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VANGUARD(R)
EQUITY INCOME FUND
March 31, 2000
[SHIP PHOTO]
SEMIANNUAL REPORT
[THE VANGUARD GROUP LOGO]
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HAVE THE PRINCIPLES OF INVESTING CHANGED?
In a world of frenetic change in business, technology, and the financial
markets, it is natural to wonder whether the basic principles of investing have
changed.
We don't think so.
The most successful investors over the coming decade will be those who
began the new century with a fundamental understanding of risk and who had the
discipline to stick with long-term investment programs.
Certainly, investors today confront a challenging, even unprecedented,
environment. Valuations of market indexes are at or near historic highs. The
strength and duration of the bull market in U.S. stocks have inflated people's
expectations and diminished their recognition of the market's considerable
risks. And the incredible divergence in stock returns--many technology-related
stocks gained 100% or more in 1999, yet prices fell for more than half of all
stocks--has made some investors question the idea of diversification.
And then there is the Internet. Undeniably, it is a powerful medium for
communications and transacting business. For investors, the Internet is a vast
source of information about investments, and online trading has made it
inexpensive and convenient to trade stocks and invest in mutual funds.
However, new tools do not guarantee good workmanship. Information is not the
same as wisdom. Indeed, much of the information, opinion, and rumor that swirl
about financial markets each day amounts to "noise" of no lasting significance.
And the fact that rapid-fire trading is easy does not make it beneficial.
Frequent trading is almost always counterproductive because costs--even at low
commission rates--and taxes detract from the returns that the markets provide.
Sadly, many investors jump into a "hot" mutual fund just in time to see it cool
off. Meanwhile, long-term fund investors are hurt by speculative trading
activity because they bear part of the costs involved in accommodating purchases
and redemptions.
Vanguard believes that intelligent investors should resist short-term
thinking and focus instead on a few time-tested principles:
o Invest for the long term. Pursuing your long-term investment goals is more
like a marathon than a sprint.
o Diversify your investments with holdings in stocks, bonds, and cash
investments. Remember that, at any moment, some part of a diversified portfolio
will lag other parts, and be wary of taking on more risk by "piling onto" the
best-performing part of your holdings. Today's leader could well be tomorrow's
laggard.
o Step back from the daily frenzy of the markets; focus on your overall asset
allocation.
o Capture as much of the market's return as possible by minimizing costs
and taxes. Costs and taxes diminish long-term returns while doing nothing to
reduce the risks you incur as an investor.
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CONTENTS
REPORT FROM THE CHAIRMAN 1 FUND PROFILE 8
THE MARKETS IN PERSPECTIVE 4 PERFORMANCE SUMMARY 10
REPORT FROM THE ADVISERS 6 FINANCIAL STATEMENTS 11
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All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
unless otherwise noted.
"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.
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REPORT FROM THE CHAIRMAN
[PHOTO OF JOHN J. BRENNAN]
JOHN J. BRENNAN
Vanguard Equity Income Fund had a disappointing return of -1.1% during the six
months ended March 31, 2000, a period when value stocks were generally out of
favor.
The adjacent table presents the six-month total return (capital change plus
reinvested dividends) for the fund, its average peer, and the unmanaged Russell
1000 Value Index, which consists of the value stocks among the 1,000 largest
U.S. stocks. For reference, we also present the return of the Standard & Poor's
500 Index, which consists of both growth and value stocks. The fund's return was
4.1 percentage points behind that of its average peer and 7.0 percentage points
behind that of the Russell 1000 Value Index.
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TOTAL RETURNS
SIX MONTHS ENDED
MARCH 31, 2000
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Vanguard Equity Income Fund -1.1%
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Average Equity Income Fund* 3.0%
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Russell 1000 Value Index 5.9%
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S&P 500 Index 17.5%
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*Derived from data provided by Lipper Inc.
The fund's return is based on a decrease in net asset value from $24.14 per
share on September 30, 1999, to $22.67 per share on March 31, 2000, with the
latter figure adjusted for a dividend of $0.34 per share paid from net
investment income and a distribution of $0.87 per share paid from net realized
capital gains. The fund's yield as of March 31 was 2.51%.
THE PERIOD IN REVIEW
During the six months, the remarkably vibrant U.S. economy completed its 108th
month of uninterrupted expansion--a record nine full years without a recession.
By the last quarter of 1999, the economy was growing at an astounding 7.3% rate.
The U.S. stock market, as measured by the Wilshire 5000 Total Market Index, rose
an impressive 23.2% for the half-year.
However, returns were wildly disparate within the market. Small- and
mid-cap stocks far outpaced large-cap companies. The Wilshire 4500 Completion
Index-- essentially the total U.S. market minus the S&P 500--had a total return
of 42.6% for the period. And despite a momentary rally of so-called "old
economy" stocks in late March, the "new economy" group (i.e., technology, media,
and telecommunications stocks) dominated the market, as it had in 1999. The
growth portion of the S&P 500 Index gained 24.7%, while the value portion
returned 9.2%. The tech-heavy Nasdaq Composite Index rose 67.3% for the period.
Meanwhile, after years of mostly nominal inflation, the cost of living
seemed to be on the rise, though much of the increase stemmed from a sharp hike
in oil prices that many analysts regarded as temporary. In March the Consumer
Price Index was 3.7% above its level in March 1999.
The Federal Reserve Board--fearing that the rapidly growing economy would
spur rising prices--took preemptive action on March 21, raising short-term
interest rates by 25 basis points (0.25 percentage point) for the fifth time in
nine months.
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The Fed's action, together with the U.S. Treasury's announced plans to buy back
some of its long-term debt, caused a relatively rare "inversion of the yield
curve"--a situation when yields of short-term debt exceed those of long-term
bonds. During the six months, the 30-year Treasury bond's yield fell 22 basis
points (0.22 percentage point) to 5.83%, while the yield of 3-month Treasury
bills rose 102 basis points to 5.87%. The Lehman Brothers Aggregate Bond Index,
a proxy for the entire taxable bond market, posted a total return of 2.1% for
the six months.
PERFORMANCE OVERVIEW
The market's continuing love affair with technology-related stocks and its lack
of emphasis on dividend-paying stocks hampered Equity Income Fund's performance
during the first half of our fiscal year. Tech stocks constituted 25% of the S&P
500 Index by market capitalization and generated a return of 53.4%--almost 17
percentage points higher than producer durables, the second-best-performing
sector. While our fund's tech stocks generated a 37.0% return, this sector
accounted for less than 2% of the fund's assets.
Equity Income's underrepresentation in technology is not surprising, given
the fund's long-standing goal of providing both current income and long-term
capital growth with relatively low volatility. The fund invests predominantly in
large-cap value stocks that have above-average dividends and below-average
prices relative to earnings. Most technology stocks pay little or no dividends,
and many had price/earnings ratios of 100 or higher during the half-year, with a
number of the best-performing ones showing no earnings.
Compared with the S&P 500 Index, the fund's overweighting in the relatively
poorly performing electric utilities and integrated-oils sectors did not help
matters. The fund had almost three times the index's weighting in large oil
refiners, whose stocks did not benefit much from rising oil prices. Instead,
rising prices cut into refiners' profits.
The producer-durables and consumer-discretionary (mainly retailers) sectors
only added to the fund's woes during the period. However, the weakness in these
sectors provided an opportunity for our advisers to build the fund's holdings of
many high-quality companies at attractive prices.
Although the stock market has been heavily focused on growth of revenue and
on even the mere prospect of such growth, we continue to believe that actual
earnings and dividends are what drive long-term returns for common stocks.
Vanguard Equity Income Fund reflects that belief, and we will maintain our
emphasis on solid, dividend-paying stocks as a sound long-term strategy.
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TOTAL ASSETS MANAGED
AS OF MARCH 31, 2000
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$ MILLION PERCENT
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Newell Associates $1,275 54%
John A. Levin & Company, Inc. 573 24
Wellington Management Company, LLP 461 19
Cash Reserve* 81 3
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Total $2,390 100%
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*This cash reserve is invested in equity index futures to simulate investment in
stocks; each adviser also maintains a modest cash reserve.
As you may be aware, as of January 1, 2000, Wellington Management Company,
LLP, replaced Spare, Kaplan, Bischel & Associates as one of the fund's three
advisers. The table at left shows the current allocation of assets among the
advisers, each of which uses its own methodology to pick stocks.
IN SUMMARY
In the first two weeks of April, just after the end of this reporting period,
tech stocks plummeted, going into
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negative territory for the calendar year, while value stocks registered modest
gains. This episode served to show how quickly and unpredictably market sectors
can move in and out of favor.
Lacking a crystal ball to tell the market's future, we advocate the
tried-and-true strategy of diversification and investing for the long run.
Holding well-diversified stock funds, as well as bond and money market funds,
gives you exposure to the major asset classes and can help you to maintain your
balance in turbulent times. We urge investors to base their plans on their own
goals, time horizon, and risk tolerance--and to stick with those plans over the
long haul.
/S/
John J. Brennan
Chairman and Chief Executive Officer
April 17, 2000
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NOTICE TO SHAREHOLDERS
In the past, the quarterly income dividend that Vanguard Equity Income Fund
distributed to shareholders was paid at a "set rate" of $0.15 per share. Any
income the fund earned in excess of the set rate was distributed in the December
income dividend. Beginning with the dividend of $0.14 per share that was paid in
March 2000, the fund will distribute income on a "pay as you go" basis, rather
than according to a set rate. This policy change provides for a more even
distribution of income throughout the year.
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THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED MARCH 31, 2000
A strong economy and an extraordinary run-up in prices for technology stocks
carried broad market indexes higher during a volatile but generally rewarding
six months ended March 31, 2000.
The rise in stocks was surprising in light of higher inflation and
rising interest rates, both of which did some damage to bond prices. For stock
investors, however, worries about inflation and interest rates did little to
dampen enthusiasm for technology, telecommunications, and media companies.
The U.S. economy continued its rapid growth during the semiannual period.
Gross domestic product, an estimate of total economic output, increased at a
7.3% pace, even after inflation, during the final three months of 1999. The
economy expanded by more than 4% during 1999, which is a brisk clip for a large
economy, especially one that in March completed a record 108 consecutive months
without a recession.
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TOTAL RETURNS
PERIODS ENDED MARCH 31, 2000
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6 MONTHS 1 YEAR 5 YEARS*
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STOCKS
S&P 500 Index 17.5% 17.9% 26.8%
Russell 2000 Index 26.8 37.3 17.2
Wilshire 5000 Index 23.2 24.0 25.9
MSCI EAFE Index 17.0 25.4 12.7
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BONDS
Lehman Aggregate Bond Index 2.1% 1.9% 7.1%
Lehman 10 Year Municipal Bond Index 2.2 0.5 6.2
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 2.6 5.0 5.2
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OTHER
Consumer Price Index 1.9% 3.7% 2.5%
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*Annualized.
Inflation measures sent mixed messages. Higher oil prices did cause the
Consumer Price Index to increase by 1.9% and 3.7% for the six- and twelve-month
periods ended March 31. But if energy and food prices were factored out,
inflation remained tame. Nonetheless, the Federal Reserve Board, concerned that
rapid growth and low unemployment (around 4% of the workforce) would cause
inflation to build momentum, continued the efforts it began in June 1999 to slow
the economy. The Fed raised its target for short-term interest rates by 0.25
percentage point on three occasions during the six months, bringing the federal
funds rate to 6.0%.
U.S. STOCK MARKETS
The technology sector continued to dominate the stock market during the
half-year, although it suffered some setbacks. Over a five-week period from
March 10 through April 14, technology stocks fell sharply and the Nasdaq
Composite Index, which is dominated by large tech issues, declined -34%.
However, for the six months ended March 31, the Nasdaq Composite registered an
incredible 67.3% return.
The overall stock market, as measured by the Wilshire 5000 Index, posted a
23.2% gain. Large-capitalization stocks didn't do quite as well--the S&P 500
Index returned 17.5%. The small-cap Russell 2000 Index gained 26.8%.
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Computer software and hardware companies, semiconductor makers, and an
array of Internet-related companies powered the advance on Wall Street. Indeed,
one-third of the 57 companies in the S&P 500's tech group gained more than 100%
during the six months. A number of tech-related companies within the
producer-durables and utility groups also posted impressive gains. For the
half-year, technology stocks, which accounted for one-quarter of the total
market capitalization of the S&P 500 Index, gained 53%. Producer-durables
companies returned 36%. The oil-drilling and services companies in the "other
energy" category benefited from higher oil prices and returned about 30% for the
six months.
Despite the impressive gains for the market averages, many individual
stocks declined. The market's worst-performing sectors were consumer staples
(-14%), including large food, beverage, supermarket, and tobacco stocks, and the
materials & processing group (-6%), which was hurt by higher energy prices,
competitive pressure from imports, and higher interest rates.
With demand for stocks high, Wall Street came up with new supply: During
the first three months of 2000, a record $75 billion in new stock was issued
through underwriters.
U.S. BOND MARKETS
The step-by-step increases in short-term interest rates by the Federal Reserve
did succeed in elevating other short-term rates. For example, yields of 3-month
U.S. Treasury bills rose by 102 basis points (about 1 percentage point) during
the half-year, from 4.85% on September 30 to 5.87% on March 31. Yields on 3-year
Treasury notes rose about 75 basis points, in line with the Fed's actions.
But for long-term Treasury bonds, interest rates fell during the period.
This was due primarily to the federal government's budget surplus, which
resulted in reduced issuance of new bonds and steps by the Treasury to buy back
some of its existing long-term securities. This reduced supply of long-term
bonds caused the yield on the 30-year Treasury to fall 22 basis points--from
6.05% to 5.83%--during the half-year. Yields of 10-year Treasury securities rose
only 12 basis points to 6.00% as of March 31.
Higher short-term rates and lower or relatively stable long-term rates
resulted in an inversion in the yield curve. Instead of the usual upward sloping
curve--with yields rising along with the maturity of Treasury securities--yields
were lower for long-term bonds.
Outside of the Treasury market, yields rose and prices fell for most
intermediate- to long-term corporate and municipal bonds. The overall bond
market, as measured by the Lehman Aggregate Bond Index, posted a 2.1% return, as
an average price decline of -1.3% offset much of the 3.4% income provided by the
market.
INTERNATIONAL STOCK MARKETS
Stock markets in Europe, Asia, and many emerging markets produced double-digit
gains during the half-year as investors responded to improving global economic
growth and a rise in corporate merger and acquisition activity. The overall
return from developed foreign markets was an excellent 17.0%, as measured by the
Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index.
In Europe, an average return of 27.7% in local-currency terms was reduced
to 17.6% for U.S. investors because of the U.S. dollar's gains against European
currencies. (Returns from abroad are diminished when the dollar rises in value
against other currencies, and increased when the dollar falls.) Stocks in the
Pacific region, which is dominated by Japan, returned 15.6% in dollars and 12.8%
in local-currency terms. The Select Emerging Markets Free Index soared 26.2% in
dollars, led by big gains in Turkey (111%) and Brazil (60%).
5
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REPORT FROM THE ADVISERS
Vanguard Equity Income Fund's total return was -1.1% for the fiscal half-year
ended March 31, 2000. This was quite disappointing, as it lagged both the 3.0%
return for the average equity income fund and the 5.9% gain for the Russell 1000
Value Index, which consists of the value issues within the 1,000 largest U.S.
stocks. The S&P 500 Index, which holds both growth stocks and value stocks,
posted a 17.5% return.
During the first six months of the fund's fiscal year, the stock market was
effectively split in two. One part comprised "old economy" companies whose
valuations are driven by corporate and economic fundamentals. The other part was
the "new economy" group of technology and tech-related companies, whose stock
prices were driven by euphoric expectations and momentum, with little or no
regard for price level. Companies governed by the old rules plunged into a bear
market during the autumn and winter of 1999, while the new economy stocks shot
up to price levels never before seen in the U.S. market.
The technology-heavy Nasdaq Composite Index rose a stunning 67% in the six
month period. The S&P 500 Index and the Dow Jones Industrial Average also rose
nicely, by virtue of the considerable overlap of large-capitalization technology
companies in the three market barometers.
The extraordinary performance of tech stocks has attracted even the
supposedly conservative managers of mutual funds within Lipper Inc.'s Equity
Income Funds category. The technology-sector exposure for the 30 largest funds
now averages about 9% of assets and in at least one case is as high as 36%. Your
fund's exposure to this sector is only about 2%--the high prices and low (or
nonexistent) dividend yields of most tech stocks make them inappropriate for us.
However, without a large exposure to tech stocks, it was virtually impossible to
generate strong returns during the past half-year.
CASH FLOWS DRIVING PERFORMANCE
This split of old and new worlds has been driven, in part, by cash flows from
investors, including mutual funds. Investors have been withdrawing billions of
dollars from managers of traditional value portfolios and sending that
money--and more--to aggressive-growth portfolios. The managers of value funds
have been forced to sell stocks that they regard as good bargains, driving these
stocks' prices even lower. Meanwhile, the aggressive-growth managers have been
doing what they're expected to do--buy the popular stocks even though the prices
may seem ridiculously high.
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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.
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Even conservative investors, who only a decade ago could scarcely be coaxed
out of bank savings accounts, have been embracing the riskiest segments of the
stock market, all on the basis of untested investment theories. No matter how
enticing the theories of the new economy, they are still in the realm of
speculation. Selling conservative stocks after a bull market of nearly 20 years
to buy risky stocks at unheard-of price levels is exactly the opposite of what
conservative investors should be doing.
6
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In the end, the rules of valuation will be the same for both old-economy
and new-economy stocks. The value of stocks, as for any commercial enterprise,
ultimately depends on the profits they generate. We recognize that there are
many great technology companies that will lead the economy in the decade ahead.
However, we also are aware that investors have not been carefully
differentiating among these businesses. When such differentiation occurs, a lot
of capital will be vaporized.
During March, the final month of the semiannual period, the market seemed
to focus more on actual fundamentals and less on theoretical prospects. The
result was helpful to your fund--our total return was 11.6% in March, while the
Nasdaq Composite Index declined, posting a -2.6% return. One month does not a
trend make, but it did suggest what can happen when fundamentals, not
expectations, guide the market.
YOUR FUND'S HOLDINGS
Your fund's holdings include many companies whose revenue and earnings growth
are quite sound. Some of these stocks were rewarded during the half-year,
including Seagate Technology (+102%), Northern Trust (+62%), Fox Entertainment
Group (+42%), and Monsanto (+40%). But even among our worst-performing holdings,
a majority reported earnings that met or beat expectations during the second
fiscal quarter. Unfortunately, the market paid little attention to these stocks.
Importantly for a fund that seeks to provide significant income, a number
of our holdings boosted their dividends during the period, including American
General, Alcoa, Citigroup, 3M, National City, Washington Mutual, and U.S.
Bancorp. The fund's income yield as of March 31 was 2.5%, more than double the
1.1% yield of the S&P 500 Index.
The overall complexion of the Equity Income Fund changed little during the
half-year. The biggest change in sector commitments was a decline in utility
holdings from 22.9% of assets a year ago to 18.9% on March 31, 2000. Six of our
top ten holdings a year ago remain in the top ten today (Bell Atlantic, AT&T,
American Home Products, Bristol-Myers Squibb, Pharmacia & Upjohn, and Atlantic
Richfield). None of the other top-ten stocks is new to the fund.
Looking forward, we see that the Federal Reserve Board may have to raise
rates further to achieve its goal of slowing the economy, given that
interest-rate-sensitive sectors such as housing and autos represent a smaller
portion of economic activity than in the past. Many corporations say they have
trouble raising prices in the current competitive environment, so they are
concerned that rising wages and commodity prices could squeeze profits. On the
other hand, stronger economic growth outside of the United States suggests good
prospects for a number of basic-economy stocks in the materials & processing,
energy, and producer-durables sectors.
Newell Associates
John A. Levin & Company, Inc.
Wellington Management Company, LLP
April 12, 2000
7
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FUND PROFILE
EQUITY INCOME FUND
This Profile provides a snapshot of the fund's characteristics as of March 31,
2000, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 9.
PORTFOLIO CHARACTERISTICS
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EQUITY INCOME S&P 500
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Number of Stocks 180 500
Median Market Cap $30.6B $94.4B
Price/Earnings Ratio 18.1x 28.7x
Price/Book Ratio 3.1x 5.7x
Yield 2.5% 1.1%
Return on Equity 20.4% 24.2%
Earnings Growth Rate 7.3% 16.4%
Foreign Holdings 4.6% 1.2%
Turnover Rate 46%* --
Expense Ratio 0.43%* --
Cash Reserves 3.5% --
*Annualized.
INVESTMENT FOCUS
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[GRID]
STYLE VALUE
MARKET CAP LARGE
VOLATILITY MEASURES
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EQUITY INCOME S&P 500
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R-Squared 0.72 1.00
Beta 0.75 1.00
TEN LARGEST HOLDINGS
(% OF TOTAL NET ASSETS)
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Exxon Mobil Corp. 3.6%
Bell Atlantic Corp. 2.9
AT&T Corp. 2.5
American Home Products Corp. 2.2
Bristol-Myers Squibb Co. 2.0
Pharmacia & Upjohn, Inc. 1.9
SBC Communications Inc. 1.8
General Electric Co. 1.7
Atlantic Richfield Co. 1.6
BellSouth Corp. 1.5
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Top Ten 21.7%
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
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MARCH 31, 1999 MARCH 31, 2000
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EQUITY INCOME EQUITY INCOME S&P 500
-------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation ................. 3.3% 3.4% 1.9%
Consumer Discretionary ................ 6.4 6.3 12.5
Consumer Staples ...................... 8.0 7.1 5.0
Financial Services .................... 19.9 20.0 13.5
Health Care ........................... 11.2 12.4 9.0
Integrated Oils ....................... 14.8 12.9 4.6
Other Energy .......................... 0.9 2.7 1.7
Materials & Processing ................ 6.4 6.0 2.5
Producer Durables ..................... 2.5 3.2 4.0
Technology ............................ 0.8 2.0 29.4
Utilities ............................. 22.9 18.9 9.7
Other 2.9 5.1 6.2
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</TABLE>
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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 35%.) 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.
9
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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. An investor's shares, when
redeemed, could be worth more or less than their original cost.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: MARCH 21, 1988-MARCH 31, 2000
- ----------------------------------------------------------------------------------------------------
EQUITY INCOME FUND S&P 500 EQUITY INCOME FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN YEAR RETURN RETURN RETURN RETURN
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1988 5.8% 2.5% 8.3% 3.2% 1995 19.8% 5.0% 24.8% 29.7%
1989 23.8 5.0 28.8 33.0 1996 14.2 4.0 18.2 20.3
1990 -20.5 4.3 -16.2 -9.2 1997 30.0 4.2 34.2 40.4
1991 18.0 8.5 26.5 31.2 1998 6.5 3.0 9.5 9.0
1992 6.4 5.9 12.3 11.1 1999 9.6 3.0 12.6 27.8
1993 14.1 5.1 19.2 13.0 2000* -2.6 1.5 -1.1 17.5
1994 -6.5 4.3 -2.2 3.7
- -----------------------------------------------------------------------------------------------------
</TABLE>
*Six months ended March 31, 2000.
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 2000
- --------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -----------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Equity Income Fund 3/21/1988 -0.52% 17.35% 8.63% 4.55% 13.18%
- --------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE>
FINANCIAL STATEMENTS
MARCH 31, 2000 (UNAUDITED)
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, 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, but may differ because certain investments or
transactions may be treated differently for financial statement and tax
purposes. 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.
- --------------------------------------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- --------------------------------------------------------------------------------
COMMON STOCKS (91.6%)(1)
- --------------------------------------------------------------------------------
AUTO & TRANSPORTATION (3.1%)
Ford Motor Co. 717,091 $ 32,941
Eaton Corp. 120,000 9,360
Union Pacific Corp. 198,900 7,782
Norfolk Southern Corp. 509,258 7,321
CSX Corp. 294,200 6,914
Genuine Parts Co. 233,346 5,571
The Goodyear Tire & Rubber Co. 157,500 3,672
------------------
73,561
------------------
CONSUMER DISCRETIONARY (5.8%)
May Department Stores Co. 721,804 20,571
Kimberly-Clark Corp. 290,075 16,244
Tribune Co. 437,200 15,985
Eastman Kodak Co. 229,224 12,450
Gillette Co. 303,700 11,446
Black & Decker Corp. 241,000 9,053
J.C. Penney Co., Inc. 586,580 8,725
o Fox Entertainment Group, Inc.
Class A 247,500 7,410
Avon Products, Inc. 202,200 5,876
The McGraw-Hill Cos., Inc. 124,800 5,678
The Stanley Works 184,400 4,864
Sears, Roebuck & Co. 154,829 4,780
Gannett Co., Inc. 62,000 4,363
Whirlpool Corp. 63,500 3,723
International Flavors &
Fragrances, Inc. 102,400 3,590
Newell Rubbermaid, Inc. 138,400 3,434
------------------
138,192
------------------
CONSUMER STAPLES (6.5%)
Anheuser-Busch Cos., Inc. 344,100 21,420
Philip Morris Cos., Inc. 949,150 20,051
Procter & Gamble Co. 239,900 13,494
Sara Lee Corp. 608,300 10,949
PepsiCo, Inc. 305,200 10,548
Nabisco Holdings Corp. Class A 292,500 9,415
The Coca-Cola Co. 185,800 8,721
H.J. Heinz Co. 248,940 8,682
The Quaker Oats Co. 116,200 7,045
Albertson's, Inc. 216,600 6,715
General Mills, Inc. 183,200 6,630
Kellogg Co. 209,100 5,358
Bestfoods 110,401 5,168
The Clorox Co. 143,200 4,654
Campbell Soup Co. 146,500 4,505
Hershey Foods Corp. 78,900 3,846
ConAgra, Inc. 193,600 3,509
UST, Inc. 138,900 2,170
Ralston-Ralston Purina Group 78,600 2,152
------------------
155,032
------------------
FINANCIAL SERVICES (18.3%)
Bank of America Corp. 574,923 30,148
Marsh & McLennan Cos., Inc. 272,300 30,038
The Chase Manhattan Corp. 330,857 28,847
First Union Corp. 644,530 24,009
J.P. Morgan & Co., Inc. 156,000 20,553
American General Corp. 356,400 20,003
Bank One Corp. 492,422 16,927
FleetBoston Financial Corp. 462,699 16,889
Aon Corp. 483,100 15,580
Wachovia Corp. 227,735 15,386
XL Capital Ltd. Class A 272,300 15,079
CIGNA Corp. 170,000 12,877
First Data Corp. 276,450 12,233
Ace, Ltd. 516,000 11,803
11
<PAGE>
- --------------------------------------------------------------------------------
MARKET VALUE*
EQUITY INCOME FUND SHARES (000)
- --------------------------------------------------------------------------------
Northern Trust Corp. 173,600 $ 11,729
The Bank of New York Co., Inc 273,400 11,363
Washington Mutual, Inc. 412,710 10,937
Lincoln National Corp. 304,900 10,214
Equity Residential Properties
Trust REIT 250,000 10,047
U.S. Bancorp 415,349 9,086
PNC Financial Services Group 194,694 8,773
Merrill Lynch & Co., Inc. 83,416 8,759
o John Hancock Financial
Services, Inc. 450,000 8,128
Mellon Financial Corp. 270,900 7,992
Equity Office Properties
Trust REIT 315,000 7,914
Citigroup, Inc. 128,000 7,592
St. Paul Cos., Inc. 221,733 7,567
MBIA, Inc. 140,000 7,289
The Chubb Corp. 92,901 6,277
Fannie Mae 108,300 6,112
National City Corp. 293,100 6,045
KeyCorp 278,370 5,289
Wells Fargo Co. 123,165 5,042
SAFECO Corp. 169,500 4,502
Sun Communities, Inc. REIT 110,000 3,176
Urban Shopping Centers,
Inc. REIT 80,000 2,325
Crescent Real Estate, Inc. REIT 130,000 2,275
------------------
438,805
------------------
HEALTH CARE (11.3%)
American Home Products Corp. 996,300 53,427
Bristol-Myers Squibb Co. 821,800 47,459
Pharmacia & Upjohn, Inc. 755,074 44,738
Merck & Co., Inc. 438,200 27,223
Glaxo Wellcome PLC ADR 371,700 21,303
Baxter International, Inc. 263,259 16,503
Eli Lilly & Co. 203,100 12,795
Johnson & Johnson 151,600 10,621
SmithKline Beecham PLC ADR 119,600 7,901
Abbott Laboratories 215,200 7,572
Aetna Inc. 129,000 7,184
McKesson HBOC, Inc. 280,000 5,880
Columbia/HCA Healthcare Corp. 155,000 3,923
Schering-Plough Corp. 106,600 3,918
------------------
270,447
------------------
INTEGRATED OILS (11.9%)
Exxon Mobil Corp. 1,109,282 86,316
Atlantic Richfield Co. 451,900 38,411
BP Amoco PLC ADR 573,482 30,430
Texaco Inc. 566,000 30,352
Chevron Corp. 279,646 25,850
Royal Dutch Petroleum Co. ADR 393,300 22,639
Shell Transport & Trading
Co. ADR 275,000 13,492
Unocal Corp. 407,700 12,129
USX-Marathon Group 403,100 10,506
Conoco Inc. Class A 301,500 7,424
Phillips Petroleum Co. 124,800 5,772
------------------
283,321
------------------
OTHER ENERGY (2.4%)
Williams Cos., Inc. 547,000 24,034
Schlumberger Ltd. 226,600 17,335
Baker Hughes, Inc. 198,400 6,002
Ultramar Diamond
Shamrock Corp. 154,900 3,931
Ashland, Inc. 110,000 3,678
Sunoco, Inc. 104,000 2,847
Arch Coal, Inc. 27,070 189
------------------
58,016
------------------
MATERIALS & PROCESSING (5.5%)
Dow Chemical Co. 307,829 35,093
Weyerhaeuser Co. 362,200 20,645
Alcoa Inc. 200,000 14,050
International Paper Co. 317,252 13,563
E.I. du Pont de Nemours & Co. 221,527 11,713
Eastman Chemical Co. 204,500 9,305
The Timber Co. 250,000 6,406
Georgia Pacific Group 158,000 6,251
Engelhard Corp. 305,000 4,613
Crown Cork & Seal Co., Inc. 215,763 3,452
Temple-Inland Inc. 60,400 3,009
o Owens-Illinois, Inc. 80,500 1,358
USX-U.S. Steel Group 40,600 1,015
------------------
130,473
------------------
PRODUCER DURABLES (2.9%)
Emerson Electric Co. 343,259 18,150
Xerox Corp. 487,400 12,672
United Technologies Corp. 192,116 12,139
Caterpillar, Inc. 182,464 7,196
Pitney Bowes, Inc. 155,700 6,958
The Boeing Co. 124,200 4,712
Lockheed Martin Corp. 189,500 3,873
Deere & Co. 100,746 3,828
Thomas & Betts Corp. 12,300 347
------------------
69,875
------------------
TECHNOLOGY (1.8%)
o Seagate Technology Inc. 238,400 14,364
Compaq Computer Corp. 286,500 7,628
Rockwell International Corp. 161,100 6,736
International Business
Machines Corp. 49,400 5,829
Hewlett-Packard Co. 35,100 4,653
Electronic Data Systems Corp. 60,000 3,851
------------------
43,061
------------------
UTILITIES (17.4%)
Bell Atlantic Corp. 1,132,140 69,202
AT&T Corp. 1,057,752 59,499
SBC Communications Inc. 1,038,273 43,607
BellSouth Corp. 763,604 35,889
U S WEST, Inc. 405,036 29,416
GTE Corp. 376,673 26,744
Potomac Electric Power Co. 700,200 15,842
KeySpan Corp. 466,236 12,880
SCANA Corp. 485,527 11,926
Duke Energy Corp. 176,452 9,264
Southern Co. 397,310 8,641
DTE Energy Co. 264,500 7,670
Allegheny Energy, Inc. 272,000 7,497
Dominion Resources, Inc. 171,083 6,576
Edison International 392,640 6,503
ScottishPower PLC ADR 195,645 6,200
Pinnacle West Capital Corp. 206,900 5,832
NICOR, Inc. 172,700 5,688
Eastern Utilities Associates 177,600 5,572
Texas Utilities Co. 176,296 5,234
12
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
Constellation Energy Group 158,150 $ 5,041
National Fuel Gas Co. 100,000 4,456
PECO Energy Corp. 115,000 4,241
FPL Group, Inc. 84,635 3,899
Questar Corp. 200,000 3,713
Central & South West Corp 191,600 3,269
Washington Gas Light Corp. 120,000 3,263
Northern States Power Co. 162,100 3,222
TECO Energy, Inc. 163,400 3,176
Sempra Energy 47,838 801
------------------
414,763
------------------
OTHER (4.7%)
General Electric Co. 265,000 41,125
Minnesota Mining &
Manufacturing Co. 326,407 28,907
Monsanto Co. 355,000 18,282
Honeywell International Inc. 204,862 10,794
Cooper Industries, Inc. 176,000 6,160
Fortune Brands, Inc. 159,431 3,986
Brunswick Corp. 210,000 3,977
------------------
113,231
------------------
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,549,316) 2,188,777
- --------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (0.6%)
- --------------------------------------------------------------------------------
Owens-Illinois Inc. 4.75% Cvt. Pfd. 294,400 7,967
Loral Space & Communications
Ltd. 6.00% Cvt. Pfd. 137,200 4,253
(3)+Loral Space & Communications
Ltd. 6.00% Cvt. Pfd. 57,000 1,824
- --------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $21,833) 14,044
- --------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
CONVERTIBLE BONDS (1.1%)
- --------------------------------------------------------------------------------
Hewlett-Packard Co.
(3)0.00%, 10/14/2017 $ 24,100 18,205
Security Capital U.S. Realty
(3)2.00%, 5/22/2003 8,300 6,220
Waste Management Inc.
4.00%, 2/1/2002 4,000 3,523
- --------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $25,041) 27,948
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (6.2%)(1)
- --------------------------------------------------------------------------------
FEDERAL HOME LOAN MORTGAGE CORP.
(2) 5.77%, 4/20/2000 8,000 7,978
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.12%, 4/3/2000 138,849 138,849
6.14%, 4/3/2000--Note G 1,155 1,155
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $147,980) 147,982
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.5%)
(COST $1,744,170) 2,378,751
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.5%)
Other Assets--Note C $ 32,846
Liabilities--Note G (21,205)
---------------------
11,641
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 105,442,002 outstanding $0.001
par value shares of beneficial interest
(unlimited authorization) $2,390,392
================================================================================
NET ASSET VALUE PER SHARE $22.67
================================================================================
*See Note A in Notes to Financial Statements.
o Non-Income-Producing Security.
+Non-Income-Producing Security. New issue that has not paid a dividend as of
March 31, 2000.
(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
94.8% and 3.0%, respectively, of net assets.
See Note F in Notes to Financial Statements.
(2)Security segregated as initial margin for open futures contracts.
(3)Security exempt from registration under Rule 144A of theSecurities Act of
1933. These securities may be sold in transactions exempt from registration,
normally to qualified institutional buyers. At March 31, 2000, the aggregate
value of these securities was $26,249,000, representing 1.1% of net assets.
ADR--American Depositary Receipt.
REIT--Real Estate Investment Trust.
- --------------------------------------------------------------------------------
AT MARCH 31, 2000, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
Paid in Capital $1,690,086 $16.03
Overdistributed Net
Investment Income (608) (.01)
Accumulated Net
Realized Gains 62,253 .59
Unrealized Appreciation--Note F
Investment Securities 634,581 6.02
Futures Contracts 4,080 .04
- --------------------------------------------------------------------------------
NET ASSETS $2,390,392 $22.67
================================================================================
13
<PAGE>
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.
- --------------------------------------------------------------------------------
EQUITY INCOME FUND
SIX MONTHS ENDED MARCH 31, 2000
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends $ 36,287
Interest 4,832
Security Lending 76
-------------
Total Income 41,195
-------------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 2,080
Performance Adjustment (287)
The Vanguard Group--Note C
Management and Administrative 3,794
Marketing and Distribution 216
Custodian Fees 29
Auditing Fees 9
Shareholders' Reports 61
Trustees' Fees and Expenses 2
-------------
Total Expenses 5,904
Expenses Paid Indirectly--Note D (329)
-------------
Net Expenses 5,575
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 35,620
- --------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 63,220
Futures Contracts 7,182
- --------------------------------------------------------------------------------
REALIZED NET GAIN 70,402
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities (168,544)
Futures Contracts 10,702
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (157,842)
- --------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (51,820)
================================================================================
14
<PAGE>
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, 2000 SEP. 30, 1999
(000) (000)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 35,620 $ 75,905
Realized Net Gain 70,402 109,251
Change in Unrealized Appreciation (Depreciation) (157,842) 108,420
---------------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations (51,820) 293,576
---------------------------------
DISTRIBUTIONS
Net Investment Income (39,143) (78,305)
Realized Capital Gain (105,953) (87,951)
---------------------------------
Total Distributions (145,096) (166,256)
---------------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 194,257 931,840
Issued in Lieu of Cash Distributions 131,229 149,024
Redeemed (746,921) (576,972)
---------------------------------
Net Increase (Decrease) from Capital Share Transactions (421,435) 503,892
- -----------------------------------------------------------------------------------------------------------
Total Increase (Decrease) (618,351) 631,212
- -----------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 3,008,743 2,377,531
---------------------------------
End of Period $2,390,392 $3,008,743
===========================================================================================================
1Shares Issued (Redeemed)
Issued 8,408 37,304
Issued in Lieu of Cash Distributions 5,679 6,175
Redeemed (33,270) (23,137)
---------------------------------
Net Increase (Decrease) in Shares Outstanding (19,183) 20,342
===========================================================================================================
</TABLE>
15
<PAGE>
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, 2000 1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $24.14 $22.80 $22.28 $17.69 $15.65 $13.16
- ---------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .31 .64 .64 .64 .63 .60
Net Realized and Unrealized Gain (Loss)
on Investments (.57) 2.20 1.44 5.17 2.18 2.56
-----------------------------------------------------------------
Total from Investment Operations (.26) 2.84 2.08 5.81 2.81 3.16
-----------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.34) (.67) (.67) (.64) (.60) (.58)
Distributions from Realized Capital Gains (.87) (.83) (.89) (.58) (.17) (.09)
-----------------------------------------------------------------
Total Distributions (1.21) (1.50) (1.56) (1.22) (.77) (.67)
- ---------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $22.67 $24.14 $22.80 $22.28 $17.69 $15.65
===============================================================================================================
TOTAL RETURN -1.14% 12.56% 9.54% 34.17% 18.22% 24.77%
===============================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $2,390 $3,009 $2,378 $1,948 $1,309 $967
Ratio of Total Expenses to
Average Net Assets 0.43%* 0.41% 0.39% 0.45% 0.42% 0.47%
Ratio of Net Investment Income to
Average Net Assets 2.59%* 2.59% 2.80% 3.25% 3.69% 4.27%
Portfolio Turnover Rate 46%* 18% 23% 22% 21% 31%
===============================================================================================================
</TABLE>
*Annualized.
16
<PAGE>
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, John A. Levin & Co., Inc., and Wellington Management
Company, LLP, provide investment advisory services to the fund for fees
calculated at an annual percentage rate of average net assets. The basic fee for
John A. Levin & Co., Inc. is subject to quarterly adjustments based on
performance relative to the S&P 500 Index for the proceeding three years.
Prior to January 1, 2000, Spare, Kaplan, Bischel & Associates served as
adviser to the fund. Effective January 1, 2000, assets managed by Spare, Kaplan,
Bischel & Associates were allocated to Wellington Management Company, LLP.
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The Vanguard Group manages the cash reserves of the fund on at at-cost
basis.
For the six months ended March 31, 2000, the aggregate advisory fee
represented an effective annual basic rate of 0.15% of the fund's average net
assets before a decrease of $287,000 (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, 2000, the fund had contributed capital of $455,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 0.5% of Vanguard's capitalization. The fund's Trustees and officers are also
Directors and officers of Vanguard.
D. The fund has asked its investment advisers to direct certain security 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 management and 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, 2000, directed brokerage and custodian fee offset arrangements reduced
expenses by $322,000 and $7,000, respectively. The total expense reduction
represented an effective annual rate of 0.02% of the fund's average net assets.
E. During the six months ended March 31, 2000, the fund purchased $592,267,000
of investment securities and sold $1,061,285,000 of investment securities other
than temporary cash investments.
F. At March 31, 2000, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $634,581,000, consisting
of unrealized gains of $745,475,000 on securities that had risen in value since
their purchase and $110,894,000 in unrealized losses on securities that had
fallen in value since their purchase.
At March 31, 2000, the aggregate settlement value of open futures contracts
expiring in June 2000 and the related unrealized appreciation were:
- --------------------------------------------------------------------------------
(000)
----------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION
- --------------------------------------------------------------------------------
S&P 500 Index 131 $49,626 $2,849
S&P MidCap 400 Index 103 26,026 1,231
- --------------------------------------------------------------------------------
G. The market value of securities on loan to broker/dealers at March 31, 2000,
was $1,133,000, for which the fund held cash collateral of $1,155,000. Cash
collateral received is invested in repurchase agreements.
18
<PAGE>
THE VANGUARD(R) FAMILY OF FUNDS
STOCK FUNDS
- ----------------------------------------
500 Index Fund
Aggressive Growth Fund
Capital Opportunity Fund
Convertible Securities Fund
Emerging Markets Stock
Index Fund
Energy Fund
Equity Income Fund
European Stock Index Fund
Explorer(TM) Fund
Extended Market Index Fund*
Global Equity Fund
Gold and Precious Metals Fund
Growth and Income Fund
Growth Index Fund*
Health Care Fund
Institutional Index Fund*
International Growth Fund
International Value Fund
Mid-Cap Index Fund*
Morgan(TM) Growth Fund
Pacific Stock Index Fund
PRIMECAP Fund
REIT Index Fund
Selected Value Fund
Small-Cap Growth Index Fund*
Small-Cap Index Fund*
Small-Cap Value Index Fund*
Tax-Managed Capital
Appreciation Fund*
Tax-Managed Growth and
Income Fund*
Tax-Managed International Fund*
Tax-Managed Small-Cap Fund*
Total International Stock
Index Fund
Total Stock Market Index Fund*
U.S. Growth Fund
Utilities Income Fund
Value Index Fund*
Windsor(TM) Fund
Windsor(TM) II Fund
BALANCED FUNDS
- ----------------------------------------
Asset Allocation Fund
Balanced Index Fund
Global Asset Allocation Fund
LifeStrategy(R) Conservative
Growth Fund
LifeStrategy(R) Growth Fund
LifeStrategy(R) Income Fund
LifeStrategy(R) Moderate
Growth Fund
STAR(TM) Fund
Tax-Managed Balanced Fund
Wellesley(R) Income Fund
Wellington(TM) Fund
BOND FUNDS
- ----------------------------------------
Admiral(TM) Intermediate-Term
Treasury Fund
Admiral(TM) Long-Term Treasury
Fund
Admiral(TM) Short-Term Treasury
Fund
GNMA Fund
High-Yield Corporate Fund
High-Yield Tax-Exempt Fund
Insured Long-Term Tax-Exempt
Fund
Intermediate-Term Bond
Index Fund
Intermediate-Term Corporate Fund
Intermediate-Term Tax-Exempt
Fund
Intermediate-Term Treasury Fund
Limited-Term Tax-Exempt Fund
Long-Term Bond Index Fund
Long-Term Corporate Fund
Long-Term Tax-Exempt Fund
Long-Term Treasury Fund
Preferred Stock Fund
Short-Term Bond Index Fund
Short-Term Corporate Fund*
Short-Term Federal Fund
Short-Term Tax-Exempt Fund
Short-Term Treasury Fund
State Tax-Exempt Bond Funds
(California, Florida,
Massachusetts, New Jersey,
New York, Ohio, Pennsylvania)
Total Bond Market Index Fund*
MONEY MARKET FUNDS
- ----------------------------------------
Admiral(TM) Treasury Money
Market Fund
Federal Money Market Fund
Prime Money Market Fund*
State Tax-Exempt Money Market
Funds (California, New Jersey,
New York, Ohio, Pennsylvania)
Tax-Exempt Money Market Fund
Treasury Money Market Fund
VARIABLE ANNUITY PLAN
- ----------------------------------------
Balanced Portfolio
Diversified Value Portfolio
Equity Income Portfolio
Equity Index Portfolio
Growth Portfolio
High-Grade Bond Portfolio
High Yield Bond Portfolio
International Portfolio
Mid-Cap Index Portfolio
Money Market Portfolio
REIT Index Portfolio
Short-Term Corporate Portfolio
Small Company Growth Portfolio
*Offers Institutional Shares.
For information about Vanguard funds and our variable annuity plan, including
charges and expenses,
obtain a prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge,
PA 19482-2600.
Read it carefully before you invest or send money.
19
<PAGE>
- --------------------------------------------------------------------------------
THE PEOPLE WHO GOVERN YOUR FUND
The Trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund Trustees also serve on the Board of Directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
The majority of Vanguard's board members are independent, meaning that they
have no affiliation with Vanguard or the funds they oversee, apart from the
sizable personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers for
the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new Trustees/Directors; and electing
Vanguard officers.
The list below provides a brief description of each Trustee's
professional affiliations. Noted in parentheses is the year in which the Trustee
joined the Vanguard Board.
TRUSTEES
JOHN J. BRENNAN (1987) 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 (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BRUCE K. MACLAURY (1990) 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. (1993) Chairman, President, Chief Executive Officer, and
Director of NACCO Industries, Inc.; Director of The BFGoodrich Co.
JOHN C. SAWHILL (1991) 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. (1971) 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 (1985) Retired Chairman of Rohm & Haas Co.; Director of
AmeriSource Health Corporation, 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.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON Legal Department.
ROBERT A. DISTEFANO Information Technology.
JAMES H. GATELY Individual Investor Group.
KATHLEEN C. GUBANICH Human Resources.
IAN A. MACKINNON Fixed Income Group.
F. WILLIAM MCNABB, III Institutional Investor Group.
MICHAEL S. MILLER Planning and Development.
RALPH K. PACKARD Chief Financial Officer.
GEORGE U. SAUTER Quantitative Equity Group.
<PAGE>
[SHIP LOGO]
[THE VANGUARD GROUP(R) LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482-2600
ABOUT OUR COVER
Our cover art, depicting HMS Vanguard at sea, is a
reproduction of Leading the Way, a 1984 work created
and copyrighted by noted naval artist Tom Freeman,
of Forest Hill, Maryland.
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
This report is intended for the fund's
shareholders. It may not be distributed
to prospective investors unless it
is preceded or accompanied by the
current fund prospectus.
Q652-052000
(C)2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
