>
<CAPTION>
- -----------------------------------------------------
Investment Returns
--------------------------------
Twelve Months Ended
November 30, 1994
Insured Long-Term --------------------------------
Portfolio Income Capital Total
- -----------------------------------------------------
<S> <C> <C> <C>
CALIFORNIA 5.1% -11.0% -5.9%
NEW YORK 5.1 -11.5 -6.4
PENNSYLVANIA 5.3 -10.7 -5.4
NEW JERSEY 5.1 -11.2 -6.1
OHIO 4.9 -11.2 -6.3
FLORIDA 4.9 -11.0 -6.1
- -----------------------------------------------------
</TABLE>
Note: The California Insured Intermediate-Term Portfolio began operations on
March 4, 1994. The Portfolio's returns since inception were: Income +3.4%;
Capital -3.6%; Total -0.2%.
In last year's letter, speaking about the remarkable capital returns that had
redounded to long-term bond investors over the prior two years, I cautioned
that "capital returns of the magnitude shown simply cannot be taken for
granted," adding that "should rates reverse direction and move higher, 'capital
reward' will inevitably translate to 'capital penalty' for each of our six
Insured Long-Term Portfolios." That capital penalty has surely come to pass.
Despite a difficult 1994, the long-term returns of each of our Insured
Long-Term Portfolios remain exemplary, particularly when considered in the
context of what we would regard as our two most appropriate benchmarks: the
unmanaged Lehman Municipal Bond Index and the average competitive fund in each
respective state category. The chart above shows the cumulative returns earned
by the New Jersey Insured Long-Term Portfolio since its inception in February
1988, compared with each of these benchmarks.
You can see in the chart that the Portfolio achieved a nice margin over
the average New Jersey municipal fund, and the unmanaged Lehman Municipal Bond
Index. This Index, I would remind you, represents a challenging hurdle for all
state tax-free funds, existing, as it does, outside of the "real world" of
operating expenses and transaction costs. Given that transaction costs in the
bond market are normally quite substantial, our ability to eke out a positive
annual performance margin is exceptional.
2
<PAGE> 5
[FIGURE 3]
THE FISCAL YEAR IN REVIEW
The declining interest rate environment that had persisted with striking
consistency since October 1987 came to an end in mid-October 1993. By November
30, 1993, the yield on the long-term U.S. Treasury bond had fallen to 6.3%; by
the end of the Fund's fiscal year on November 30, 1994, the long Treasury yield
had jumped back to the 8.0% level. In all, the prices of long-term U.S.
Treasury bonds fell nearly -20% over the fiscal period. In the short-term
arena, the yield on the U.S. Treasury bill rose from 3.2% to 5.8% over the same
period. Because of the bill's short maturity, its price remained virtually flat
during the entire period.
A primary cause of the interest rate rise was investor fears about a
resurgence of inflation. So far, at least, the U.S. Consumer Price Index gives
little evidence of it. The CPI has risen just 2.7% over the past twelve months,
although more sensitive indicators--such as commodity prices and producer
prices--have been rising at higher rates.
In an effort to quell inflationary fears, the Federal Reserve has
acted to "tighten" the money supply in order to slow economic growth and rein
in potential future inflation. Fully six rate increases--in February, March,
April, May, August, and again in November--combined to raise the federal funds
rate (at which banks borrow from one another) from 3.00% to 5.50%. Still, the
specter of inflation remains, and further rate increases may well lie in
prospect.
Yields on long-term municipal bonds followed the lead of U.S. Treasury
bonds, although the prices of long municipals provided slightly better
resistance than their taxable cousins to the overall decline in the bond
market. This resistance was based largely on the fact that tax-exempt bonds
began the fiscal year with yields that were extremely attractive relative to
taxable bonds. Indeed, as I mentioned a year ago in our Annual Report for
fiscal 1993, "relative values in tax-exempt bonds are as great on a sustained
basis as they have been for two decades." The result was that municipal bond
prices pretty much held their own through January, declined slightly less than
long Treasuries through the end of August, only to fall more sharply in the
final months of the Fund's fiscal year. On balance, for the full period, the
yield on high-grade, 30-year tax-exempt bonds rose from 5.5% to 6.9%, reflected
in a price decline of about -18%.
The chart to the left shows the changing pattern of long-term and
short-term tax-exempt yields during our past five fiscal years. It provides
some perspective on the recent increase in yields, which, on the long-term
side, have merely returned to their level in mid-1991, about the same as the
yield level at the beginning of 1990. The 3.8% yield on short-term tax-exempt
notes is now approximately at the level reached in late 1991, but is well below
the 5.8% yield that prevailed when 1990 began.
The interplay of short-term and long-term rates has resulted in
dramatic changes over time in the yield "spread" (the difference between the
two yields, as shown in the lower chart). At the start of the period, the
spread amounted to only 110 "basis points" (1.1%) with 30-year municipal bonds
yielding 7.0% and 90-day notes yielding 5.9%. By early 1992 the
3
<PAGE> 6
spread had risen to nearly 400 basis points, and investors who decided to
choose short-term notes over long-term bonds had to relinquish nearly
two-thirds of their yield. Today, the spread has narrowed to about 300 basis
points, but fixed-income investors who are willing to extend the maturity of
their bond holdings still earn a solid premium in return for the additional
price volatility that they incur.
TAX-EXEMPT VERSUS TAXABLE YIELDS
One of the (too often) unsung advantages of tax-exempt income is the sharp
increase in spendable income compared to the income that would be garnered,
after taxes, on a taxable bond. In the lower rate environment of a year ago, as
I mentioned earlier in this letter, this advantage--for investors in the
highest marginal Federal tax bracket (now 39.6%)--was well above historical
norms, with tax-exempt securities providing net spendable income 45% higher
than that available on taxable U.S. Treasury bonds, and 26% higher than that
available on U.S. Treasury bills.
One year later, this "spread" remains virtually unchanged on the
long-term side (a +44% premium) but has been more than halved on the short-term
side (a +9% premium). This table presents a comparison of the income earned on
tax-exempt and taxable securities as of November 30, 1994, assuming a $100,000
investment.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
Illustration of Income on
Hypothetical $100,000 Investment
--------------------------------
Long-Term Short-Term
- ---------------------------------------------------------------
<S> <C> <C>
TAXABLE GROSS INCOME $ 8,000 $ 5,800
LESS TAXES (39.6%) (3,200) (2,300)
------- -------
NET AFTER-TAX INCOME 4,800 3,500
- ---------------------------------------------------------------
TAX-EXEMPT INCOME $ 6,900 $ 3,800
- ---------------------------------------------------------------
INCREASE IN AFTER-TAX INCOME $ 2,100 $ 300
- ---------------------------------------------------------------
</TABLE>
Table assumes current yields (as of November 30, 1994) of 8.0% for U.S.
Treasury bonds, 5.8% for U.S. Treasury bills, 6.9% for long-term municipals,
and 3.8% for short-term municipals. The illustration is not intended to
represent future results.
The table provides a clear illustration of the yield improvement available
today to an investor in the top tax bracket. Of course, the comparison is
hardly perfect, since the "full faith and credit" of the U.S. Treasury remains
peerless, while municipal bonds engender some degree of risk. Perhaps nothing
could have made this risk clearer than the recent debacle in Orange County,
California, in which an investment pool managed by the County suffered huge
losses resulting from its leveraged strategy and derivative securities
holdings. This event serves as an important reminder that "state-specific"
portfolios engender an additional level of risk due to their highly
concentrated investments in particular economic regions.
The Orange County bankruptcy reinforces the substantial value of
private portfolio insurance, which is provided--by high-quality insurance
companies--for virtually all of the bonds held in our Insured Portfolios. This
insurance, in effect, guarantees the full payment of annual income and, at
maturity, principal for the municipal bonds that we hold. (It does not, of
course, protect against price volatility.) The result is that each of our
Insured Long-Term Portfolios carries an implied average quality rating of
Aaa--the highest rating accorded by Moody's Investor Services. This insurance
provides credit quality enhancement that virtually eliminates the extra risk
that would otherwise be engendered by the concentration of investments that is
inevitably part and parcel of investing in single-state municipal bond funds.
We believe such protection is critical.
Portfolio insurance is generally not available for money market
portfolios, although the same state-specific risks exist. In the absence of
portfolio insurance, our professional money managers must be even more diligent
in their scrutiny of the credit quality of our portfolio holdings. Their
efforts here include purchasing as many high-quality and "credit-enhanced"
securities as they can. The enhancements for these securities consist of
irrevocable letters of credit from high-quality banks guaranteeing each
issuer's timely payments of principal and interest. This credit support, in
conjunction with our diligent credit analysis, has earned each of the holdings
in our Money Market Portfolios Moody's highest quality rating (or the
equivalent) for shorter-term instruments. As far as we know, our Portfolios are
unsurpassed with respect to credit quality by any competitor.
On this point, I would stress that no state money market portfolio
is exempt from credit and
4
<PAGE> 7
maturity risk. That is to say, there is no principal guarantee such as that
provided through bank savings accounts and certificates of deposit insured by
the Federal Deposit Insurance Corporation. However, we believe that the $1.00
net asset value will be preserved by state money market funds that maintain
diligent credit analysis, secure letters of credit to the degree possible, and
maintain their average portfolio maturities within the statutory maximum of 90
days.
LOOKING AHEAD
A year ago in my 1993 letter to shareholders, I cautioned that "with rates
having come down so far and so fast, there is always the risk of a sharp
rebound." That risk "came home to roost" during fiscal 1994. However, I believe
that during fiscal 1995 the probabilities now favor greater stability in
long-term tax-exempt rates, and somewhat higher short-term rates. While there
are some recent signals of higher inflation in the economy, it would not be
unusual if the financial markets' expectations are already, at least in part,
manifested in higher yields.
Whatever the future course of interest rates, I urge you to consider
the risk-reward pattern of your investment in the Vanguard State Tax-Free Fund
in terms of your own needs and circumstances. In our Insured Long-Term
Portfolios, that means balancing the need for income stability with a
commensurate level of principal volatility. Our Money Market Portfolios seek to
maintain a $1.00 per share net asset value, but this capital stability comes at
the expense of substantial income volatility.
In the final analysis, the best course of action is almost always to
"stay the course" with the long-term objectives that you have established. We,
too, intend to stay the course with the consistent objectives and policies that
we have established for our Portfolios. In doing so, we are confident that the
Vanguard State Tax-Free Portfolios will continue to provide returns that
generally exceed those of their respective competitors.
In a very real sense, this is no idle boast, since our durable cost
advantage gives us a "leg up" in performance before the year has even begun.
Indeed, while the average competitive state tax-free fund charges annual fees
at the rate of 0.78% of average net assets, the expense ratio for the Vanguard
State Tax-Free Portfolios, at 0.20%, is only about one-quarter of this amount.
In the case of a municipal money market portfolio earning a current gross yield
of, say, 3.8%, the expenses for the average state tax-free fund would consume
about 20% of their income; Vanguard's expenses, on the other hand, would
consume but 5%. This remarkable income advantage--available with no sacrifice
whatsoever in credit quality-- is there for the taking.
I look forward to writing to you again six months hence.
Sincerely,
/s/ JOHN C. BOGLE
- -----------------
John C. Bogle
Chairman of the Board December 20, 1994
Note: Mutual fund data from Lipper Analytical Services, Inc.
5
<PAGE> 8
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Net Asset Value
Total Per Share
Net Assets --------------------- Twelve Months
(millions) Average Average Nov. 30, Nov. 30, ------------------------- Current
Portfolio Nov. 30, 1994 Maturity Quality* 1993 1994 Dividends Total Return Yield**
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
MONEY MARKET
CALIFORNIA . . . . . . . . $1,159 51 DAYS MIG 1 $ 1.00 $ 1.00 $ .026 + 2.6% 3.44%
PENNSYLVANIA . . . . . . . 1,105 45 DAYS MIG 1 1.00 1.00 .025 + 2.6 3.51
NEW JERSEY . . . . . . . . 792 48 DAYS MIG 1 1.00 1.00 .025 + 2.5 3.34
OHIO . . . . . . . . . . . 147 50 DAYS MIG 1 1.00 1.00 .026 + 2.6 3.47
- -----------------------------------------------------------------------------------------------------------------------------------
INSURED LONG-TERM
CALIFORNIA . . . . . . . . $ 834 18.7 YEARS Aaa $11.30 $ 9.92 $ .756+ - 5.9% 6.49%
CALIFORNIA INTERMEDIATE-
TERM . . . . . . . . . . 100 8.2 YEARS Aaa -- 9.64 .346++ - 0.2++ 5.80
NEW YORK . . . . . . . . . 695 16.1 YEARS Aaa 10.97 9.70 .600+ - 6.4 6.32
PENNSYLVANIA . . . . . . . 1,299 18.4 YEARS Aaa 11.36 10.07 .704+ - 5.4 6.41
NEW JERSEY . . . . . . . . 645 17.2 YEARS Aaa 11.77 10.40 .685+ - 6.1 6.28
OHIO . . . . . . . . . . . 149 17.6 YEARS Aaa 11.61 10.28 .631+ - 6.3 6.31
FLORIDA . . . . . . . . . . 284 18.5 YEARS Aaa 10.86 9.61 .620+ - 6.1 6.31
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* MIG 1 and Aaa are Moody's highest ratings for short-term and long-term
municipal bonds, respectively.
** Money Market Portfolios' yields are 7-day annualized yields; others are
30-day SEC yields.
+ Include capital gains distributions of $.152 for California, $.012 for New
York, $.079 for Pennsylvania, $.063 for New Jersey, and $.032 for Ohio,
and $.070 for Florida.
++ Since inception, March 4, 1994.
Note: The shares of each of the Vanguard "single state" Portfolios are
available for purchase solely by residents of the designated states.
6
<PAGE> 9
AVERAGE ANNUAL TOTAL RETURNS
THE CURRENT YIELDS NOTED IN THE CHAIRMAN'S LETTER ARE CALCULATED IN ACCORDANCE
WITH SEC GUIDELINES. THE AVERAGE ANNUAL TOTAL RETURNS FOR THE PORTFOLIOS
(PERIODS ENDED SEPTEMBER 30, 1994) ARE AS FOLLOWS:
<TABLE>
<CAPTION>
SINCE INCEPTION
--------------------------------
INCEPTION TOTAL INCOME CAPITAL
DATE 1 YEAR 5 YEARS RETURN RETURN RETURN
---- ------ ------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
CALIFORNIA INSURED LONG-TERM 4/7/86 -3.33% +7.74% +7.44% +6.55% +0.89%
CALIFORNIA INSURED INTERMEDIATE-TERM 3/4/94 -- -- +2.23 +2.63 -0.40
CALIFORNIA MONEY MARKET 6/1/87 +2.46 +3.69 +4.22 +4.22 0.00
NEW YORK INSURED TAX-FREE 4/7/86 -3.25 +8.04 +6.96 +6.54 +0.42
PENNSYLVANIA INSURED LONG-TERM 4/7/86 -2.23 +8.36 +7.81 +6.77 +1.04
PENNSYLVANIA MONEY MARKET 6/13/88 +2.44 +3.77 +4.25 +4.25 0.00
NEW JERSEY INSURED LONG-TERM 2/3/88 -3.30 +8.10 +8.22 +6.56 +1.66
NEW JERSEY MONEY MARKET 2/3/88 +2.36 +3.73 +4.23 +4.23 0.00
OHIO INSURED LONG-TERM 6/18/90 -3.32 -- +8.31 +6.05 +2.26
OHIO MONEY MARKET 6/18/90 +2.44 -- +3.43 +3.43 0.00
FLORIDA INSURED TAX-FREE 9/1/92 -2.98 -- +5.99 +5.25 +0.74
</TABLE>
THESE DATA REPRESENT PAST PERFORMANCE. THE INVESTMENT RETURN AND PRINCIPAL
VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN
REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
PLEASE NOTE THAT AN INVESTMENT IN A MONEY MARKET FUND, SUCH AS THE MONEY MARKET
PORTFOLIO OF VANGUARD NEW JERSEY TAX-FREE FUND, IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT, AND THERE IS NO ASSURANCE THAT THE FUND WILL
BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
7
<PAGE> 10
REPORT FROM THE INVESTMENT ADVISER
STATE INSURED LONG-TERM PORTFOLIOS
LOOK TO THE LONG TERM
It has been a volatile fiscal year for fixed-income investors. The economy
continued down the path of robust expansion, raising fears of a pick-up in
inflation and resulting in a broadbased decline in bond prices. For example,
the Bond Buyer 40 Municipal Bond Index lost -18% of its principal value over
the period as its yield rose from 5.7% to 7.2%.
Considering this hostile economic environment, the State Insured
Long-Term Portfolios performed somewhat better than one might expect. On a
total return basis, each Portfolio performed competitively relative to similar
long-term bond funds. It is particularly important in difficult markets to
remain focused on long-term objectives. While share price volatility is far
easier to endure when prices rise than when they fall, the long-term reward of
a period of falling prices is ultimately a higher and more durable level of
tax-exempt income.
LIQUIDITY "CRISIS"
Municipal bonds fell sharply in price during the spring, leveled off briefly
during the early summer, and then resumed falling sharply after August.
Shareholder redemptions created periods of distressed municipal bond fund
selling; for many portfolios, maintaining liquidity was a key factor in
weathering the downturn. Our Portfolios carry a high percentage of cash
reserves (8%-10%) to meet shareholder transactions, a policy which proved
especially helpful during the recent price declines. At no time were the State
Insured Long-Term Portfolios forced to sell securities at "distressed" levels.
On the plus side, the higher yields in the marketplace have greatly
reduced the issuance of new municipal bonds. The total issuance of tax-exempt
securities has declined 37% during the fiscal year. Rising yields increased
municipal issuers' cost of funds, eliminating the economic rationale for
refundings that bloated supply last year. Other factors held equal, the drop in
new supply enhances the value of existing tax-exempt securities, particularly
in higher tax states where investor demand is greater.
PURSUING THE DIVIDEND
As we mentioned in our last Semi-Annual Report, a reduction in average maturity
prior to the recent bear market enhanced our relative fund performance. The
State Insured Long-Term Portfolios focused on the slightly lower-yielding but
less volatile securities maturing in the 15- to 20-year range. This strategy
provided a moderate amount of insulation as bond prices fell. Over the next six
months, the Portfolios will pursue 25- to 30-year securities, effecting a
gradual extension of average maturity to a more normal historical range. The
commensurate benefit will be an anticipated increase in dividend, as current
yields on longer securities have reached substantially higher levels.
Looking forward at year end, various market sources estimate that
anywhere from $45 to $60 billion in proceeds will be received by tax-exempt
participants by January 1, 1995. Barring a significant increase in new
issuance, this bodes well for adequate liquidity and should continue to provide
more attractive returns for municipal bonds than their taxable brethren.
STATE MONEY MARKET PORTFOLIOS
WEATHERING THE STORM . . .
The fiscal year can be characterized as one of protracted economic strength. In
an attempt to curb inflation and target a moderate economic growth rate, the
Federal Reserve Board tightened money supply. During 1994, the Federal Reserve
was forced to raise the Federal funds rate (the rate banks charge each other
for overnight loans) six times, for a total increase of 2.50%. The most recent
change occurred on November 15, when the Fed increased rates 0.75%, the largest
single move by the Fed since 1981. The markets reacted accordingly, with yields
on 1-year U.S. Treasury bills rising 3.3 percentage points over the fiscal
year, to 6.9%, and yields on comparable 1-year municipal notes rising 2.1
percentage points, to 4.5%.
The relative underperformance of municipal versus taxable yields can
be attributed to the dwindling supply of short-term municipal securities. The
8
<PAGE> 11
reduction was a result of municipalities extending issuance beyond one year,
and economic strength reducing the amount of borrowing necessary to finance
their cash needs. This filtered down to the fund level, as yields on state
tax-exempt money market funds increased a mere 1.0% over the fiscal year, while
taxable money fund yields increased 2.0%. For investors in lower tax brackets,
this differential meant that taxable money market funds became a viable
alternative.
The Vanguard State Tax-Free Money Market Portfolios were prepared for
the rise in interest rates early in the year, as we positioned average weighted
maturities in a bearish range of 45-60 days. This strategy enabled us to take
advantage of rising rates while further assuring our $1.00 net asset value. Our
low expense ratios also helped us to outperform our competitors on a net yield
basis, despite the fact that many of them continue to inflate their gross
yields through quality differentials and securities subject to the alternative
minimum tax (AMT).
HISTORICAL EVENT???
Much has been written this past year about the risks of "derivative securities"
in taxable money market funds. Most notably, Community Banker's U.S. Government
Money Market Fund went down in history as being the first money fund to "break
the buck." The fund sacrificed its net asset value in exchange for higher
returns by investing in certain types of exotic and inappropriate derivative
securities. While it is true that some derivatives can be dangerous when used
inappropriately, not all derivatives are "evil." In fact, certain derivatives
can be used safely and may even improve the total quality of one's portfolio.
The definition of a derivative (a security whose return is derived
from another security) is broad, and encompasses instruments that are "exotic"
as well as "plain vanilla." The Vanguard State Tax-Free Money Market Portfolios
do invest in securities which fall under the derivative definitional
"umbrella," but those securities do not even remotely resemble the exotic
instruments used in the now defunct Community Banker's Fund. The derivative
structures held in our Portfolios are floating rate or "put" securities, with
minimum ratings of AA or better. In addition, all of our derivatives have
coupons that reset frequently to ensure that their market prices remain close
to par (100), and they contain the option to tender or sell them at par (100).
These securities, more commonly referred to as tender option bonds, are
designed to imitate the same characteristics of non-derivative variable rate
securities. The indexes used to determine the coupon reset are the same as
those used to determine non-derivative variable rate securities.
In contrast, the derivatives responsible for the recent taxable money
fund problems utilized indexes not directly related to short-term money market
rates. This is a dangerous game to play, particularly in the rising interest
rate environment experienced in 1994. The U.S. Securities and Exchange
Commission (SEC) has clearly outlined the types of derivative securities that
are inappropriate for money market funds. We affirm to our investors that at no
time has any Vanguard Portfolio invested in securities deemed inappropriate by
the SEC.
It is unfortunate that all derivatives are being branded as
speculative, when indeed many are used to enhance the overall quality of a
portfolio. Unlike Vanguard, some money market funds may engage in investments
that fail to adhere to conservative guidelines. Consequently, investors should
remember that there is no such thing as a "free lunch." When money market funds
are offering yields too good to be true, they probably are too good to be true,
unless a fund has the advantage of low expenses. We have this advantage. Our
extremely low expense ratios permit us to take and maintain the "high ground"
with respect to both liquidity and quality.
Sincerely,
Ian A. MacKinnon Jerome J. Jacobs
Senior Vice President Vice President
Pamela W. Tynan David E. Hamlin
Vice President Assistant Vice President
Reid O. Smith Danine A. Mueller
Assistant Vice President Portfolio Manager
December 12, 1994
9
<PAGE> 12
FINANCIAL STATEMENTS
November 30, 1994
STATEMENT OF NET ASSETS
<TABLE>
<CAPTION>
Face Market
Amount Value
INSURED LONG-TERM PORFOLIO (000) (000)+
- -----------------------------------------------------------------
<S> <C> <C>
MUNICIPAL BONDS (96.4%)
- -----------------------------------------------------------------
ISSUER INSURED (82.8%)
Atlantic County COP
6.00%, 3/1/14 (3) $ 3,685 $ 3,382
6.00%, 3/1/15 (3) 1,480 1,351
7.30%, 3/1/05 (3) 2,000 2,152
7.30%, 3/1/06 (3) 1,800 1,954
7.40%, 3/1/10 (3) 1,755 1,892
7.40%, 3/1/11 (3) 4,025 4,330
Atlantic County Utilities Auth.
5.85%, 1/15/15 (2) 3,000 2,666
Bayshore Regional Sewer Auth.
5.40%, 5/1/12 (1) 500 429
Bergen County Utilities Auth. PCR
5.50%, 12/15/15 (3) 15,750 13,359
5.75%, 12/15/05 (3) 2,000 1,919
Bordentown Sewer Auth.
5.375%, 12/1/15 (1) 6,250 5,183
5.40%, 12/1/20 (1) 1,400 1,132
Camden County GO
5.00%, 2/1/10 (3) 1,500 1,227
5.00%, 2/1/11 (3) 2,950 2,386
Camden County Municipal Utilities
Auth. Sewer Rev.
0.00%, 9/1/04 (3) 8,345 4,493
0.00%, 9/1/05 (3) 18,545 9,312
0.00%, 9/1/06 (3) 18,545 8,665
8.25%, 12/1/17 (3) 850 912
Cape May County Industrial
Development Auth.
(Atlantic City Electric)
6.80%, 3/1/21 (1) 15,400 15,258
Cape May County Municipal
Utility Auth.
5.75%, 1/1/16 (1) 14,975 13,075
Delaware River Port Auth.
6.50%, 1/1/09 (2) 3,500 3,484
7.375%, 1/1/07 (2) 9,500 9,988
Edison Township GO
7.10%, 1/1/95 (2) 1,715 1,719
Elizabeth City Fiscal Year
Adjustment Bonds
6.60%, 8/1/06 (1) 8,750 8,911
Essex County Improvement
Auth. Lease Rev. GO
5.50%, 12/1/08 (2) 2,560 2,275
5.50%, 12/1/13 (2) 7,500 6,454
7.00%, 12/1/00 (2) (Prere.) 5,000 5,382
Essex County Improvement Auth.
Township of Irvington GO
6.625%, 10/1/02 (4) (Prere.) 7,000 7,349
Evesham Municipal Utility Auth.
7.00%, 7/1/10 (1) 1,700 1,725
7.00%, 7/1/15 (1) 450 454
Gloucester Township GO
5.75%, 7/15/10 (2) 2,880 2,597
Gloucester Township Municipal
Utilities Auth.
5.65%, 3/1/18 (2) 2,755 2,364
Hamilton Township Municipal
Utility Auth.
6.00%, 8/15/17 (3) 1,000 902
Hoboken-Union City-Weehawken
Sewer Auth.
0.00%, 8/1/03 (1) 3,800 2,218
0.00%, 8/1/04 (1) 3,750 2,030
0.00%, 8/1/05 (1) 3,805 1,921
0.00%, 8/1/06 (1) 2,000 940
6.25%, 8/1/13 (1) 9,590 9,192
Hudson County Correctional
Facility COP
6.30%, 6/1/04 (1) 1,720 1,718
6.30%, 12/1/04 (1) 1,770 1,767
6.50%, 12/1/11 (1) 9,000 8,828
Hudson County General
Improvement GO
6.55%, 7/1/04 (3) 1,300 1,346
6.55%, 7/1/05 (3) 1,290 1,328
6.55%, 7/1/06 (3) 700 719
6.55%, 7/1/07 (3) 1,300 1,327
6.55%, 7/1/09 (3) 635 641
Hudson County Improvement
Auth. Lease
6.00%, 12/1/12 (3) 10,000 9,186
Irvington Township GO
0.00%, 8/1/07 (1) 1,000 437
0.00%, 8/1/09 (1) 2,580 991
0.00%, 8/1/10 (1) 2,080 742
Jersey City Water Auth. GO
7.60%, 10/1/12 (2) 700 731
7.60%, 10/1/13 (2) 700 730
Lacey Township Municipal
Utility Auth.
7.00%, 12/1/99 (6) (Prere.) 3,000 3,218
Manchester Township Board of
Education COP
7.20%, 12/15/99 (1) (Prere.) 1,000 1,075
Middlesex County Utility Auth.
6.50%, 9/15/11 (3) 6,300 6,220
6.75%, 8/15/09 (2) 3,500 3,528
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- -----------------------------------------------------------------
<S> <C> <C>
Millville Board of Education GO
5.30%, 8/1/04 (2) $ 1,100 $ 1,022
5.30%, 8/1/05 (2) 1,100 1,005
5.30%, 8/1/06 (2) 1,100 988
5.30%, 8/1/07 (2) 1,067 943
Monmouth County
Improvement Auth.
5.00%, 2/1/13 (1) 750 604
6.75%, 2/1/01 (1) (Prere.) 1,250 1,320
6.875%, 8/1/00 (1) (Prere.) 2,700 2,881
Monroe Township Municipal
Utility Auth.
6.875%, 2/1/17 (1) 1,700 1,741
Mount Laurel Township Municipal
Utility Auth.
6.00%, 7/1/15 (1) 4,250 3,867
Muscanectong Sewer Auth.
7.15%, 1/1/00 (1) (Prere.) 1,000 1,074
New Brunswick Housing & Urban
Development
5.75%, 7/1/24 (1) 8,640 7,336
6.00%, 7/1/12 (1) 6,000 5,506
New Brunswick Housing Auth.
5.50%, 8/1/16 (1) 525 430
New Brunswick Parking Auth.
5.40%, 9/1/15 (3) 1,000 835
New Jersey Economic Development
Auth. (Hackensack Water)
7.00%, 1/1/19 (2) 2,400 2,403
(Market Transition)
5.80%, 7/1/09 (1) 5,500 5,005
5.875%, 7/1/11 (1) 12,675 11,425
New Jersey Educational
Facilities Auth.
(Kean College)
6.60%, 7/1/21 (1) 3,700 3,574
(NJ Institute of Technology)
6.00%, 7/1/24 (1) 1,500 1,332
6.25%, 7/1/11 (2) 5,165 5,292
(Rider College)
6.20%, 7/1/17 (2) 4,000 3,699
(Trenton State College)
6.00%, 7/1/12 (2) 3,005 2,772
New Jersey Health Care
Facilities Auth.
(Beth Israel)
6.00%, 7/1/16 (4) 8,500 7,603
(Bridgeton & Millville Hosp.)
7.875%, 7/1/98 (1) (Prere.) 3,305 3,611
(Burdette Tomlin
Memorial Hosp.)
6.50%, 7/1/12 (3) 1,500 1,463
(Community Medical Center)
7.00%, 7/1/20 (1) 2,850 2,866
(Helene Fuld Medical Center)
6.60%, 7/1/21 (2) 4,080 3,908
(Jersey Shore Medical Center)
8.00%, 7/1/98 (2) (Prere.) 1,905 2,084
(Memorial Health Alliance)
6.25%, 7/1/10 (3) 8,000 7,610
(Mercer Medical Center)
6.50%, 7/1/10 (1) 6,000 5,896
(Mountainside Hosp.)
3.45%, 7/1/95 (1) 1,620 1,607
5.35%, 7/1/07 (1) 3,215 2,837
5.50%, 7/1/14 (1) 3,975 3,367
(Muhlenberg Medical Center)
8.00%, 7/1/97 (2) (Prere.) 750 800
(Riverview Medical Center)
6.25%, 7/1/10 (2) 2,935 2,795
(Shore Medical Center)
6.20%, 7/1/13 (2) 3,130 2,949
6.20%, 7/1/14 (2) 3,075 2,861
(Shore Memorial Hosp.)
7.875%, 7/1/97 (1) (Prere.) 750 810
(Society of the Valley Hosp.)
6.625%, 7/1/10 (1) 2,750 2,707
(St. Clare's Riverside
Medical Center)
5.75%, 7/1/14 (1) 7,500 6,559
7.75%, 7/1/14 (6) 5,800 6,242
(West Jersey Health System)
6.00%, 7/1/09 (1) 5,175 4,827
6.125%, 7/1/12 (1) 1,000 930
New Jersey Housing and Mortgage
Finance Agency
7.875%, 10/1/17 (1) 450 464
New Jersey Sports &
Exposition Auth. VRDO
3.55%, 3/1/95 (1) 1,750 1,750
New Jersey Turnpike Auth.
VRDO 3.25%, 1/1/95 (3) 17,300 17,300
6.50%, 1/1/13 (1) 20,000 19,685
6.50%, 1/1/16 (1) 18,250 17,879
Newark General Improvement
5.30%, 10/1/06 (2) 1,710 1,536
5.40%, 10/1/07 (2) 1,685 1,506
5.50%, 10/1/08 (2) 1,660 1,476
Newark Water Utility
5.30%, 10/1/06 (2) 2,625 2,357
North Bergen Hudson City GO
8.00%, 8/15/06 (4) 1,885 2,161
North Jersey Water Dist.
6.00%, 7/1/12 (1) 10,125 9,310
</TABLE>
11
<PAGE> 14
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- -----------------------------------------------------------------
<S> <C> <C>
Ocean County Utilities Waste
Water Rev.
5.00%, 1/1/14 (3) $ 2,000 $ 1,596
6.60%, 1/1/18 (3) (ETM) 2,500 2,462
6.60%, 1/1/18 (3) 4,000 3,880
6.75%, 1/1/13 (3) 14,810 14,732
Ocean Township Municipal
Utility Auth.
6.00%, 8/1/17 (1) 3,975 3,576
Old Bridge Municipal Utility Auth.
6.25%, 11/1/16 (3) 1,400 1,308
6.40%, 11/1/09 (3) 3,000 2,960
Passaic Valley Sewer Comm.
5.75%, 12/1/08 (2) 4,450 4,051
5.75%, 12/1/13 (2) 4,000 3,556
7.10%, 12/1/97 (2) (Prere.) 6,785 7,224
Plainfield GO
6.25%, 7/15/07 (2) 6,930 6,882
Roselle GO
5.05%, 10/15/07 (1) 1,435 1,228
5.10%, 10/15/08 (1) 1,405 1,184
Salem County Improvement Auth.
7.125%, 5/1/99 (2) (Prere.) 1,000 1,072
Salem County Pollution Control
Finance Auth.
(Public Service Electric & Gas)
5.55%, 11/1/33 (1) 8,000 6,377
5.70%, 5/1/28 (1) 5,000 4,104
South Jersey Transportation Auth.
5.80%, 11/1/05 (1) 1,645 1,574
5.90%, 11/1/06 (1) 3,435 3,288
5.90%, 11/1/07 (1) 2,545 2,408
6.00%, 11/1/12 (1) 5,250 4,854
Stafford Municipal Utility Auth.
5.50%, 6/1/11 (3) 3,100 2,683
Sussex County Solid Waste Rev.
5.75%, 12/1/09 (1) 19,820 17,753
Sussex Municipal Utility Auth.
5.25%, 12/1/08 (1) 1,150 982
5.375%, 12/1/14 (1) 2,000 1,668
West Windsor-Plainsboro School
Dist. COP
7.60%, 3/15/97 (6) (Prere.) 5,000 5,347
OUTSIDE NEW JERSEY:
Puerto Rico Public Building Auth.
0.00%, 7/1/02 (3) 4,000 2,535
--------
GROUP TOTAL 533,608
--------
- -----------------------------------------------------------------
PORTFOLIO INSURED (.2%)
Rutgers State Univ.
7.375%, 5/1/96 (Prere.) 1,500 1,576
- -----------------------------------------------------------------
SECONDARY MARKET INSURED (7.0%)
Atlantic County Utility
6.875%, 1/1/12 (2) (ETM) 3,000 3,056
New Jersey Educational Facilities
Auth. (Montclair State College)
7.20%, 7/1/10 (1) 1,000 1,019
New Jersey Highway Auth.
(Garden State Parkway)
6.00%, 1/1/16 (2) 5,000 4,534
6.20%, 1/1/10 (2) 20,000 19,186
New Jersey Sports &
Exposition Auth.
6.50%, 3/1/13 (1) 10,000 9,852
Port Auth. of New York &
New Jersey
6.875%, 1/1/25 (2) 3,200 3,181
Univ. of Medicine & Dentistry
6.50%, 12/1/12 (1) 4,000 3,942
--------
GROUP TOTAL 44,770
--------
- -----------------------------------------------------------------
NON-INSURED (6.4%)
Burlington County Bridge Comm.
5.30%, 10/1/13 9,500 7,893
Cherry Hill Township GO
6.30%, 6/1/12 3,745 3,614
Delaware River & Bay Auth.
4.50%, 1/1/95 4,000 4,002
Mercer County Improvement Auth.
5.75%, 12/15/07 1,110 1,033
5.75%, 12/15/08 1,165 1,070
5.95%, 12/15/12 4,895 4,428
6.00%, 12/1/14 1,000 905
Monmouth County Improvement
Auth. GO
(Correctional Facilities)
6.40%, 8/1/11 1,850 1,786
New Jersey Economic Development
Auth. VRDO
(Dow Chemical)
3.40%, 12/1/94 (LOC) 800 800
Port Auth. of New York &
New Jersey VRDO
3.40%, 12/1/94 3,900 3,900
Rutgers State Univ. GO
6.40%, 5/1/13 3,000 2,881
OUTSIDE NEW JERSEY:
Puerto Rico Electric Power Auth.
9.00%, 7/1/95 (Prere.) 4,750 5,024
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- -----------------------------------------------------------------
<S> <C> <C>
Puerto Rico Govt.
Development Bank VRDO
3.45%, 12/1/94 (LOC) $ 4,100 $ 4,100
--------
GROUP TOTAL 41,436
--------
- -----------------------------------------------------------------
TOTAL MUNICIPAL BONDS
(Cost $644,519) 621,390
- -----------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (3.6%)
- -----------------------------------------------------------------
Other Assets--Note B 24,956
Liabilities (1,723)
--------
23,233
- -----------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------
Applicable to 62,012,622 outstanding
shares of beneficial interest
(unlimited authorization--no par
value) $644,623
NET ASSET VALUE PER SHARE $10.40
=================================================================
</TABLE>
+ See Note A to Financial Statements.
For explanations of abbreviations and other references, see page 15.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
AT NOVEMBER 30, 1994,
NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------
Amount Per
(000) Share
-------- --------
<S> <C> <C>
Paid in Capital $667,967 $10.77
Undistributed Net
Investment Income -- --
Accumulated Net
Realized Gains--Note C 848 .02
Unrealized Depreciation
of Investments--Note D (24,192) (.39)
- -----------------------------------------------------------------
NET ASSETS $644,623 $10.40
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Face Market
Amount Value
MONEY MARKET PORTFOLIO (000) (000)+
- -----------------------------------------------------------------
<S> <C> <C>
MUNICIPAL BONDS (99.3%)
- -----------------------------------------------------------------
Bergenfield BAN
3.25%, 1/12/95 $ 2,534 $ 2,536
Bernards Township BAN
4.75%, 5/26/95 5,323 5,345
Borough of Bernardsville BAN
4.625%, 8/11/95 4,190 4,211
Cherry Hill Township BAN
3.00%, 12/14/94 8,794 8,795
Denville Township BAN
3.00%, 12/29/94 6,080 6,082
Essex County Improvement
Auth. Pooled Govt. Loan VRDO
3.45%, 12/7/94 (LOC) 35,250 35,250
Fair Lawn Borough BAN
3.50%, 12/16/94 4,011 4,012
Freehold BAN
3.50%, 12/14/94 5,905 5,907
Fort Lee Borough TAN
3.24%, 2/1/95 6,500 6,500
Gloucester County PCR VRDO
(Mobil Oil Corp.)
3.00%, 12/7/94 12,500 12,500
Hopewell Township TAN
4.50%, 4/28/95 7,000 7,018
Hunterdon County BAN
3.91%, 5/26/95 15,000 15,001
Lawrence Township BAN
4.25%, 2/10/95 2,745 2,748
Lenape Regional School Dist. RAN
4.50%, 6/30/95 4,575 4,590
Mendham Township BAN
5.00%, 10/18/95 2,000 2,014
Monmouth County BAN
4.75%, 8/31/95 5,200 5,228
Monmouth County Improvement
Auth. Pooled Govt. Loan VRDO
3.45%, 12/7/94 (LOC) 30,000 30,000
Monroe Township
Board of Education RAN
4.46%, 6/30/95 2,200 2,204
Moorestown Township BAN
4.12%, 9/6/95 5,135 5,136
New Jersey Economic
Development Auth. CP
(Chambers Cogeneration)
3.55%, 1/13/95 (LOC) 7,100 7,100
3.55%, 1/17/95 (LOC) 17,600 17,600
(Keystone Project)
3.55%, 1/17/95 (LOC) 14,000 14,000
3.55%, 1/24/95 (LOC) 5,300 5,300
</TABLE>
13
<PAGE> 16
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- -----------------------------------------------------------------
<S> <C> <C>
New Jersey Economic Development
Auth. VRDO
TOB 3.50%, 12/8/94 $ 15,000 $ 15,000
(Dow Chemical Co.)
3.40%, 12/2/94 (LOC) 4,700 4,700
New Jersey Educational Facilities
Auth. College & Univ. Capital
Improvement VRDO
3.35%, 12/7/94 (3) 7,450 7,450
New Jersey GO
TOB 3.75%, 2/15/95* 22,000 22,000
TOB VRDO 3.70%, 12/8/94 9,370 9,370
5.80%, 8/1/95 6,000 6,075
6.80%, 4/15/95 (ETM) 4,000 4,051
New Jersey Health Care
Facilities Auth. VRDO
(Carrier Foundation)
3.35%, 12/7/94 (3) 4,800 4,800
(Pooled Capital Assets)
3.70%, 12/8/94 (LOC) 38,100 38,100
New Jersey Housing Finance
Agency TOB VRDO
3.85%, 12/8/94 (1) 2,910 2,910
3.95%, 12/8/94 (1) 8,900 8,900
New Jersey Sports &
Exposition Auth. VRDO
3.65%, 12/8/94 (1) 81,255 81,255
New Jersey State Highway Auth.
(Garden State Parkway)
10.00%, 1/1/95 (Prere.) 4,150 4,258
10.50%, 1/1/95 (Prere.) 2,500 2,566
New Jersey Transportation Trust
3.50%, 6/15/95 20,000 19,977
New Jersey Turnpike Auth. VRDO
3.25%, 12/7/94 (3) 74,800 74,800
North Brunswick BAN
3.75%, 2/9/95 2,800 2,802
4.70%, 2/9/95 2,000 2,003
North Brunswick TAN
4.00%, 12/1/94 1,750 1,750
Passaic County BAN
4.75%, 9/28/95 10,000 10,048
3.75%, 4/6/95 11,000 11,019
Port Auth. of New York &
New Jersey CP
3.35%, 12/6/94 15,500 15,500
3.35%, 12/9/94 9,565 9,565
3.35%, 12/13/94 4,695 4,695
3.45%, 12/15/94 16,655 16,655
3.55%, 1/13/95 4,570 4,570
3.55%, 1/18/95 10,760 10,760
3.75%, 2/1/95 5,860 5,860
3.75%, 2/13/95 3,640 3,640
Port Auth. of New York &
New Jersey VRDO
3.40%, 12/2/94 27,900 27,900
(Kiac Partners)
3.45%, 12/7/94 (LOC) 51,000 51,000
Randolph Township BAN
4.75%, 9/8/95 2,365 2,377
Salem County PCR CP
(Philadelphia Electric)
3.55%, 1/18/95 (LOC) 5,000 5,000
Secaucus TAN
3.69%, 1/25/95 3,500 3,500
Spartan Township BAN
4.50%, 6/16/95 1,775 1,784
OUTSIDE NEW JERSEY:
Puerto Rico Public Building Auth.
8.875%, 7/1/95 (Prere.) 8,000 8,409
Puerto Rico Electric Power Auth.
9.125%, 7/1/95 (Prere.) 9,010 9,551
Puerto Rico Govt.
Development Bank VRDO
3.45%, 12/7/94 (LOC) 37,150 37,150
Puerto Rico Highway &
Transportation Auth. VRDO
3.00%, 12/7/94 (LOC) 25,600 25,600
- -----------------------------------------------------------------
TOTAL MUNICIPAL BONDS
(Cost $786,427) 786,427
- -----------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (.7%)
- -----------------------------------------------------------------
Other Assets--Note B 10,061
Liabilities (4,240)
---------
5,821
- -----------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------
Applicable to 792,250,377
outstanding shares of
beneficial interest
(unlimited authorization--no par
value) $792,248
- -----------------------------------------------------------------
NET ASSET VALUE PER SHARE $1.00
=================================================================
</TABLE>
+ See Note A to Financial Statements.
14
<PAGE> 17
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
AT NOVEMBER 30, 1994,
NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------
Amount Per
(000) Share
-------- --------
<S> <C> <C>
Paid in Capital $792,266 $1.00
Undistributed Net
Investment Income -- --
Accumulated Net
Realized Losses (18) --
Unrealized Appreciation
of Investments -- --
- -----------------------------------------------------------------
NET ASSETS $792,248 $1.00
- -----------------------------------------------------------------
</TABLE>
COP=Certificate of Participation
CP=Commercial Paper
GO=General Obligation
PCR=Pollution Control Revenue
RAN=Revenue Anticipation Note
RAW=Revenue Anticipation Warrant
TAN=Tax Anticipation Note
TOB=Tender Option Bond
TRAN=Tax Revenue Anticipation Note
VRDO=Variable Rate Demand Obligation
(Prere.)=Prerefunded
*Put Option Obligation.
Scheduled principal and interest payments are guaranteed by:
(1) MBIA (Municipal Bond Insurance Association)
(2) AMBAC (AMBAC Indemnity Corporation)
(3) FGIC (Financial Guaranty Insurance Company)
(4) FSA (Financial Security Assurance)
(5) CGI (Capital Guaranty Insurance)
(6) BIGI (Bond Investors Guaranty Insurance)
(7) Connie Lee Inc.
(8) FHA (Federal Housing Authority)
The insurance does not guarantee the market value of the
municipal bonds.
(LOC)=Scheduled principal and interest payments are guaranteed by
bank letter of credit.
15
<PAGE> 18
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
INSURED LONG-TERM MONEY MARKET
PORTFOLIO PORTFOLIO
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended
November 30, 1994 November 30, 1994
(000) (000)
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INVESTMENT INCOME
INCOME
Interest . . . . . . . . . . . . . . . . . . . . . $ 41,034 $ 20,801
- --------------------------------------------------------------------------------------------------------------------------------
Total Income . . . . . . . . . . . . . . . . . . 41,034 20,801
- --------------------------------------------------------------------------------------------------------------------------------
EXPENSES
The Vanguard Group--Note B
Investment Advisory Services . . . . . . . . . . $ 83 $ 87
Management and Administrative . . . . . . . . . 1,219 1,302
Marketing and Distribution . . . . . . . . . . . 155 1,457 211 1,600
-------- --------
Insurance Expense . . . . . . . . . . . . . . . . . 4 --
Auditing Fees . . . . . . . . . . . . . . . . . . . 7 7
Shareholders' Reports . . . . . . . . . . . . . . . 33 26
Annual Meeting and Proxy Costs . . . . . . . . . . 4 3
Trustees' Fees and Expenses . . . . . . . . . . . . 3 3
- --------------------------------------------------------------------------------------------------------------------------------
Total Expenses . . . . . . . . . . . . . 1,508 1,639
- --------------------------------------------------------------------------------------------------------------------------------
Net Investment Income . . . . . . . . 39,526 19,162
- --------------------------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold . . . . . . . . . . . . (316) (18)
Futures Contracts . . . . . . . . . . . . . . . . . 4,404 --
- --------------------------------------------------------------------------------------------------------------------------------
Realized Net Gain (Loss) . . . . . . . . 4,088 (18)
- --------------------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
(DEPRECIATION)
Investment Securities . . . . . . . . . . . . . . . (87,578) --
Futures Contracts . . . . . . . . . . . . . . . . . (1,708) --
- --------------------------------------------------------------------------------------------------------------------------------
Change in Unrealized
Appreciation (Depreciation) . . . . . (89,286) --
- --------------------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations . . . . . . $(45,672) $ 19,144
================================================================================================================================
</TABLE>
16
<PAGE> 19
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
INSURED LONG-TERM PORTFOLIO
- ------------------------------------------------------------------------------------------------------------------
YEAR ENDED Year Ended
NOVEMBER 30, November 30,
1994 1993
(000) (000)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 39,526 $ 37,680
Realized Net Gain (Loss) . . . . . . . . . . . . . . . . . . . . . . . . . . 4,088 754
Change in Unrealized Appreciation (Depreciation) . . . . . . . . . . . . . . (89,286) 39,488
- ------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations . . . (45,672) 77,922
- ------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS (1)
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . (39,526) (37,680)
Realized Net Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,995) (7,008)
- ------------------------------------------------------------------------------------------------------------------
Total Distributions . . . . . . . . . . . . . . . . . . . . . . . . . (43,521) (44,688)
- ------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (2)
Issued -- Regular . . . . . . . . . . . . . . . . . . . . . . . . . . 120,507 205,923
-- In Lieu of Cash Distributions . . . . . . . . . . . . . . . 34,307 36,036
-- Exchange . . . . . . . . . . . . . . . . . . . . . . . . . 57,419 76,871
Redeemed -- Regular . . . . . . . . . . . . . . . . . . . . . . . . . . (103,810) (93,405)
-- Exchange . . . . . . . . . . . . . . . . . . . . . . . . . (122,738) (82,075)
- ------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) from Capital Share Transactions . . . . . . . (14,315) 143,350
- ------------------------------------------------------------------------------------------------------------------
Total Increase (Decrease) . . . . . . . . . . . . . . . . . . . . . (103,508) 176,584
- ------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 748,131 571,547
- ------------------------------------------------------------------------------------------------------------------
End of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $644,623 $748,131
==================================================================================================================
(1) Distributions Per Share
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . $.622 $.637
Realized Net Gain . . . . . . . . . . . . . . . . . . . . . . . . . . $.063 $.135
- ------------------------------------------------------------------------------------------------------------------
(2) Shares Issued and Redeemed
Issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,697 24,358
Issued in Lieu of Cash Distributions . . . . . . . . . . . . . . . . . 3,048 3,114
Redeemed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (20,279) (15,067)
- ------------------------------------------------------------------------------------------------------------------
(1,534) 12,405
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE> 20
STATEMENT OF CHANGES IN NET ASSETS (continued)
<TABLE>
<CAPTION>
MONEY MARKET PORTFOLIO
- ------------------------------------------------------------------------------------------------------------------
YEAR ENDED Year Ended
NOVEMBER 30, November 30,
1994 1993
(000) (000)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,162 $ 15,397
Realized Net Gain (Loss) . . . . . . . . . . . . . . . . . . . . . . . . . . (18) 2
Change in Unrealized Appreciation (Depreciation) . . . . . . . . . . . . . . -- --
- ------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations . . 19,144 15,399
- ------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS (1)
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . (19,162) (15,397)
Realized Net Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- --
- ------------------------------------------------------------------------------------------------------------------
Total Distributions . . . . . . . . . . . . . . . . . . . . . . . . (19,162) (15,397)
- ------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (2)
Issued -- Regular . . . . . . . . . . . . . . . . . . . . . . . . . . 516,267 551,033
-- In Lieu of Cash Distributions . . . . . . . . . . . . . . . 18,247 14,556
-- Exchange . . . . . . . . . . . . . . . . . . . . . . . . . 208,722 130,139
Redeemed -- Regular . . . . . . . . . . . . . . . . . . . . . . . . . . (503,920) (458,197)
-- Exchange . . . . . . . . . . . . . . . . . . . . . . . . . (170,862) (140,713)
- ------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) from Capital Share Transactions . . . . . . 68,454 96,818
- ------------------------------------------------------------------------------------------------------------------
Total Increase (Decrease) . . . . . . . . . . . . . . . . . . . . 68,436 96,820
- ------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 723,812 626,992
- ------------------------------------------------------------------------------------------------------------------
End of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $792,248 $723,812
==================================================================================================================
(1) Distributions Per Share
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . $.025 $.023
Realized Net Gain . . . . . . . . . . . . . . . . . . . . . . . . . . -- --
- ------------------------------------------------------------------------------------------------------------------
(2) Shares Issued and Redeemed
Issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 724,989 681,172
Issued in Lieu of Cash Distributions . . . . . . . . . . . . . . . . . 18,247 14,556
Redeemed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (674,782) (598,910)
- ------------------------------------------------------------------------------------------------------------------
68,454 96,818
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
18
<PAGE> 21
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
INSURED LONG-TERM PORTFOLIO
- --------------------------------------------------------------------------------------------------------------------
Year Ended November 30,
---------------------------------------------------------
For a Share Outstanding Throughout Each Year 1994 1993 1992 1991 1990
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR . . . . . . . $11.77 $11.18 $10.75 $10.51 $10.45
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income . . . . . . . . . . . . . .622 .637 .659 .676 .692
Net Realized and Unrealized Gain (Loss)
on Investments . . . . . . . . . . . . . . . (1.307) .725 .438 .245 .073
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS . . . . (.685) 1.362 1.097 .921 .765
- --------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income . . . . . . (.622) (.637) (.659) (.676) (.692)
Distributions from Realized Capital Gains . . . (.063) (.135) (.008) (.005) (.013)
------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS . . . . . . . . . . . (.685) (.772) (.667) (.681) (.705)
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR . . . . . . . . . . $10.40 $11.77 $11.18 $10.75 $10.51
====================================================================================================================
TOTAL RETURN . . . . . . . . . . . . . . . . . . -6.10% +12.53% +10.48% +9.01% +7.66%
- --------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
Net Assets, End of Year (Millions) . . . . . . . . $645 $748 $572 $434 $245
Ratio of Expenses to Average Net Assets . . . . . . .21% .20% .25% .24%+ .25%+
Ratio of Net Investment Income to
Average Net Assets . . . . . . . . . . . . . . . 5.53% 5.47% 5.99% 6.33% 6.73%
Portfolio Turnover Rate . . . . . . . . . . . . . . 13% 12% 34% 18% 7%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Insurance expense represents .01% and .01%.
19
<PAGE> 22
FINANCIAL HIGHLIGHTS (continued)
<TABLE>
<CAPTION>
MONEY MARKET PORTFOLIO
- --------------------------------------------------------------------------------------------------------------------
Year Ended November 30,
---------------------------------------------------------
For a Share Outstanding Throughout Each Year 1994 1993 1992 1991 1990
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR . . . . . . . . $1.00 $1.00 $1.00 $1.00 $1.00
----- ----- ----- ----- -----
INVESTMENT OPERATIONS
Net Investment Income . . . . . . . . . . . . . .025 .023 .030 .045 .056
Net Realized and Unrealized Gain (Loss)
on Investments . . . . . . . . . . . . . . . -- -- -- -- --
----- ----- ----- ----- -----
TOTAL FROM INVESTMENT OPERATIONS . . . . .025 .023 .030 .045 .056
- --------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income . . . . . . (.025) (.023) (.030) (.045) (.056)
Distributions from Realized Capital Gains . . . -- -- -- -- --
----- ----- ----- ----- -----
TOTAL DISTRIBUTIONS . . . . . . . . . . (.025) (.023) (.030) (.045) (.056)
- --------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR . . . . . . . . . . . $1.00 $1.00 $1.00 $1.00 $1.00
====================================================================================================================
TOTAL RETURN . . . . . . . . . . . . . . . . . . +2.49% +2.31% +3.04% +4.54% +5.78%
- --------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
Net Assets, End of Year (Millions) . . . . . . . . $792 $724 $627 $547 $464
Ratio of Expenses to Average Net Assets . . . . . . .21% .20% .24% .24% .24%
Ratio of Net Investment Income to
Average Net Assets . . . . . . . . . . . . . . . 2.46% 2.29% 2.98% 4.43% 5.61%
Portfolio Turnover Rate . . . . . . . . . . . . . . N/A N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
20
<PAGE> 23
NOTES TO FINANCIAL STATEMENTS
Vanguard New Jersey Tax-Free Fund is registered under the Investment Company
Act of 1940 as an open-end investment company and consists of the Insured
Long-Term and Money Market Portfolios. Each Portfolio invests in debt
instruments of municipal issuers whose ability to meet their obligations may be
affected by economic and political developments in the State of New Jersey.
A. The following significant accounting policies are in conformity with
generally accepted accounting principles for investment companies. Such
policies are consistently followed by the Fund in the preparation of financial
statements.
1. SECURITY VALUATION: Money Market Portfolio: investment securities are
stated at amortized cost which approximates market value. Insured
Long-Term Portfolio: municipal bonds are valued utilizing primarily
the latest bid prices or, if bid prices are not available, on the
basis of valuations based on a matrix system (which considers such
factors as security prices, yields, maturities, and ratings), both as
furnished by an independent pricing service.
2. FEDERAL INCOME TAXES: Each Portfolio of the Fund intends to continue
to qualify as a regulated investment company and distribute all of its
income. Accordingly, no provision for Federal income taxes is required
in the financial statements.
3. FUTURES: The Insured Long-Term Portfolio utilizes Municipal Bond
Index, U.S. Treasury Bond, and U.S. Treasury Note futures contracts to
a limited extent, with the objectives of enhancing returns, managing
interest rate risk, maintaining liquidity, diversifying credit risk
and minimizing transaction costs. The Portfolio may purchase futures
contracts instead of municipal bonds when futures contracts are
believed to be priced more attractively than municipal bonds. The
Portfolio may also seek to take advantage of price differences among
bond market sectors by simultaneously buying futures (or bonds) of one
market sector and selling futures (or bonds) of another sector.
Futures contracts may also be used to simulate a fully invested
position in the underlying bonds while maintaining a cash balance for
liquidity.
The primary risks associated with the use of futures contracts are imperfect
correlation between changes in market values of bonds held by the Portfolio and
the prices of futures contracts, and the possibility of an illiquid market.
Futures contracts are valued based upon their quoted daily settlement prices.
Fluctuations in the values of futures contracts are recorded as unrealized
appreciation (depreciation) until terminated at which time realized gains
(losses) are recognized. Unrealized appreciation (depreciation) related to open
futures contracts is required to be treated as realized gain (loss) for Federal
income tax purposes.
4. DISTRIBUTIONS: Distributions from net investment income are declared
on a daily basis payable on the first business day of the following
month. Annual distributions from realized gains, if any, are recorded
on the ex-dividend date. Capital gain distributions are determined on
a tax basis and may differ from realized capital gains for financial
reporting purposes due to differences in the timing of realization of
gains.
5. OTHER: Security transactions are accounted for on the date the
securities are purchased or sold. Costs used in determining realized
gains and losses on the sale of investment securities are those of
specific securities sold. Premiums and original issue discounts are
amortized and accreted, respectively, to interest income over the
lives of the respective securities.
B. The Vanguard Group, Inc. furnishes at cost investment advisory,
corporate management, administrative, marketing and distribution services. The
costs of such services are allocated to the Fund under methods approved by the
Board of Trustees. At November 30, 1994, the Fund had contributed capital
aggregating $223,000 to Vanguard (included in Other Assets), representing 1.1%
of Vanguard's capitalization. The Fund's officers and trustees are also
officers and directors of Vanguard.
21
<PAGE> 24
NOTES TO FINANCIAL STATEMENTS (continued)
C. During the year ended November 30, 1994, the Insured Long-Term
Portfolio made purchases of $87,658,000 and sales of $101,413,000 of investment
securities other than temporary cash investments.
At November 30, 1994, the Fund had available a capital loss carryforward of
$214,000 to offset future net capital gains through November 30, 2002.
D. At November 30, 1994, unrealized depreciation of investment securities
of the Insured Long-Term Portfolio for financial reporting and Federal income
tax purposes aggregated $23,129,000 of which $7,382,000 related to appreciated
securities and $30,511,000 related to depreciated securities.
At November 30, 1994, the aggregate settlement value of the Insured Long-Term
Portfolio's long positions in Municipal Bond Index futures contracts expiring
through March 1995, and the market value of securities deposited as initial
margin for open futures contracts were $49,480,000 and $2,054,000,
respectively. Net unrealized depreciation on open futures contracts of
$1,063,000 was required to be treated as realized loss for Federal income tax
purposes, and accordingly was included in the Portfolio's capital loss
carryforward.
22
<PAGE> 25
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Trustees
Vanguard New Jersey Tax-Free Fund
In our opinion, the accompanying statements of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
the Insured Long-Term Portfolio and the Money Market Portfolio (constituting
the Vanguard New Jersey Tax-Free Fund, hereafter referred to as the "Fund") at
November 30, 1994, the results of each of their operations, the changes in
each of their net assets and the financial highlights for each of the
respective periods presented, 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 by correspondence with the custodian and brokers and
the application of alternative auditing procedures where confirmations from
brokers were not received, provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
December 30, 1994
23
<PAGE> 26
TRUSTEES AND OFFICERS
JOHN C. BOGLE, Chairman and Chief Executive Officer
Chairman and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The
Vanguard Group.
JOHN J. BRENNAN, President
President and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman and Chief Executive
Officer of Rhone-Poulenc Rorer Inc.; Director of Sun
Company, Inc.
BARBARA BARNES HAUPTFUHRER, Director of The Great
Atlantic and Pacific Tea Company, Alco Standard Corp.,
Raytheon Company, Knight-Ridder, Inc., and
Massachusetts Mutual Life Insurance Co.
BURTON G. MALKIEL, 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 Communications Company.
ALFRED M. RANKIN, JR., Chairman, President, and
Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich
Company, Reliance Electric Company, and The Standard
Products Company.
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 Company and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco
Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc.
J. LAWRENCE WILSON, Chairman and Chief Executive
Officer of Rohm & Haas Company; Director of
Cummins Engine Company; Trustee of Vanderbilt
University and the Culver Educational Foundation.
OTHER FUND OFFICERS
RICHARD F. HYLAND, Treasurer; Treasurer of The
Vanguard Group, Inc., and of each of the investment
companies in The Vanguard Group.
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President
and Secretary of The Vanguard Group, Inc.; Secretary of
each of the investment companies in The Vanguard
Group.
KAREN E. WEST, Controller; Vice President of The
Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD GROUP OFFICERS
JEREMY G. DUFFIELD VINCENT S. MCCORMACK
Senior Vice President Senior Vice President
Planning & Development Operations
JAMES H. GATELY RALPH K. PACKARD
Senior Vice President Senior Vice President
Institutional Chief Financial Officer
IAN A. MACKINNON
Senior Vice President
Fixed Income Group
24
<PAGE> 27
THE VANGUARD VOYAGE . . . STAYING THE COURSE
(continued from inside front cover)
* We set specific standards for each Fund's investment policies and
principles.
* We adhere to the highest standards of investment quality, consistent
with each Fund's objectives.
* We offer candor in our Fund descriptions (including full disclosure of
risk) to prospective investors, and in our description to shareholders
of each Fund's success (or, sometimes, lack of the same).
These principles make at least as much sense today as they did in 1929, perhaps
even more. For we live in an era when many fund organizations have become
asset-gathering machines, capitalizing on past performance that is unrepeatable
and investment fads that today, as yesterday, will come and go. The new
marketing policy is too often "if investors want it, we'll sell it to them."
But our principle remains "if it makes sound investment sense, we'll offer it,
even if it takes years to attract substantial assets."
FOUNDING CORPORATE VALUES
With the founding of The Vanguard Group in 1974, a new concept of values was
brought to bear on mutual fund management. Unlike other fund organizations,
Vanguard alone is structured to serve only its Funds' shareholders. Vanguard's
corporate structure places not the fund management company, but the fund
shareholders, "at the top" of the organizational chart. Vanguard Fund
shareholders are literally the owners of the firm and are entitled to all of
the benefits that, at other fund firms, accrue to the owners of the management
company.
Because of this unique structure, Vanguard has become best known for
its low costs, which we believe are just as essential a consideration in
investing in mutual funds as risk potential and total return. We call this
relationship between risk, return, and cost the "eternal triangle" of mutual
fund investing.
We take special pride in our position as (by far) the lowest-cost
provider of financial services in the world. Under our "no-load" offering
structure, shareholders begin their Vanguard investment program with $1,000 of
assets (not, say, $950) for each $1,000 investment. Then, under our "at-cost"
operating structure, each $1,000 is managed for only about $3 per year; our
competitors may charge three, four, or even five times that amount.
In all, Vanguard has distinguished itself by providing Funds with
sound and durable goals to investors with long-term time horizons, and doing so
at the fairest financial terms available. We believe that the unique Vanguard
structure "promotes a healthy and viable mutual fund complex within which each
Fund can better prosper; enables the Funds to realize substantial savings from
advisory fee reductions; promotes savings from economies of scale; and provides
the Funds with direct and conflict-free control over distribution functions."
We are not alone in this belief. Indeed, the quotation is taken verbatim from
the unanimous decision of the U.S. Securities and Exchange Commission when, in
1981, it approved our application for the structure under which we operate
today.
A CLOSING THOUGHT
We are proud of what Wellington Fund, the other Vanguard Funds, and The
Vanguard Group have come to represent, and we are grateful for the success and
growth with which we have been blessed. We are an industry leader, and, as a
competitor observed a few years ago, we are "the standard by which all fund
organizations are judged."
In battle terms, "the vanguard" is the first wave of troops or ships,
and Vanguard surely is in the first wave of the battle for investment survival.
As we look behind us, however, the "second wave" is not in sight. No fund
organization has followed our lead, leaving ours a lonely course. No matter. We
have an organization that places the interests of our Fund shareholders first.
We have Funds that shall endure the vicissitudes of the future. Come what may,
we intend to "stay the course," and we shall do our very best to continue to
deserve your confidence and loyalty. We hope that you will stay the course
with us.
<PAGE> 28
THE VANGUARD FAMILY OF FUNDS
FIXED INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Admiral Funds
U.S. Treasury Money Market Portfolio
Vanguard Money Market Reserves
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Money Market Portfolio
Vanguard State Tax-Free Funds
Money Market Portfolios (CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
Insured Longer-Term Portfolios
(CA, FL, NJ, NY, OH, PA)
INCOME FUNDS
Vanguard Admiral Funds
Vanguard Fixed Income Securities Fund
Vanguard Preferred Stock Fund
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard Convertible Securities Fund
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard/Trustees' Equity Fund
U.S. Portfolio
Vanguard/Windsor Fund
Vanguard/Windsor II
BALANCED FUNDS
Vanguard Asset Allocation Fund
Vanguard STAR Fund
Vanguard/Wellesley Income Fund
Vanguard/Wellington Fund
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity Fund
International Portfolio
INDEX FUNDS
Vanguard Index Trust
Total Stock Market Portfolio
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Value Portfolio
Small Capitalization Stock Portfolio
Vanguard International Equity Index Fund
European Portfolio
Pacific Portfolio
Emerging Markets Portfolio
Vanguard Bond Index Fund
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
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Vanguard Financial Center Valley Forge, Pennsylvania 19482
New Account Information: 1-(800) 662-7447 Shareholder Account Services: 1-(800) 662-2739
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This Report has been prepared for shareholders and may be distributed
to others only if preceded or accompanied by a current prospectus. All Funds in
the Vanguard Family are offered by prospectus only.
Q140-11/94
<PAGE> 29
EDGAR APPENDIX
This appendix describes the components of the printed version of this
report that do not translate into a format acceptable to the EDGAR system.
The front cover of the printed version of this report features the
Vanguard ship in the crashing sea.
A small picture of a rear view of the Vanguard ship crashing through
the sea appears at the top of the inside covers of the report.
A running head featuring a sextant appears on pages one through six.
A photograph of John C. Bogle appears at the lower-right of page one.
A cumulative performance line chart for the period January 31, 1988,
to November 30, 1994 appears at the top of page two.
Two line charts appear at the upper-left of page three--the top chart
depicts the month-end yields of a 30-Year Prime Municipal Bond and a 90-Day
MIG 1 Note for the fiscal years 1990 through 1994, and the bottom chart
indicates the yield spread for the same periods.
A running head featuring a coiled rope appears on page seven.
A running head featuring a map and telescope appears on pages eight
and nine.
A running head featuring a log book and pen appears on pages ten
through twenty-three.
A running head featuring a compass appears on page twenty-four.
At the bottom of the back cover there appears a triangle with the
sides labeled "risk," "cost," and "return."
A seagull in flight is featured at the top of the outside back cover
of the report.
