<PAGE> 1
VANGUARD
EQUITY INCOME
FUND
Semiannual Report - March 31, 1998
[PHOTO]
[THE VANGUARD GROUP LOGO]
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OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--more than 7,000 highly
motivated men and women--who form the cornerstone of our operations. As with any
cornerstone, we could not survive long--let alone prosper--without it. That's
why we chose this fiscal year's fund reports to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also take
time to recognize the importance of the individual. Each calendar quarter, we
present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more than
300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving
you in the years ahead.
[PHOTO] [PHOTO]
John C. Bogle John J. Brennan
Senior Chairman Chairman & CEO
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
A MESSAGE TO OUR SHAREHOLDERS .............. 1
THE MARKETS IN PERSPECTIVE ................. 3
REPORT FROM THE ADVISERS ................... 5
PORTFOLIO PROFILE .......................... 6
PERFORMANCE SUMMARY ........................ 8
FINANCIAL STATEMENTS ....................... 9
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
Vanguard Equity Income Fund matched strides with a streaking bull market
in stocks--and provided returns well in excess of its peers--during the six
months ended March 31, 1998, the first half of the Fund's fiscal year.
The adjacent table presents the six-month returns earned by the Fund and
its two primary benchmarks, the average equity income fund and the unmanaged
Standard & Poor's 500 Composite Stock Price Index. As the table shows, the
Equity Income Fund's +17.2% total return (capital change plus reinvested
dividends) was one-third higher than that earned by the average competing fund
and matched the S&P 500 Index's return.
<TABLE>
<CAPTION>
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TOTAL RETURNS
SIX MONTHS ENDED
----------------
MARCH 31, 1998
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<S> <C>
Vanguard Equity Income Fund +17.2%
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Average Equity Income Fund +12.9%
- ---------------------------------------------------------
S&P 500 Index +17.2%
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</TABLE>
The Fund's return is based on an increase in net asset value from $22.28
per share on September 30, 1997, to $24.69 per share on March 31, 1998, with the
latter figure adjusted for income dividends of $0.39 per share paid from net
investment income and a distribution totaling $0.89 per share paid from net
realized capital gains.
THE PERIOD IN REVIEW
The U.S. stock market flourished during the six months ended March 31 as the
economy grew at a solid pace, consumers were ebullient, inflation remained
dormant, and interest rates declined. Yields on longer-term bonds fell on
balance by nearly 50 basis points (0.50 percentage point), with the 30-year U.S.
Treasury bond's yield closing the period at 5.93%. Yields on three-month U.S.
Treasury bills were fairly stable during the period, ending at 5.12% on March
31, 1998.
Stocks stumbled early in the fiscal year amid concerns that Asian
economic problems would seriously dent the U.S. economy and corporate earnings.
But the decline was brief; after a negative return of -3.3% in October, the S&P
500 Index chalked up gains in each of the five following months.
Gains were biggest for large-capitalization stocks. The S&P 500, which is
dominated by large-cap stocks, advanced +17.2%, while the rest of the stock
market, as measured by the Wilshire 4500 Equity Index, earned +10.0%. The
growth-stock component of the S&P 500 gained +20.3%, versus +14.0% for the value
component.
Your Fund benefited in comparison with competitors and the S&P 500 Index
from its emphasis on utility stocks. Utility stocks, which accounted for about
one-quarter of your Fund's assets during the period, gained 36.6%, making them
the market's strongest sector in the half-year. Your Fund's strategy of
investing in stocks whose dividend yields are relatively high compared with
their own past levels and the overall market's yield virtually requires a strong
commitment to utilities and the avoidance of technology stocks, many of which
don't pay dividends at all. Our light stake (0.9% on average) in technology
stocks helped during the period, when tech stocks were among the market's
laggards with a return of 5.4%.
Investing in utility stocks and other relatively high-yielding issues
makes the Fund somewhat sensitive to fluctuations in interest rates, a
characteristic that works in our favor
1
<PAGE> 4
when interest rates are declining, as during the half-year, but works against us
when rates are rising (as in 1994, for example).
Our low cost is a consistent aid versus competitors, most of which charge
heavy expenses. Our expense ratio--equal to 0.42% of net assets on an annual
basis--is nearly 1 percentage point below the 1.40% expense ratio charged by the
average equity income fund. Of course, even our low cost is a disadvantage
versus the Index, which exists only on paper and incurs no operating costs.
The Index also is always fully invested, while the typical mutual fund
holds a small cash reserve, which over the long term serves as a drag on
returns. To avoid this drag, your Fund began in January to invest in equity
index futures contracts to give its cash pool the performance of common stocks.
This practice enables the Fund to simulate full investment in stocks while
maintaining a cash pool of about 5% of assets to meet share redemptions. This
change should improve returns over the long run, although it also is expected to
slightly increase the Fund's share-price fluctuations.
As you know, your Fund uses three investment advisers to select stocks.
The table below shows the allocation to each adviser as of March 31, 1998. The
allocations changed little during the half year.
<TABLE>
<CAPTION>
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TOTAL ASSETS MANAGED
AS OF MARCH 31, 1998
---------------------
$ MILLION PERCENT
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<S> <C> <C>
Newell Associates $1,544 62%
John A. Levin & Company, Inc. 408 16
Spare, Kaplan, Bischel & Associates 406 16
Cash Reserves* 152 6
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TOTAL $2,510 100%
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</TABLE>
*Index futures are used so that the performance of cash reserves mimics that of
common stocks. Each adviser also may maintain a modest cash reserve.
Newell Associates has served as adviser for the Fund since its inception,
and we congratulate the Newell team on the Fund's tenth anniversary, which was
reached on March 21, ten days before the end of the period. On behalf of our
fellow shareholders, we thank all of our advisers for their work.
IN SUMMARY
For nearly 16 years--more than the entire lifetime of Vanguard Equity Income
Fund--the U.S. stock market has experienced a bull market that is without
precedent. Returns over this period--and during the six-month period just
concluded--have been nearly twice the average long-term return of about 11% a
year from common stocks. While investors have good reason to celebrate such
remarkable returns, we believe they also should be aware of the risks that are
part of investing in stocks. Investors must be able and willing to withstand
these risks--which are substantial--in order to reap the rewards of owning
stocks. We recommend a balanced portfolio consisting of stock funds, bond funds,
and money market investments in proportions suitable for each investor's goals
and circumstances as a time-tested vessel for staying the course toward your
financial goals.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
April 14, 1998 Chief Executive Officer
2
<PAGE> 5
THE MARKETS IN PERSPECTIVE
Six Months Ended March 31, 1998
The U.S. stock and bond markets benefited from a favorable, if rare, combination
of influences during the fiscal half-year ended March 31. Economic growth was
strong, inflationary forces were weak, interest rates were subdued, and
consumers were in an upbeat mood.
Asia's economic troubles--currency and banking crises afflicted several
nations--created anxiety and were largely blamed for a slump in stock prices
during October, when the S&P 500 Index declined by 7% in a single day. However,
a drumbeat of good news from the domestic economy soon restored the spring to
the markets' step. Economic growth continued to be robust. The U.S. economy
expanded at a 3.7% rate in the October-December quarter, job growth was rapid,
and the nation's unemployment rate was 4.7% in March. Despite the strong growth,
inflation was a virtual no-show, as consumer prices rose only 0.6% during the
half-year and were up a mere 1.4% for the 12 months ended March 31. Prices were
generally held in check by falling oil prices, improved productivity, and a
strengthening of the U.S. dollar, which has substantially reduced the prices of
imported products and materials. The combination of plentiful jobs and low
inflation helped to raise the spirits of consumers, whose spending is the
biggest force in the economy.
U.S. EQUITY MARKETS
Spirits were also high among investors in U.S. stocks, and they powered the
market averages to yet another impressive gain. The big blue chip stocks led the
advance, as the S&P 500 Index provided a total return of 17.2% during the six
months. Smaller stocks, as represented by the Russell 2000 Index, returned 6.4%.
<TABLE>
<CAPTION>
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TOTAL RETURNS
PERIODS ENDED MARCH 31, 1998
-----------------------------------
6 MONTHS 1 YEAR 5 YEARS*
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 17.2% 48.0% 22.4%
Russell 2000 Index 6.4 42.0 17.7
MSCI EAFE Index 5.9 18.9 12.2
- --------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 4.5% 12.0% 6.9%
Lehman 10-Year Municipal Bond Index 3.7 10.4 7.0
Salomon Brothers Three-Month
U.S. Treasury Bill Index 3.1 5.3 4.8
- --------------------------------------------------------------------------------
OTHER
Consumer Price Index 0.6% 1.4% 2.5%
- --------------------------------------------------------------------------------
</TABLE>
*Annualized.
Two key underpinnings of the stock market are corporate earnings and
interest rates. Investors hold stocks as long-term investments because they
expect the underlying earnings to grow over time, thereby making each share of
stock more valuable. Interest rates affect stocks in two ways. First, the
current level of interest rates represents the return an investor could get by
holding fixed-income securities instead of stocks. Second, the level of interest
rates reflects market expectations about inflation.
During the fiscal half-year, stock prices benefited from a moderate
decline in long-term interest rates and the low inflation rate. The news
concerning corporate earnings was more ambiguous. Security analysts'
expectations about earnings of stocks in the S&P 500
3
<PAGE> 6
Index began to decline in November and have continued to do so. However,
analysts still are forecasting gains in the high single digits for overall
profits in 1998. Despite the so-so news on profits, stock prices generally
advanced.
The best-performing market sectors during the six months appeared to
benefit from a combination of factors. One of these was concern about how much
Asia's economic troubles would affect the profits of U.S. companies. Another was
the confidence demonstrated by U.S. consumers, who continued to spend freely.
Primary beneficiaries of these influences were sectors unlikely to be affected
much by foreign competitors: utilities (which gained an extraordinary 36.6% for
the six months), health care (up 28.2%), and consumer staples (up 20.6%).
The sectors that lagged were those considered to be particularly
vulnerable to price-cutting by foreign competition or to a downturn in demand
caused by slower economic growth. This group included oil service and
exploration companies (down 4.4%), integrated oil companies (up only 2.0%), and
the materials & processing, technology, and producer-durables groups (up,
respectively, by 4.3%, 5.4%, and 6.4%).
U.S. FIXED-INCOME MARKETS
Inflation--the enemy of the fixed-income investor--was extraordinarily
well-behaved during the first half of the fiscal year. Consequently, bond prices
rose and the total return of the Lehman Brothers Aggregate Bond Index, a good
measure of the overall market for taxable bonds, provided a 4.5% return for the
six months, bringing its return over the past 12 months to 12.0%, a phenomenal
inflation-adjusted return of more than 10%. The yield on the benchmark 30-year
U.S. Treasury bond declined from 6.40% on September 30, 1997, to 5.93% on March
31.
Short-term interest rates were nearly unchanged, reflecting the stable
monetary policy of the Federal Reserve Board, whose policymakers seem to have
taken a "wait and see" approach to the question of how significantly the Asian
financial crisis will affect the U.S. economy.
INTERNATIONAL EQUITY MARKETS
Europe's stock markets generally rose during the first half of fiscal 1998,
while most Asian markets declined. Overall, the Morgan Stanley Capital
International Europe, Australasia, Far East Index gained 5.9% in U.S. dollar
terms. The Index returned 10.7% in local currency terms, but this was cut nearly
in half for U.S. investors by the dollar's strength (the U.S. currency gained
against every other key currency except the British pound).
The bull market in Europe was even more powerful than that on Wall
Street. European stocks returned more than 23% in local currency terms, which
translated to gains of 20.4% for the MSCI Europe Index in dollar terms. Stocks
were buoyed by signs that economic growth is accelerating throughout Europe and
by progress toward the planned adoption of a single European currency later in
1998.
The Pacific was a world away, economically as well as geographically,
from Europe. Although the emerging markets in Asia (Malaysia, Thailand, South
Korea) rebounded from their lows reached in late 1997, the overall downturn in
Pacific stocks was nearly as pronounced as the European upturn. Japan, the
Pacific Rim's largest market, returned -18.0%, and Hong Kong was hit even harder
(-28.1%). The Tokyo market was beset by fears about the soundness of Japan's
banking system and skepticism about the will and ability of Japan's government
to deal with the nation's financial problems.
4
<PAGE> 7
REPORT FROM THE ADVISERS
The stock market extended its powerful rise during the six months ended March
31, 1998, and Vanguard Equity Income Fund participated fully. Our 17.2% return
matched that of the S&P 500 Index and was well ahead of the 12.9% return
achieved by the average equity income fund.
The star performers for the Fund were regional telephone companies, whose
returns during the period were double that of the Index. These companies have
produced unexpectedly strong earnings, partly because they have yet to be
seriously affected by deregulation and increased competition. Other important
contributors to the Fund's return during the first half of fiscal 1998 were
banking, health care, automotive, and electric utility stocks.
Because of fears that deregulation would deal them a heavy blow, electric
utilities had been investment outcasts until late in 1997, when interest in the
group revived. Many utilities have made good progress in preparing themselves
for a competitive environment, and we believe that many investors continue to
underestimate their value.
The Fund's biggest disappointments were petroleum stocks, which
suffered from declining oil prices and expectations that weak economic growth in
Asia would keep oil demand and prices depressed. But oil companies generally
have strong balance sheets and their stocks offer attractive yields. Our
petroleum holdings provide something of a hedge against any unexpected pickup in
inflation.
The overall stock market is richly valued, as share prices have risen far
faster than corporate earnings. Traditional indicators of value, including
price/earnings ratios and dividend yields, suggest that the market is extended.
Certainly, there is little room for any adverse developments.
Although many sophisticated arguments are made to explain the stock
market's amazing ascent, the most important reason is simply that there is a lot
of money pouring into it. It is not just baby boomers saving for retirement who
are responsible. Nor is this purely a U.S. phenomenon. Around the globe, and
notably in Asia, government policies designed to stimulate local economies have
created investment opportunities for enormous amounts of capital. As this flood
of money sloshes around the world, it is bound to drive one market or another to
speculative excess. At the moment, the U.S. stock market is a key destination.
No one can say how all of this will end. For years, rumors of the bull
market's imminent demise have turned out to be greatly exaggerated. However, it
does not seem totally rash to say that the market's pace during the first three
months of 1998, when the S&P 500 Index rose 13.9%, will not be sustained for
long. One ancient adage may still hold true: Trees do not grow to the sky.
Newell Associates
John A. Levin & Company, Inc.
Spare, Kaplan, Bischel & Associates
April 14, 1998
INVESTMENT PHILOSOPHY
The advisers believe that a portfolio 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.
5
<PAGE> 8
PORTFOLIO PROFILE
Equity Income Fund
This Profile provides a snapshot of the Fund's characteristics as of March 31,
1998, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 7.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
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EQUITY INCOME S&P 500
- -----------------------------------------------------------
<S> <C> <C>
Number of Stocks 161 500
Median Market Cap $21.9B $41.7B
Price/Earnings Ratio 20.6x 24.5x
Price/Book Ratio 3.4x 4.6x
Yield 2.6% 1.4%
Return on Equity 18.5% 20.7%
Earnings Growth Rate 9.6% 17.2%
Foreign Holdings 2.2% 1.9%
Turnover Rate 21%* --
Expense Ratio 0.42%* --
Cash Reserves 1.1% --
</TABLE>
*Annualized.
INVESTMENT FOCUS
- ------------------------------------------------------------
[GRAPHIC]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
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EQUITY INCOME S&P 500
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<S> <C> <C>
R-Squared 0.86 1.00
Beta 0.70 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
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<S> <C>
Bell Atlantic Corp. 2.8%
Bristol-Myers Squibb Co. 2.3
Philip Morris Cos., Inc. 2.1
Exxon Corp. 2.0
GTE Corp. 1.9
Atlantic Richfield Co. 1.8
U S WEST Communications Group 1.8
Chevron Corp. 1.8
Texaco Inc. 1.8
American Home Products Corp. 1.7
- ------------------------------------------------------------
Top Ten 20.0%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- ----------------------------------------------------------------------------------------
MARCH 31, 1997 MARCH 31, 1998
---------------------------------------------
EQUITY INCOME EQUITY INCOME S&P 500
---------------------------------------------
<S> <C> <C> <C>
Auto & Transportation ............. 2.6% 3.4% 3.6%
Consumer Discretionary ............ 5.5 7.2 10.0
Consumer Staples .................. 10.0 7.7 10.9
Financial Services ................ 18.3 19.3 17.9
Health Care ....................... 11.4 9.8 11.7
Integrated Oils ................... 15.2 13.8 6.7
Other Energy ...................... 0.2 0.1 1.2
Materials & Processing ............ 6.3 6.7 5.6
Producer Durables ................. 1.9 2.2 4.1
Technology ........................ 1.1 1.0 12.0
Utilities ......................... 24.6 26.1 10.7
Other ............................. 2.9 2.7 5.6
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</TABLE>
6
<PAGE> 9
BETA. A measure of the magnitude of a portfolio'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 portfolio 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 portfolio'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 portfolio.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a portfolio's net assets represented by
stocks or American Depositary Receipts of companies based outside the United
States.
INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of the stocks in a portfolio. Half the stocks in the portfolio have
higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
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 portfolio, 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 portfolio, 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 portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio'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 portfolio, the weighted average return
on equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a portfolio'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 portfolio has invested
in its ten largest holdings. (The average for stock mutual funds is about 30%.)
As this percentage rises, a portfolio'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 period. Portfolios
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 portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio'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.
7
<PAGE> 10
PERFORMANCE SUMMARY
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.
EQUITY INCOME FUND
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: MARCH 21, 1988-MARCH 31, 1998
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EQUITY INCOME FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ------------------------------------------------------------
<S> <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* 15.3 1.9 17.2 17.2
- ------------------------------------------------------------
</TABLE>
*Six months ended March 31, 1998.
See Financial Highlights table on page 14 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 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 41.34% 19.74% 11.30% 5.14% 16.44%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
FINANCIAL STATEMENTS
March 31, 1998 (unaudited)
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (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>
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MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- --------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (91.0%)(1)
- --------------------------------------------------------------------
AUTO & TRANSPORTATION (3.0%)
Chrysler Corp. 105,500 $ 4,385
Ford Motor Co. 387,200 25,095
General Motors Corp. 87,300 5,887
Genuine Parts Co. 394,250 15,031
Norfolk Southern Corp. 221,000 8,260
Union Pacific Corp. 244,400 13,731
- - US Airways Group, Inc. 57,790 4,284
---------
76,673
---------
CONSUMER DISCRETIONARY (6.6%)
Black & Decker Corp. 162,100 8,601
Browning-Ferris Industries, Inc. 59,800 1,951
Deluxe Corp. 199,500 6,571
Eastman Kodak Co. 174,650 11,330
Fortune Brands, Inc. 679,400 27,091
IKON Office Solutions, Inc. 217,100 7,504
- - Kmart Corp. 509,200 8,497
May Department Stores Co. 310,500 19,717
The McGraw-Hill Cos., Inc. 111,200 8,458
J.C. Penney Co., Inc. 473,500 35,838
Reader's Digest Assn., Inc.
Class A 109,200 2,983
Tribune Co. 148,000 10,434
Wal-Mart Stores, Inc. 80,700 4,101
Waste Management Inc. 128,100 3,947
Whirlpool Corp. 99,900 6,849
- - Woolworth Corp. 31,300 783
---------
164,655
---------
CONSUMER STAPLES (7.0%)
Anheuser-Busch Cos., Inc. 412,800 19,118
The Clorox Co. 124,000 10,625
Gallaher Group PLC ADR 342,800 7,413
General Mills, Inc. 321,300 24,419
H.J. Heinz Co. 205,100 11,973
International Flavors &
Fragrances, Inc. 312,100 14,708
Kellogg Co. 191,800 8,271
Philip Morris Cos., Inc. 1,262,650 52,637
The Quaker Oats Co. 185,700 10,631
Ralston-Ralston Purina Group 31,300 3,318
UST, Inc. 406,900 13,122
---------
176,235
---------
FINANCIAL SERVICES (17.6%)
Ace, Ltd. 259,500 9,780
American General Corp. 449,818 29,097
Banc One Corp. 428,753 27,119
Bankers Trust New York Corp. 152,700 18,372
Beneficial Corp. 20,800 2,586
H & R Block, Inc. 184,000 8,752
Citicorp 25,900 3,678
CoreStates Financial Corp. 222,000 19,925
The Dun & Bradstreet Corp. 437,900 14,971
EXEL Ltd. 92,500 7,169
First Chicago NBD Corp. 183,500 16,171
First Data Corp. 333,200 10,829
First Union Corp. 331,600 18,818
Fleet Financial Group, Inc. 160,100 13,619
KeyCorp 292,800 11,072
Lincoln National Corp. 311,000 26,396
Marsh & McLennan Cos., Inc. 215,200 18,790
Mellon Bank Corp. 419,000 26,607
J.P. Morgan & Co., Inc. 173,500 23,303
NationsBank Corp. 550,018 40,117
</TABLE>
9
<PAGE> 12
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- --------------------------------------------------------------------
<S> <C> <C>
PartnerRe Ltd. 86,000 $ 4,225
PNC Bank Corp. 353,400 21,182
SAFECO Corp. 260,000 14,211
St. Paul Cos., Inc. 69,000 6,150
TIG Holdings, Inc. 206,600 5,436
U.S. Bancorp 79,183 9,878
Wachovia Corp. 149,600 12,688
Washington Mutual, Inc. 288,540 20,694
---------
441,635
---------
HEALTH CARE (9.0%)
Aetna Inc. 100,100 8,352
American Home Products Corp. 457,600 43,643
Baxter International, Inc. 110,500 6,091
Bristol-Myers Squibb Co. 542,000 56,537
Glaxo Wellcome PLC ADR 394,400 21,347
Eli Lilly & Co. 209,000 12,462
Merck & Co., Inc. 167,800 21,541
Pfizer, Inc. 100,100 9,979
Pharmacia & Upjohn, Inc. 891,925 39,022
Warner-Lambert Co. 35,000 5,961
---------
224,935
---------
INTEGRATED OILS (12.6%)
Amerada Hess Corp. 64,400 3,755
Amoco Corp. 406,800 35,137
Atlantic Richfield Co. 583,900 45,909
Chevron Corp. 558,300 44,838
Equitable Resources, Inc. 42,500 1,413
Exxon Corp. 730,400 49,393
Mobil Corp. 474,300 36,343
Phillips Petroleum Co. 259,200 12,944
Royal Dutch Petroleum Co. ADR 358,600 20,373
Texaco Inc. 735,200 44,296
USX-Marathon Group 272,000 10,234
Unocal Corp. 280,000 10,832
---------
315,467
---------
OTHER ENERGY (0.1%)
- - Oryx Energy Co. 90,200 2,345
---------
MATERIALS & PROCESSING (6.0%)
ARCO Chemical Co. 123,700 5,860
Allegheny Teledyne Inc. 298,800 8,310
BetzDearborn Inc. 21,700 1,225
Dow Chemical Co. 372,400 36,216
E.I. du Pont de Nemours & Co. 244,400 16,619
Eastman Chemical Co. 180,700 12,186
- - Getchell Gold Corp. 130,700 2,728
International Paper Co. 155,500 7,279
Kimberly-Clark Corp. 128,400 6,436
Lubrizol Corp. 174,600 6,722
- - Owens-Illinois, Inc. 61,700 2,668
Phelps Dodge Corp. 41,000 2,647
Potlatch Corp. 193,400 8,328
Union Camp Corp. 234,400 14,005
Weyerhaeuser Co. 333,300 18,831
Witco Chemical Corp. 73,400 2,890
---------
152,950
---------
PRODUCER DURABLES (2.0%)
Emerson Electric Co. 115,400 7,523
Honeywell, Inc. 60,200 4,978
Lockheed Martin Corp. 100,300 11,284
Pitney Bowes, Inc. 196,100 9,842
Thomas & Betts Corp. 139,800 8,947
United Technologies Corp. 83,400 7,699
---------
50,273
---------
TECHNOLOGY (1.0%)
Electronic Data Systems Corp. 111,478 5,114
International Business
Machines Corp. 106,100 11,021
Rockwell International Corp. 135,600 7,780
---------
23,915
---------
UTILITIES (23.7%)
AT&T Corp. 639,600 41,974
Allegheny Energy, Inc. 463,700 15,563
Ameren Corp. 307,500 12,953
Ameritech Corp. 799,100 39,505
Baltimore Gas & Electric Co. 380,150 12,426
Bell Atlantic Corp. 681,988 69,904
BellSouth Corp. 295,700 19,978
Central & South West Corp. 422,600 11,305
Consolidated Edison Inc. 170,700 7,980
Consolidated Natural Gas Co. 390,100 22,504
Dominion Resources, Inc. 162,300 6,817
Duke Energy Corp. 330,000 19,656
Edison International 463,100 13,603
Energy Group PLC ADR 20,350 1,146
Enova Corp. 128,200 3,582
FPL Group, Inc. 115,400 7,414
Florida Progress Corp. 130,200 5,428
GTE Corp. 783,000 46,882
KeySpan Energy Corp. 67,600 2,455
Long Island Lighting Co. 388,700 12,244
New Century Energies, Inc. 71,900 3,622
NICOR, Inc. 272,200 11,500
Northern States Power Co. 132,700 7,829
OGE Energy Corp. 197,300 11,419
PP&L Resources Inc. 234,000 5,528
Pacific Enterprises 317,500 12,958
PacifiCorp 573,400 14,120
Potomac Electric Power Co. 627,400 15,724
Public Service Enterprise
Group, Inc. 176,600 6,689
SBC Communications Inc. 587,538 25,631
SCANA Corp. 190,600 5,897
Southern Co. 486,100 13,459
Southern New England
Telecommunications Corp. 23,600 1,707
TECO Energy, Inc. 214,900 6,071
Texas Utilities Co. 336,500 13,229
U S WEST Communications
Group 819,050 44,843
- - U S WEST Media Group 166,100 5,772
Western Resources, Inc. 64,800 2,770
Wisconsin Energy Corp. 449,600 13,797
---------
595,884
---------
OTHER (2.4%)
Federal Signal Corp. 225,200 5,123
General Electric Co. 216,200 18,634
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------
<S> <C> <C>
Minnesota Mining &
Manufacturing Co. 335,350 $ 30,580
Ogden Corp. 181,400 5,215
---------
59,552
---------
- --------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,376,279) 2,284,519
- --------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (1.4%)
- --------------------------------------------------------------------
AirTouch Communications, Inc.
6.00% Cvt. Pfd. 140,000 5,775
+ Cendant Corp.
7.50% Cvt. Pfd. 58,400 3,037
Globalstar Telecommunications Ltd.
6.50% Cvt. Pfd. 76,100 8,010
Host Marriott Corp.
6.75% Cvt. Pfd. 75,000 4,284
Loral Space & Communications Ltd.
6.00% Cvt. Pfd. 90,000 6,784
Premier Parks Inc.
7.50% Cvt. Pfd. 52,700 3,057
Union Pacific Capital Trust
6.25% Cvt. Pfd. 77,300 4,107
- --------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $25,529) 35,054
- --------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------
CONVERTIBLE BONDS (0.2%)
- --------------------------------------------------------------------
Hewlett-Packard Co.
0.00%, 10/14/2017 $ 8,500 4,521
National Semiconductor
6.50%, 10/1/2002 1,590 1,530
- --------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $6,374) 6,051
- --------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (7.5%)
- --------------------------------------------------------------------
U.S. TREASURY BILL
(2)5.107%, 4/30/1998 6,000 5,974
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.97%, 4/1/1998 181,019 181,019
- --------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $186,994) 186,993
- --------------------------------------------------------------------
TOTAL INVESTMENTS (100.1%)
(COST $1,595,176) 2,512,617
- --------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.1%)
- --------------------------------------------------------------------
Other Assets--Note C $ 14,941
Liabilities (17,290)
----------
(2,349)
- --------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------
Applicable to 101,671,633 outstanding
$.001 par value shares
(authorized 1,000,000,000 shares) $2,510,268
====================================================================
NET ASSET VALUE PER SHARE $24.69
====================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
- -Non-Income-Producing Security.
+New issue that has not paid a dividend as of
March 31, 1998.
ADR--American Depositary Receipt.
(1) The combined market value of common stocks, convertible preferred stocks,
and futures contracts represents 98.6% of net assets.
(2) Security segregated as initial margin for open futures contracts.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
AT MARCH 31, 1998, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------
<S> <C> <C>
Paid in Capital--Note A $1,542,442 $15.17
Undistributed Net Investment
Income--Notes A and D 280 --
Accumulated Net
Realized Gains--Note D 45,299 .45
Unrealized Appreciation--Note E
Investment Securities 917,441 9.02
Futures Contracts 4,806 .05
- ----------------------------------------------------------------
NET ASSETS $2,510,268 $24.69
================================================================
</TABLE>
11
<PAGE> 14
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Fund during the
reporting period, and details the operating expenses charged to the Fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period. If the
Fund invested in futures contracts during the period, the results of these
investments are shown separately.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
EQUITY INCOME FUND
SIX MONTHS ENDED MARCH 31, 1998
(000)
- -------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 29,732
Interest 4,510
--------
Total Income 34,242
--------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 1,701
Performance Adjustment (169)
The Vanguard Group--Note C
Management and Administrative 2,566
Marketing and Distribution 243
Taxes (other than income taxes) 78
Custodian Fees 22
Auditing Fees 8
Shareholders' Reports 32
Annual Meeting and Proxy Costs 21
Directors' Fees and Expenses 2
--------
Total Expenses 4,504
Expenses Paid Indirectly--Note C (123)
--------
Net Expenses 4,381
- -------------------------------------------------------------------
NET INVESTMENT INCOME 29,861
- -------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 40,652
Futures Contracts 12,954
- -------------------------------------------------------------------
REALIZED NET GAIN 53,606
- -------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 265,954
Futures Contracts 4,806
- -------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 270,760
- -------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $354,227
===================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information 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
---------------------------------
SIX MONTHS YEAR
ENDED ENDED
MAR. 31, 1998 SEP. 30, 1997
(000) (000)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 29,861 $ 52,021
Realized Net Gain 53,606 87,674
Change in Unrealized Appreciation (Depreciation) 270,760 330,068
---------------------------------
Net Increase in Net Assets Resulting from Operations 354,227 469,763
---------------------------------
DISTRIBUTIONS
Net Investment Income (36,285) (51,653)
Realized Capital Gain (78,881) (43,397)
---------------------------------
Total Distributions (115,166) (95,050)
---------------------------------
NET EQUALIZATION CREDITS--Note A -- 2,336
---------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 378,551 438,790
Issued in Lieu of Cash Distributions 104,168 85,052
Redeemed (159,522) (262,262)
---------------------------------
Net Increase from Capital Share Transactions 323,197 261,580
- ---------------------------------------------------------------------------------------------------
Total Increase 562,258 638,629
- ---------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 1,948,010 1,309,381
---------------------------------
End of Period $ 2,510,268 $ 1,948,010
===================================================================================================
(1)Shares Issued (Redeemed)
Issued 16,586 22,366
Issued in Lieu of Cash Distributions 4,695 4,493
Redeemed (7,059) (13,431)
---------------------------------
Net Increase in Shares Outstanding 14,222 13,428
===================================================================================================
</TABLE>
13
<PAGE> 16
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the Fund;
and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in the
Fund for one year. Finally, the table lists the Fund's Average Commission Rate
Paid, a disclosure required by the Securities and Exchange Commission beginning
in 1996. This rate is calculated by dividing total commissions paid on portfolio
securities by the total number of shares purchased and sold on which commissions
were charged.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30,
FOR A SHARE OUTSTANDING SIX MONTHS ENDED -------------------------------------------------------------
THROUGHOUT EACH PERIOD MARCH 31, 1998 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $22.28 $17.69 $15.65 $13.16 $14.62 $12.81
- -----------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .32 .64 .63 .60 .59 .59
Net Realized and Unrealized Gain (Loss)
on Investments 3.37 5.17 2.18 2.56 (.92) 1.81
-------------------------------------------------------------------------
Total from Investment Operations 3.69 5.81 2.81 3.16 (.33) 2.40
-------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.39) (.64) (.60) (.58) (.61) (.59)
Distributions from Realized Capital Gains (.89) (.58) (.17) (.09) (.52) --
-------------------------------------------------------------------------
Total Distributions (1.28) (1.22) (.77) (.67) (1.13) (.59)
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $24.69 $22.28 $17.69 $15.65 $13.16 $14.62
===================================================================================================================================
TOTAL RETURN 17.23% 34.17% 18.22% 24.77% -2.19% 19.17%
===================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $2,510 $1,948 $1,309 $967 $901 $1,106
Ratio of Total Expenses to
Average Net Assets 0.42%* 0.45% 0.42% 0.47% 0.43% 0.40%
Ratio of Net Investment Income to
Average Net Assets 2.79%* 3.25% 3.69% 4.27% 4.41% 4.39%
Portfolio Turnover Rate 21%* 22% 21% 31% 18% 15%
Average Commission Rate Paid $.0587 $.0599 $.0598 N/A N/A N/A
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
14
<PAGE> 17
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.
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.
15
<PAGE> 18
NOTES TO FINANCIAL STATEMENTS (continued)
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; the basic fee for John A.
Levin & Co., Inc., is subject to quarterly adjustments based on performance
relative to the S&P 500 Index.
The Vanguard Group manages the cash reserves of the Fund on an at-cost
basis.
For the six months ended March 31, 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 $169,000 (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 Directors. At
March 31, 1998, the Fund had contributed capital of $140,000 to Vanguard
(included in Other Assets), representing 0.7% of Vanguard's capitalization. The
Fund's Directors 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
six months ended March 31, 1998, these arrangements reduced the Fund's expenses
by $123,000 (an annual rate of 0.01% of average net assets).
D. During the six months ended March 31, 1998, the Fund purchased
$403,042,000 of investment securities and sold $210,753,000 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 March 31, 1998, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $917,441,000,
consisting of unrealized gains of $919,448,000 on securities that had risen in
value since their purchase and $2,007,000 in unrealized losses on securities
that had fallen in value since their purchase.
At March 31, 1998, the aggregate settlement value of open futures
contracts expiring in June 1998 and the related unrealized appreciation were:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
(000)
------------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
S&P 500 Index 368 $102,166 $3,239
S&P Midcap 400 Index 289 53,964 1,567
-------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 19
DIRECTORS AND OFFICERS
JOHN C. BOGLE
Senior Chairman of the Board and Director of The Vanguard Group, Inc., and 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
of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
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.
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., and
NACCO Industries.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. 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.
RICHARD F. HYLAND
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
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 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," 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> 20
VANGUARD FAMILY OF FUNDS
STOCK FUNDS
Convertible Securities Fund
Equity Income Fund
Explorer Fund
Growth and Income Portfolio
Horizon Fund
Aggressive Growth Portfolio
Capital Opportunity Portfolio
Global Equity Portfolio
Index Trust
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Small Capitalization Stock
Portfolio
Total Stock Market Portfolio
Value Portfolio
Institutional Index Fund
International Equity Index Fund
Emerging Markets Portfolio
European Portfolio
Pacific Portfolio
International Growth Portfolio
International Value Portfolio
Morgan Growth Fund
PRIMECAP Fund
Selected Value Portfolio
Specialized Portfolios
Energy Portfolio
Gold & Precious Metals
Portfolio
Health Care Portfolio
REIT Index Portfolio
Utilities Income Portfolio
Tax-Managed Fund
Capital Appreciation
Portfolio
Growth and Income Portfolio
Total International Portfolio
Trustees' Equity Fund
U.S. Portfolio
U.S. Growth Portfolio
Windsor Fund
Windsor II
BALANCED FUNDS
Asset Allocation Fund
Balanced Index Fund
Horizon Fund
Global Asset Allocation
Portfolio
LifeStrategy Portfolios
Conservative Growth
Portfolio
Growth Portfolio
Income Portfolio
Moderate Growth Portfolio
STAR Portfolio
Tax-Managed Fund
Balanced Portfolio
Wellesley Income Fund
Wellington Fund
BOND FUNDS
Admiral Funds
Intermediate-Term U.S.
Treasury Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term U.S. Treasury
Portfolio
Bond Index Fund
Intermediate-Term Bond
Portfolio
Long-Term Bond Portfolio
Short-Term Bond Portfolio
Total Bond Market Portfolio
Fixed Income Securities Fund
GNMA Portfolio
High Yield Corporate Portfolio
Intermediate-Term Corporate
Portfolio
Intermediate-Term U.S.
Treasury Portfolio
Long-Term Corporate
Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term Corporate
Portfolio
Short-Term Federal Portfolio
Short-Term U.S. Treasury
Portfolio
Municipal Bond Fund
High-Yield Portfolio
Insured Long-Term Portfolio
Intermediate-Term Portfolio
Limited-Term Portfolio
Long-Term Portfolio
Short-Term Portfolio
Preferred Stock Fund
State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
MONEY MARKET FUNDS
Admiral Funds
U.S. Treasury Money Market
Portfolio
Money Market Reserves
Federal Portfolio
Prime Portfolio
Municipal Bond Fund
Money Market Portfolio
State Tax-Free Funds
(CA, NJ, NY, OH, PA)
Treasury Money Market Portfolio
Q652-3/1998
(C) 1998 Vanguard Marketing
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and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
