<PAGE> 1
VANGUARD
EQUITY INCOME
FUND
[PHOTO]
SEMIANNUAL
REPORT
MARCH 31, 1999
[THE VANGUARD GROUP LOGO]
<PAGE> 2
AT VANGUARD, WE BELIEVE THAT TRADITION MATTERS
Our 8,000 crew members embrace the traditional values on which our success is
built, including integrity, hard work, thrift, teamwork, and fair dealing on
behalf of our clients.
Our report cover pays homage to three anniversaries, each of great significance
to The Vanguard Group:
- - The 200th anniversary of the Battle of the Nile, which commenced on August 1,
1798. HMS Vanguard, the victorious British flagship at the Nile, is our
namesake. And its motto--"Leading the way"--serves as a guiding principle for
our company.
- - The 100th birthday, on July 23, 1998, of Walter L. Morgan, founder of
Wellington Fund, the oldest member of what became The Vanguard Group. Mr.
Morgan was friend and mentor to Vanguard founder John C. Bogle, and helped to
shape the standards and business principles that Mr. Bogle laid down for
Vanguard at its beginning nearly 25 years ago: a stress on balanced,
diversified investments; insistence on fair dealing and candor with clients;
and a focus on long-term investing. To our great regret, Mr. Morgan died on
September 2, 1998.
- - The 70th anniversary, on December 28, 1998, of the incorporation of Vanguard
Wellington Fund. It is the nation's oldest balanced mutual fund, and one of
only a handful of funds created in the 1920s that are still in operation.
Although Vanguard constantly tackles new challenges, adopts new technology, and
develops new services, we treasure the traditions and values that set us apart
in a crowded, competitive industry. And we salute our shareholders, whose
support and trust we strive to earn each and every day.
[PHOTO]
CONTENTS
A MESSAGE TO
OUR SHAREHOLDERS
1
THE MARKETS IN
PERSPECTIVE
3
REPORT FROM
THE ADVISERS
5
FUND PROFILE
6
PERFORMANCE SUMMARY
8
FINANCIAL STATEMENTS
9
All comparative mutual fund data
are from Lipper or Morningstar,
unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
[PHOTO] [PHOTO]
JOHN J. BRENNAN JOHN C. BOGLE
CHAIRMAN & CEO SENIOR CHAIRMAN
The U.S. stock market resumed its astonishing climb during the six months ended
March 31, 1999, the first half of the fiscal year for Vanguard Equity Income
Fund. Your fund earned a robust +11.9% return for the period, although we
trailed our comparative benchmarks.
The table below presents the six-month total return (capital change plus
reinvested dividends) for the fund, its average peer, and the unmanaged Standard
& Poor's 500 Composite Stock Price Index, whose performance is dominated by
large-capitalization stocks. Your fund's return slightly lagged that of the
average equity income fund and was far behind the remarkable +27.3% return of
the index.
<TABLE>
<CAPTION>
- --------------------------------------------------------
TOTAL RETURNS
SIX MONTHS ENDED
MARCH 31, 1999
- --------------------------------------------------------
<S> <C>
Vanguard Equity Income Fund +11.9%
- --------------------------------------------------------
Average Equity Income Fund +13.2%
- --------------------------------------------------------
S&P 500 Index +27.3%
- --------------------------------------------------------
</TABLE>
The fund's return is based on an increase in net asset value from $22.80
per share on September 30, 1998, to $24.28 per share on March 31, 1999, with the
latter figure adjusted for dividends totaling $0.37 per share paid from net
investment income and distributions totaling $0.83 per share paid from net
realized capital gains.
THE PERIOD IN REVIEW
During the six months ended March 31, the U.S. stock market rebounded in a big
way from 1998's midyear slump, when most market benchmarks declined by -20% or
more. The total stock market, as measured by the Wilshire 5000 Equity Index,
rose +26.1% during the first half of our fiscal year, setting record highs along
the way. Large-cap stocks, as measured by the S&P 500 Index, were up even more
strongly, at +27.3%.
The stock market soared despite two factors that might have daunted
investors. First, corporate earnings declined slightly in the final months of
1998 and were forecast to rise modestly, at best, during early 1999. Second,
interest rates rose. The yield of the benchmark 30-year U.S. Treasury bond rose
65 basis points (0.65 percentage point), from 4.98% when the fiscal year began
to 5.63% as of March 31. Short-term rates rose less sharply--the yield on
3-month Treasury bills increased by 12 basis points, from 4.36% to 4.48%. Bond
prices declined during the half-year, subtracting -3.2% from the return of the
Lehman Brothers Aggregate Bond Index, a proxy for the taxable bond market. This
price decline resulted in a -0.2% total return for the index.
The optimism that drove stocks higher also was evident in the behavior
of consumers, whose increased spending spurred the U.S. economy's growth.
Inflation remained more of a potential threat than a real one. Consumer prices
rose 0.9% during the half-year.
The stock market's gains were not evenly distributed. Returns for the
growth stocks within the S&P 500 Index, for example, were an amazing +33.1%,
compared with +20.8% for value stocks. The growth/value split was even more
pronounced among small-cap stocks: +21.6% returns for growth issues versus a
decline of -1.5% for value stocks.
The dominance of large growth stocks explains much of the Equity Income
Fund's 15.4-percentage-point shortfall versus the S&P 500 Index. Our advisers
typically focus on out-of-favor stocks whose dividend yields are high in
comparison to the yield of the
1
<PAGE> 4
overall market. In short, they look for stocks that appear to be bargain-priced.
But in the frothy market environment that has existed in recent months, many
investors are ignoring dividend income and focusing solely on the potential for
capital appreciation. Though rewarding in the recent past, concentrating on a
narrow segment of hot growth stocks is too speculative for your fund, whose
objective is to provide both current income and long-term growth of capital
while subjecting our shareholders to below-average volatility in share price.
Largely because of our advisers' emphasis on income and disciplined
approach to valuation, your fund was significantly underweighted in the
half-year's two best-performing market sectors--retailers and other consumer
discretionary stocks (12% of the S&P 500 during the period versus 6% of fund
assets) and technology (17% of the index versus 1% of the fund). Both sectors
produced average returns of nearly 50%. However, many of these stocks have low
or nonexistent dividend payments.
Our significant tilt toward utility stocks (roughly 23% of our stocks
versus about 11% of the index) detracted slightly from our relative performance.
A bigger drawback was our emphasis within the sector on electric utilities,
whose returns lagged far behind several telecommunications stocks that led the
utilities group but whose low dividend yields made them unsuitable for the fund.
In another key sector--financial services--our stock picks didn't do as well as
the S&P 500's financial stocks (+31% for the index versus +24% for your fund).
We note that the fund's strategy of investing in relatively high-yielding stocks
makes our returns sensitive to changes in interest rates. This typically helps
our performance when interest rates are falling, as they were in the last fiscal
year's first half, but hurts our results when interest rates rise, as they did
during the most recent six months.
The fund's stocks are selected by three investment advisers, each of
which uses its own methodology. The table below shows the current allocation of
assets to each adviser.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
TOTAL ASSETS MANAGED
AS OF MARCH 31, 1999
---------------------
$ MILLION PERCENT
- ----------------------------------------------------------------
<S> <C> <C>
Newell Associates $1,799 61%
John A. Levin & Company, Inc. 515 17
Spare, Kaplan, Bischel & Associates 467 16
Cash Reserves* 163 6
- ----------------------------------------------------------------
Total $2,944 100%
- ----------------------------------------------------------------
</TABLE>
* This cash reserve is invested in equity index futures to simulate investment
in stocks; each adviser also maintains a modest cash reserve.
IN SUMMARY
The bull market in stocks that has continued since August 1982, with only a few
relatively brief interruptions, is truly unprecedented. We celebrate this
marvelous run, but we're mindful that the market is capable of surprising
investors with downward moves, just as it has amazed observers with its climb.
We believe that investment success is best achieved not by trying to
anticipate the unpredictable movements of the markets, but instead by crafting a
balanced investment program that takes into account your personal time horizon,
financial goals, and tolerance for risk. Such a program helps investors to "stay
the course" through the markets' ups and downs by combating the tendency to
become overly optimistic during upturns or overly pessimistic during downturns.
In short, our counsel is to have a plan and stick with it.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
April 13, 1999
2
<PAGE> 5
THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED MARCH 31, 1999
[PHOTO]
Stock markets worldwide provided solid gains during the six months ended March
31, 1999, as they recovered from a sharp slide in midsummer 1998. Central banks
around the world helped by easing monetary policy and lowering short-term
interest rates.
A remarkably robust performance by the U.S. economy was a key factor in
the global recovery. Indeed, the United States was the only major economy in
which policymakers and bondholders had to ponder whether growth was too rapid.
Concern about a potential inflationary surge was one reason that longer-term
interest rates rose modestly and bond prices generally slipped in the United
States.
U.S. STOCK MARKETS
The surge in U.S. stocks during the half-year reflected both the strength of the
domestic economy and the confidence of investors in future corporate and
economic prospects.
The overall market, as measured by the Wilshire 5000 Equity Index, gained 26.1%.
The S&P 500 Index, which is dominated by large-capitalization stocks, advanced
27.3%. Small-cap stocks, which have consistently underperformed large-cap stocks
in recent years, gained 10.0%, as measured by the Russell 2000 Index.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
TOTAL RETURNS
PERIODS ENDED MARCH 31, 1999
-----------------------------------
6 MONTHS 1 YEAR 5 YEARS*
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
STOCKS
S&P 500 Index 27.3% 18.5% 26.2%
Russell 2000 Index 10.0 -16.3 11.2
Wilshire 5000 Index 26.1 13.1 23.6
MSCI EAFE Index 22.5 6.4 9.1
- -----------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index -0.2% 6.5% 7.8%
Lehman 10-Year Municipal Bond Index 1.2 6.3 7.7
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 2.3 4.9 5.2
- -----------------------------------------------------------------------------
OTHER
Consumer Price Index 0.9% 1.7% 2.3%
- -----------------------------------------------------------------------------
</TABLE>
* Annualized.
There was also a striking disparity in returns from growth and value
stocks; the growth-stock segment of the S&P 500 Index gained 33.1%, while the
value-stock segment rose 20.8%.
Investors in U.S. stocks seemed to have forgotten the jitters that sent
market indexes plummeting by 20% or more during the summer of 1998. Nor did they
appear to care that corporate earnings were flat to slightly lower during the
half-year. Investors focused more on the potential for future earnings than on
near-term disappointments. Interest rate reductions by central banks, including
three separate quarter-percentage-point cuts during autumn 1998 by the U.S.
Federal Reserve Board, lessened fears that the major economies would be dragged
down by the economic and currency troubles still afflicting much of Asia,
Russia, and Latin America. There was certainly little fear among U.S. consumers,
who were encouraged by low unemployment, rising wages, and low inflation to
spend freely. Their spending propelled the economy to a 6% annualized growth
rate during the first quarter of our fiscal year.
3
<PAGE> 6
With consumer spending so strong, it is no surprise that retailers and
other companies in the consumer-discretionary sector were the stock market's
leaders during the fiscal half-year, rising 49% on average. Technology stocks
were a close second, gaining 48%. Optimism--some would say overoptimism--was
especially evident in Internet stocks.
The market's laggards were energy stocks (integrated-oil companies were
up a relatively paltry 6%; "other energy" rose about 14%) and the
consumer-staples and materials & processing groups (each up about 10%). Energy
stocks lagged because prices for oil and natural gas were weak, despite upticks
late in the period. Several large makers of consumer staples, such as beverages
and tobacco, reported disappointing overseas profits.
U.S. BOND MARKETS
Early in the fiscal year, long-term interest rates fell to 30-year lows as a
result of the favorable inflationary environment and heavy demand from investors
who sought the perceived safety of U.S. Treasury bonds amid overseas economic
turmoil. The yield of the 30-year Treasury began the period at 4.98% and fell to
a low of 4.72% on October 5. However, as prices of stocks and riskier bonds
rebounded from their summertime lows, Treasury bond prices began to fall and
their yields began to rise. By March 31, the yield on the 30-year Treasury was
at 5.63%, up 65 basis points (0.65 percentage point) for the half-year. The
Lehman Brothers Long U.S. Treasury Bond Index declined -5.2% during the
half-year. The overall U.S. taxable bond market, as measured by the Lehman
Aggregate Bond Index, which has an intermediate-term average maturity, had a
negative return of -0.2%. High-yield bonds, which had suffered along with other
risky assets during last summer's slump in financial markets, produced positive
returns during the half-year.
Short-term interest rates, which were most directly affected by the
Federal Reserve Board's reductions, rose only slightly. Yields on 3-month
Treasury bills began the half-year at 4.36% but fell as low as 3.62% in
mid-October. By March 31, the 3-month T-bill was yielding 4.48%, only 12 basis
points higher than the rate when the period began.
INTERNATIONAL STOCK MARKETS
International stock markets, heartened by Wall Street's strong rally and easier
monetary policy, rallied during the half-year. Overall, the Morgan Stanley
Capital International Europe, Australasia, Far East (EAFE) Index gained 22.5% in
U.S. dollars. The gains were due, in part, to interest rate cuts by monetary
authorities in Japan, Europe, and Latin America. Investors also were heartened
by an increase in corporate restructuring and merger activity in Europe and
recession-wracked Japan.
The biggest gains overseas were for those bourses hit hardest during 1997
and 1998: emerging markets (the MSCI Select Emerging Markets Free Index rose
30.5% during the six months) and the Pacific region (up 40.1%). Further boosting
returns for U.S. investors was a weakening of the U.S. dollar against the
Japanese yen. In a turnabout, Europe's developed stock markets--which account
for some 70% of the EAFE Index--were the laggards, although they performed well
on balance, providing an aggregate return of 16.3% for U.S. investors. While the
U.S. dollar was weakening against the Japanese yen, and thus boosting returns
from the Pacific region for U.S. investors by more than 12 percentage points, it
was gaining against most European currencies, cutting U.S. investors' returns on
European stocks by about 5 percentage points.
In some emerging markets where stocks had plummeted in 1997 and 1998, the
six-month gains were spectacular: about 130% in U.S.-dollar terms in South
Korea, 115% in Indonesia, 69% in Malaysia, 66% in the Philippines, and 43% in
Mexico.
4
<PAGE> 7
REPORT FROM THE ADVISERS
[PHOTO]
Vanguard Equity Income Fund earned a total return of 11.9% during the fiscal
half-year ended March 31, 1999. This result, while quite good on an absolute
basis, trailed both the average equity income fund, which earned 13.2%, and the
S&P 500 Index, which returned 27.3%.
The market's surge was remarkable, but so was the degree to which large
growth stocks outperformed other large stocks. The growth stocks within the S&P
500 were up 33.1%, while the rest of the index gained 20.8%. In general, stocks
with above-average dividend yields--the pool from which we select securities for
Vanguard Equity Income Fund--have continued to significantly underperform the
market averages. Yet in terms of dividend yields and other fundamental measures,
many of these value stocks are more attractively priced than ever in comparison
with the overall market. Recently, it has become apparent that a good many
corporations also see some of the values that we have identified. A significant
number of the fund's holdings have been subjects of recent acquisition or merger
offers, including AMP, Amoco, Atlantic Richfield, Bankers Trust, BetzDearborn,
Chrysler, Mobil, Rubbermaid, Sundstrand, Union Camp, and Williams Companies.
With technology stocks up nearly 50% during the six months, our
near-absence from this sector seriously hurt our performance in relation to the
S&P 500 Index. Our relative results also were hurt by our larger position in
electric utility stocks, which lagged the overall market. There were no big
changes in the sector weightings of our holdings during the half-year.
It seems as if many investors have ceased trying to find good companies
at attractive prices, and instead are merely chasing stocks that are already
rising rapidly, without regard to risk. The result has been stratospheric
valuations for some of the stocks that have captured the public's attention. At
the end of our fiscal half-year, Microsoft, which is the world's
largest-capitalization stock, was priced at 70 times its trailing 12-month
earnings.
As tempting as it is to look away from traditional valuation measures in
such a time, we believe that fundamental security analysis and long-followed
investment disciplines should not be abandoned in favor of a concentration on
fast-moving stocks. The vast majority of our shareholders are engaged in the
serious work of providing for their retirement years. Such investors cannot
afford to take big risks by gambling on a few hot stocks. A successful
retirement plan rests on three legs: sufficient time, consistent saving, and
circumspect investing. It is not a throw of the dice.
We believe the current market offers considerable potential for our
disciplined investment style. With market averages at record levels, the
potential for a correction is certainly present. But we take comfort in the fact
that many of the stocks we hold are trading at 10 or 12 times their operating
earnings and paying dividend yields 2-2.5 times higher than the yield of the S&P
500 Index.
Newell Associates
John A. Levin & Company, Inc.
Spare, Kaplan, Bischel & Associates
April 14, 1999
INVESTMENT PHILOSOPHY
The advisers believe that a fund made up of undervalued stocks, most of which
offer high dividend yields compared to their past levels and to the overall
market, can provide a high level of current income, the potential for capital
appreciation, and below-average price volatility for a stock mutual fund.
5
<PAGE> 8
FUND PROFILE
EQUITY INCOME FUND
This Profile provides a snapshot of the fund's characteristics as of March 31,
1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 7.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- ----------------------------------------------------------
EQUITY INCOME S&P 500
- ----------------------------------------------------------
<S> <C> <C>
Number of Stocks 182 500
Median Market Cap $23.5B $64.6B
Price/Earnings Ratio 21.9x 29.1x
Price/Book Ratio 3.2x 5.1x
Yield 2.6% 1.3%
Return on Equity 19.8% 22.5%
Earnings Growth Rate 7.8% 16.8%
Foreign Holdings 4.3% 1.5%
Turnover Rate 19%* --
Expense Ratio 0.40%* --
Cash Reserves 2.1% --
</TABLE>
* Annualized.
INVESTMENT FOCUS
- ---------------------------
[GRAPH]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ------------------------------------------------------
EQUITY INCOME S&P 500
- ------------------------------------------------------
<S> <C> <C>
R-Squared 0.87 1.00
Beta 0.69 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- -------------------------------------------------------
<S> <C>
Bell Atlantic Corp. 2.7%
Bristol-Myers Squibb Co. 2.3
Chevron Corp. 2.1
American Home Products Corp. 2.1
BP Amoco PLC ADR 1.9
Pharmacia & Upjohn, Inc. 1.8
AT&T Corp. 1.8
Texaco Inc. 1.8
Atlantic Richfield Co. 1.7
U S WEST, Inc. 1.7
- -------------------------------------------------------
Top Ten 19.9%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- ----------------------------------------------------------------------------------------------
MARCH 31, 1998 MARCH 31, 1999
-----------------------------------------------------
EQUITY INCOME EQUITY INCOME S&P 500
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation 3.4% 3.3% 2.5%
Consumer Discretionary 7.2 6.4 13.2
Consumer Staples 7.7 8.0 8.4
Financial Services 19.3 20.0 16.7
Health Care 9.8 11.2 12.4
Integrated Oils 13.8 14.8 5.1
Other Energy 0.1 0.9 1.1
Materials & Processing 6.7 6.4 3.3
Producer Durables 2.2 2.5 3.1
Technology 1.0 0.8 17.3
Utilities 26.1 22.9 11.1
Other 2.7 2.8 5.8
- ----------------------------------------------------------------------------------------------
</TABLE>
6
<PAGE> 9
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come from
each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a fund has invested in
its ten largest holdings. (The average for stock mutual funds is about 30%.) As
this percentage rises, a fund's returns are likely to be more volatile because
they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the period. Funds with
high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
7
<PAGE> 10
PERFORMANCE SUMMARY
EQUITY INCOME FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely, so an investment in the fund could
lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: MARCH 21, 1988-March 31, 1999
- --------------------------------------------------------
EQUITY INCOME FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------
<S> <C> <C> <C> <C>
1988 5.8% 2.5% 8.3% 3.2%
1989 23.8 5.0 28.8 33.0
1990 -20.5 4.3 -16.2 -9.2
1991 18.0 8.5 26.5 31.2
1992 6.4 5.9 12.3 11.1
1993 14.1 5.1 19.2 13.0
1994 -6.5 4.3 -2.2 3.7
1995 19.8 5.0 24.8 29.7
1996 14.2 4.0 18.2 20.3
1997 30.0 4.2 34.2 40.4
1998 6.5 3.0 9.5 9.0
1999* 10.2 1.7 11.9 27.3
- ----------------------------------------------------------
</TABLE>
* Six months ended March 31, 1999.
See Financial Highlights table on page 14 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 1999
- ------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Equity Income Fund 3/21/1988 4.52% 20.89% 9.80% 4.87% 14.67%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
FINANCIAL STATEMENTS
MARCH 31, 1999 (UNAUDITED)
[PHOTO]
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
industry sector. Other assets are added to, and liabilities are subtracted from,
the value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the fund's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the fund had available to distribute to shareholders as income dividends or
capital gains as of the statement date. Any Accumulated Net Realized Losses, and
any cumulative excess of distributions over net income or net realized gains,
will appear as negative balances. Unrealized Appreciation (Depreciation) is the
difference between the market value of the fund's investments and their cost,
and reflects the gains (losses) that would be realized if the fund were to sell
all of its investments at their statement-date values.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- ---------------------------------------------------------
COMMON STOCKS (90.3%)(1)
- ---------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (3.0%)
Ford Motor Co. 417,400 $ 23,687
Genuine Parts Co. 510,950 14,722
Union Pacific Corp. 261,800 13,990
Dana Corp. 237,600 9,029
Norfolk Southern Corp. 291,700 7,694
General Motors Corp. 80,100 6,959
TRW, Inc. 142,200 6,470
CSX Corp. 146,300 5,697
----------
88,248
----------
CONSUMER DISCRETIONARY (5.7%)
J.C. Penney Co., Inc. 873,300 35,369
May Department Stores Co. 547,650 21,427
Tribune Co. 282,300 18,473
Fortune Brands, Inc. 457,600 17,703
Whirlpool Corp. 230,900 12,555
The McGraw-Hill Cos., Inc. 199,600 10,878
Eastman Kodak Co. 162,650 10,389
Kimberly-Clark Corp. 191,200 9,166
Black & Decker Corp. 128,800 7,140
The Stanley Works 264,400 6,775
Newell Rubbermaid, Inc. 102,900 4,888
Browning-Ferris Industries, Inc. 89,800 3,463
Avon Products, Inc. 58,900 2,772
Wal-Mart Stores, Inc. 30,000 2,766
- - Kmart Corp. 135,300 2,275
- - Fox Entertainment Group, Inc.
Class A 74,700 2,026
Sears, Roebuck & Co. 22,100 999
----------
169,064
----------
CONSUMER STAPLES (7.2%)
Philip Morris Cos., Inc. 1,243,450 43,754
Anheuser-Busch Cos., Inc. 358,400 27,306
General Mills, Inc. 264,700 20,001
International Flavors &
Fragrances, Inc. 385,700 14,488
UST, Inc. 535,500 13,990
H.J. Heinz Co. 277,800 13,161
The Clorox Co. 105,400 12,352
The Quaker Oats Co. 195,800 12,250
Ralston-Ralston Purina Group 385,400 10,285
Nabisco Holdings Corp. Class A 244,500 10,162
Kellogg Co. 272,300 9,207
Sara Lee Corp. 279,400 6,915
Campbell Soup Co. 157,300 6,400
Gallaher Group PLC ADR 263,600 6,195
Hershey Foods Corp. 44,700 2,503
Bestfoods 49,800 2,341
Rite Aid Corp. 37,000 925
----------
212,235
----------
FINANCIAL SERVICES (18.0%)
Bank One Corp. 832,123 45,819
First Union Corp. 730,582 39,040
BankAmerica Corp. 513,118 36,239
Marsh & McLennan Cos., Inc. 391,500 29,044
Mellon Bank Corp. 397,700 27,988
J.P. Morgan & Co., Inc. 200,700 24,761
PNC Bank Corp. 423,500 23,531
American General Corp. 323,100 22,779
First Data Corp. 473,950 20,261
SAFECO Corp. 484,200 19,580
Lincoln National Corp. 195,500 19,330
Dun & Bradstreet Corp. 507,900 18,094
</TABLE>
9
<PAGE> 12
<TABLE>
<CAPTION>
- ---------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- ---------------------------------------------------------
<S> <C> <C>
Washington Mutual, Inc. 432,810 $ 17,691
XL Capital Ltd. Class A 282,500 17,162
Bankers Trust Corp. 189,400 16,715
Wachovia Corp. 162,600 13,201
Fleet Financial Group, Inc. 345,600 13,003
KeyCorp 337,700 10,237
The Chase Manhattan Corp. 122,500 9,961
The Bank of New York Co., Inc. 273,400 9,825
Merrill Lynch & Co., Inc. 105,900 9,366
St. Paul Cos., Inc. 296,300 9,204
U.S. Bancorp 266,349 9,073
H & R Block, Inc. 184,000 8,717
Ace, Ltd. 251,000 7,828
Northern Trust Corp. 86,800 7,709
PartnerRe Ltd. 152,300 6,168
The Chubb Corp. 101,900 5,968
TIG Holdings, Inc. 330,900 5,398
Irvine Apartment Communities,
Inc. REIT 159,600 5,247
Crescent Real Estate, Inc. REIT 214,300 4,607
Prison Realty Corp. REIT 264,000 4,603
Mercury General Corp. 119,600 4,171
Wells Fargo Co. 95,800 3,359
National City Corp. 31,200 2,071
Deluxe Corp. 50,300 1,465
- - Scottish Annuity & Life
Holdings, Ltd. 142,500 1,389
----------
530,604
----------
HEALTH CARE (10.1%)
Bristol-Myers Squibb Co. 1,066,600 68,596
American Home Products Corp. 929,500 60,650
Pharmacia & Upjohn, Inc. 870,125 54,274
Merck & Co., Inc. 401,000 32,155
Glaxo Wellcome PLC ADR 415,000 27,779
Eli Lilly & Co. 183,500 15,575
Aetna Inc. 173,600 14,409
Baxter International, Inc. 152,000 10,032
Johnson & Johnson 95,700 8,966
Pfizer, Inc. 32,500 4,509
----------
296,945
----------
INTEGRATED OILS (13.4%)
Chevron Corp. 687,800 60,827
BP Amoco PLC ADR 555,609 56,082
Texaco Inc. 910,600 51,677
Atlantic Richfield Co. 703,100 51,326
Mobil Corp. 539,800 47,502
Exxon Corp. 644,100 45,449
Royal Dutch Petroleum Co. ADR 484,400 25,189
Phillips Petroleum Co. 416,500 19,680
Unocal Corp. 416,500 15,332
USX-Marathon Group 303,900 8,357
Conoco Inc. 301,500 7,406
Equitable Resources, Inc. 210,000 5,473
----------
394,300
----------
OTHER ENERGY (0.8%)
Williams Cos., Inc. 280,800 11,092
Schlumberger Ltd. 101,700 6,121
Baker Hughes, Inc. 225,700 5,487
----------
22,700
----------
MATERIALS & PROCESSING (5.7%)
Dow Chemical Co. 405,100 37,750
Weyerhaeuser Co. 416,100 23,094
Union Camp Corp. 278,700 18,708
E.I. du Pont de Nemours & Co. 281,100 16,321
Eastman Chemical Co. 314,500 13,229
International Paper Co. 229,100 9,665
Potlatch Corp. 238,900 8,108
The BFGoodrich Co. 222,000 7,617
Nalco Chemical Co. 230,300 6,117
Lubrizol Corp. 271,500 6,109
- - Owens-Illinois, Inc. 215,000 5,375
Phelps Dodge Corp. 85,000 4,186
Armstrong World Industries Inc. 90,600 4,094
Temple-Inland Inc. 60,400 3,790
- - Getchell Gold Corp. 95,900 2,505
USX-U.S. Steel Group 103,400 2,430
----------
169,098
----------
PRODUCER DURABLES (2.3%)
Pitney Bowes, Inc. 211,400 13,477
United Technologies Corp. 73,100 9,900
Emerson Electric Co. 183,000 9,688
Lockheed Martin Corp. 237,000 8,932
Sundstrand Corp. 102,000 7,089
Thomas & Betts Corp. 150,500 5,653
Caterpillar, Inc. 84,700 3,891
Honeywell, Inc. 50,700 3,844
The Boeing Co. 69,700 2,378
Deere & Co. 51,300 1,981
----------
66,833
----------
TECHNOLOGY (0.8%)
International Business
Machines Corp. 81,200 14,393
- - Seagate Technology 196,700 5,815
- - Loral Space & Communications 150,800 2,177
----------
22,385
----------
UTILITIES (20.7%)
Bell Atlantic Corp. 1,541,496 79,676
AT&T Corp. 659,800 52,660
U S WEST, Inc. 893,986 49,225
GTE Corp. 802,700 48,563
Ameritech Corp. 745,700 43,157
BellSouth Corp. 644,300 25,812
SBC Communications Inc. 485,734 22,890
Potomac Electric Power Co. 914,000 21,193
Consolidated Natural Gas Co. 419,600 20,429
Duke Energy Corp. 362,800 19,818
- - MediaOne Group, Inc. 287,500 18,256
Southern Co. 655,700 15,286
Texas Utilities Co. 365,497 15,237
Allegheny Energy, Inc. 465,000 13,717
Sempra Energy 660,155 12,667
Edison International 551,100 12,262
KeySpan Energy Corp. 466,236 11,714
Consolidated Edison Inc. 252,000 11,419
NICOR, Inc. 302,500 10,871
Baltimore Gas & Electric Co. 414,850 10,527
PacifiCorp 609,300 10,510
Wisconsin Energy Corp. 373,300 9,752
Northern States Power Co. 396,400 9,191
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ----------------------------------------------------------------
<S> <C> <C>
Ameren Corp. 248,800 $ 9,003
FPL Group, Inc. 132,900 7,077
Dominion Resources, Inc. 191,500 7,074
Central & South West Corp. 284,200 6,661
Public Service Enterprise
Group, Inc. 155,300 5,931
OGE Energy Corp. 223,100 5,034
Eastern Utilities Associates 177,600 5,028
Florida Progress Corp. 130,200 4,915
TECO Energy, Inc. 214,000 4,253
SCANA Corp. 190,600 4,134
New Century Energies, Inc. 119,400 4,067
----------
608,009
----------
OTHER (2.6%)
General Electric Co. 230,100 25,455
Minnesota Mining &
Manufacturing Co. 338,300 23,935
Monsanto Co. 257,000 11,806
Federal Signal Corp. 297,200 6,204
Tenneco, Inc. 173,800 4,856
Cooper Industries, Inc. 85,000 3,623
Ogden Corp. 39,500 950
----------
76,829
----------
- -----------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,777,525) 2,657,250
- -----------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (1.4%)
- -----------------------------------------------------------------
Owens-Illinois Inc. 4.75% Cvt. Pfd. 294,400 10,727
Loral Space & Communications
Ltd. 6.00% Cvt. Pfd. 222,600 9,905
AirTouch Communications, Inc.
6.00% Cvt. Pfd. 110,000 8,662
Crown Cork & Seal Co., Inc.
4.50% Cvt. Pfd. 201,200 5,483
Comcast Corp. 3.35% Cvt. Pfd. 64,300 5,120
Globalstar Telecommunications
Ltd. 8.00% Cvt. Pfd. 60,100 2,348
- -----------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $41,160) 42,245
- -----------------------------------------------------------------
<CAPTION>
- -----------------------------------------------------------------
FACE
AMOUNT
(000)
- -----------------------------------------------------------------
<S> <C> <C>
CONVERTIBLE BONDS (0.6%)
- -----------------------------------------------------------------
Hewlett-Packard Co.
0.00%, 10/14/2017 $ 22,600 12,628
National Semiconductor
6.50%, 10/1/2002 2,590 2,137
Security Capital U.S. Realty
2.50%, 5/22/2003 5,800 4,365
- -----------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(Cost $19,966) 19,130
- -----------------------------------------------------------------
<CAPTION>
- -----------------------------------------------------------------
FACE MARKET
AMOUNT VALUE
(000) (000)
- -----------------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENTS (8.1%)
- -----------------------------------------------------------------
U.S. TREASURY BILLS
(2) 4.25%, 4/22/1999 $ 7,000 $ 6,980
(2) 4.41%, 4/29/1999 2,000 1,993
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
4.94%, 4/1/1999 224,583 224,583
4.97%, 4/1/1999--Note G 4,344 4,344
- -----------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $237,903) 237,900
- -----------------------------------------------------------------
TOTAL INVESTMENTS (100.4%)
(COST $2,076,554) 2,956,525
- -----------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.4%)
- -----------------------------------------------------------------
Other Assets--Note C 16,769
Liabilities--Note G (28,916)
------------
(12,147)
- -----------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------
Applicable to 121,266,019 outstanding
$.001 par value shares of beneficial interest
(unlimited authorization) $2,944,378
=================================================================
NET ASSET VALUE PER SHARE $24.28
=================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- Non-Income-Producing Security.
(1) The fund invests a portion of its cash reserves in equity markets through
the use of index futures contracts. After giving effect to futures
investments, the fund's effective common stock and temporary cash investment
positions represent 95.8% and 2.5%, respectively, of net assets. See Note F
in Notes to Financial Statements.
(2) Securities with an aggregate value of $8,973,000 have been segregated as
initial margin for open futures contracts.
ADR--American Depositary Receipt.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
AT MARCH 31, 1999, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------
<S> <C> <C>
Paid in Capital $2,023,906 $16.69
Overdistributed Net
Investment Income (35) --
Accumulated Net
Realized Gains 41,591 .34
Unrealized Appreciation
(Depreciation)--Note F
Investment Securities 879,971 7.26
Futures Contracts (1,055) (.01)
- ----------------------------------------------------------
NET ASSETS $2,944,378 $24.28
==========================================================
</TABLE>
11
<PAGE> 14
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period. If the
fund invested in futures contracts during the period, the results of these
investments are shown separately.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
EQUITY INCOME FUND
SIX MONTHS ENDED MARCH 31, 1999
(000)
- ----------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 36,299
Interest 5,018
Security Lending 26
-----------
Total Income 41,343
-----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 2,090
Performance Adjustment (236)
The Vanguard Group--Note C
Management and Administrative 3,323
Marketing and Distribution 255
Custodian Fees 30
Auditing Fees 10
Shareholders' Reports 46
Trustees' Fees and Expenses 2
-----------
Total Expenses 5,520
Expenses Paid Indirectly--Note D (252)
-----------
Net Expenses 5,268
- ----------------------------------------------------------------------------------------
NET INVESTMENT INCOME 36,075
- ----------------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 25,843
Futures Contracts 27,193
- ----------------------------------------------------------------------------------------
REALIZED NET GAIN 53,036
- ----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 192,347
Futures Contracts (1,514)
- ----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 190,833
========================================================================================
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $279,944
========================================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
EQUITY INCOME FUND
---------------------------------
SIX MONTHS YEAR
ENDED ENDED
MAR. 31, 1999 SEP. 30, 1998
(000) (000)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 36,075 $ 63,904
Realized Net Gain 53,036 84,810
Change in Unrealized Appreciation (Depreciation) 190,833 36,596
---------------------------------
Net Increase in Net Assets Resulting from Operations 279,944 185,310
---------------------------------
DISTRIBUTIONS
Net Investment Income (41,425) (65,293)
Realized Capital Gain (87,949) (78,880)
---------------------------------
Total Distributions (129,374) (144,173)
---------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 590,959 691,426
Issued in Lieu of Cash Distributions 116,671 129,534
Redeemed (291,353) (432,576)
---------------------------------
Net Increase from Capital Share Transactions 416,277 388,384
- ------------------------------------------------------------------------------------------------------------------------
Total Increase 566,847 429,521
- ------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 2,377,531 1,948,010
---------------------------------
End of Period $2,944,378 $2,377,531
========================================================================================================================
(1)Shares Issued (Redeemed)
Issued 24,127 29,627
Issued in Lieu of Cash Distributions 4,873 5,766
Redeemed (12,017) (18,560)
---------------------------------
Net Increase in Shares Outstanding 16,983 16,833
========================================================================================================================
</TABLE>
13
<PAGE> 16
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30,
FOR A SHARE OUTSTANDING SIX MONTHS ENDED -----------------------------------------------------------
THROUGHOUT EACH PERIOD MARCH 31, 1999 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $22.80 $22.28 $17.69 $15.65 $13.16 $14.62
- -------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .32 .64 .64 .63 .60 .59
Net Realized and Unrealized Gain (Loss)
on Investments 2.36 1.44 5.17 2.18 2.56 (.92)
---------------------------------------------------------------------------
Total from Investment Operations 2.68 2.08 5.81 2.81 3.16 (.33)
---------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.37) (.67) (.64) (.60) (.58) (.61)
Distributions from Realized Capital Gains (.83) (.89) (.58) (.17) (.09) (.52)
---------------------------------------------------------------------------
Total Distributions (1.20) (1.56) (1.22) (.77) (.67) (1.13)
- -------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $24.28 $22.80 $22.28 $17.69 $15.65 $13.16
=========================================================================================================================
TOTAL RETURN 11.86% 9.54% 34.17% 18.22% 24.77% -2.19%
=========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $2,944 $2,378 $1,948 $1,309 $967 $901
Ratio of Total Expenses to
Average Net Assets 0.40%* 0.39% 0.45% 0.42% 0.47% 0.43%
Ratio of Net Investment Income to
Average Net Assets 2.62%* 2.80% 3.25% 3.69% 4.27% 4.41%
Portfolio Turnover Rate 19%* 23% 22% 21% 31% 18%
=========================================================================================================================
</TABLE>
* Annualized.
14
<PAGE> 17
NOTES TO FINANCIAL STATEMENTS
Vanguard Equity Income Fund is registered under the Investment Company Act of
1940 as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid
and asked prices. Prices are taken from the primary market in which each
security trades. Temporary cash investments acquired over 60 days to maturity
are valued using the latest bid prices or using valuations based on a matrix
system (which considers such factors as security prices, yields, maturities,
and ratings), both as furnished by independent pricing services. Other
temporary cash investments are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued by methods deemed by the Board of Trustees to represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard
Group, transfers uninvested cash balances to a Pooled Cash Account, which is
invested in repurchase agreements secured by U.S. government securities.
Securities pledged as collateral for repurchase agreements are held by a
custodian bank until the agreements mature. Each agreement requires that the
market value of the collateral be sufficient to cover payments of interest and
principal; however, in the event of default or bankruptcy by the other party to
the agreement, retention of the collateral may be subject to legal proceedings.
4. FUTURES: The fund uses S&P 500 Index and S&P MidCap 400 Index futures
contracts to a limited extent, with the objective of maintaining full exposure
to the stock market while maintaining liquidity. The fund may purchase or sell
futures contracts to achieve a desired level of investment, whether to
accommodate portfolio turnover or cash flows from capital share transactions.
The primary risks associated with the use of futures contracts are imperfect
correlation between changes in market values of stocks held by the fund and the
prices of futures contracts, and the possibility of an illiquid market.
Futures contracts are valued at their quoted daily settlement prices. The
aggregate principal amounts of the contracts are not recorded in the financial
statements. Fluctuations in the value of the contracts are recorded in the
Statement of Net Assets as an asset (liability) and in the Statement of
Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized futures gains (losses).
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Newell Associates; Spare, Kaplan, Bischel & Associates; and John A. Levin &
Co., Inc., provide investment advisory services to the fund for fees calculated
at an annual percentage rate of average net assets. The basic fee of Spare,
Kaplan, Bischel & Associates is subject to quarterly adjustments based on
performance relative to the S&P/BARRA Value Index for the preceding three years;
the basic fee for John A. Levin & Co., Inc., is subject to quarterly adjustments
based on performance for the preceding three years relative to the S&P 500
Index.
15
<PAGE> 18
NOTES TO FINANCIAL STATEMENTS (continued)
The Vanguard Group manages the cash reserves of the fund on an at-cost
basis.
For the six months ended March 31, 1999, the aggregate advisory fee
represented an effective annual basic rate of 0.15% of the fund's average net
assets before a decrease of $236,000 (0.02%) based on performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At March 31, 1999, the fund had contributed capital of $483,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 0.7% of Vanguard's capitalization. The fund's Trustees and officers are also
Directors and officers of Vanguard.
D. Vanguard has asked the fund's investment advisers to direct certain portfolio
trades, subject to obtaining the best price and execution, to brokers who have
agreed to rebate to the fund part of the commissions generated. Such rebates are
used solely to reduce the fund's administrative expenses. The fund's custodian
bank has also agreed to reduce its fees when the fund maintains cash on deposit
in the non-interest-bearing custody account. For the six months ended March 31,
1999, directed brokerage and custodian fee offset arrangements reduced the
fund's expenses by $250,000 and $2,000, respectively. The total expense
reduction represented an effective annual rate of 0.02% of the fund's average
net assests.
E. During the six months ended March 31, 1999, the fund purchased $509,129,000
of investment securities and sold $244,613,000 of investment securities other
than temporary cash investments.
F. At March 31, 1999, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $879,971,000, consisting
of unrealized gains of $937,598,000 on securities that had risen in value since
their purchase and $57,627,000 in unrealized losses on securities that had
fallen in value since their purchase.
At March 31, 1999, the aggregate settlement value of open futures contracts
expiring in June 1999 and the related unrealized depreciation were:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------
(000)
-----------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE DEPRECIATION
-----------------------------------------------------------------------------
<S> <C> <C> <C>
S&P 500 Index 384 $124,157 $(1,012)
S&P MidCap 400 Index 208 38,303 (43)
-----------------------------------------------------------------------------
</TABLE>
G. The market value of securities on loan to broker/dealers at March 31, 1999,
was $4,233,000, for which the fund held cash collateral of $4,344,000. Cash
collateral received is invested in repurchase agreements.
16
<PAGE> 19
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director/Trustee of The Vanguard
Group, Inc., and each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman of the Board, Chief Executive Officer, and Director/Trustee of The
Vanguard Group, Inc., and each of the investment companies in The Vanguard
Group.
JoANN HEFFERNAN HEISEN
Vice President, Chief Information Officer, and a member of the Executive
Committee of Johnson & Johnson; Director of Johnson & JohnsonoMerck Consumer
Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and
Dyslexic, The Medical Center at Princeton, and Women's Research and Education
Institute.
BRUCE K. MacLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co.,
NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DiSTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MacKINNON
Managing Director, Fixed Income Group.
F. WILLIAM McNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," and
"500" are trademarkS of The McGraw-Hill Companies, Inc. Frank Russell
Company is the owner of trademarks and copyrights relating to the
Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are
trademarks of Wilshire Associates.
<PAGE> 20
VANGUARD
MILESTONES
[PHOTO]
The Vanguard Group is
named for HMS Vanguard,
Admiral Horatio Nelson's flagship
at the Battle of the Nile on
August 1, 1798. Our founder,
John C. Bogle, chose the name
after reading Nelson's inspiring
tribute to his fleet: "Nothing could
withstand the squadron . . .
with the judgment of the captains,
together with their valour, and that
of the officers and men of every
description, it was absolutely irresistible."
[PHOTO]
Walter L. Morgan, founder of
Wellington Fund, the nation's
oldest balanced mutual fund
and forerunner of today's family
of some 100 Vanguard funds,
celebrated his 100th birthday on
July 23, 1998. Mr. Morgan,
a true investment pioneer, died
six weeks later on September 2.
[PHOTO]
Wellington Fund,
The Vanguard Group's oldest fund,
was incorporated by Mr. Morgan
70 years ago, on December 28, 1928.
The fund was named after
the Duke of Wellington,
whose forces defeated
Napoleon Bonaparte at the
Battle of Waterloo in 1815.
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
www.vanguard.com
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
Q652-05/12/1999
(C) 1999 The Vanguard Group, Inc.
All rights reserved. Vanguard Marketing Corporation, Distributor.
