<PAGE> 1
VANGUARD
EQUITY INCOME
FUND
Annual Report - September 30, 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.
[COMPASS]
CONTENTS
A MESSAGE TO
OUR SHAREHOLDERS
1
THE MARKETS IN
PERSPECTIVE
5
REPORT FROM
THE ADVISERS
7
PERFORMANCE SUMMARY
9
FUND PROFILE
10
FINANCIAL STATEMENTS
12
REPORT OF
INDEPENDENT ACCOUNTANTS
20
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
With a total return of +9.5% during the fiscal year ended September 30,
1998, our tenth anniversary year, Vanguard Equity Income Fund more than held its
own in a turbulent stock market. In fact, this return was far ahead of the
minuscule return of +0.1% by the average equity income fund and slightly higher
than that of the Standard & Poor's 500 Composite Stock Price Index.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
SEPTEMBER 30, 1998
- -------------------------------------------------------------------
<S> <C>
Vanguard Equity Income Fund +9.5%
- -------------------------------------------------------------------
Average Equity Income Fund +0.1%
- -------------------------------------------------------------------
S&P 500 Index +9.0%
- -------------------------------------------------------------------
</TABLE>
The table at right presents the fiscal-year total returns (capital change
plus reinvested dividends) of the Equity Income Fund, our average peer, and the
unmanaged S&P 500 Index. Our fund's return is based on an increase in net asset
value from $22.28 per share on September 30, 1997, to $22.80 on September 30,
1998, with the ending net asset value adjusted for dividends totaling $0.67 per
share paid from net investment income and distributions totaling $0.89 per share
paid from net capital gains realized during 1997. We anticipate making a
distribution of roughly $0.75 per share in net realized capital gains in
December 1998.
FINANCIAL MARKETS IN REVIEW
Through the first 91/2 months of the fiscal year that ended September 30, the
U.S. stock market continued the remarkable climb that began in August 1982. The
market's advance--spearheaded by a relatively few large-capitalization growth
stocks--had boosted the S&P 500 Index to a +26.8% gain as of July 17. However,
the market took back most of that gain during the following six weeks, and the
index earned +9.0% for the full fiscal year. Within the S&P 500, there was a
sharp split in returns for growth and value stocks during our fiscal year: The
growth-stock component of the index earned +18.2%, while the value component
declined -0.2%--a remarkable difference of some 18 percentage points during a
single year. Smaller stocks did far worse: The Wilshire 4500 Equity Index,
representing stocks outside of the S&P 500, declined -12.1%, and the small-cap
Russell 2000 Index fell -19.0%. It was not an easy year!
Interest rates, meanwhile, fell sharply, providing some support for stock
valuations. The yield on the 30-year U.S. Treasury bond, which began the year at
6.40%, plummeted to 4.98% on September 30, the lowest level for long-term
Treasury bonds since way back in 1968. Yields on 3-month Treasury bills declined
during the year by 74 basis points (0.74 percentage point) to 4.36% on September
30.
For most of the year, investors shrugged off the serious economic
problems that had surfaced in Asia beginning in July 1997. The U.S. economy kept
expanding, propelled by strong consumer spending. Asia's economic woes seemed at
first to benefit the United States by helping to reduce prices for many
commodities and industrial products. These lower prices eased the inflationary
pressures that might have been expected to develop in response to low
unemployment (as low as 4.3% of the workforce) and rising wages.
However, investor attitudes shifted abruptly in mid-July. Among the
reasons analysts cited for the shift were the stubborn economic crisis in Asia,
which dampened
1
<PAGE> 4
demand for U.S. exports; worsening political and economic troubles in Russia;
and uncertainty about U.S. political leadership.
But there may be a simpler explanation for the market's summer swoon:
After 16 years of a bull market--the last three of which provided stupendous
gains--stock prices may just have gotten too far ahead of corporate profits.
Earnings are the key fundamental that ultimately drives the stock market, yet
earnings during the first half of 1998 were slightly below those reported during
the first half of 1997. Absent strong earnings growth, even optimists couldn't
justify stock prices that in mid-July were averaging some 25 times projected
earnings for the year ahead.
FISCAL 1998 PERFORMANCE OVERVIEW
The Equity Income Fund's +9.5% return during fiscal 1998 trounced the +0.1%
return earned by the average equity income fund. In a topsy-turvy year for
stocks, our fund did just what it aims to do--provide competitive returns with
below-average volatility. From September 30, 1997, through July 17, 1998, our
+18.1% return was nearly 9 percentage points behind the S&P 500 Index. But
thereafter, as prices tumbled, our -7.3% decline was only about half of the
- -14.0% decline in the index.
Several factors contributed to our wide margin of superiority over other
equity income funds. We were aided by a larger-than-average stake in
utilities--the market's best-performing sector (+42%) during the fiscal year.
Utility stocks, which tend to sport relatively high dividend yields, typically
get a boost from falling interest rates. Also, we had slightly smaller stakes
than many competitors in two market-lagging sectors: financial services and
producer durables. And our producer-durables stocks had smaller losses than the
sector as a whole (-8% versus -22%). Finally, our low operating expenses--equal
to 0.39% of average net assets during the year compared to the average 1.40%
expense ratio charged by our peers--gave us a "head start" of 1 percentage point
in performance. Enhancing our return without increasing our risk, it is a nice
tailwind.
Outperforming the S&P 500 Index was remarkable in a year when value
stocks--our bread and butter--badly lagged growth stocks. We overcame this bias
because of our large weighting in utilities--which accounted for about 25% of
our assets during the period versus about 10% for the index.
Since December 31, 1994, three advisers--Newell Associates; John A. Levin
& Company; and Spare, Kaplan, Bischel & Associates--have managed separate
portions of the fund's assets. We'd like to give special credit to Newell
Associates, our adviser since the fund's inception, for its outstanding
contribution to our return in the 1998 fiscal year, continuing the fine record
it has established throughout our decade-long history. The allocations of fund
assets are shown in the adjacent table.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
TOTAL ASSETS MANAGED
-----------------------
$ MILLION PERCENT
- -------------------------------------------------------------------
<S> <C> <C>
Newell Associates $1,503 64%
Spare, Kaplan, Bischel & Associates 391 16
John A. Levin & Company, Inc. 382 16
Cash Reserves* 102 4
- -------------------------------------------------------------------
Total $2,378 100%
- -------------------------------------------------------------------
</TABLE>
* This cash reserve is invested in equity index futures to simulate investment
in stocks; each adviser also maintains a modest cash reserve.
LONG-TERM PERFORMANCE OVERVIEW
The long-term record of Vanguard Equity Income Fund, which marked its tenth
anniversary on March 21, 1998, is quite solid. The table on page 3 presents the
average annual return of the fund and of its comparative benchmarks for the past
ten years, along with the results of hypothetical $10,000 investments made a
decade ago in the fund, its average competitor, and the S&P 500 Index.
2
<PAGE> 5
Over the past decade--a glorious period for common stocks--our average
annual return of +14.5% exceeded the return of the average equity income fund by
1.4 percentage points, resulting in a significant difference in wealth. A
$10,000 investment in the Equity Income Fund would have grown over ten years to
$38,709, versus $34,320 for the same sum invested in the average equity income
fund. The difference of $4,389 is equal to more than 40% of the original
investment.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED SEPTEMBER 30, 1998
-----------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- --------------------------------------------------------------------------------
<S> <C> <C>
Vanguard Equity Income Fund +14.5% $38,709
- --------------------------------------------------------------------------------
Average Equity Income Fund +13.1% $34,320
- --------------------------------------------------------------------------------
S&P 500 Index +17.3% $49,261
- --------------------------------------------------------------------------------
</TABLE>
About two-thirds of our margin over competing funds during the decade was
due to our annual cost advantage of about 1 percentage point. Our advisers also
contributed meaningfully to our performance edge.
Neither our fund nor its average peer has matched the S&P 500 Index over
the past decade. Two factors account for our underperformance. First, our
emphasis on value stocks--those with relatively high dividend yields and
below-average prices in relation to earnings and book value--was a disadvantage
during the decade, when growth stocks within the S&P 500 Index outperformed
value stocks by almost 4 percentage points a year (+19.0% versus +15.2%).
Second, the index exists only on paper and has no operating or transaction
costs, which all real-world funds incur.
History suggests that value stocks will not always lag growth stocks. We
need look back only to fiscal 1993 to find an occasion when value stocks
(+22.5%) outpaced growth stocks (+3.5%) by a margin as wide as the growth-stock
lead during fiscal 1998. In the long run, as such episodes suggest, the returns
from all investment styles strongly tend to revert to the market norm.
We emphasize that the past decade is no guide to the future performance
of the Equity Income Fund or the stock market. It would not be wise to expect
absolute returns over the next decade to match the +17.3% average annual return
on stocks from the past decade, which was more than 50% above the long-term
average return of +11% a year.
IN SUMMARY
A year ago, after a third consecutive year of big gains for the stock market,
our letter suggested that investors be mindful of the considerable risks that
accompany high market valuations. The market's recent volatility has underscored
that point and reaffirmed our longstanding belief in the importance of balanced
investing--holding stock funds, bond funds, and reserves in proportions suited
to your goals, time horizon, and tolerance for market fluctuations.
With such a balanced, long-term investment plan in place, you should be
prepared to stick with it through fluctuations in returns or investor
psychology.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
October 12, 1998
3
<PAGE> 6
NOTICE TO SHAREHOLDERS
At a special meeting on May 1, 1998, shareholders of Vanguard Equity Income
Fund overwhelmingly approved three proposals. The proposals and voting results
were:
1. REORGANIZATION INTO A DELAWARE BUSINESS TRUST. Based on the fund's assets at
the time of the vote, this change will reduce the amount of state taxes the fund
pays annually by $122,000. Approved by 96.77% of the shares voted, as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------
FOR AGAINST ABSTAIN
------------------------------------------------------------------
<S> <C> <C>
62,210,141 880,914 1,195,322
------------------------------------------------------------------
</TABLE>
2A. INVESTMENT LIMITATION CHANGES--INTERFUND LENDING PROGRAM. This change
permits the Equity Income Fund to participate in Vanguard's interfund lending
program, which allows funds to loan money to each other if--and only if--it
makes good financial sense to do so on both sides of the transaction. The
interfund lending program won't be an integral part of your fund's investment
program; it is a contingency arrangement for managing unusual cash flows.
Approved by 94.10% of shares voted, as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------
FOR AGAINST ABSTAIN
------------------------------------------------------------------
<S> <C> <C>
60,494,316 2,148,504 1,643,557
------------------------------------------------------------------
</TABLE>
2B. INVESTMENT LIMITATION CHANGES--BORROWING MONEY AND PLEDGING ASSETS. This
change sets standard limits of 15% of net assets on the amount of money
Vanguard funds can borrow from all sources and on the amount of assets that can
be pledged to secure any loans. Approved by 92.81% of the shares voted, as
follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------
FOR AGAINST ABSTAIN
-----------------------------------------------------------------
<S> <C> <C>
59,664,734 2,680,113 1,941,530
-----------------------------------------------------------------
</TABLE>
4
<PAGE> 7
THE MARKETS IN PERSPECTIVE
YEAR ENDED SEPTEMBER 30, 1998
U.S. financial markets displayed both bull-market ebullience and bear-market
jitters during the fiscal year ended September 30. Investor sentiment, which had
been relentlessly upbeat for most of the fiscal year, abruptly changed in July
and August.
Several factors combined to make investors less sanguine about the risks
facing them. Among these were a drearier outlook for corporate earnings,
political uncertainty in the United States, a debt moratorium in Russia, sharp
fluctuations in the values of many currencies, and a murkier global economic
picture. Asia's economic troubles--which began more than a year ago--not only
were persistent but were spreading and beginning to look like more than a minor
threat to the powerhouse U.S. economy and to the recovering economies of Europe.
As the fiscal year ended, the big question for U.S. markets was whether
U.S. consumers--whose robust spending had been "the little engine that could"
keep economic activity expanding both at home and abroad--would become more
cautious. For most of the fiscal year, consumers spent freely, encouraged by low
unemployment, which fell to levels last seen in 1970, and by wages that had
increased on average by more than twice the 1.5% inflation rate.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED SEPTEMBER 30, 1998
-----------------------------------
1 YEAR 3 YEARS 5 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
STOCKS
S&P 500 Index 9.0% 22.6% 19.9%
Russell 2000 Index -19.0 6.9 9.1
MSCI EAFE Index -8.1 4.0 5.6
- --------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 11.5% 8.7% 7.2%
Lehman 10-Year Municipal Bond Index 8.8 7.7 6.6
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 5.2 5.3 5.0
- --------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.5% 2.2% 2.4%
- --------------------------------------------------------------------------------
</TABLE>
U.S. STOCK MARKETS
The S&P 500 Index, which is dominated by large-capitalization stocks, returned
9.0% for the fiscal year, close to its long-term average return of about 11.0% a
year. Events during the year reminded investors that volatility is a normal part
of owning stocks. After rising strongly to a record high on July 17, the S&P 500
began retracing its steps. During the following six weeks, it fell 19.2%, just
shy of the 20% mark generally considered the "boundary" that separates a bear
market from a mere "correction." However, declines for most smaller stocks were
certifiably bearish. The Russell 2000 Index, which peaked in April, fell by 31%
from its high to end the fiscal year with a 19.0% decline.
There also was a big gap between returns on growth and value stocks.
Value stocks, reflecting modest market expectations for future growth, typically
sell at below-average prices in comparison to earnings, dividends, and book
value. Growth stocks, by contrast, tend to sell at high multiples of earnings
and dividends. In the past, value stocks have usually trailed growth stocks
during rising markets, but held up better during slumps. But this year growth
stocks did better in both up and down phases, and for the twelve months gained
18.2%, while value stocks declined 0.2%.
5
<PAGE> 8
Although analysts can point to many factors to "explain" any move in the
market, actual and expected corporate earnings hold the long-term key to stock
prices. Early in the fiscal year, stocks seemed to be "priced for perfection"--a
continuance of strong growth in corporate profits and economic growth in an
environment of low interest rates and inflation.
Perfection, as it turned out, was not in the cards. Economic problems
abroad threatened to depress profits for U.S. companies by weakening overseas
demand for their products and by boosting price competition at home, as foreign
companies flocked to the relatively strong U.S. market. Slower revenue growth
combined with rising wages in a strong job market make it tough to generate
higher profits.
For the year, the S&P 500's strongest performers were utilities (up 42%)
and health-care companies (up 37%), two groups believed to be less vulnerable to
recessions, weak foreign markets, and strong foreign competition. The
worst-performing sectors were those hurt most by falling prices for commodities
and basic industrial goods. Victims included oil services and exploration
companies (down 35%); makers of producer durables such as machinery and aircraft
(-22%); and makers and processors of such materials as steel, paper, and
chemicals (-14%).
U.S. BOND MARKETS
Interest rates declined significantly during the fiscal year. Inflation, the
bugbear of bond investors, was surprisingly well-behaved. Lower rates mean
higher prices for bonds, and the Lehman Brothers Aggregate Bond Index, a
benchmark for the overall market for taxable bonds, earned a total return of
11.5%, equal to an astounding 10% after inflation.
The rate decline was steepest for U.S. Treasury notes and bonds, whose
yields fell by 1.4 to 1.7 percentage points. Treasury prices benefited from a
slight decline in supply due to the $70 billion surplus achieved by the federal
government, its first year "in the black" since 1969. Also, Treasury securities
benefited late in the fiscal year from a "flight to safety" among investors
shying away from riskier investments, including U.S. and foreign stocks and
lower-quality bonds. The result was a widening in interest-rate spreads between
Treasuries and corporate or mortgage-backed bonds. Treasury yields fell so far
that by fiscal year-end, they were nearly as low as yields on comparable
municipal bonds, even though interest on municipals is exempt from federal
income tax.
INTERNATIONAL STOCK MARKETS
The general downturn of the world's stock markets in July and August changed
returns for the fiscal year from marvelous to mediocre for investors in U.S. and
European stocks. Elsewhere, the slump changed things from bad to horrendous.
As a group, European stocks earned 8.8% in U.S.-dollar terms, thanks to a
gain of about 5% from a strengthening of most currencies against the dollar.
European stocks benefited from firmer economic growth, increased corporate
restructuring and merger activity, and heightened optimism about the long-term
impact of the euro, a common currency due to be adopted in 1999 by 11 nations.
Markets in Norway (-40%) and Sweden (-11%) were notable exceptions to the
general rise in European equities.
Japan's stock market, wracked by recession and a shaky banking system,
declined 33% in U.S.-dollar terms. As bad as it was, Japan's showing actually
was the Pacific region's second-best, after Australia (-18%). Declines elsewhere
ranged from about 40% in Taiwan to more than 60% in South Korea, Thailand, and
Malaysia. Most of the world's emerging markets--which are particularly
vulnerable to slowing global growth and currency instability-- suffered sharp
reverses, including our neighbor and key trading partner, Mexico (-42%), as well
as Venezuela (-66%), Argentina (-35%), and Brazil and Chile (both -48%).
6
<PAGE> 9
REPORT FROM THE ADVISERS
For much of the fiscal year ended September 30, 1998, strength in the stock
prices of a small cadre of large growth companies allowed investors to remain
calm in the face of a pervasive deterioration in the broader market. Late in the
period, however, complacency evaporated as troubles in Japan and in
emerging-market economies threatened to choke off profit growth in U.S.
companies. The S&P 500 Index fell almost 10% during the July-September quarter.
As it characteristically does in times of market weakness, Vanguard Equity
Income Fund declined much less than the general market. The fund thus
outperformed the S&P 500 over both the 6-month and 12-month periods ended
September 30. For the fiscal year, the fund earned 9.5%, versus 9.0% for the
index, and it outperformed the average equity income fund by a large margin.
As investors flocked to the popular growth stocks during the first part
of the year, some of the fund's largest stock groups underperformed the market.
Most of our holdings were solid, large-capitalization stocks with defensive
characteristics and--in most cases--dividend yields above that of the overall
market. Many also had little exposure to the problems in Asia and emerging
markets. These characteristics were largely ignored early in the year, as many
investors came to believe that the "Asian contagion" had gone into remission.
However, when sentiment shifted and the stock market turned downward during July
and August, these stocks proved attractive to investors who saw them as safe
havens.
Leaders in this group were the large telecommunications stocks, which
made the biggest contribution to the fund's performance during the fiscal year.
They offered above-average dividend yields, continued to report respectable
growth in earnings, and had little exposure to foreign economic problems. All of
these attributes made telecom stocks an appealing harbor in the U.S. equity
market. The large pharmaceutical stocks fared well during both the up and down
phases of the market. Although their valuation levels are higher now than for
some years past, these stocks are still viewed as defensive, since people tend
to take care of their health even during recessions. Also, the drug stocks have
less earnings exposure in Asia than do most multinational corporations.
Electric companies--investment outcasts for several years because of
deregulation worries--have revived recently and regained some of their previous
reputation as relatively low-risk holdings. They continue to provide very high
dividend yields, and investors bought them aggressively during the recent
decline, a factor that helped the group to outperform the overall market for the
full fiscal year. Financial-services stocks, which were leaders during the
market's advance in the first part of the fiscal year, suffered the most when
the decline began in mid-July. Prices of bank and brokerage stocks fell well
below their peaks because of fears that a slowdown in the economy would reduce
profitability from lending and securities underwriting. Investors also worried
about unexpected losses from derivatives trading and loans to hedge funds.
7
<PAGE> 10
There is no doubt that these are extraordinary times. Even veteran
market-watchers acknowledge that current world economic and financial conditions
are beyond their experience and that the risk level has risen because there is
no precedent for the present situation. Clearly, risk returned to the investing
lexicon in the final quarter of our fiscal year, although it is still a word
largely overlooked by many market participants.
Considering the degree of economic and political turmoil in the world,
U.S. stock investors continue to display remarkably little fear, and despite the
drama of the recent decline, the stock market's overall valuation remains high,
especially for stocks regarded as reliable sources of earnings growth.
This is not a time for stock investors to take big risks. In periods of
heightened uncertainty, a time-tested method for keeping risk down is to own a
diversified group of stocks of large U.S.-based companies with above-average
dividend yields and long histories of success, selected according to a
disciplined investment strategy. This is what Vanguard Equity Income Fund is all
about. We believe that the stock market currently presents favorable
opportunities for investors who follow such a value-oriented approach to
investing.
Newell Associates
Spare, Kaplan, Bischel & Associates
John A. Levin & Company, Inc.
October 12, 1998
INVESTMENT PHILOSOPHY
The advisers believe that a fund made up of undervalued stocks, most of which
offer high dividend yields compared to their past levels and to the overall
market, can provide a high level of current income, the potential for capital
appreciation, and below-average price volatility for a stock mutual fund.
8
<PAGE> 11
PERFORMANCE SUMMARY
EQUITY INCOME 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: MARCH 21, 1988-SEPTEMBER 30, 1998
- -------------------------------------------------------------
EQUITY INCOME FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -------------------------------------------------------------
<C> <C> <C> <C> <C>
1988 5.8% 2.5% 8.3% 3.2%
1989 23.8 5.0 28.8 33.0
1990 -20.5 4.3 -16.2 -9.2
1991 18.0 8.5 26.5 31.2
1992 6.4 5.9 12.3 11.1
1993 14.1 5.1 19.2 13.0
1994 -6.5 4.3 -2.2 3.7
1995 19.8 5.0 24.8 29.7
1996 14.2 4.0 18.2 20.3
1997 30.0 4.2 34.2 40.4
1998 6.5 3.0 9.5 9.0
- -------------------------------------------------------------
</TABLE>
See Financial Highlights table on page 17 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: SEPTEMBER 30, 1988-SEPTEMBER 30, 1998
- -----------------------------------------------------------------------------
Equity Income Fund Average Equity Income Fund S&P 500 Index
------------------ -------------------------- -------------
<S> <C> <C> <C>
1988 10000 10000 10000
1988 10264 10228 10309
1989 11019 10826 11040
1989 11888 11574 12014
1989 12885 12315 13301
1989 12985 12482 13575
1990 12490 12091 13167
1990 12715 12351 13995
1990 10792 10905 12072
1990 11437 11698 13154
1991 12968 13046 15064
1991 12890 13063 15030
1991 13646 13834 15834
1991 14340 14807 17161
1992 14177 14722 16728
1992 14857 14982 17046
1992 15319 15335 17583
1992 15657 16211 18469
1993 16833 17141 19275
1993 17264 17313 19369
1993 18255 17988 19870
1993 17950 18370 20330
1994 16773 17621 19559
1994 17102 17632 19641
1994 17856 18227 20602
1994 17665 17928 20599
1995 19355 19164 22604
1995 20528 20433 24762
1995 22279 21876 26730
1995 24260 23333 28339
1996 24985 24231 29860
1996 25851 24947 31200
1996 26339 25558 32165
1996 28478 27731 34846
1997 29310 28014 35780
1997 32895 31615 42026
1997 35339 34286 45174
1997 37355 35360 46471
1998 41427 38657 52954
1998 40906 38235 54703
1998 38709 34320 49261
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED SEPTEMBER 30, 1998
----------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity Income Fund 9.54% 16.22% 14.49% $38,709
Average Equity Income Fund 0.10 13.79 13.12 34,320
S&P 500 Index 9.05 19.91 17.29 49,261
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
<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>
Equity Income Fund 3/21/1988 9.54% 16.22% 9.56% 4.93% 14.49%
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE> 12
FUND PROFILE
EQUITY INCOME FUND
This Profile provides a snapshot of the fund's characteristics as of September
30, 1998, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 11.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- -----------------------------------------------------------
EQUITY INCOME S&P 500
- -----------------------------------------------------------
<S> <C> <C>
Number of Stocks 168 500
Median Market Cap $22.8B $43.4B
Price/Earnings Ratio 19.4x 22.3x
Price/Book Ratio 3.0x 4.0x
Yield 2.9% 1.6%
Return on Equity 19.3% 21.9%
Earnings Growth Rate 9.0% 16.9%
Foreign Holdings 2.3% 1.7%
Turnover Rate 23% --
Expense Ratio 0.39% --
Cash Reserves 1.8% --
</TABLE>
INVESTMENT FOCUS
- ----------------------
[GRAPH]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ---------------------------------------------------
EQUITY INCOME S&P 500
- ---------------------------------------------------
<S> <C> <C>
R-Squared 0.91 1.00
Beta 0.72 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ---------------------------------------------------
<S> <C>
Bell Atlantic Corp. 2.9%
Philip Morris Cos., Inc. 2.5
Bristol-Myers Squibb Co. 2.3
Chevron Corp. 2.2
GTE Corp. 2.0
American Home Products Corp. 2.0
Texaco Inc. 2.0
Exxon Corp. 1.9
Amoco Corp. 1.9
Pharmacia & Upjohn, Inc. 1.9
- ---------------------------------------------------
Top Ten 21.6%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- ----------------------------------------------------------------------------
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
-----------------------------------------
EQUITY INCOME EQUITY INCOME S&P 500
-----------------------------------------
<S> <C> <C> <C>
Auto & Transportation 3.1% 3.5% 3.0%
Consumer Discretionary 7.7 6.1 10.3
Consumer Staples 8.1 8.8 9.5
Financial Services 18.9 16.2 16.3
Health Care 10.3 11.5 13.4
Integrated Oils 15.0 15.1 7.0
Other Energy 0.1 0.1 1.1
Materials & Processing 6.9 6.5 4.4
Producer Durables 1.8 2.2 3.2
Technology 0.7 1.0 14.8
Utilities 24.5 26.5 11.7
Other 2.9 2.5 5.3
- ----------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
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.
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by
stocks or American Depositary Receipts of companies based outside the United
States.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's
assets invested in each stock. Stocks representing half of the fund's assets
have market capitalizations above the median, and the rest are below it.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come
from each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a 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 based on the current annualized rate of
dividends paid on stocks in the index.
11
<PAGE> 14
FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
STATEMENT OF NET ASSETS [GRAPHIC]
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 (common stocks, preferred stocks, bonds,
etc.) and by industry sector. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the 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*
EQUITY INCOME FUND SHARES (000)
- ------------------------------------------------------------------------------
COMMON STOCKS (92.8%)(1)
- ------------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (3.3%)
CSX Corp. 131,300 $ 5,523
Chrysler Corp. 105,500 5,051
Dana Corp. 77,500 2,892
Ford Motor Co. 412,200 19,348
General Motors Corp. 102,300 5,595
Genuine Parts Co. 461,850 13,884
Norfolk Southern Corp. 266,000 7,731
TRW, Inc. 184,400 8,183
Union Pacific Corp. 219,200 9,343
---------
77,550
---------
CONSUMER DISCRETIONARY (5.6%)
Avon Products, Inc. 58,900 1,653
Black & Decker Corp. 165,800 6,901
Browning-Ferris Industries, Inc. 59,800 1,809
- - Corrections Corp. of America 125,000 1,695
Deluxe Corp. 164,000 4,664
Eastman Kodak Co. 119,150 9,212
Fortune Brands, Inc. 641,800 19,013
Kimberly-Clark Corp. 156,800 6,350
- - Kmart Corp. 314,600 3,756
May Department Stores Co. 326,800 16,830
The McGraw-Hill Cos., Inc. 111,200 8,813
J.C. Penney Co., Inc. 634,000 28,490
Reader's Digest Assn.,
Inc. Class A 109,200 2,088
R.H. Donnelley Corp. 29,180 361
Rubbermaid, Inc. 43,700 1,046
Tribune Co. 282,300 14,203
Wal-Mart Stores, Inc. 47,800 2,611
Whirlpool Corp. 99,900 4,695
---------
134,190
---------
CONSUMER STAPLES (8.2%)
Anheuser-Busch Cos., Inc. 391,600 $ 21,146
Campbell Soup Co. 59,500 2,986
The Clorox Co. 124,000 10,230
Gallaher Group PLC ADR 342,800 10,070
General Mills, Inc. 260,300 18,221
H.J. Heinz Co. 239,100 12,224
International Flavors &
Fragrances, Inc. 370,800 12,236
Kellogg Co. 264,300 8,705
Philip Morris Cos., Inc. 1,302,650 60,003
The Quaker Oats Co. 185,700 10,956
Ralston-Ralston Purina Group 240,800 7,043
Sara Lee Corp. 91,400 4,936
UST, Inc. 521,900 15,429
---------
194,185
---------
FINANCIAL SERVICES (15.1%)
Ace, Ltd. 266,000 7,980
American General Corp. 325,100 20,766
Associates First Capital Corp. 22,168 1,446
Banc One Corp. 481,753 20,535
The Bank of New York Co., Inc. 278,900 7,635
Bankers Trust Corp. 158,100 9,328
H & R Block, Inc. 184,000 7,613
The Chase Manhattan Corp. 81,200 3,512
Dun & Bradstreet Corp. 507,900 13,713
EXEL Ltd. Class A 92,500 5,827
First Chicago NBD Corp. 183,500 12,570
First Data Corp. 417,750 9,817
First Union Corp. 598,382 30,630
Fleet Financial Group, Inc. 166,100 12,198
KeyCorp 292,800 8,455
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ------------------------------------------------------------------------------
<S> <C> <C>
Lincoln National Corp. 224,000 $ 18,424
Marsh & McLennan Cos., Inc. 341,000 16,965
Mellon Bank Corp. 386,800 21,298
J.P. Morgan & Co., Inc. 185,300 15,681
Morgan Stanley Dean Witter & Co. 32,100 1,382
NationsBank Corp. 456,018 24,397
Northern Trust Corp. 62,000 4,231
PartnerRe Ltd. 86,000 3,445
PNC Bank Corp. 361,400 16,263
SAFECO Corp. 378,800 15,791
St. Paul Cos., Inc. 229,100 7,446
TIG Holdings, Inc. 294,400 4,140
U.S. Bancorp 237,549 8,448
Wachovia Corp. 162,600 13,862
Washington Mutual, Inc. 432,810 14,607
---------
358,405
---------
HEALTH CARE (10.6%)
Aetna Inc. 183,600 12,760
American Home Products Corp. 915,200 47,934
Baxter International, Inc. 144,100 8,574
Bristol-Myers Squibb Co. 537,000 55,781
- - Genentech, Inc. 137,650 9,894
Glaxo Wellcome PLC ADR 411,400 23,501
Eli Lilly & Co. 285,200 22,335
Merck & Co., Inc. 180,800 23,425
Pfizer, Inc. 32,500 3,443
Pharmacia & Upjohn, Inc. 904,925 45,416
---------
253,063
---------
INTEGRATED OILS (14.0%)
Amerada Hess Corp. 64,600 3,727
Amoco Corp. 855,700 46,101
Atlantic Richfield Co. 615,900 43,690
Chevron Corp. 611,300 51,387
Equitable Resources, Inc. 110,000 2,798
Exxon Corp. 658,600 46,225
Mobil Corp. 520,100 39,495
Phillips Petroleum Co. 327,200 14,765
Royal Dutch Petroleum Co. ADR 374,400 17,831
Texaco Inc. 759,200 47,592
USX-Marathon Group 272,000 9,639
Unocal Corp. 295,700 10,719
---------
333,969
---------
OTHER ENERGY (0.1%)
- - Oryx Energy Co. 117,600 1,521
---------
MATERIALS & PROCESSING (6.0%)
Armstrong World Industries Inc. 31,000 1,659
BetzDearborn Inc. 21,700 1,500
Dow Chemical Co. 377,400 32,244
E.I. du Pont de Nemours & Co. 294,200 16,512
Eastman Chemical Co. 195,700 9,871
- - Getchell Gold Corp. 119,900 2,525
International Paper Co. 178,500 8,323
Lubrizol Corp. 174,600 4,638
MacMillan Bloedel Ltd. 65,000 618
Monsanto Co. 141,500 7,977
Nalco Chemical Co. 92,900 2,741
Olin Corp. 186,000 5,336
- - Owens-Illinois, Inc. 168,200 4,205
Phelps Dodge Corp. 85,000 4,436
Potlatch Corp. 217,900 7,422
- - Sealed Air Corp. 71,900 2,292
Union Camp Corp. 303,200 11,938
Weyerhaeuser Co. 404,600 17,069
Witco Chemical Corp. 106,700 2,241
---------
143,547
---------
PRODUCER DURABLES (2.1%)
Caterpillar, Inc. 60,600 2,700
Deere & Co. 22,800 690
Emerson Electric Co. 115,400 7,184
Honeywell, Inc. 16,200 1,038
Lockheed Martin Corp. 82,100 8,277
Pitney Bowes, Inc. 207,800 10,922
Sundstrand Corp. 78,400 3,636
Thomas & Betts Corp. 139,800 5,321
United Technologies Corp. 120,200 9,188
---------
48,956
---------
TECHNOLOGY (1.0%)
AMP, Inc. 180,300 6,446
International Business
Machines Corp. 94,800 12,134
- - Loral Space & Communications 289,700 4,273
---------
22,853
---------
UTILITIES (24.5%)
AT&T Corp. 603,900 35,290
Allegheny Energy, Inc. 476,700 15,046
Ameren Corp. 293,500 12,309
Ameritech Corp. 763,500 36,171
Baltimore Gas & Electric Co. 380,150 12,687
Bell Atlantic Corp. 1,433,976 69,458
BellSouth Corp. 253,400 19,068
Central & South West Corp. 275,000 7,855
Consolidated Edison Inc. 130,700 6,813
Consolidated Natural Gas Co. 404,100 22,023
Dominion Resources, Inc. 162,300 7,243
Duke Energy Corp. 354,000 23,430
Edison International 463,100 11,896
FPL Group, Inc. 119,400 8,321
Florida Progress Corp. 130,200 5,639
GTE Corp. 876,500 48,207
- - Globalstar
Telecommunications Ltd. 186,962 2,162
MarketSpan Corp. 670,636 19,239
- - MediaOne Group, Inc. 152,700 6,786
New Century Energies, Inc. 87,400 4,255
NICOR, Inc. 289,100 11,980
Northern States Power Co. 351,800 9,872
OGE Energy Corp. 353,500 10,207
PP&L Resources Inc. 70,800 1,832
PacifiCorp 593,400 11,386
Potomac Electric Power Co. 609,400 16,149
Public Service Enterprise
Group, Inc. 176,600 6,943
SBC Communications Inc. 491,534 21,843
SCANA Corp. 190,600 6,397
Sempra Energy 605,655 15,785
Southern Co. 486,100 14,310
TECO Energy, Inc. 214,900 6,138
Texas Utilities Co. 314,697 14,653
U S West, Inc. 860,286 45,111
Western Resources, Inc. 86,300 3,571
Wisconsin Energy Corp. 433,800 13,692
---------
583,767
---------
</TABLE>
13
<PAGE> 16
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- ------------------------------------------------------------------------------
<S> <C> <C>
OTHER (2.3%)
Federal Signal Corp. 225,200 $ 4,743
General Electric Co. 222,200 17,679
Minnesota Mining &
Manufacturing Co. 342,425 25,232
Ogden Corp. 113,600 3,230
Tenneco, Inc. 110,100 3,620
----------
54,504
----------
- ------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,518,620) 2,206,510
- ------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (0.6%)
- ------------------------------------------------------------------------------
AirTouch Communications, Inc.
6.00% Cvt. Pfd. 110,000 5,170
Loral Space & Communications
Ltd. 6.00% Cvt. Pfd. 81,000 3,685
Owens-Illinois Inc. 4.75% Cvt. Pfd. 170,200 6,085
- ------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $14,309) 14,940
- ------------------------------------------------------------------------------
<CAPTION>
- ------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- ------------------------------------------------------------------------------
<S> <C> <C>
CONVERTIBLE BONDS (0.6%)
- ------------------------------------------------------------------------------
Hewlett-Packard Co.
0.00%, 10/14/2017 $ 18,000 9,898
National Semiconductor
6.50%, 10/1/2002 1,590 1,300
Security Capital U.S. Realty
2.00%, 5/22/2003 3,830 3,002
- ------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $15,101) 14,200
- ------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (6.2%)
- ------------------------------------------------------------------------------
U.S. TREASURY BILL
(2) 4.96%, 10/22/1998 6,000 5,987
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.46%, 10/1/1998 141,335 141,335
- ------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $147,318) 147,322
- ------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.2%)
(COST $1,695,348) 2,382,972
- ------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.2%)
Other Assets--Note C $ 13,231
Liabilities (18,672)
----------
(5,441)
- ------------------------------------------------------------------------------
NET ASSETS (100%)
- ------------------------------------------------------------------------------
Applicable to 104,282,846 outstanding
$0.001 par value shares of beneficial interest
(unlimited authorization) $2,377,531
- ------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE $22.80
==============================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- - Non-Income-Producing Security.
(1) The combined market value of common stocks and index futures contracts
represents 97.0% of net assets. See Note E in Notes to Financial Statements.
(2) Security segregated as initial margin for open futures contracts.
ADR--American Depositary Receipt.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AT SEPTEMBER 30, 1998, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital--Note A $1,607,629 $15.42
Undistributed Net Investment
Income--Notes A and D 5,315 .05
Accumulated Net Realized
Gains--Note D 76,504 .73
Unrealized Appreciation--Note E
Investment Securities 687,624 6.60
Futures Contracts 459 --
- --------------------------------------------------------------------------------
NET ASSETS $2,377,531 $22.80
================================================================================
</TABLE>
14
<PAGE> 17
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. If the
fund invested in futures contracts during the period, the results of these
investments are shown separately.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30, 1998
(000)
- -------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 63,399
Interest 9,199
Security Lending 26
-----------
Total Income 72,624
-----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 3,587
Performance Adjustment (370)
The Vanguard Group--Note C
Management and Administrative 4,944
Marketing and Distribution 499
Taxes (other than income taxes) 112
Custodian Fees 39
Auditing Fees 16
Shareholders' Reports 68
Annual Meeting and Proxy Costs 27
Trustees' Fees and Expenses 5
-----------
Total Expenses 8,927
Expenses Paid Indirectly--Note C (207)
-----------
Net Expenses 8,720
- -------------------------------------------------------------------------------
NET INVESTMENT INCOME 63,904
- -------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 82,809
Futures Contracts 2,001
- -------------------------------------------------------------------------------
REALIZED NET GAIN 84,810
- -------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 36,137
Futures Contracts 459
- -------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 36,596
- -------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $185,310
===============================================================================
</TABLE>
15
<PAGE> 18
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>
- ----------------------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30,
------------------------------
1998 1997
(000) (000)
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 63,904 $ 52,021
Realized Net Gain 84,810 87,674
Change in Unrealized Appreciation (Depreciation) 36,596 330,068
------------------------------
Net Increase in Net Assets Resulting from Operations 185,310 469,763
------------------------------
DISTRIBUTIONS
Net Investment Income (65,293) (51,653)
Realized Capital Gain (78,880) (43,397)
------------------------------
Total Distributions (144,173) (95,050)
------------------------------
NET EQUALIZATION CREDITS--Note A -- 2,336
------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 691,426 438,790
Issued in Lieu of Cash Distributions 129,534 85,052
Redeemed (432,576) (262,262)
------------------------------
Net Increase from Capital Share Transactions 388,384 261,580
- ----------------------------------------------------------------------------------------------
Total Increase 429,521 638,629
- ----------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 1,948,010 1,309,381
------------------------------
End of Year $2,377,531 $1,948,010
==============================================================================================
(1)Shares Issued (Redeemed)
Issued 29,627 22,366
Issued in Lieu of Cash Distributions 5,766 4,493
Redeemed (18,560) (13,431)
Net Increase in Shares Outstanding 16,833 13,428
==============================================================================================
</TABLE>
16
<PAGE> 19
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>
- ----------------------------------------------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $22.28 $17.69 $15.65 $13.16 $14.62
- ----------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .64 .64 .63 .60 .59
Net Realized and Unrealized Gain (Loss)
on Investments 1.44 5.17 2.18 2.56 (.92)
----------------------------------------------------------
Total from Investment Operations 2.08 5.81 2.81 3.16 (.33)
----------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.67) (.64) (.60) (.58) (.61)
Distributions from Realized Capital Gains (.89) (.58) (.17) (.09) (.52)
----------------------------------------------------------
Total Distributions (1.56) (1.22) (.77) (.67) (1.13)
- ----------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $22.80 $22.28 $17.69 $15.65 $13.16
======================================================================================================================
TOTAL RETURN 9.54% 34.17% 18.22% 24.77% -2.19%
======================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $2,378 $1,948 $1,309 $967 $901
Ratio of Total Expenses to Average Net Assets 0.39% 0.45% 0.42% 0.47% 0.43%
Ratio of Net Investment Income to Average Net Assets 2.80% 3.25% 3.69% 4.27% 4.41%
Portfolio Turnover Rate 23% 22% 21% 31% 18%
======================================================================================================================
</TABLE>
17
<PAGE> 20
NOTES TO FINANCIAL STATEMENTS
Vanguard Equity Income 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. Temporary cash investments acquired over 60 days to maturity are valued
using the latest bid prices or using valuations based on a matrix system (which
considers such factors as security prices, yields, maturities, and ratings),
both as furnished by independent pricing services. Other temporary cash
investments are valued at amortized cost, which approximates market value.
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. EQUALIZATION: Prior to October 1997, the fund followed the accounting
practice known as "equalization," under which a portion of the price of capital
shares issued and redeemed, equivalent to undistributed net investment income
per share on the date of the transaction, was credited or charged to
undistributed net investment income. As a result, undistributed income per share
was unaffected by capital share transactions. As of October 1, 1997, the fund
has discontinued equalization accounting and has reclassified accumulated net
equalization credits of $18,182,000 from undistributed net investment income to
paid in capital. This reclassification has no effect on the fund's net assets,
results of operations, or net asset value per share.
4. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
5. FUTURES: The fund uses S&P 500 Index and S&P MidCap 400 Index futures
contracts to a limited extent, with the objective of maintaining full exposure
to the stock market while maintaining liquidity. The fund may purchase or sell
futures contracts to achieve a desired level of investment, whether to
accommodate portfolio turnover or cash flows from capital share transactions.
The primary risks associated with the use of futures contracts are imperfect
correlation between changes in market values of stocks held by the fund and the
prices of futures contracts, and the possibility of an illiquid market.
Futures contracts are valued at their quoted daily settlement prices. The
aggregate principal amounts of the contracts are not recorded in the financial
statements. Fluctuations in the value of the contracts are recorded in the
Statement of Net Assets as an asset (liability) and in the Statement of
Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized futures gains (losses).
6. 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.
7. 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.
18
<PAGE> 21
B. Newell Associates; Spare, Kaplan, Bischel & Associates; and John A. Levin &
Co., Inc., provide investment advisory services to the fund for fees calculated
at an annual percentage rate of average net assets. The basic fee of Spare,
Kaplan, Bischel & Associates is subject to quarterly adjustments based on
performance relative to the S&P/BARRA Value Index for the preceding three years;
the basic fee for John A. Levin & Co., Inc., is subject to quarterly adjustments
based on performance for the preceding three years relative to the S&P 500
Index.
The Vanguard Group manages the cash reserves of the fund on an at-cost
basis.
For the year ended September 30, 1998, the aggregate advisory fee
represented an effective annual basic rate of 0.16% of the fund's average net
assets before a decrease of $370,000 (0.02%) based on performance.
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 September 30, 1998, the fund had contributed capital of $462,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 0.7% of Vanguard's capitalization. The fund's Trustees and officers are also
Directors and officers of Vanguard.
Vanguard has asked the fund's investment advisers to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the fund part of the commissions generated. Such
rebates are used solely to reduce the fund's administrative expenses. For the
year ended September 30, 1998, these arrangements reduced the fund's expenses
by $207,000 (an annual rate of 0.01% of average net assets).
D. During the year ended September 30, 1998, the fund purchased $777,645,000 of
investment securities and sold $487,770,000 of investment securities other than
temporary cash investments. Gains of $9,250,000 on securities held for less than
one year are treated as ordinary income for tax purposes and have been included
in income dividends to shareholders; accordingly, such gains have been
reclassified from accumulated net realized gains to undistributed net investment
income.
E. At September 30, 1998, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $687,624,000,
consisting of unrealized gains of $735,407,000 on securities that had risen in
value since their purchase and $47,783,000 in unrealized losses on securities
that had fallen in value since their purchase.
At September 30, 1998, the aggregate settlement value of open futures
contracts expiring in December 1998 and the related unrealized appreciation
(depreciation) were:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
(000)
---------------------------------
AGGREGATE UNREALIZED
NUMBER OF SETTLEMENT APPRECIATION
FUTURES CONTRACTS LONG CONTRACTS VALUE (DEPRECIATION)
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
S&P 500 Index 287 $73,616 $ (840)
S&P MidCap 400 Index 166 25,830 1,299
- --------------------------------------------------------------------------------------------
</TABLE>
19
<PAGE> 22
REPORT OF INDEPENDENT
ACCOUNTANTS
[GRAPHIC]
To the Shareholders and
Board of Trustees of
Vanguard Equity Income 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 Equity Income Fund (the "Fund") at September 30, 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 September 30, 1998 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
October 30, 1998
SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR VANGUARD EQUITY INCOME FUND
This information for the fiscal year ended September 30, 1998, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $74,448,000 as capital gain dividends (from net
long-term capital gains) to shareholders in December 1997. Of the $74,448,000
capital gain dividends, the fund designates $41,088,000 as a 20% rate gain
distribution.
For corporate shareholders, 70.77% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
20
<PAGE> 23
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director of The Vanguard Group, Inc.,
and Trustee of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman, Chief Executive Officer, and Director of The Vanguard
Group, Inc., and Trustee of 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.
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> 24
VANGUARD
MILESTONES
[GRAPHIC]
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."
[GRAPHIC]
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.
[GRAPHIC]
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 VANGUARDGROUP 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.
Q650-11/10/1998
(C) 1998 Vanguard Marketing Corporation, Distributor. All rights reserved.
