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A Member of The Vanguard Group
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PROSPECTUS -- January 22, 1998
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NEW ACCOUNT INFORMATION: Investor Information Department -- 1-800-662-7447
(SHIP)
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SHAREHOLDER ACCOUNT SERVICES: Client Services Department -- 1-800-662-2739
(CREW)
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INVESTMENT Vanguard Equity Income Fund, Inc. (the "Fund") is an
OBJECTIVE AND open-end diversified investment company which seeks a high
POLICIES level of current income by investing principally in
dividend-paying equity securities. In the selection of
these securities, the Fund will also consider the
potential for capital appreciation.
The average income yield of the common stocks held by the
Fund is expected to be at least 50% greater than that of
the Standard and Poor's 500 Composite Stock Price Index
("S&P 500 Index"). It is also anticipated that the Fund
will have less price volatility than the S&P 500 Index.
There is no assurance that the Fund will achieve its stated
objective. Shares of the Fund are neither insured nor
guaranteed by any agency of the U.S. Government, including
the FDIC.
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OPENING AN To open a regular (non-retirement) account, please complete
ACCOUNT and return the Account Registration Form. If you need
assistance in completing this Form, please call the Investor
Information Department. To open an Individual Retirement
Account (IRA), please use a Vanguard IRA Adoption Agreement.
To obtain a copy of this form, call 1-800-662-7447, Monday
through Friday, from 8:00 a.m. to 9:00 p.m., and Saturday,
from 9:00 a.m. to 4:00 p.m. (Eastern time). The minimum
initial investment is $3,000, or $1,000 for Uniform
Gifts/Transfers to Minors Act accounts. The Fund is offered
on a no-load basis (i.e., there are no sales commissions or
12b-1 fees). However, the Fund incurs expenses for
investment advisory, management, administrative and
distribution services.
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ABOUT THIS This Prospectus is designed to set forth concisely the
PROSPECTUS information you should know about the Fund before you
invest. It should be retained for future reference. A
"Statement of Additional Information" containing additional
information about the Fund has been filed with the
Securities and Exchange Commission. Such Statement is dated
January 22, 1998 and has been incorporated by reference into
this Prospectus. It may be obtained without charge by
writing to the Fund, by calling the Investor Information
Department at 1-800-662-7447 or by visiting the Securities
and Exchange Commission's Website (www.sec.gov).
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<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page Page Page
<S> <C> <C> <C>
Fund Expenses ............... 2 Investment Limitations ...... 8 SHAREHOLDER GUIDE
Financial Highlights ......... 2 Management of the Fund ...... 9 Opening an Account and
Yield and Total Return ...... 3 Investment Advisers ......... 10 Purchasing Shares ......... 16
FUND INFORMATION Performance Record ............ 12 When Your Account Will Be
Investment Objective ......... 4 Dividends, Capital Gains and Credited .................. 19
Investment Policies ......... 4 Taxes ..................... 13 Selling Your Shares ......... 20
Investment Risks ............ 5 The Share Price of the Fund ... 14 Exchanging Your Shares ...... 22
Who Should Invest ............ 5 General Information ......... 15 Important Information About
Implementation of Policies ... 6 Telephone Transactions ... 24
Transferring Registration ... 24
Other Vanguard Services ...... 25
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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<PAGE>
FUND EXPENSES The following table illustrates all expenses and fees that
you would incur as a shareholder of the Fund. The expenses
set forth below are for the 1997 fiscal year.
Shareholder Transaction Expenses
---------------------------------------------------------
Sales Load Imposed on Purchases .................. None
Sales Load Imposed on Reinvested Dividends ...... None
Redemption Fees ................................. None
Exchange Fees .................................... None
Annual Fund Operating Expenses
-------------------------------------------------------------
Management & Administrative Expenses ...... 0.26%
Investment Advisory Fees .................. 0.15
12b-1 Fees ................................. None
Other Expenses
Distribution Costs ........................ 0.02%
Miscellaneous Expenses .................. 0.02
----
Total Other Expenses ..................... 0.04%
----
Total Operating Expenses ............... 0.45%
====
The purpose of this table is to assist you in understanding
the various costs and expenses that you would bear directly
or indirectly as an investor in the Fund.
The following example illustrates the expenses that you
would incur on a $1,000 investment over various periods,
assuming (1) a 5% annual rate of return and (2) redemption
at the end of each time period. As noted in the table
above, the Fund charges no redemption fees of any kind.
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$ 5 $ 14 $ 25 $ 57
This example should not be considered a representation of
past or future expenses or performance. Actual expenses may
be higher or lower than those shown.
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FINANCIAL The following information on financial highlights for a
HIGHLIGHTS share outstanding throughout each period, insofar as it
relates to each of the five years in the period ended
September 30, 1997, has been derived from financial
statements which were audited by Price Waterhouse LLP,
independent accountants, whose report thereon was
unqualified. This information should be read in conjunction
with the Fund's financial statements and notes thereto,
which, together with the remaining portions of the Fund's
1997 Annual Report to Shareholders, are incorporated by
reference in the Statement of Additional Information and
this Prospectus, and which appear, along with the report of
Price Waterhouse LLP, in the Fund's 1997 Annual Report to
Shareholders. For a more complete discussion of the Fund's
performance, please see the Fund's 1997 Annual Report to
Shareholders which may be obtained without charge by writing
to the Fund or by calling our Investor Information
Department at 1-800-662-7447.
2
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<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ............................... $17.69 $15.65 $ 13.16 $ 14.62 $ 12.81
. ------- ------- -------- --------- --------
Investment Operations
Net Investment Income ................ .64 .63 .60 .59 .59
Net Realized and Unrealized Gain
(Loss) on Investments ............. 5.17 2.18 2.56 (.92) 1.81
------- ------- --------- --------- --------
Total from Investment
Operations ......................... 5.81 2.81 3.16 (.33) 2.40
- --------------------------------------- ------- ------- --------- --------- --------
Distributions
Dividends from Net Investment
Income ............................ (.64) (.60) (.58) (.61) (.59)
Distributions from Realized Capital
Gains ............................... (.58) (.17) (.09) (.52) --
------- ------- -------- --------- --------
Total Distributions ................ (1.22) (.77) (.67) (1.13) (.59)
- --------------------------------------- ------- ------- -------- --------- --------
Net Asset Value, End of Period ....... $22.28 $ 17.69 $ 15.65 $ 13.16 $ 14.62
======================================= ======= ======= ======== ========= ========
Total Return ......................... 34.17% 18.22% 24.77% (2.19)% 19.17%
======================================= ======= ======= ======== ========= ========
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $ 1,948 $ 1,309 $ 967 $ 901 $ 1,106
Ratio of Total Expenses to Average
Net Assets ......................... 0.45% 0.42% 0.47% 0.43% 0.40%
Ratio of Net Investment Income to
Average Net Assets ................... 3.25% 3.69% 4.27% 4.41% 4.39%
Portfolio Turnover Rate ............. 22% 21% 31% 18% 15%
Average Commission Rate Paid .......... $ .0599 $ .0598 N/A N/A N/A
<PAGE>
<CAPTION>
Mar. 21, 1988**
to
1992 1991 1990 1989 Sept. 30, 1988
---------- ---------- ----------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ............................... $ 12.14 $ 10.36 $ 13.07 $ 10.58 $ 10.00
-------- -------- -=------ -------- ---------
Investment Operations
Net Investment Income ................ .59 .65 .73 .76 .33
Net Realized and Unrealized Gain
(Loss) on Investments ............... .83 1.99 (2.77) 2.23 .49
-------- -------- -------- -------- ---------
Total from Investment
Operations ......................... 1.42 2.64 (2.04) 2.99 .82
- --------------------------------------- -------- -------- -------- -------- ---------
Distributions
Dividends from Net Investment
Income ............................ (.65) (.79) (.64) (.48) (.24)
Distributions from Realized Capital
Gains ............................... (.10) (.07) (.03) (.02) --
-------- -------- -------- -------- ---------
Total Distributions ................ (.75) (.86) (.67) (.50) (.24)
- --------------------------------------- -------- -------- -------- -------- ---------
Net Asset Value, End of Period ....... $ 12.81 $ 12.14 $ 10.36 $ 13.07 $ 10.58
======================================= ======== ======== ======== ======== =========
Total Return ......................... 12.26% 26.46% (16.25)% 28.85% 8.26%
======================================= ======== ======== ======== ======== =========
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $ 778 $ 518 $ 353 $ 267 $ 28
Ratio of Total Expenses to Average
Net Assets ......................... 0.44% 0.46% 0.48% 0.44% 0.72%*
Ratio of Net Investment Income to
Average Net Assets ................... 4.74% 5.52% 5.67% 6.01% 4.82%*
Portfolio Turnover Rate ............. 13% 9% 5% 8% 3%
Average Commission Rate Paid .......... N/A N/A N/A N/A N/A
</TABLE>
*Annualized.
**Commencement of operations.
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YIELD AND TOTAL From time to time the Fund may advertise its yield and total
RETURN return. Both yield and total return figures are based on
historical earnings and are not intended to indicate future
performance. The "total return" of the Fund refers to the
average annual compounded rates of return over one-, five-,
and ten-year periods or the life of the Fund (as stated in
the advertisement) that would equate an initial amount
invested at the beginning of a stated period to the ending
redeemable value of the investment, assuming the
reinvestment of all dividend and capital gains
distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "thirty-day
yield" of the Fund is calculated by dividing the net
investment income per share earned during a thirty-day
period by the net asset value per share on the last day of
the period. Net investment income includes interest and
dividend income earned on the Portfolio's securities; it is
net of all expenses and all recurring and nonrecurring
charges that have been applied to all shareholder accounts.
The yield calculation assumes that the net investment
income earned over thirty days is compounded monthly for
six months and then annualized. Accounting methods used to
calculate advertised yields are standardized for all stock
and bond mutual funds. However, yield accounting methods
differ from other accounting standards, and so the
advertised thirty-day yield may not fully reflect the
income paid to an investor's account.
3
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INVESTMENT The objective of the Fund is to provide a high level of
OBJECTIVE current income by investing principally in dividend-paying
equity securities. In the selection of these securities, the
The Fund seeks to Fund will also consider the potential for capital
provide a high appreciation. The average income yield of the Fund's common
level of income stocks is expected to be at least 50% greater than that of
the S&P 500 Index. It is also anticipated that the Fund will
have less price volatility than the S&P 500 Index. There is
no assurance that the Fund will achieve its objective.
The investment objective of the Fund is fundamental and so
cannot be changed without the approval of a majority of the
Fund's shareholders.
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INVESTMENT Under normal circumstances, the Fund will invest at least
POLICIES 80% of its assets in income-producing equity securities,
including dividend-paying common stocks and securities which
The Fund invests in are convertible into common stocks. The Fund intends to
income-producing invest in securities which generate relatively high levels
equity securities of dividend income and have the potential for capital
appreciation. These generally include common stocks of
established, high-quality U.S. corporations. In addition,
the Fund will seek to diversify its investments over a
carefully selected list of securities in order to moderate
the risks inherent in equity investments. The Fund is
managed without regard to tax ramifications.
The Fund will invest in a company's securities following a
fundamental analysis of the issuing company. An important
part of this analysis will be the examination of the
company's ability to maintain its dividend. Over time,
dividend income has proved to be an important component of
total return. For example, during the ten-year period ended
September 30, 1997, reinvested dividend income accounted
for approximately 23% of the total return of the S&P 500
Index. Also, dividend income tends to be a more stable
source of total return than capital appreciation. While the
price of a company's common stock can be significantly
affected by market fluctuations and other short-term
factors, its dividend level usually has greater stability.
For this reason, securities which pay a high level of
dividend income are generally less volatile in price than
securities which pay a low level of dividend income.
Although the Fund intends to invest primarily in equity
securities, it may invest up to 20% of its assets in
certain cash investments and certain short-term fixed
income securities. See "Implementation of Policies" for a
description of these and other investment practices of the
Fund.
The Fund is responsible for voting the shares of all
securities it holds.
These policies are not fundamental and so may be changed by
the Board of Directors without shareholder approval.
4
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INVESTMENT RISKS As a mutual fund investing primarily in common stocks, the
Fund is subject to market risk--i.e., the possibility that
Investors are stock prices in general will decline over short or even
exposed to the extended periods. The stock market tends to be cyclical,
market risk of with periods when stock prices generally rise and periods
common stocks when stock prices generally decline.
To illustrate the volatility of stock prices, the following
table sets forth the extremes for U.S. stock market returns
as well as the average return for the period from 1926 to
1997, as measured by the Standard & Poor's 500 Composite
Stock Price Index:
Average Annual U.S. Stock Market Returns (1926-1997)
Over Various Time Horizons
1 Year 5 Years 10 Years 20 Years
-------- --------- ---------- ---------
Best +53.9% +23.9% +20.1% +16.9%
Worst -43.3 -12.5 -0.9 -3.1
Average +13.0 +10.5 +10.9 +10.9
As shown, common stocks have provided annual total returns
(capital appreciation plus dividend income) averaging
+10.9% for all 10-year periods from 1926 to 1997. The
return in individual years has varied from a low of --43.3%
to a high of +53.9%, reflecting the short-term volatility
of stock prices. Average return may not be useful for
forecasting future returns in any particular period, as
stock returns are quite volatile from year to year.
This table of U.S. stock market returns should not be
viewed as a representation of future returns from the Fund
or the U.S. stock market. The illustrated returns represent
historical investment performance, which may be a poor
guide to future returns. Also, stock market indexes such as
the S&P 500 are based on unmanaged portfolios of securities
before transaction costs and other expenses. Such costs
will reduce the relative investment performance of the Fund
and other "real world" portfolios. Finally, the Fund is
likely to differ in portfolio composition from broad stock
market averages, and so the Fund's performance should not
be expected to mirror the returns provided by a specific
index.
Investors are also The Fund's investment advisers manage the Fund according to
exposed to manager the traditional methods of "active" investment management,
risk which involve the buying and selling of securities based
upon economic, financial and market analysis and investment
judgment. Manager risk refers to the possibility that the
Fund's investment advisers may fail to execute the Fund's
investment strategy effectively. As a result, the Fund may
fail to achieve its stated objective.
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WHO SHOULD INVEST The Fund is designed for investors who are seeking a high
level of the potential for long-term capital appreciation
Investors seeking with lower investment risk and volatility than is normally
current income and available from common stock funds. Because of the risk
capital growth associated with common stock investments, the Fund is
intended to be a current income and long-term investment
vehicle and is not designed to provide investors with a
means of speculating on short-term market movements.
Investors who engage in
5
<PAGE>
excessive account activity generate additional costs which
are borne by all of the Fund's shareholders. In order to
minimize such costs, the Fund has adopted the following
policies. The Fund reserves the right to reject any
purchase request (including exchange purchases from other
Vanguard portfolios) that is reasonably deemed to be
disruptive to efficient portfolio management, either
because of the timing of the investment or previous
excessive trading by the investor. Additionally, the Fund
has adopted exchange privilege limitations as described in
the section "Exchange Privilege Limitations." Finally, the
Fund reserves the right to suspend the offering of its
shares. While the Fund is intended to provide current
income and above average stability for an equity fund, it
should be considered part of a well rounded investment
portfolio and not its sole component.
Although the Fund may exhibit somewhat less volatility than
most other equity funds, the Fund should not be used as a
short-term investment vehicle. All equity portfolios, no
matter how they are structured, are influenced by price
movements in the broad equity market. Over the long term,
however, it is anticipated that the volatility of the
Fund's total return (dividend income plus capital
appreciation) will be lower than that of most other equity
funds and the S&P 500 Index due to the emphasis on equities
with above-average dividend yields. Investors may wish to
reduce the potential risk of investing in the Fund by
purchasing shares on a regular, periodic basis (dollar-cost
averaging) rather than making an investment in one lump
sum.
No assurance can be given that the Fund will attain its
objective or that shareholders will be protected from the
risk of loss that is inherent in equity investing.
Investors should not consider the Fund a complete
investment program, but should also maintain holdings in
investments with different risk characteristics, such as
bonds and money market instruments. Investors may also wish
to complement an investment in the Fund with other types of
common stock investments.
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IMPLEMENTATION In addition to investing primarily in equity securities, the
OF POLICIES Fund uses a number of other investment vehicles to achieve
its objective.
The Fund may invest Although it normally seeks to remain fully invested in
in short-term fixed equity securities, the Fund may invest in certain short-term
income securities fixed income securities. Such securities may be used without
limitation to invest uncommitted cash balances, to maintain
liquidity to meet shareholder redemptions, or to take a
temporary defensive position against potential stock market
declines. These securities include: obligations of the
United States Government and its agencies or
instrumentalities; commercial paper, bank certificates of
deposit, and bankers' acceptances; and repurchase agreements
collateralized by these securities.
The Fund, along with other Vanguard Funds, may deposit its
daily cash reserves into a joint account which invests such
reserves in repurchase agreements and other short-term
instruments. CoreStates Bank, N.A. is the custodian for the
joint account. A repurchase agreement is a means of
investing monies for a short period. In a repurchase
agreement, a seller--a U.S. commercial bank or recognized
6
<PAGE>
U.S. securities dealer--sells securities to the Fund and
agrees to repurchase the securities at the Fund's cost plus
interest within a specified period (normally one day). In
these transactions, the securities purchased by the Fund
will have a total value equal to, or in excess of, the
value of the repurchase agreement, and will be held by the
Custodian Bank for the joint account until repurchased.
Derivative Derivatives are instruments whose values are linked to or
Investing derived from an underlying security or index. The most
common and conventional types of derivative securities are
futures and options.
The Fund may invest The Fund may invest in futures contracts and options, but
in derivative only to a limited extent. Specifically, the Fund may enter
securities into futures contracts provided that not more than 5% of its
total assets are required as a futures contract deposit; in
addition, the Fund may enter into futures contracts and
options transactions only to the extent that obligations
under such contracts or transactions represent not more than
20% of the Fund's total assets.
Futures contracts and options may be used for several
common fund management strategies: to maintain cash
reserves while simulating full investment, to facilitate
trading, to reduce transaction costs, or to seek higher
investment returns when a specific futures contract is
priced more attractively than other futures contracts or
the underlying security or index.
The Fund will use futures contracts for bona fide "hedging"
purposes. In executing a hedge, a manager sells, for
example, stock index futures to protect against a decline
in the stock market. As such, if the market drops, the
value of the futures position will rise, thereby offsetting
the decline in value of the Fund's stock holdings.
Futures contracts The primary risks associated with the use of futures
and options pose contracts and options are: (i) imperfect correlation between
certain risks the change in market value of the stocks held by the Fund
and the prices of futures contracts and options; and (ii)
possible lack of a liquid secondary market for a futures
contract and the resulting inability to close a futures
position prior to its maturity date. The risk of imperfect
correlation will be minimized by investing in those
contracts whose price fluctuations are expected to resemble
those of the Fund's underlying securities. The risk that the
Fund will be unable to close out a futures position will be
minimized by entering into such transactions on a national
exchange with an active and liquid secondary market.
The risk of loss in trading futures contracts in some
strategies can be substantial, due both to the low margin
deposits required and the extremely high degree of leverage
involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in
immediate and substantial loss (as well as gain) to the
investor. When investing in futures contracts, the Fund
will segregate cash or other liquid portfolio securities in
the amount of the underlying obligation.
7
<PAGE>
The Fund may invest The Fund may invest up to 20% of its assets in foreign
in securities of securities and may engage in currency transactions with
foreign issuers respect to such investments. Securities of foreign issuers
may trade in U.S. or foreign securities markets. Securities
of foreign issuers may involve investment risks that are
different from those of domestic issuers. Such risks include
the effect of foreign economic policies and conditions,
future political and economic developments, and the possible
imposition of exchange controls or other foreign
governmental restrictions on foreign debt issuers. There may
also be less publicly available information about a foreign
issuer than a domestic issuer of securities. Foreign issuers
are generally not subject to the uniform accounting,
auditing and financial reporting standards that apply to
domestic issuers. Foreign debt markets may be characterized
by lower liquidity, greater price volatility, and higher
transactions costs. Additionally, it may be difficult to
obtain or enforce a legal judgment in a foreign court.
The Fund may lend The Fund may lend its investment securities to qualified
its securities institutional investors for either short-term or long-term
purposes of realizing additional income. Loans of securities
by the Fund will be collateralized by cash, letters of
credit, or securities issued or guaranteed by the U.S.
Government or its agencies. The collateral will equal at
least 100% of the current market value of the loaned
securities.
The Fund may The Fund may borrow money, subject to the limits set forth
borrow money below, for temporary or emergency purposes, including the
meeting of redemption requests which might otherwise require
the untimely disposition of securities.
Portfolio turnover Although it generally seeks to invest for the long term, the
is not expected to Fund retains the right to sell securities irrespective of
exceed 100% how long they have been held. It is anticipated that the
annual portfolio turnover of the Fund will not exceed 100%,
exclusive of securities with maturities less than one year.
A turnover rate of 100% would occur, for example, if all the
securities of the Fund were replaced within one year.
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INVESTMENT The Fund has adopted certain fundamental limitations on some
LIMITATIONS of its investment policies. Some of these limitations are
that the Fund may not:
The Fund has (a) invest more than 25% of its assets in any one industry;
adopted certain (b) with respect to 75% of the value of its total assets,
fundamental purchase the securities of any issuer (except
limitations obligations of the United States government and its
instrumentalities) if as a result the Fund would hold
more than 10% of the outstanding voting securities of
the issuer, or more than 5% of the value of the Fund's
total assets would be invested in the securities of
such issuer;
(c) engage in the business of underwriting securities
issued by other persons, except to the extent that the
Fund may technically be deemed to be an underwriter
under the Securities Act of 1933, as amended, in
disposing of investment securities;
(d) purchase or otherwise acquire any security if, as a
result, more than 15% of its net assets would be
invested in securities that are illiquid;
8
<PAGE>
(e) borrow money except from banks for temporary or
emergency purposes, and then only in an amount not in
excess of 15% of total assets taken at the lower of
their value or cost of its total assets; and
(f) pledge, mortgage or hypothecate any of its assets to an
extent greater than 5% of its total assets.
A complete list of applicable investment limitations can be
found in the Statement of Additional Information; these are
fundamental and may be changed only by approval of a
majority of the Fund's shareholders.
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MANAGEMENT OF The Fund is a member of The Vanguard Group of Investment
THE FUND Companies, a family of more than 30 investment companies
with more than 90 distinct investment portfolios and total
Vanguard assets in excess of $320 billion. Through their
administers and jointly-owned subsidiary, The Vanguard Group, Inc.
distributes the ("Vanguard"), the Fund and the other funds in the Group
Fund obtain at cost virtually all of their corporate management,
administrative, shareholder accounting and distribution
services. Vanguard also provides investment advisory
services on an at-cost basis to certain Vanguard funds. As a
result of Vanguard's unique corporate structure, the
Vanguard funds have costs substantially lower than those of
most competing mutual funds. In 1997, the average expense
ratio (annual costs including advisory fees divided by total
net assets) for the Vanguard funds amounted to approximately
.29% compared to an average of 1.21% for the mutual fund
industry (data provided by Lipper Analytical Services).
The Officers of the Fund manage its day-to-day operations
and are responsible to the Fund's Board of Directors. The
Directors set broad policies for the Fund and choose its
Officers. A list of the Directors and Officers of the Fund
and a statement of their present positions and principal
occupations during the past five years can be found in the
Statement of Additional Information, which is available
upon request.
Vanguard employs a supporting staff of management and
administrative personnel needed to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings and equipment. Each
fund pays a share of Vanguard's total expenses, which are
allocated among the funds under methods approved by the
Board of Directors (Trustees) of each fund. In addition,
each fund bears its own direct expenses, such as legal,
auditing and custodian fees.
Vanguard also provides distribution and marketing services
to the Vanguard funds. The funds are available on a no-load
basis (i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears a share of the Group's
distribution costs.
- --------------------------------------------------------------------------------
9
<PAGE>
INVESTMENT The Fund currently has four investment advisers: Newell
ADVISERS Associates ("Newell"), 525 University Avenue, Palo Alto,
California 94301; Spare, Kaplan, Bischel & Associates
The Fund employs ("Spare/Kaplan"), 44 Montgomery Street, Suite 3500, San
four investment Francisco, California 94104; John A. Levin & Co., Inc.
advisers ("Levin"), One Rockefeller Plaza, 25th Floor, New York, NY
10020; and The Vanguard Group, Inc., Post Office Box 2600,
Valley Forge, PA 19482. Prior to January 1, 1995, Newell was
the sole investment adviser to the Fund. Spare/Kaplan and
Levin were added as investment advisers effective January 1,
1995 and The Vanguard Group, Inc. was added as an adviser
effective January 16, 1998.
The proportion of the net assets of the Fund managed by
each adviser is established by the Board of Directors, and
may be changed in the future as circumstances warrant.
Presently, Newell is responsible for approximately 70% of
the Fund's investments; Spare/Kaplan and Levin are
responsible for approximately 15% each. Vanguard manages
the Fund's cash reserves which normally represent
approximately 5% of the Fund's net assets.
The Fund has entered into investment advisory agreements
with Newell, Spare/ Kaplan and Levin which provide that the
advisers manage the investment and reinvestment of the
Fund's assets and continuously review, supervise and
administer the Fund's investment program. The advisers
discharge their responsibilities subject to the control of
the Officers and Directors of the Fund.
For the fiscal year ended September 30, 1997, the Fund paid
advisory fees to Newell, Spare/Kaplan, and Levin of
$2,739,000 before a decrease of $287,000 based on
performance. The Vanguard Group, Inc. provides advisory
services on an at-cost basis.
Newell Associates The principal investment officer of Newell, Roger D.
Newell, has managed equity-income portfolios for more than
thirty years, and relative yield strategy portfolios since
1975. The relative yield approach is based upon an analysis
of how a stock's yield, relative to the market, varies over
time. This strategy asserts that relative yield is an
excellent guide to relative value. Mr. Newell has
implemented the firm's strategy for the Fund since the
Fund's inception in 1988.
The Fund pays Newell an advisory fee at the end of each
fiscal quarter, calculated by applying a quarterly rate,
based on the following annual percentage rates, to the
average month-end net assets managed by Newell for the
quarter:
Net Assets Rate
------------------ ------
First $250 million .200%
Next $500 million .150%
Next $250 million .100%
Over $1 billion .080%
Spare, Kaplan, Spare, Kaplan, Bischel & Associates ("Spare/Kaplan"), a
Bischel & California corporation founded in 1989, provides investment
Associates advisory services primarily to institutions. The investment
approach utilized by Spare/Kaplan is a relative yield
approach.
10
<PAGE>
Anthony E. Spare, Chief Investment Officer, has had
responsibility for the portion of the Fund managed by
Spare/Kaplan since Spare/Kaplan was added as an investment
adviser to the Fund in 1995. Mr. Spare has been associated
with Spare/Kaplan since 1989.
The Fund pays Spare/Kaplan a basic advisory fee at the end
of each fiscal quarter, calculated by applying a quarterly
rate, based on the following annual percentage rates, to
the average month-end assets of the Fund managed by
Spare/Kaplan for the quarter:
Net Assets Annual Rate
------------------ ------------
First $500 million 0.175%
Next $500 million 0.125%
Over $1 billion 0.100%
The basic fee paid to Spare/Kaplan, as provided above, may
be increased or decreased by applying an incentive/penalty
adjustment to the basic fee reflecting the investment
performance of the assets managed by Spare/Kaplan relative
to the return of the Standard and Poor's/BARRA Value Index
("Value Index"). Under the incentive/penalty fee schedule,
the fee payable to Spare/Kaplan may represent as much as
120% or as little as 80% of the basic fee, depending on the
net investment performance of the portfolio managed by
Spare/Kaplan.
John A. Levin & John A. Levin & Co. Inc. ("Levin"), an indirect wholly-owned
Co., Inc. subsidiary of Baker Fentress, founded in 1982, provides
investment advisory services primarily to institutions and
several partnerships. The investment process at Levin
emphasizes identifying investment value through fundamental
research. John A. Levin, and Jeffrey A. Kigner have had
responsibility for the portion of the Fund managed by Levin
since inception of the firm's relationship with the Fund.
Mr. Levin founded Levin in 1982, and Mr. Kigner has been
associated with Levin since 1984.
The Fund pays Levin a basic advisory fee at the end of each
fiscal quarter, calculated by applying a quarterly rate,
based on the following annual percentage rates, to the
average month-end assets of the Fund managed by Levin for
the quarter:
Net Assets Annual Rate
------------------ ------------
First $100 million 0.40%
Next $200 million 0.25%
Over $300 million 0.30%
The basic fee paid to Levin, as provided above, may be
increased or decreased by applying an incentive/penalty
adjustment to the basic fee reflecting the investment
performance of the assets managed by Levin relative to the
return of the Standard and Poor's 500 Composite Stock Price
Index ("S&P 500 Index"). Under the incentive/penalty fee
schedule, the basic fee payable to Levin may represent as
much as 140% or as little as 60% of the basic fee depending
on the investment performance of the equity investments
managed by Levin.
11
<PAGE>
The Vanguard Vanguard's Core Management Group began managing the Fund's
Group's Core cash reserves on an at-cost basis in January of 1998. Cash
Management Group reserves normally make up about 5% of the Fund's assets. In
order to keep the Fund more fully invested in common stocks
while retaining cash on hand to meet liquidity needs,
Vanguard may invest the Fund's cash reserves in stock
futures. Vanguard's Core Management Group serves as
investment adviser to several other Vanguard funds, and as
of September 30, 1997 managed more than $90 billion in total
assets.
The Fund's advisers are authorized to choose brokers or
dealers to handle the purchase and sale of the Fund's
securities, and are directed to get the best available
price and most favorable execution from these brokers with
respect to all transactions. At times, the advisers may
choose brokers who charge higher commissions in the
interests of obtaining better execution of a transaction.
If more than one broker can obtain the best available price
and favorable execution of a transaction, then the advisers
are authorized to choose a broker who, in addition to
executing the transaction, will provide research services
to the advisers or the Fund. However, the advisers will not
pay higher commissions specifically for the purpose of
obtaining research services. The Fund may direct the
advisers to use a particular broker for certain
transactions in exchange for commission rebates or research
services provided to the Fund.
The Fund's Board of Directors may, without the approval of
shareholders, provide for: (a) the employment of a new
investment adviser pursuant to the terms of a new advisory
agreement either as a replacement for an existing adviser
or as an additional adviser; (b) a change in the terms of
an advisory agreement; and (c) the continued employment of
an existing adviser on the same advisory contract terms
where a contract has been assigned because of a change in
control of the adviser. Any such change will only be made
upon not less than 30 days prior written notice to
shareholders of the Fund which shall include substantially
the information concerning the adviser that would have
normally been included in a proxy statement.
- --------------------------------------------------------------------------------
PERFORMANCE The table on page 13 provides investment results for the
RECORD Fund for one and five years and since inception. The results
shown represent "total return" investment performance, which
assumes the reinvestment of all capital gains and income
dividends for the indicated periods. Also included is
comparative information with respect to the unmanaged
Standard & Poor's 500 Composite Stock Price Index, a
widely-used barometer of stock market activity, and the
Consumer Price Index, a statistical measure of changes in
the prices of goods and services. The tables do not make any
allowance for federal, state or local income taxes, which
shareholders must pay on a current basis.
The results should not be considered a representation of
the total return from an investment made in the Fund today.
This information is provided to help investors better
understand the Fund and may not provide a basis for
comparison with other investments or mutual funds which use
a different method to calculate performance. Prior to
January 1, 1995, Newell Associates served as the Fund's
sole investment adviser.
12
<PAGE>
Average Annual Return for Vanguard Equity Income Fund
Percentage Change
--------------------------------------------
Fiscal Periods Vanguard Equity S&P 500 Consumer
Ended 9/30/97 Income Fund Index Price Index
-------------- ----------------- --------- ------------
1 Year +34.2% +40.4% +2.2%
5 Year +18.2 +20.8 +2.7
Lifetime* +15.1 +17.5 --
*March 21, 1988, to September 30, 1997.
- --------------------------------------------------------------------------------
DIVIDENDS, CAPITAL The Fund expects to pay quarterly dividends from ordinary
GAINS AND TAXES income. Capital gain distributions, if any, will be made
annually.
The Fund pays
quarterly dividends
and any capital In addition, in order to satisfy certain distribution
gains annually requirements of the Tax Reform Act of 1986, the Fund may
declare special year-end dividend and capital gains
distributions during December. Such distributions, if
received by shareholders by January 31, are deemed to have
been paid by the Fund and received by shareholders on
December 31 of the prior year.
Dividend and capital gains distributions may be
automatically reinvested or received in cash. See "Choosing
a Distribution Option" for a description of these
distribution methods.
The Fund intends to continue to qualify for taxation as a
"regulated investment company" under the Internal Revenue
Code so that it will not be subject to federal income tax
to the extent its income is distributed to shareholders.
Dividends paid by the Fund from net investment income and
net short-term capital gains, whether received in cash or
reinvested in additional shares, will be taxable to
shareholders as ordinary income. For corporate investors,
dividends from net investment income and net short-term
capital gains will generally qualify in part for the
intercorporate dividends-received deduction. However, the
portion of the dividends so qualified depends on the
aggregate taxable qualifying dividend income received by
the Fund from domestic (U.S.) sources.
Distributions paid by the Fund from long-term capital
gains, whether received in cash or reinvested in additional
shares, are taxable as long-term capital gains, regardless
of the length of time you have owned shares in the Fund.
Long-term gains may be taxed at different rates depending
on how long the Fund held the securities. Capital gains
distributions are made when the Fund realizes net capital
gains on sales of portfolio securities during the year. The
Fund does not seek to realize any particular amount of
capital gains during a year; rather, realized gains are a
by-product of portfolio management activities.
Consequently, capital gains distributions may be expected to
vary considerably from year to year; there will be no
capital gains distributions in years when the Fund realizes
net capital losses.
Note that if you accept capital gains distributions in cash,
instead of reinvesting them in additional shares, you are
in effect reducing the capital at work for you in the Fund.
Also, keep in mind that if you purchase shares in the Fund
shortly
13
<PAGE>
before the record date for a dividend or capital gains
distribution, a portion of your investment will be returned
to you as a taxable distribution, regardless of whether you
are reinvesting your distributions or receiving them in
cash.
The Fund will notify you annually as to the tax status of
dividend and capital gains distributions paid by the Fund.
A capital gain or A sale of shares of the Fund is a taxable event and may
loss may be result in a capital gain or loss. A capital gain or loss may
realized upon be realized from an ordinary redemption of shares or an
exchange or exchange of shares between two mutual funds (or two
redemption portfolios of a mutual fund).
Dividend distributions, capital gains distributions, and
capital gains or losses from redemptions and exchanges may
be subject to state and local taxes.
The Fund is required to withhold 31% of taxable dividends,
capital gains distributions, and redemptions paid to
shareholders who have not complied with IRS taxpayer
identification regulations. You may avoid this withholding
requirement by certifying on your Account Registration Form
your proper Social Security or employer identification
number and by certifying that you are not subject to backup
withholding.
The Fund has obtained a Certificate of Authority to do
business as a foreign corporation in Pennsylvania and does
business and maintains an office in that state. In the
opinion of counsel, the shares of the Fund are exempt from
Pennsylvania personal property taxes.
The tax discussion set forth above is included for general
information only. Prospective investors should consult
their own tax advisers concerning the tax consequences of
an investment in the Fund. The Fund is managed without
regard to tax ramifications.
- --------------------------------------------------------------------------------
THE SHARE PRICE The Fund's share price or "net asset value" per share is
OF THE FUND calculated by dividing the total assets of the Fund, less
all liabilities, by the total number of shares outstanding.
The net asset value is determined as of the close of the New
York Stock Exchange (generally 4:00 p.m. Eastern time), each
day that the exchange is open for trading.
Fund securities for which market quotations are readily
available (includes those securities listed on national
securities exchanges, as well as those quoted on the NASDAQ
Stock Market) will be valued at the last quoted sales price
on the day the valuation is made. Such securities which are
not traded on the valuation date are valued at the mean of
the bid and ask prices. Price information on exchange-listed
securities is taken from the exchange where the security is
primarily traded. Any foreign securities are valued at the
latest quoted sales price available before the time when
assets are valued. Securities may be valued on the basis of
prices provided by a pricing service when such prices are
believed to reflect the fair market value of such
securities.
14
<PAGE>
Short-term instruments (those with remaining maturities of
60 days or less) may be valued at cost, plus or minus any
amortized discount or premium, which approximates market
value.
Bonds and other fixed income securities may be valued on
the basis of prices provided by a pricing service when such
prices are believed to reflect the fair market value of
such securities. The prices provided by a pricing service
may be determined without regard to bid or last sale prices
of each security, but take into account institutional-size
transactions in similar groups of securities as well as any
developments related to specific securities.
Other assets and securities for which no quotations are
readily available or which are restricted as to sale (or
resale) are valued by such methods as the Board of
Directors deems in good faith to reflect fair value.
The share price for the Fund can be found daily in the
mutual fund listings of most major newspapers under the
heading of Vanguard Funds.
- --------------------------------------------------------------------------------
GENERAL The Fund is a Maryland corporation. The Fund's Articles of
INFORMATION Incorporation permit the Directors to issue 1,000,000,000
shares of common stock, with a $.001 par value. The Board of
Directors has the power to designate one or more classes
("Portfolios") of shares of common stock and to classify or
reclassify any unissued shares with respect to such
Portfolios. Currently the Fund is offering one class of
shares.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other
applicable law. An annual meeting will be held to vote on
the removal of a Director or Directors of the Fund if
requested in writing by the holders of not less than 10% of
the outstanding shares of the Fund.
The shares of the Fund are fully paid and nonassessable;
have no preferences as to conversion, exchange, dividends,
retirement or other features; and have no pre-emptive
rights. Such shares have non-cumulative voting rights,
meaning that the holders of more than 50% of the shares
voting for the election of Directors can elect 100% of the
Directors if they so choose. A shareholder is entitled to
one vote for each full share held (and a fractional vote
for each fractional share held).
All securities and cash are held by State Street Bank and
Trust Company, Boston, MA. The Vanguard Group, Inc., Valley
Forge, PA, serves as the Fund's Transfer and Dividend
Disbursing Agent. Price Waterhouse LLP, serves as
independent accountants for the Fund and will audit its
financial statements annually. The Fund is not involved in
any litigation.
- --------------------------------------------------------------------------------
15
<PAGE>
SHAREHOLDER GUIDE
OPENING AN You may open a regular (non-retirement) account, either by
ACCOUNT AND mail or wire. Simply complete and return an Account
PURCHASING Registration Form and any required legal documentation,
SHARES indicating the amount you wish to invest. Your purchase must
be equal to or greater than the $3,000 minimum initial
investment ($1,000 for Uniform Gifts/Transfers to Minors Act
accounts). You may open a new Individual Retirement Account
by mail (IRAs may not be opened by wire) using a Vanguard
IRA Adoption Agreement. Your purchase must be equal to or
greater than the $1,000 minimum initial investment
requirement, but no more than $2,000 if you are making a
regular IRA contribution. Rollover contributions are
generally limited to the amount withdrawn within the past 60
days from an IRA or other qualified retirement plan. If you
need assistance with the forms or have any questions about
the Fund, please call our Investor Information Department at
1-800-662-7447. Note: For other types of account
registrations (e.g., corporations, associations, other
organizations, trusts or powers of attorney), please call us
to determine which additional forms you may need.
The Fund's shares are purchased at the next-determined net
asset value after your investment has been received. The
Fund is offered on a no-load basis (i.e., there are no
sales commissions or 12b-1 fees).
Purchase 1) Because of the risks associated with common stock
Restrictions investments, the Fund is intended to be a long-term
investment vehicle and is not designed to provide
investors with a means of speculating on short-term
stock market movements. Consequently, the Fund reserves
the right to reject any specific purchase (or exchange
purchase) request. The Fund also reserves the right to
suspend the offering of shares for a period of time.
2) Vanguard will not accept third-party checks to purchase
shares of the Fund. Please be sure your purchase check
is made payable to The Vanguard Group.
Additional Subsequent investments may be made by mail ($100 minimum),
Investments wire ($1,000 minimum), exchange from another Vanguard Fund
account, or Vanguard Fund Express. Subsequent investments to
Individual Retirement Accounts may be made by mail ($100
minimum) or exchange from another Vanguard Fund account. In
some instances, contributions may be made by wire or
Vanguard Fund Express. Please call us for more information
on these options.
------------------------------------------------------------
16
<PAGE>
<TABLE>
<CAPTION>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
<S> <C> <C>
Purchasing By Mail Please include the amount of your Additional investments should
Complete and sign initial investment, make your include the Invest-by-Mail remittance
the enclosed check payable to The Vanguard form attached to your Fund
Account Group-65 and mail to: confirmation statements. Please
Registration Form make your check payable to The
Vanguard Financial Center Vanguard Group-65, write your
P.O. Box 2600 account number on your check
Valley Forge, PA 19482-2600 and, using the return envelope
provided, mail to the address indicated
on the Invest-by-Mail Form.
and, using the return
envelope provided, mail
to the address indicated
on the Invest-by-Mail
Form.
For express Vanguard Financial Center All written requests should be
or registered 455 Devon Park Drive mailed to one of the addresses
mail, send to: Wayne, PA 19087-1815 indicated for new accounts. Do not
send registered or express mail to
the post office box address.
--------------------------------------------------------------------------
</TABLE>
Purchasing By Wire CORESTATES BANK, N.A.
Money should be ABA 031000011
wired to: CORESTATES NO. 0101 9897
ATTN VANGUARD
Before Wiring
Please contact VANGUARD EQUITY INCOME FUND
Client Services ACCOUNT NUMBER
(1-800-662-2739) ACCOUNT REGISTRATION
To assure proper receipt, please be sure your bank includes
the name of the Fund, the account number Vanguard has
assigned to you and the eight digit CoreStates number. If
you are opening a new account, you must contact our Client
Services Department (1-800-662-2739) before wiring funds.
Also, please complete the Account Registration Form and
mail it to the "New Account" address above after completing
your wire arrangement. Note: Federal Funds wire purchase
orders will be accepted only when the Fund and Custodian
Bank are open for business.
------------------------------------------------------------
Purchasing By You may open a new account or purchase additional shares by
Exchange (from a making an exchange from an existing Vanguard account.
Vanguard account) However, the Fund reserves the right to refuse any exchange
purchase request. Please call our Client Services Department
at 1-800-662-2739 for assistance. The new account will have
the same registration as the existing account.
------------------------------------------------------------
Purchasing By Fund The Fund Express Special Purchase option lets you move
Express money from your bank account to your Vanguard account at
your request. Or if you choose the Automatic Investment
Special Purchase option, money will be moved from your bank account to your
and Automatic Vanguard account on the schedule (monthly, bimonthly [every
Investment other month],
17
<PAGE>
quarterly, semi-annually or annually) you select. To
establish these Fund Express options, please provide the
appropriate information on the Account Registration Form.
We will send you a confirmation of your Fund Express
service; please wait two weeks before using the service.
- -------------------------------------------------------------------------------
CHOOSING A You must select one of three distribution options:
DISTRIBUTION 1. Automatic Reinvestment Option--Both dividend and capital
OPTION gains distributions will be reinvested in additional
Fund shares. This option will be selected for you
automatically unless you specify one of the other options.
2. Cash Dividend Option--Your dividends will be paid in
cash and your capital gains will be reinvested in
additional Fund shares.
3. All Cash Option--Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client Services
Department (1-800-662-2739).
If a shareholder has chosen to receive dividend and/or
capital gains distributions in cash, and the postal or other
delivery service is unable to deliver checks to the
shareholder's address of record, we will change the
distribution option so that all dividends and other
distributions are automatically reinvested in additional
shares. We will not pay interest on uncashed distribution
checks.
In addition, an option to invest your cash dividend and/or
capital gains distributions in another Vanguard Fund account
is available. Please call our Client Services Department
(1-800-662-2739) for information. You may also elect
Vanguard Dividend Express which allows you to transfer your
cash dividend and/or capital gains distributions
automatically to your bank account. Please see "Other
Vanguard Services" for more information.
- --------------------------------------------------------------------------------
TAX CAUTION Under Federal tax laws, the Fund is required to distribute
net capital gains and dividend income to Fund shareholders.
Investors should These distributions are made to all shareholders who own
ask about the Fund shares as of the distribution's record date, regardless
timing of capital how long the shares have been owned. Purchasing shares just
gains and dividend prior to the record date could have a significant impact on
distributions your tax liability the year. For example, if you purchase
before investing shares immediately prior to the record date of a sizable
capital gain, you will be assessed taxes on the amount of
the capital gains distribution, even though you owned the
Fund shares for just a short period of time. (Taxes are due
on the distributions even if the dividend or gain is
reinvested in additional Fund shares.) While the total
value of your investment will be the same after the capital
gains distribution--the amount of the capital gain
distribution will offset the drop in the net asset value of
the shares--you should be aware of the tax implications the
timing of your purchase may have.
Prospective investors should, therefore, inquire about
potential distributions before investing. The Fund's annual
capital gains distributions normally occur in December,
while income dividends are generally paid quarterly in
March, June,
18
<PAGE>
September and December. In addition, the Fund may
occasionally be required to make supplemental dividend or
capital gains distributions at some other time during the
year. For additional information on distributions and
taxes, see the section titled "Dividends, Capital Gains,
and Taxes."
- --------------------------------------------------------------------------------
IMPORTANT The easiest way to establish optional Vanguard services on
ACCOUNT your account is to select the options you desire when you
INFORMATION complete your Registration Form. If you wish to add
shareholder options later, you may need to provide Vanguard
Establishing with additional information and a signature guarantee.
Optional Please call our Client Services Department (1-800-662-2739)
Services for assistance.
Signature For our mutual protection, we may require a signature
Guarantees guarantee on certain written transaction requests. A
signature guarantee verifies the authenticity of your
signature, and may be obtained from banks, brokers and any
other guarantor that Vanguard deems acceptable. A signature
guarantee cannot be provided by a notary public.
Certificates Share certificates will be issued upon request. If a
certificate is lost, you may incur an expense to replace
it.
Broker-Dealer If you purchase shares in Vanguard Funds through a
Purchases registered broker-dealer or investment adviser, the
broker-dealer or adviser may charge a service fee.
Cancelling Trades The Fund will not cancel any trade (e.g., purchase,
exchange or redemption) believed to be authentic, received
in writing or by telephone, once the trade request has been
received.
Electronic You may receive a prospectus for the Fund or any of the
Prospectus Vanguard Funds in an electronic format through Vanguard's
Delivery website at www.vanguard.com. For additional information
please see "Other Vanguard Services--Computer Access."
- --------------------------------------------------------------------------------
WHEN YOUR Your trade date is the date on which your account is
ACCOUNT WILL BE credited. If your purchase is made by check, Federal Funds
CREDITED wire or exchange and is received before the close of
trading on the New York Stock Exchange (generally 4:00
p.m. Eastern time), your trade date is the day of receipt.
If your purchase is received after the close of the
Exchange, your trade date is the next business day. Your
shares are purchased at the net asset value determined on
your trade date.
In order to prevent lengthy processing delays caused by the
clearing of foreign checks, Vanguard will only accept a
foreign check which has been drawn in U.S. dollars and has
been issued by a foreign bank with a United States
correspondent bank. The name of the U.S. correspondent bank
must be printed on the face of the foreign check.
- --------------------------------------------------------------------------------
19
<PAGE>
SELLING YOUR You may withdraw any portion of the funds in your account
SHARES by redeeming shares at any time. (Please see "Important
Redemption Information.") You generally may initiate a
request by writing or by telephoning. Your redemption
proceeds are normally mailed within two business days after
the receipt of the request in Good Order. No interest will
accrue on amounts represented by uncashed redemption checks.
------------------------------------------------------------
Selling By Mail Requests should be mailed to Vanguard Financial Center,
Vanguard Equity Income Fund, P.O. Box 1120, Valley Forge,
PA 19482-1120. (For express or registered mail, send your
request to Vanguard Financial Center, Vanguard Equity
Income Fund, 455 Devon Park Drive, Wayne, PA 19087-1815.)
The redemption price of shares will be the Fund's net asset
value next determined after Vanguard has received all
required documents in Good Order.
------------------------------------------------------------
Definition of Good Order means that the request includes the following:
Good Order
1. The account number and Fund name.
2. The amount of the transaction (specified in dollars or
shares).
3. The signatures of all owners exactly as they are
registered on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that may be
required in cases of estates, corporations, trusts, and
certain other accounts.
6. Any certificates you hold for the account.
If you have any questions about this definition as it
pertains to your request, please call our Client Services
Department at 1-800-662-2739.
------------------------------------------------------------
Selling By To sell shares by telephone, you or your pre-authorized
Telephone representative may call our Client Services Department at
1-800-662-2739. The proceeds will be sent to you by mail.
Please Note: As a protection against fraud, your telephone
mail redemption privilege will be suspended for 15 calendar
days following any expedited address change to your
account. An expedited address change is one that is made by
telephone or in writing, without the signatures of all
account owners. Please see "Important Information About
Telephone Transactions."
------------------------------------------------------------
Selling By Fund If you select the Fund Express Automatic Withdrawal option,
Express money will be automatically moved from your Vanguard Fund
account to your bank account according to the schedule you
Automatic have selected. The Special Redemption option lets you move
Withdrawal money from your Vanguard account to your bank account on
& Special your request. You may elect Fund Express on the Account
Redemption Registration Form, or call our Investor Information
Department at 1-800-662-7447 for a Fund Express application.
------------------------------------------------------------
Selling By You may sell shares of the Fund by making an exchange into
Exchange another Vanguard Fund account. Please see "Exchanging Your
Shares" for details.
------------------------------------------------------------
20
<PAGE>
Important Shares purchased by check or Fund Express may be redeemed
Redemption at any time. However, your redemption proceeds will not be
Information paid until payment for the purchase is collected, which may
take up to ten calendar days.
------------------------------------------------------------
Delivery of Redemption requests received by telephone prior to the
Redemption close of trading on the New York Stock Exchange
Proceeds (generally 4:00 p.m. Eastern time) are processed on
the day of receipt and the redemption proceeds are normally
sent on the following business day.
Redemption requests received by telephone after the close
of trading on the New York Stock Exchange (generally 4:00
p.m. Eastern time) are processed on the business day
following receipt and the proceeds are normally sent on the
second business day following receipt.
All unpaid dividends credited to your account up to the
date of redemption will be included in the redemption
check. Redemption proceeds must be sent to you within seven
days of receipt of your request in Good Order, except as
described above in "Important Redemption Information."
If you experience difficulty in making a telephone
redemption during periods of drastic economic or market
changes, your redemption request may be made by regular or
express mail. It will be implemented at the net asset value
next determined after your request has been received by
Vanguard in Good Order. The Fund reserves the right to
revise or terminate the telephone redemption privilege at
any time.
The Fund may suspend the redemption right or postpone
payment at times when the New York Stock Exchange is
closed, or under any emergency circumstances as determined
by the United States Securities and Exchange Commission.
If the Board of Directors determines that it would be
detrimental to the best interests of the Fund's remaining
shareholders to make payment in cash, the Fund may pay the
redemption proceeds in whole or in part by a distribution
in kind of readily marketable securities.
------------------------------------------------------------
Vanguard's Average If you make a redemption from a qualifying account,
Cost Statement Vanguard will send you an Average Cost Statement which
provides you with the cost and tax basis of the shares you
redeemed. Please see "Statements and Reports" for
additional information.
------------------------------------------------------------
Low Balance Fee Due to the relatively high cost of maintaining smaller
and Minimum accounts, the Fund will automatically deduct a $10 annual
Account Balance fee in either June or December from non-retirement
Requirement accounts with balances falling below $2,500 ($500 for
Uniform Gifts/Transfers to Minors Act accounts). The fee
generally will be waived for investors whose aggregate
Vanguard assets exceed $50,000. In addition, the Fund
reserves the right to liquidate any non-retirement account
that is below the minimum initial investment amount of
$3,000. If at any time your total investment does not have a
value of at least $3,000, you may be notified that the value
of your account is below the Fund's
21
<PAGE>
minimum account balance requirement. You would then be
allowed 60 days to make an additional investment before the
account is liquidated. Proceeds would be promptly paid to
the registered shareholder.
Vanguard will not liquidate your account if it has fallen
below $3,000 solely as a result of declining markets (i.e.,
a decline in a Fund's net asset value).
- --------------------------------------------------------------------------------
EXCHANGING YOUR Should your investment goals change, you may exchange your
SHARES shares of Vanguard Equity Income Fund for those of other
available Vanguard Funds.
Exchanging By In addition to the details below, please see "Important
Telephone Information About Telephone Transactions."
Call Client When exchanging shares by telephone, please have ready the
Services Fund name, account number, Social Security number or
(1-800-662-2739) employer identification number listed on the account, and
the exact name and address in which the account is
registered. Only the registered shareowner (or his or her
pre-authorized representative) may complete such an
exchange. Requests for telephone exchanges received prior
to the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) are processed at the
close of business that same day.
Requests received after the close of trading on the New
York Stock Exchange (generally 4 p.m. Eastern time) are
processed the next business day. Telephone exchanges are
not accepted into or from non-IRA investments in Vanguard
Balanced Index Fund, Vanguard Index Trust, Vanguard
International Equity Index Fund, Vanguard Growth and Income
Portfolio, Vanguard Star Fund-Total International
Portfolio, and Vanguard REIT Index Portfolio. If you
experience difficulty in making a telephone exchange, your
exchange request may be made by regular or express mail,
and it will be implemented at the closing net asset value
on the date received by Vanguard provided the request is
received in Good Order.
Neither the Fund nor Vanguard is responsible for the
authenticity of exchange instructions received by
telephone. Investors bear the full risk of any loss arising
from unauthorized telephone exchanges. To prohibit
telephone exchanges on your account, please notify the Fund
in writing. Otherwise, the telephone exchange privilege
will be automatically established for your account.
------------------------------------------------------------
Exchanging By Mail Please be sure to include on your exchange request the name
and account number of your current Fund, the name of the
Fund you wish to exchange into, the amount you wish to
exchange, and the signatures of all registered account
holders. Send your request to Vanguard Financial Center,
Vanguard Equity Income Fund, P.O. Box 1120, Valley Forge,
PA 19482-1120. (For express or registered mail, send your
request to Vanguard Financial Center, Vanguard Equity
Income Fund, 455 Devon Park Drive, Wayne, PA 19087-1815.)
------------------------------------------------------------
22
<PAGE>
Exchanging Online You may use your personal computer to exchange shares of
most Vanguard funds by accessing Vanguard's website
(www.vanguard.com). To establish this service on your
account, you must first register through our website. We
will then send to you by mail, an account access password
that will enable you to make online exchanges.
The Vanguard funds that you cannot purchase or sell through
online exchange are Vanguard Index Trust, Vanguard Balanced
Index Fund, Vanguard International Equity Index Fund,
Vanguard REIT Index Portfolio, Vanguard Total International
Portfolio, and Vanguard Growth and Income Portfolio
(formerly known as Vanguard Quantitative Portfolios). These
funds do permit online exchanges within IRAs and other
retirement accounts.
------------------------------------------------------------
Important Exchange Before you make an exchange, you should consider the
Information following:
o Please read the Fund's prospectus before making an
exchange. For a copy and for answers to any questions you
may have, call our Investor Information Department
(1-800-662-7447).
o An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on the
transaction.
o Exchanges by telephone are accepted only if the
registrations and the taxpayer identification numbers of
the two accounts are identical.
o In order to exchange into an account with a different
registration (including a different name, address, or
taxpayer identification number), you must obtain the
guaranteed signatures of all current account owners on
your written instructions.
o The shares to be exchanged must be on deposit and not
held in certificate form.
o New accounts are not currently accepted in
Vanguard/Windsor Fund.
o The redemption price of shares redeemed by exchange is
the net asset value next determined after Vanguard has
received the required documentation in Good Order.
o When opening a new account by exchange, you must meet the
minimum investment requirement of the new Fund.
Every effort will be made to maintain the exchange
privilege. However, the Fund reserves the right to revise
or terminate its provisions, limit the amount of, or reject
any exchange, as deemed necessary, at any time.
The exchange privilege is only available in states in which
the shares of the Fund are registered for sale. The Fund's
shares are currently registered for sale in all 50 states
and the Fund intends to maintain such registration.
- --------------------------------------------------------------------------------
23
<PAGE>
EXCHANGE The Fund's exchange privilege is not intended to afford
PRIVILEGE shareholders a way to speculate on short-term movements in
LIMITATIONS the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive exchange
activity.
Exchange activity generally will not be deemed excessive if
limited to two substantive exchange redemptions (at least
30 days apart) from the Fund during any twelve month
period. "Substantive" means either a dollar amount large
enough to have a negative impact on the Fund or a series of
movements between Vanguard Funds. Notwithstanding these
limitations, the Fund reserves the right to reject any
purchase request (including exchange purchases from other
Vanguard portfolios) that is reasonably deemed to be
disruptive to efficient portfolio management.
- --------------------------------------------------------------------------------
IMPORTANT The ability to initiate redemptions (except wire or Fund
INFORMATION Express redemptions) and exchanges by telephone is
ABOUT TELEPHONE automatically established on your unless you request in
TRANSACTIONS writing that telephone transactions on your account not be
permitted.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions, Vanguard
adheres to the following security procedures:
1. Security Check. To request a transaction by telephone,
the caller must know (i) the name of the Fund; (ii) the
10-digit account number; (iii) the exact name and address
used in the registration; and (iv) the Social Security or
employer identification number listed on the account.
2. Payment Policy. The proceeds of any telephone redemption
made by mail will be made payable to the registered
shareowner and mailed to the address of record, only.
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by
telephone, provided that reasonable security procedures
have been followed. Vanguard believes that the security
procedures described above are reasonable, and that if such
procedures are followed, you will bear the risk of any
losses resulting from unauthorized or fraudulent telephone
transactions on your account.
- --------------------------------------------------------------------------------
TRANSFERRING You may transfer the registration of any of your Fund
REGISTRATION shares to another person by completing a transfer form
and sending it to: Vanguard Financial Center, P.O. Box
1110, Valley Forge, PA 19482-1110. Attention: Transfers
Department. The request must be in Good Order. To receive a
transfer form and full instructions, please call our Client
Services Department (1-800-662-2739).
- --------------------------------------------------------------------------------
STATEMENTS AND Vanguard will send you a confirmation statement each time
REPORTS you initiate a trans action in your account except for
checkwriting redemptions from Vanguard money market
accounts. You will also receive a comprehensive account
statement at the end of each calendar quarter. The
fourth-quarter statement will be a year-end statement,
listing all transaction activity for the entire calendar
year.
24
<PAGE>
Vanguard's Average Cost Statement provides you with the
average cost of shares redeemed from your account during
the calendar year, using the average cost single category
method. This service is available for most taxable accounts
opened since January 1, 1986. In general, investors who
redeemed shares from a qualifying Vanguard account may
expect to receive their Average Cost Statement along with
their Portfolio Summary Statement. Please call our Client
Services Department (1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you
semi-annually, according to the Fund's fiscal year-end.
- --------------------------------------------------------------------------------
OTHER VANGUARD For more information about any of these services, please
SERVICES call our Investor Information Department at 1-800-662-7447.
Vanguard Direct With Vanguard's Direct Deposit Service, most U.S.
Deposit Service Government checks (including Social Security and military
pension checks) and private payroll checks may be
automatically deposited into your Vanguard Fund account.
Separate brochures and forms are available for direct
deposit of U.S. Government and private payroll checks.
Vanguard Automatic Vanguard's Automatic Exchange Service allows you to move
Exchange Service money automatically among your Vanguard Fund accounts. For
instance, the service can be used to "dollar cost average"
from a money market portfolio into a stock or bond fund or
to contribute to an IRA or other retirement plan.
Vanguard Fund Vanguard's Fund Express allows you to transfer money
Express between your Fund account and your account at a bank,
savings and loan association, or a credit union that is a
member of the Automated Clearing House (ACH) system. You
may elect this service on the Account Registration Form or
call our Investor Information Department (1-800-662-7447)
for a Fund Express application.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition, some
services of Fund Express cannot be used with specific
Vanguard Funds. For more information, please refer to the
Vanguard Fund Express brochure.
Vanguard Dividend Vanguard's Dividend Express allows you to transfer your
Express dividend and/or capital gains distributions automatically
from your Fund account, one business day after the Fund's
payable date, to your account at a bank, savings and loan
association, or a credit union that is a member of the
Automated Clearing House (ACH) system. You may elect this
service on the Account Registration Form or call our
Investor Information Department (1-800-662-7447) for a
Vanguard Dividend Express application.
Vanguard Vanguard's Tele-Account is a convenient, automated service
Tele-Account(R) that provides share price, price change and yield quotations
on Vanguard Funds through any TouchTone(TM) telephone. This
service also lets you obtain information about your account
balance, your last transaction, and your most recent
dividend or capital gains payment. In addition, you may
perform investment exchanges of Vanguard
25
<PAGE>
Fund shares and redemptions by check using Tele-Account. To
contact Vanguard's Tele-Account service, dial
1-800-ON-BOARD (1-800-662-6273). A brochure offering
detailed operating instructions is available from our
Investor Information Department (1-800-662-7447).
Computer Access
Vanguard Online Use your personal computer to learn more about Vanguard's
www.vanguard.com funds and services; keep in touch with your Vanguard
accounts; map out a long-term investment strategy; initiate
certain transactions; and ask questions, make suggestions,
and send messages to Vanguard.
Our education-oriented website provides timely news and
information about Vanguard funds and services, an online
"university" that offers a variety of mutual fund classes,
and easy-to-use, interactive tools to help you create your
own investment and retirement strategies.
- --------------------------------------------------------------------------------
26
<PAGE>
[LOGO} [LOGO}
-----------------
The Vanguard Group
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
Investor Information
Department:
1-800-662-7447 (SHIP)
P R O S P E C T U S
Client Services
Department:
1-800-662-2739 (CREW)
JANUARY 22, 1998
Tele-Account for
24-Hour Access:
1-800-662-6273 (ON-BOARD)
Telecommunication
Service for the
Hearing-Impaired:
1-800-662-2738
Transfer Agent:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
P065
<PAGE>
PART B
VANGUARD EQUITY INCOME FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
January 22, 1998
This Statement is not a Prospectus but should be read in conjunction with
the Fund's current Prospectus (January 22, 1998). To obtain the Prospectus
please call:
Investor Information Department
1-800-662-7447
TABLE OF CONTENTS
Page
-----
Investment Objectives and Policies .................................... 1
Investment Limitations ................................................ 5
Purchase of Shares ................................................... 7
Redemption of Shares ................................................... 7
Management of the Fund ................................................ 8
Yield and Total Returns ................................................ 11
Investment Advisory Services .......................................... 11
Portfolio Transactions ................................................ 16
Financial Statements ................................................... 17
Comparative Indexes ................................................... 18
INVESTMENT OBJECTIVES AND POLICIES
The following policies supplement the Fund's investment objectives and
policies set forth in the Prospectus of the Fund.
FUTURES CONTRACTS AND OPTIONS
The Fund may enter into futures contracts, options, and options on futures
contracts for the purpose of remaining fully invested and reducing transactions
costs. Futures contracts provide for the future sale by one party and purchase
by another party of a specified amount of a specific security at a specified
future time and at a specified price. Futures contracts which are standardized
as to maturity date and underlying financial instrument are traded on national
futures exchanges. Futures exchanges and trading are regulated under the
Commodity Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a
U.S. Government Agency. Assets committed to futures contracts will be
segregated at the Fund's custodian bank to the extent required by law.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery.
Closing out an open futures position is done by taking an opposite position
("buying" a contract which has previously been "sold," "selling" a contract
previously "purchased") in an identical contract to terminate the position.
Brokerage commissions are incurred when a futures contract is bought or sold.
B-1
<PAGE>
Futures traders are required to make a good faith margin deposit in cash
or government securities with a broker or custodian to initiate and maintain
open positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin that
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to the market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations
in the value of the underlying securities. The Fund intends to use futures
contracts only for bona fide hedging purposes. Regulations of the CFTC
applicable to the Fund require that all of its futures transactions constitute
bona fide hedging transactions except to the extent that the aggregate initial
margins and premiums required to establish any non-hedging positions do not
exceed five percent of the value of the Fund's portfolio.
Although techniques other than the sale and purchase of futures contracts
could be used to control the exposure of the Fund to fluctuations in the market
value of its securities, the use of futures contracts may be a more effective
means of hedging this exposure. While the Fund will incur commission expenses
in both opening and closing out futures positions, these costs are lower than
transaction costs incurred in the purchase and sale of the underlying
securities.
Restrictions on the Use of Futures Contracts and Options
The Fund will not enter into futures contract transactions to the extent
that, immediately thereafter, the sum of its initial margin deposits on open
contracts exceeds 5% of the Portfolio's total assets. In addition, the Fund
will not enter into futures contracts to the extent that its outstanding
obligations to purchase securities under these contracts would exceed 20% of
the Portfolio's total assets.
Risk Factors in Futures Transactions
Positions in futures may be closed out only on an Exchange which provides
a secondary market for such futures. However, there can be no assurance that a
liquid secondary market will exist for any particular futures contract at any
specific time. Thus, it may not be possible to close a futures position. In the
event of adverse price movements, the Fund would continue to be required to
make daily cash payments to maintain its required margin. In such situations,
if the Fund has insufficient cash, it may have to sell portfolio securities to
meet daily margin requirements at a time when it may be disadvantageous to do
so. In addition, the Fund may be required to make delivery of the instruments
underlying the futures contracts it holds. The
B-2
<PAGE>
inability to close options and futures positions also could have an adverse
impact on the ability to effectively hedge. A Fund will minimize the risk that
it will be unable to close out a futures contract by only entering into futures
which are traded on national futures exchanges and for which there appears to
be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the Futures Contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of the Portfolio are engaged in only for hedging purposes, the
Adviser does not believe that the Fund is subject to the risks of loss
frequently associated with futures transactions. The Fund would presumably have
sustained comparable losses if, instead of the futures contract, it had
invested in the underlying financial instrument and sold it after the decline.
Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is
also possible that the Fund could both lose money on futures contracts and also
experience a decline in the value of its portfolio securities. There is also
the risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a futures contract or related
option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
Federal Tax Treatment of Futures Contracts
The Fund is required for Federal income tax purposes to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts held as of the end of the year as well as those actually realized
during the year. In most cases, any gain or loss recognized with respect to a
futures contract is considered to be 60% long-term capital gain or loss and 40%
short-term capital gain or loss, without regard to the holding period of the
contract. Furthermore, sales of futures contracts which are intended to hedge
against a change in the value of securities held by the Fund may affect the
holding period of such securities and, consequently, the nature of the gain or
loss on such securities upon disposition. The Fund may be required to defer the
recognition of losses on futures contracts to the extent of any unrecognized
gains on related positions held by the Fund.
B-3
<PAGE>
In order for the Fund to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, and gains from the sale of
securities or foreign currencies, or other income derived with respect to its
business of investing in such securities or currencies. It is anticipated that
any net gain realized from the closing out of futures contracts will be
considered gain from the sale of securities and therefore be qualifying income
for purposes of the 90% requirement.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes including unrealized
gains at the end of the Fund's fiscal year on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Fund's other investments and shareholders will be advised on the nature of
the payments.
Repurchase Agreements
Each Portfolio along with other members of the Vanguard Group may invest
in repurchase agreements with commercial banks, brokers or dealers either for
defensive purposes due to market conditions or to generate income from its
excess cash balances. A repurchase agreement is an agreement under which the
Portfolio acquires a money market instrument (generally a security issued by
the U.S. Government or an agency thereof, a banker's acceptance or a
certificate of deposit) from a commercial bank, broker or dealer, subject to
resale to the seller at an agreed upon price and date (normally, the next
business day). A repurchase agreement may be considered a loan collateralized
by securities. The resale price reflects an agreed upon interest rate effective
for the period the instrument is held by the Portfolio and is unrelated to the
interest rate on the underlying instrument. In these transactions, the
securities acquired by the Portfolio (including accrued interest earned
thereon) must have a total value in excess of the value of the repurchase
agreement and are held by a custodian bank until repurchased. In addition, the
Fund's Board of Directors will monitor repurchase agreement transactions
generally and will establish guidelines and standards for review by the
investment adviser of the creditworthiness of any bank, broker or dealer party
to a repurchase agreement. No more than an aggregate of 15% of the Portfolio's
net assets, at the time of investment, will be invested in repurchase
agreements having maturities longer than seven days and in securities subject
to legal or contractual restrictions on resale or for which there are no
readily available market quotations. From time to time, the Fund's Board of
Directors may determine that certain restricted securities known as Rule 144A
securities are liquid and not subject to the 15% limitation described above.
Lending of Securities
Each Portfolio may lend its investment securities to qualified
institutional investors who need to borrow securities in order to complete
certain transactions, such as covering short sales, avoiding failures to
deliver securities or completing arbitrage operations. By lending its
investment securities, a Portfolio attempts to increase its net investment
income through the receipt of interest on the loan. Any gain or loss in the
market price of the securities loaned that might occur during the term of the
loan would be for the account of the Portfolio. Each Portfolio may lend its
investment securities to qualified brokers, dealers, banks or other financial
institutions, so long as the terms and the structure and the aggregate amount
of such loans are not inconsistent with the Investment Company Act of 1940, or
the Rules and Regulations or interpretations of the Securities and Exchange
Commission (the "Commission") thereunder, which currently require that (a) the
borrower pledge and maintain with the Portfolio collateral consisting of cash,
an irrevocable letter of credit or securities issued or guaranteed by the
United States Government having at all times not less than 100% of
B-4
<PAGE>
the value of the securities loaned, (b) the borrower add to such collateral
whenever the price of the securities loaned rises (i.e. the borrower "marks to
the market" on a daily basis), (c) the loan be made subject to termination by
the Portfolio at any time and (d) the Portfolio receive reasonable interest on
the loan (which may include the Portfolio's investing any cash collateral in
interest bearing short-term investments), any distribution on the loaned
securities and any increase in their market value. The Portfolio will not lend
investment securities if as a result, the aggregate of such loans exceeds
33 1/3% of the value of the Portfolio's net assets. Loan arrangements made by
the Portfolio will comply with all other applicable regulatory requirements,
including the rules of the New York Stock Exchange, which presently require the
borrower, after notice, to redeliver the securities within the normal
settlement time of three business days. All relevant facts and circumstances,
including the creditworthiness of the broker, dealer or institution, will be
considered in making decisions with respect to the lending of securities,
subject to review by the Fund's Board of Directors.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in written contract and approved
by the investment company's Directors. In addition, voting rights pass with the
loaned securities, but if a material event will occur affecting an investment
on the loan, the loan must be called and the securities voted.
Foreign Investments
As indicated in the Prospectus, the Fund may include foreign securities.
Investors should recognize that investing in foreign companies involves certain
special considerations which are not typically associated with investing in
U.S. companies.
Country Risk. As foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards and practices comparable
to those applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more
volatile than securities of comparable domestic companies. There is generally
less government supervision and regulation of stock exchanges, brokers and
listed companies than in the U.S. In addition, with respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
U.S. investments in companies in those countries.
Although the Fund will endeavor to achieve most favorable execution costs
in its portfolio transactions in foreign securities, fixed commissions on many
foreign stock exchanges are generally higher than negotiated commissions on
U.S. exchanges. In addition, it is expected that the expenses for custodial
arrangements of foreign securities will be somewhat greater than the expenses
for the custodial arrangement for handling U.S. securities of equal value.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income the Fund receives from its foreign investments.
Currency Risk. Since the stocks of foreign companies are frequently
denominated in foreign currencies, and since the Fund may temporarily hold
uninvested reserves in bank deposits in foreign currencies, the Fund will be
affected favorably or unfavorably by changes in currency rates and in exchange
control regulations, and may incur costs in connection with conversions between
various currencies. The investment policies of
B-5
<PAGE>
the Fund permit it to enter into forward foreign currency exchange contracts in
order to hedge holdings and commitments against changes in the level of future
currency rates. Such contracts involve an obligation to purchase or sell a
specific currency at a future date at a price set at the time of the contract.
Illiquid Securities
The Fund may not invest more than 15% of its net assets in illiquid
securities. Illiquid securities are securities that may not be sold or disposed
of in the ordinary course of business within seven business days at
approximately the value at which they are being carried on the Fund's books. An
illiquid security includes repurchase agreements which have a majority of
longer than seven days, securities which are illiquid by virtue of the absence
of a readily available market, and demand instruments with a demand notice
exceeding seven days. Illiquid securities may include securities that are not
registered under the Securities Act of 1933 (the "1933 Act"), however,
unregistered securities that can be sold to "qualified institutional buyers" in
accordance with rule 144A under the 1933 Act will not be considered illiquid so
long as it is determined by the Fund's adviser that an adequate trading market
exists for the security.
INVESTMENT LIMITATIONS
The following restrictions supplement the Fund's investment limitations
set forth in the Prospectus. Except as otherwise indicated, these restrictions
are fundamental policies of the Fund which cannot be changed without the
approval of a majority (as defined in the Investment Company Act of 1940 (the
"1940 Act") of the Fund's outstanding voting shares. The Fund may not under any
circumstances:
1) Invest for the purpose of exercising control of management of any
company;
2) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if as a result the Fund would hold
more than 10% of the outstanding voting securities of the issuer, or more
than 5% of the value of the Fund's total assets would be invested in the
securities of such issuer;
3) Invest in securities of other investment companies, except as may be
acquired as a part of a merger, consolidation or acquisition of assets
approved by the Fund's shareholders or otherwise to the extent permitted by
Section 12 of the Investment Company Act of 1940. The Fund will invest only
in investment companies which have investment objectives and investment
policies consistent with those of the Fund;
4) Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in disposing
of investment securities;
5) Purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are illiquid
(included in this limitation is the Fund's investment in The Vanguard
Group, Inc.);
6) Invest in commodities, except that the Fund may invest in stock
futures contracts, stock options and options on stock futures contracts to
the extent that not more than 5% of the Fund's assets are required as
deposit to secure obligations under futures contracts and not more than 20%
of the Fund's assets are invested in futures contracts and options at any
time, or sell real estate although the Fund may purchase and sell
securities of companies which deal in real estate, or interests therein;
B-6
<PAGE>
7) Purchase securities on margin or sell any securities short except as
specified in investment limitation No. 6;
8) Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements, subject to the limitation
described in (5) above) which are either publicly distributed or
customarily purchased by institutional investors, and (ii) by lending its
securities to banks, brokers, dealers and other financial institutions so
long as such loans are not inconsistent with the Investment Company Act or
the Rules and Regulations or interpretations of the Securities and Exchange
Commission thereunder;
9) Pledge, mortgage, or hypothecate any of its assets to an extent
greater than 5% of its total assets; and
10) Invest more than 25% of the value of its total assets in any one
industry. Utility companies will be divided according to their services;
for example, gas, gas transmission, electric and gas, electric, and
telephone will each be considered a separate industry.
The investment limitations set forth above are considered at the time that
investment securities are purchased. If a percentage restriction is adhered to
at the time the investment is made, a later increase in percentage resulting
from a change in the market value of assets will not constitute a violation of
such restriction. Notwithstanding these limitations, the Fund may own all or
any portion of the securities of, or make loans to, or contribute to the costs
or other financial requirements of any company which will be wholly owned by
the Fund and one or more other investment companies and is primarily engaged in
the business of providing, at-cost, management, administrative, distribution or
related services to the Fund and other investment companies. See "Management of
the Fund."
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offerings of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund, and (iii) to
reduce or waive the minimum investment for, or any other restrictions on,
initial and subsequent investments for certain fiduciary accounts or under
circumstances where certain economies can be achieved in sales of the Fund's
shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the Rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods
as the Commission may permit.
B-7
<PAGE>
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part, in investment securities or in cash, as the Directors
may deem advisable; however, payment will be made wholly in cash unless the
Directors believe that economic or market conditions exist which would make
such a practice detrimental to the best interests of the Fund. If redemptions
are paid in investment securities, such securities will be valued as set forth
in the Prospectus under "Determining the Fund's share price" and a redeeming
shareholder would normally incur brokerage expenses if he converted these
securities to cash.
No charge is made by the Fund for redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the
securities held by the Fund.
B-8
<PAGE>
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Directors. The Directors set broad policies
for the Fund and choose its Officers. The following is a list of Directors and
Officers of the Fund and a statement of their present positions and principal
occupations during the past five years. As of September 30, 1997, the Directors
owned less than 1% of the Fund's outstanding shares. The mailing address of the
Fund's Directors and Officers is Post Office Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, (DOB: 5/8/1929) Chairman and Director*
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group. Director of The Mead
Corporation, General Accident Insurance, and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, (DOB: 7/29/1954) President, Chief Executive Officer & Director*
President, Chief Executive Officer and Director of The Vanguard Group,
Inc., and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, (DOB: 9/28/1935) Director
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing
Director of Global Health Care Partners/DLJ Merchant Banking Partners;
Director of Sun Company, Inc., and Westinghouse Electric Corporation.
BARBARA BARNES HAUPTFUHRER, (DOB: 10/11/1928) Director
Director of The Great Atlantic and Pacific Tea Company, IKON Office
Solutions, Inc., Raytheon Company, Knight-Ridder, Inc., Massachusetts
Mutual Life Insurance Co., and Ladies Professional Golf Association; and
Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY, (DOB: 5/7/1931) Director
President Emeritus of The Brookings Institution; Director of American
Express Bank, Ltd., The St. Paul Companies, Inc., and National Steel
Corporation.
ALFRED M. RANKIN, Jr., (DOB: 10/8/1941) Director
Chairman, President, Chief Executive Officer, and Director of NACCO
Industries, Inc.; Director of The BFGoodrich Company, and The Standard
Products Company.
JOHN C. SAWHILL, (DOB: 6/12/1936) Director
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co., and President of New York
University; Director of Pacific Gas and Electric Company, Procter & Gamble
Company, and NACCO Industries.
JAMES O. WELCH, Jr., (DOB: 5/13/1931) Director
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and
Director of RJR Nabisco; Director of TECO Energy, Inc., and Kmart
Corporation.
J. LAWRENCE WILSON, (DOB: 3/2/1936) Director
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company, and The Mead Corporation; and Trustee of Vanderbilt
University.
RAYMOND J. KLAPINSKY, (DOB: 12/7/1938) Secretary*
Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of
each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, (DOB: 3/22/1937) Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, (DOB: 9/13/1946) Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ------------------------
* Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
B-9
<PAGE>
The Vanguard Group
Vanguard Equity Income Fund, Inc. is a member of The Vanguard Group of
Investment Companies. Through their jointly-owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other Funds in the Group obtain at
cost virtually all of their corporate management, administrative and
distribution services. Vanguard also provides investment advisory services on
an at-cost basis to certain of the Vanguard Funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment.
Each Fund pays a share of Vanguard's total expenses which are allocated among
the Funds under methods approved by the Board of Directors (Trustees) of each
Fund. In addition, each Fund bears its own direct expenses such as legal,
auditing and custodian fees. In order to generate additional revenues for
Vanguard and thereby reduce the Funds' expenses, Vanguard also provides certain
administrative services to other organizations.
The Fund's Officers are also Officers and employees of Vanguard. No
Officer or employee owns, or is permitted to own, any securities of any
external adviser for the Funds.
Vanguard was established and operates under a Funds' Service Agreement
which was approved by the shareholders of each of the Funds. The amounts which
each of the Funds have invested are adjusted from time to time in order to
maintain the proportionate relationship between each Fund's relative net assets
and its contribution to Vanguard's capital. At September 30, 1997, the Fund had
contributed $130,000 to Vanguard, representing .6% of Vanguard's
capitalization. The Fund's Service Agreement provides as follows: (a) each
Vanguard Fund may invest up to .40% of its current assets in Vanguard, and (b)
there is no other limitation on the amount that each Vanguard Fund may
contribute to Vanguard's capitalization.
Management
Corporate management and administrative services include: (1) executive
staff; (2) accounting and financial; (3) legal and regulatory; (4) shareholder
account maintenance; (5) monitoring and control of custodian relationships; (6)
shareholder reporting; and (7) review and evaluation of advisory and other
services provided to the Funds by third parties. For the year ended September
30, 1997, such costs allocated to the Fund approximated $4,112,000.
Distribution
Vanguard provides all distribution and marketing activities for the Funds
in the Group. Vanguard Marketing Corporation, a wholly-owned subsidiary of
Vanguard, acts as Sales Agent for the shares of the Funds in connection with
any sales made directly to investors in the states of Florida, Missouri, New
York, Ohio, Texas and such other states as it may be required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Directors and
Officers of Vanguard determine the amount to be spent annually on distribution
activities, the manner and amount to be spent on each Fund, and whether to
organize new investment companies.
B-10
<PAGE>
One half of the distribution expenses of a marketing and promotional
nature is allocated among the Funds based upon relative net assets. The
remaining one half of those expenses is allocated among the Funds based upon
each Fund's sales for the preceding 24 months relative to the total sales of
the Funds as a Group, provided, however, that no Fund's aggregate quarterly
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of 20/100
of 1% of its average month-end net assets. The Group's marketing and
distribution expenses allocated to the Fund for the year ended September 30,
1997, was $311,000 or approximately .02% of its average month-end net assets.
Investment Advisory Services
Vanguard provides investment advisory services to Vanguard Money Market
Reserves; Vanguard Treasury Fund; Vanguard Admiral Funds; Vanguard Municipal
Bond Fund; several Portfolios of Vanguard Fixed Income Securities Fund;
Vanguard Institutional Index Fund; several Portfolios of Vanguard Variable
Insurance Fund; Vanguard Bond Index Fund; Vanguard California Tax-Free Fund;
Vanguard Florida Insured Tax-Free Fund; Vanguard New Jersey Tax-Free Fund;
Vanguard New York Tax-Free Fund; Vanguard Ohio Tax-Free Fund; Vanguard
Pennsylvania Tax-Free Fund; Vanguard Balanced Index Fund; Vanguard Index Trust;
Vanguard International Equity Index Fund; Vanguard Tax-Managed Fund; Aggressive
Growth Portfolio of Vanguard Horizon Fund; Total International Portfolio of
Vanguard STAR Fund; a portion of Vanguard/Windsor II; Vanguard/Morgan Growth
Fund and Vanguard/Explorer Fund, as well as several indexed separate accounts.
These services are provided on an at-cost basis from a money management staff
employed directly by Vanguard. The compensation and other expenses of this
staff are paid by the Funds utilizing these services.
Remuneration of Directors and Officers
The Fund pays each Director (Trustee), who is not also an Officer, an
annual fee plus a proportionate share of travel and other expenses incurred in
attending Board meetings. Directors who are also Officers receive no
remuneration for their services as Directors. The Fund's Officers and employees
are paid by Vanguard which, in turn, is reimbursed by the Fund (and each other
Fund in the Group), for its proportionate share of Officers' and employees'
salaries and retirement benefits. During the year ended September 30, 1997, the
remuneration paid by Vanguard to all Officers as a group and allocated to the
Fund, was approximately $38,630.
Directors who are not Officers are paid an annual fee based on the number
of years of service on the Board upon retirement. The fee is equal to $1,000
for each year of service (up to fifteen years) and each investment company
member of the Vanguard Group contributes a proportionate amount to this fee
based on its relative net assets. Under its retirement plan, Vanguard
contributes annually an amount equal to 10% of each eligible Officer's annual
compensation plus 5.7% of that part of an eligible Officer's compensation
during the year, if any, that exceeds the Social Security Taxable Wage Base
then in effect. Under its thrift plan, all eligible Officers are permitted to
make pre-tax contributions in an amount up to 4% of total compensation, subject
to federal tax limitations, which are matched by Vanguard on a 100% basis. The
Fund's proportionate share of retirement contributions made by Vanguard under
its retirement and thrift plans on behalf of all Officers of the Fund, as a
group, during the 1997 fiscal year was approximately $900.
The following table provides detailed information with respect to the
amounts paid to or accrued for the Directors for the fiscal year ended
September 30, 1997.
B-11
<PAGE>
VANGUARD EQUITY INCOME FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
Aggregate Pension or Retirement Estimated Total Compensation
Compensation Benefits Accrued As Annual Benefits From All Vanguard Funds
Names of Directors From Fund Part of Fund Expenses Upon Retirement Paid to Directors (2)
- -------------------------------- -------------- ----------------------- ----------------- ------------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) ............... -- -- -- --
John J. Brennan(1) ............ -- -- -- --
Barbara Barnes Hauptfuhrer ..... $517 $74 $15,000 $70,000
Robert E. Cawthorn ............ $517 $61 $13,000 $70,000
Bruce K. MacLaury ............ $547 $70 $12,000 $65,000
Alfred M. Rankin, Jr. ......... $517 $39 $15,000 $70,000
John C. Sawhill ............... $517 $46 $15,000 $70,000
James O. Welch, Jr. ............ $517 $57 $15,000 $70,000
J. Lawrence Wilson ............ $517 $41 $15,000 $70,000
</TABLE>
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no
compensation for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid to
each Director for his or her service as Director or Trustee of 35 Vanguard
Funds (28 in the case of Mr. MacLaury).
YIELD AND TOTAL RETURNS
The yield of the Fund for the 30-day period ended September 30, 1997 was
2.89%. The yield of the Fund is calculated daily. The average annual total
return of the Fund for one and five years ended September 30, 1997, and since
its inception on March 21, 1988, was +34.17%, +18.20% and +15.12%,
respectively.
Total return is computed by determining the average compounded rates of
return over the periods set forth above that would equate an initial amount
invested at the beginning of the period to the ending redeemable value of the
investment.
INVESTMENT ADVISORY SERVICES
The Fund currently has four investment advisers: Newell Associates
("Newell"), 525 University Avenue, Palo Alto, California 94301; Spare, Kaplan,
Bischel & Associates ("Spare/Kaplan"), 44 Montgomery Street, Suite 3500, San
Francisco, California 94104; John A. Levin & Co., Inc. ("Levin"), One
Rockefeller Plaza, 25th Floor, New York, NY 10020; and The Vanguard Group,
Inc., Post Office Box 2600, Valley Forge, PA 19482. Prior to January 1, 1995,
Newell was the sole investment adviser to the Fund. Spare/Kaplan and Levin were
added as investment advisers effective January 1, 1995; The Vanguard Group,
Inc. was added as an adviser effective January 16, 1998. The Fund has entered
into investment advisory agreements with Newell, Spare/Kaplan and Levin which
provide that the advisers manage the investment and reinvestment of the Fund's
assets and continuously review, supervise and administer the Fund's investment
program. The advisers discharge their responsibilities subject to the control
of the Officers and Directors of the Fund.
The proportion of the net assets of the Fund managed by each adviser is
established by the Board of Directors, and may be changed in the future as
circumstances warrant. Presently, Newell is responsible for approximately 70%
of the Fund's investment; Spare/Kaplan and Levin are responsible for
approximately 15% each. Vanguard's advisory role is limited; it currently
manages just the Fund's cash reserves, which normally represent about 5% of the
Fund's assets.
B-12
<PAGE>
Newell Associates. The Fund pays Newell an advisory fee at the end of each
fiscal quarter, calculated by applying a quarterly rate, based on the following
annual percentage rates, to the average month-end net assets managed by Newell
for the quarter:
Net Assets Annual Rate
- ---------------------------- ------------
First $250 million ......... .200%
Next $500 million ......... .150%
Next $250 million ......... .100%
Over $1 billion ............ .080%
Spare, Kaplan, Bischel & Associates. The Fund pays Spare/Kaplan a basic
advisory fee at the end of each fiscal quarter, calculated by applying a
quarterly rate, based on the following annual percentage rates, to the average
month-end assets of the Fund managed by Spare/Kaplan ("Spare/Kaplan Portfolio")
for the quarter:
Net Assets Annual Rate
- ---------------------------- ------------
First $500 million ......... 0.175%
Next $500 million ......... 0.125%
Over $1 billion ............ 0.100%
The basic fee may be increased or decreased by applying an
incentive/penalty adjustment to the basic fee reflecting the investment
performance of the assets managed by Spare/Kaplan relative to the return of the
Standard and Poor's/BARRA Value Index ("Value Index"), an index which includes
stocks in the S&P 500 Index with lower than average ratios of market price to
book value.
The following table sets forth the incentive/penalty fee rates payable by
the Fund to Spare/Kaplan under the new investment advisory agreement:
Three Year Performance Performance Fee
Differential vs. the Value Index Adjustment*
- ---------------------------------- ------------------
Less than 3% .................. -.20 x Basic Fee
Between 3% and 6% ............ 0 x Basic Fee
More than 6% .................. 0.20 x Basic Fee
- ------------
* For purposes of this calculation, the Basic Fee is calculated by applying a
quarterly rate based on the Annual Basic Fee Rate using average assets over
the same period over which the performance is measured.
The investment performance of the Spare/Kaplan Portfolio, for any period,
expressed as a percentage of the "Spare/Kaplan Portfolio Unit Value" at the
beginning of such period, will be the sum of: (i) the change in the
Spare/Kaplan Portfolio Unit Value during such period; (ii) the unit value of
the Fund's cash distributions from the Spare/Kaplan Portfolio's net investment
income and realized net capital gains (whether long-term or short- term) having
an ex-dividend date occurring within such period; and (iii) the unit value of
capital gains taxes paid or accrued during such period by the Fund for
undistributed realized long-term capital gains realized from the Spare/Kaplan
Portfolio.
The "Spare/Kaplan Portfolio Unit Value" will be determined by dividing the
total net assets of the Spare/Kaplan Portfolio by a given number of units. On
the initial date of the agreement, the number of units
B-13
<PAGE>
in the Spare/Kaplan Portfolio will equal the total shares outstanding of the
Fund. After such initial date, as assets are added to or withdrawn from the
Spare/Kaplan Portfolio, the number of units of the Spare/Kaplan Portfolio will
be adjusted based on the unit value of the Spare/Kaplan Portfolio on the day
such changes are executed.
The investment record of the Value Index will be calculated monthly by (i)
multiplying the total return for the month (change in market price plus
dividends) of each stock included in the Value Index by its weighings in the
Value Index at the beginning of the month, and (ii) adding the values discussed
in (i). For any period, therefore, the investment record of the Value Index
will be the compounded monthly returns of the Value Index.
For the purposes of determining the incentive/penalty fee adjustment, the
net assets managed by Spare/Kaplan will be averaged over the same period as the
investment performance of those assets and the investment record of the Value
Index are computed.
In the event of termination of this Agreement, the fee provided in this
Section shall be computed on the basis of the period ending on the last
business day on which this Agreement is in effect subject to a pro rata
adjustment based on the number of days elapsed in the current fiscal quarter as
a percentage of the total number of days in such quarter.
In April 1972, the Securities and Exchange Commission ("Commission")
issued Release No. 7113 under the Investment Company Act of 1940 to call
attention of directors and investment advisers to certain factors which must be
considered in connection with investment company incentive fee arrangements.
One of these factors is to "avoid basing significant fee adjustments upon
random or insignificant differences" between the investment performance of a
fund and that of the particular index with which it is being compared. The
Release provides that "preliminary studies (of the Commission staff) indicate
that as a 'rule of thumb' the performance difference should be at least +/-10
percentage points" annually before the maximum performance adjustment may be
made. However, the Release also states that "because of the preliminary nature
of these studies, the Commission is not recommending, at this time, that any
particular performance difference exist before the maximum fee adjustment may
be made." The Release concludes that the directors of a fund "should satisfy
themselves that the maximum performance adjustment will be made only for
performance differences that can reasonably be considered significant." The
Board of Directors of the Fund has fully considered the Release and believes
that the performance adjustments as included in the proposed agreement are
entirely appropriate although not within the +/-10 percentage points per year
range suggested in the Release. Under the Fund's investment advisory agreement
with Spare/Kaplan, the maximum performance adjustment for an incentive fee is
made at a difference of +6 percentage points from the performance of the index
over a thirty-six month period. The maximum performance adjustment for a
penalty fee is made at a difference of less than +3 percentage points from the
performance of the index over a thirty-six month period. On a per year basis,
these maximum adjustments effectively would occur at differences from the index
of +2 percentage points and less than +1 percentage point, respectively.
B-14
<PAGE>
John A. Levin & Co., Inc. The Fund pays Levin a basic advisory fee at the
end of each fiscal quarter, calculated by applying a quarterly rate, based on
the following annual percentage rates, to the average month-end assets of the
Fund managed by Levin ("Levin Portfolio") for the quarter:
Net Assets Annual Rate
- ---------------------------- ------------
First $100 million ......... 0.40%
Next $200 million ......... 0.25%
Over $300 million ......... 0.30%
The basic fee paid to Levin, as provided above, may be increased or
decreased by applying an incentive/penalty adjustment to the basic fee
reflecting the investment performance of the Levin Portfolio relative to the
return of the Standard and Poor's 500 Composite Stock Price Index ("S&P 500
Index"), an index which emphasizes large capitalization companies.
The following table sets forth the incentive/penalty fee rates payable by
the Fund to Levin under the new investment advisory agreement:
Three Year Performance Performance Fee
Differential vs. the S&P 500 Index Adjustment*
- ------------------------------------ -------------------
Less than 0% ..................... -0.40 X Basic Fee
Between 0% and 3% .................. -0.20 X Basic Fee
Between 3% and 6% .................. 0 X Basic Fee
Between 6% and 9% .................. 0.20 X Basic Fee
More than 9% ..................... 0.40 X Basic Fee
- ------------
* For purposes of this calculation, the Basic Fee is calculated by applying a
quarterly rate based on the Annual Basic Fee Rate using average assets over
the same period over which the performance is measured.
The investment performance of the Levin Portfolio, for any period,
expressed as a percentage of the "Levin Portfolio Unit Value" at the beginning
of such period, will be the sum of: (i) the change in the Levin Portfolio Unit
Value during such period; (ii) the unit value of the Fund's cash distributions
from the Levin Portfolio's net investment income and realized net capital gains
(whether long-term or short-term) having an ex-dividend date occurring within
such period; and (iii) the unit value of capital gains taxes paid or accrued
during such period by the Fund for undistributed realized long-term capital
gains realized from the Levin Portfolio.
The "Levin Portfolio Unit Value" will be determined by dividing the total
net assets of the Levin Portfolio by a given number of units. On the initial
date of the agreement, the number of units in the Levin Portfolio will equal
the total shares outstanding of the Fund. After such initial date, as assets
are added to or withdrawn from the Levin Portfolio, the number of units of the
Levin Portfolio will be adjusted based on the unit value of the Levin Portfolio
on the day such changes are executed.
The investment record of the S&P 500 Index will be calculated monthly by
(i) multiplying the total return for the month (change in market price plus
dividends) of each stock included in the S&P 500 Index by its weighings in the
S&P 500 Index at the beginning of the month, and (ii) adding the values
discussed in (i). For any period, therefore, the investment record of the S&P
500 Index will be the compounded monthly returns of the S&P 500 Index.
For the purposes of determining the incentive/penalty fee adjustment, the
net assets managed by Levin will be averaged over the same period as the
investment performance of those assets and the investment record of the S&P 500
Index are computed.
B-15
<PAGE>
The formula used to determine the performance adjustments differs from the
view taken by the staff of the Commission. For a more detailed discussion, see
page 9. The Board of Directors of the Fund believes that the performance
adjustments, as included in the proposed agreement with Levin are appropriate
although not within the 10 percentage point per year range suggested in Release
No. 7113. Under the Fund's investment advisory agreement with Levin, the
maximum performance adjustment for an incentive fee is made at a difference of
+9 percentage points from the performance of the index over a thirty-six month
period. The maximum performance adjustment for a penalty fee is made at a
difference of less than +0 percentage points from the performance of the index
over a thirty-six month period. On a per year basis, these maximum adjustments
effectively would occur at differences from the index of +3 percentage points
and less than +0 percentage point, respectively.
In the event of termination of this Agreement, the fee provided in this
Section shall be computed on the basis of the period ending on the last
business day on which this Agreement is in effect subject to a pro rata
adjustment based on the number of days elapsed in the current fiscal quarter as
a percentage of the total number of days in such quarter.
The Fund's Board of Directors may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of a
new advisory agreement, either as a replacement for an existing adviser or
as an additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same advisory
contract terms where a contract has been assigned because of a change in
control of the adviser.
Any such change will only be made upon not less than 30 days' prior
written notice to shareholders, which shall include the information concerning
the adviser that would have normally been included in a proxy statement.
For the year ended September 30, 1995, the Fund paid to Newell,
Spare/Kaplan, and Levin an advisory fee of $1,614,000. For the fiscal year
ended September 30, 1996, the Fund paid to Newell, Spare/Kaplan, and Levin an
advisory fee of $2,151,000 before a decrease of $191,000 based on performance.
For the fiscal year ended September 30, 1997, the Fund paid to Newell,
Spare/Kaplan, and Levin an advisory fee of $2,739,000 before a decrease of
$287,000 based on performance. The Vanguard Group, Inc. provides investment
advisory services to the Fund on an at-cost basis.
Description of the Advisers
Newell Associates. Newell is a California corporation of which 90% of its
outstanding shares are owned by its directors and officers. The directors of
the corporation and the offices they currently hold are: Roger D. Newell,
Chairman & President, Robert A. Huret, Vice Chairman and Alan E. Rothenberg,
Director. Newell Associates is a General Partner of Relative Yield Associates,
a California Limited Partnership.
Spare, Kaplan, Bischel & Associates. Spare, Kaplan, Bischel & Associates,
a California corporation founded in 1989, provides investment advisory services
primarily to institutions. The investment approach utilized by Spare/Kaplan is
a relative yield approach. Anthony E. Spare, Chief Investment Officer, is
responsible for the portion of the Fund's assets managed by Spare/Kaplan.
B-16
<PAGE>
John A. Levin & Co. Inc. John A. Levin, which commenced operations in
1982, provides investment advisory services to institutional and private
clients, including registered investment funds and several private investment
partnerships. The investment process at Levin emphasizes identifying investment
value through fundamental research. John A. Levin, the founding principal and
President of Levin, and Jeffrey A. Kigner, Executive Vice Presidents of Levin,
are responsible for managing the portion of the Fund's assets managed by Levin.
Levin is an indirect subsidiary of Baker, Fentress & Company, a registered
closed-end investment fund listed on the New York Stock Exchange.
DURATION AND TERMINATION OF INVESTMENT ADVISORY AGREEMENTS
The Fund's current agreements continue until April 30, 1998, and are
renewable for successive one-year periods thereafter, only if each renewal is
specifically approved by a vote of the Fund's Board of Directors, including the
affirmative votes of a majority of Directors who are not parties to the
contract or "interested persons" (as defined in the Investment Company Act of
1940) of any such party, cast in person at a meeting called for the purpose of
considering such approval. In addition, the question of continuance of an
investment advisory agreement may be presented to the shareholders of the Fund;
in such event, such continuance shall be effected only if approved by the
affirmative vote of a majority of the outstanding voting securities of the
Fund. The agreement is automatically terminated if assigned, and may be
terminated without penalty at any time (1) by vote of the Board of Directors of
the Fund on 60 days' written notice to the adviser, or (2) by the adviser upon
90 days' written notice to the Fund.
The Vanguard Group, Inc. Please see page B-10 for a description of The
Vanguard Group, Inc.
PORTFOLIO TRANSACTIONS
The investment advisory agreements authorize the Advisers (with the
approval of the Fund's Board of Directors) to select the brokers or dealers
that will execute the purchases and sales of portfolio securities for the Fund
and direct the Advisers to use their best efforts to obtain the best available
price and most favorable execution as to all transactions for the Fund. The
Advisers have undertaken to execute each investment transaction at a price and
commission which provides the most favorable total cost or proceeds reasonably
obtainable under the circumstances.
In placing portfolio transactions, each Adviser will use its best judgment
to choose the broker most capable of providing the brokerage services necessary
to obtain best available price and most favorable execution. The full range and
quality of brokerage services available will be considered in making these
determinations. In those instances where it is reasonably determined that more
than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration may be given to
those brokers which supply investment research and statistical information and
provide other services in addition to execution services to the Fund and/or the
Adviser. The Adviser considers such information useful in the performance of
its obligations under the agreement, but is unable to determine the amount by
which such services may reduce its expenses.
The investment advisory agreements also incorporate the concepts of
Section 28(e) of the Securities Exchange Act of 1934 by providing that, subject
to the approval of the Fund's Board of Directors, each Adviser may cause the
Fund to pay a broker-dealer which furnishes brokerage and research services a
higher commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of the Adviser to the Fund.
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<PAGE>
Currently, it is the Fund's policy that each Adviser may at times pay
higher commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be in the best interest of the Fund. Some
brokers or dealers who may receive such higher commissions in recognition of
brokerage services related to execution of securities transactions are also
providers of research information to the Adviser and/or the Fund. However, each
Adviser has informed the Fund that it will not pay higher commission rates
solely for the purpose of obtaining research services.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified broker-dealers who
recommend the Fund to other clients, or who act as agent in the purchase of the
Fund's shares for their clients, and may, when a number of brokers and dealers
can provide comparable best price and execution on a particular transaction,
consider the sale of Fund shares by a broker or dealer in selecting among
qualified broker-dealers.
Some securities considered for investment by the Fund may also be
appropriate for other clients served by each Adviser. If purchase or sale of
securities consistent with the investment policies of the Fund and one or more
of these other clients serviced by the Adviser are considered at or about the
same time, transactions in such securities will be allocated among the Fund and
such other clients in a manner deemed equitable by the Adviser. During the
fiscal years ended September 30, 1995, 1996 and 1997, the Fund paid $987,000,
$777,606 and $1,097,967, respectively, in brokerage commissions.
FINANCIAL STATEMENTS
Vanguard Equity Income Fund's financial statements for the year ended
September 30, 1997, including the financial highlights for each of the five
fiscal years in the period ended September 30, 1997, appearing in the Vanguard
Equity Income Fund, Inc. 1997 Annual Report to Shareholders, and the report
thereon of Price Waterhouse LLP, independent accountants, also appearing
therein, are incorporated by reference in this Statement of Additional
Information. For a more complete discussion of the Fund's performance, please
see the Fund's 1997 Annual Report to Shareholders, which can be obtained
without charge.
B-18
<PAGE>
COMPARATIVE INDEXES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of The Vanguard Group, including
Vanguard Equity Income Fund, Inc., may, from time to time, use one or more of
the following unmanaged indexes for comparative performance purposes.
Standard & Poor's 500 Composite Stock Price Index--is a well diversified list
of 500 companies representing the U.S. Stock Market.
Standard & Poor's MidCap 400 Index--is composed of 400 medium sized domestic
stocks.
Standard & Poor's/BARRA 600 Value Index--contains stocks of the S&P SmallCap
600 Index which have a lower than average price-to-book ratio.
Standard & Poor's/BARRA 600 Growth Index--contains stocks of the S&P SmallCap
600 Index which have a higher than average price-to-book ratio.
Russell 1000 Value Index--consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the lowest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000.
Wilshire 5000 Equity Index--consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily listing pricing is
available.
Wilshire 4500 Equity Index--consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard and Poor's 500 Index.
Russell 1000 Value Index--consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the lowest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000.
Russell 3000 Stock Index--a diversified portfolio of over 3,000 common stocks
accounting for over 90% of the market value of publicly traded stocks in the
U.S.
Russell 2000 Stock Index--composed of the 2,000 smallest securities in the
Russell 3000, representing approximately 7% of the Russell 3000 total market
capitalization.
Russell 2000(R) Value Index--contains stocks from the Russell 2000 Index with a
less-than-average growth orientation.
Morgan Stanley Capital International EAFE Index--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia, Asia, and the Far East.
Goldman Sachs 100 Convertible Bond Index--currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
Salomon Brothers GNMA Index--includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National
Mortgage Association.
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<PAGE>
Salomon Brothers High-Grade Corporate Bond Index--consists of publicly issued,
non-convertible corporate bonds rated Aa or Aaa. It is a value weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
Salomon Brothers Broad Investment-Grade Bond Index--is a market-weighted index
that contains over 4,800 individually priced investment-grade corporate bonds
rated BBB or better, U.S. Treasury/agency issues and mortgages pass- through
securities.
Lehman Long-Term Treasury Bond Index--is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
Merrill Lynch Corporate & Government Bond Index--consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index--all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
Lehman Brothers Long-term Corporate Bond Index--is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed- rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Bond Index--is a yield index on current coupon high grade
general obligation municipal bonds.
Standard & Poor's Preferred Index--is a yield index based upon the average
yield of four high grade, non-callable preferred stock issues.
NASDAQ Industrial Index--is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
Composite Index--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
Composite Index--65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
Composite Index--65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index, and 12.5% Standard & Poor's Utilities Index and 12.5% Standard & Poor's
Telephone Index).
Lehman Long-Term Corporate AA or Better Bond Index--consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
Lehman Brothers Aggregate Bond Index--is a market weighted index that contains
over 4,000 individually priced U.S. Treasury, agency, corporate, and mortgage
pass-through securities corporate rated BBB-- or better. The Index has a market
value of over $4 trillion.
Lehman Brothers Mutual Fund Short (1-5) Government/Corporate Index--is a market
weighted index that contains over 1,500 individually priced U.S. Treasury,
agency, and corporate investment grade bonds rated BBB-- or better with
maturities between 1 and 5 years. The index has a market value of over $1.6
trillion.
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<PAGE>
Lehman Brothers Mutual Fund Intermediate (5-10) Government/Corporate Index-- is
a market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate securities rated BBB-- or better with
maturities between 5 and 10 years. The index has a market value of over $700
billion.
Lehman Brothers Mutual Fund Long (10+) Government/Corporate Index--is a market
weighted index that contains over 1,900 individually priced U.S. Treasury,
agency, and corporate securities rated BBB-- or better with maturities greater
than 10 years. The index has a market value of over $900 billion.
Lipper Small Company Growth Fund Average--the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company. From time to time, Vanguard may advertise using the average
performance and/or the average expense ratio of the small company growth funds.
(This fund category was first established in 1982. For years prior to 1982, the
results of the Lipper Small Company Growth category were estimated using the
returns of the Funds that constituted the Group at its inception.)
Lipper Balanced Fund Average--an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
Lipper Non-Government Money Market Fund Average--an industry benchmark of
average non-government money market funds with similar investment objectives
and policies, as measured by Lipper Analytical Services, Inc.
Lipper Government Money Market Fund Average--an industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
Lipper General Equity Fund Average--an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
Lipper Fixed Income Fund Average--an industry benchmark of average fixed income
funds with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
B-21
