<PAGE>
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Vanguard
Asset
Allocation
Fund A Member of The Vanguard Group
===============================================================================
PROSPECTUS -- January 17, 1997
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NEW ACCOUNT INFORMATION:
Investor Information Department -- 1-800-662-7447 (SHIP)
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SHAREHOLDER ACCOUNT SERVICES:
Client Services Department -- 1-800-662-2739 (CREW)
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INVESTMENT Vanguard Asset Allocation Fund, Inc. (the "Fund") is an open-end
OBJECTIVE & diversified investment company that seeks to maximize total
POLICIES return (i.e., capital change plus income). The Fund invests in
common stocks, bonds and money market instruments in proportions
consistent with their expected returns and risks as evaluated by
the Fund's adviser. The Fund should not be considered a complete
investment program. There is no assurance that the Fund will
achieve its stated objective. Shares of the Fund are neither
insured nor guaranteed by any agency of the U.S. Government,
including the FDIC.
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OPENING AN To open a regular (non-retirement) account, please complete and
ACCOUNT return the Account Registration Form. If you need assistance in
completing this Form, please call our Investor Information
Department. To open an Individual Retirement Account (IRA),
please use a Vanguard IRA Adoption Agreement. To obtain a copy of
this form, call 1-800-662-7447, Monday through Friday from 8:00
a.m. to 9:00 p.m. and Saturday, from 9:00 a.m. to 4:00 p.m.
(Eastern time). The minimum initial investment is $3,000, or
$1,000 for Uniform Gifts/Transfers to Minors Act accounts. The
Fund is offered on a no-load basis (i.e., there are no sales
commissions or 12b-1 fees). However, the Fund incurs expenses for
investment advisory, management, administrative and distribution
services.
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ABOUT THIS This Prospectus is designed to set forth concisely the
PROSPECTUS information you should know about the Fund before you invest. It
should be retained for future reference. A "Statement of
Additional Information" containing additional information about
the Fund has been filed with the Securities and Exchange
Commission. Such Statement is dated January 17, 1997 and has been
incorporated by reference into this Prospectus. A copy may be
obtained without charge by writing to the Fund or by calling the
Investor Information Department.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Page Page Page
Fund Expenses 2 Implementation of Policies 7 SHAREHOLDER GUIDE
Financial Highlights 2 Investment Limitations 9 Opening an Account and
Yield and Total Return 3 Management of the Fund 9 Purchasing Shares 15
FUND INFORMATION Investment Adviser 10 When Your Account Will Be
Investment Objective 4 Performance Record 11 Credited 18
Investment Policies 4 Dividends, Capital Gains and Selling Your Shares 18
Investment Risks 5 Taxes 12 Exchanging Your Shares 20
Who Should Invest 6 The Share Price of the Fund 13 Important Information About
General Information 14 Telephone Transactions 22
Transferring Registration 23
Other Vanguard Services 23
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
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FUND EXPENSES The following table illustrates all expenses and fees that you
would incur as a shareholder of the Fund. The expenses and fees
set forth in the table are for the 1996 fiscal year.
Shareholder Transaction Expenses
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Sales Load Imposed on Purchases .............. None
Sales Load Imposed on Reinvested Dividends ... None
Redemption Fees .............................. None
Exchange Fees ................................ None
Annual Fund Operating Expenses
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Management & Administrative Expenses 0.32%
Investment Advisory Fees ........... 0.11
12b-1 Fees ......................... None
Other Expenses
Distribution Costs ................. 0.02%
0.02
Miscellaneous Expenses ............. ------
0.04
Total Other Expenses ............... ------
Total Operating Expenses ....... 0.47%
=======
The purpose of this table is to assist you in understanding the
various costs and expenses that you would bear directly or
indirectly as an investor in the Fund.
The following example illustrates the expenses that you would
incur on a $1,000 investment over various periods, assuming (1) a
5% annual rate of return and (2) redemption at the end of each
period. As noted in the table above, the Fund charges no
redemption fees of any kind.
1 Year 3 Years 5 Years 10 Years
---------- ----------- ----------- ------------
$5 $15 $26 $59
This example should not be considered a representation of past or
future expenses or performance. Actual expenses may be higher or
lower than those shown.
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FINANCIAL The following financial highlights information, for a share
HIGHLIGHTS outstanding throughout each period, insofar as it relates to each
of the five years in the period ended September 30, 1996, has
been audited by Price Waterhouse LLP, independent accountants,
whose report thereon was unqualified. This information should be
read in conjunction with the financial statements and notes
thereto, which, together with the remaining portions of the
Fund's 1996 Annual Report to Shareholders, are incorporated by
reference in the Statement of Additional Information and this
Prospectus, and which appear, along with the report of Price
Waterhouse LLP, in the Fund's 1996 Annual Report to Shareholders.
For a more complete discussion of the Fund's performance, please
see the Fund's 1996 Annual Report to Shareholders, which may be
obtained without charge by writing to the Fund or by calling our
Investor Information Department at 1-800-662-7447.
2
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<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------------------------- Nov. 3, 1988+ to
1996 1995 1994 1993 1992 1991 1990 Sept. 30, 1989
-------- -------- --------- -------- -------- -------- --------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ............................ $17.03 $13.78 $15.08 $13.79 $13.06 $10.93 $12.11 $10.00
-------- -------- -------- -------- -------- -------- -------- --------
Investment Operations
Net Investment Income ........... .69 .64 .52 .54 .61 .60 .60 .46
Net Realized and Unrealized Gain
(Loss) on Investments ........ 1.82 3.18 (.81) 1.51 .90 2.28 (1.12) 1.90
-------- -------- -------- -------- -------- -------- -------- --------
Total from Investment Operations 2.51 3.82 (.29) 2.05 1.51 2.88 (.52) 2.36
Distributions
Dividends from Net Investment
Income ....................... (.66) (.57) (.48) (.59) (.59) (.62) (.51) (.25)
Distributions from Realized
Capital Gains ................ (.61) -- (.53) (.17) (.19) (.13) (.15) --
-------- -------- -------- -------- -------- -------- -------- --------
Total Distributions ............ (1.27) (.57) (1.01) (.76) (.78) (.75) (.66) (.25)
-------- -------- -------- -------- -------- -------- -------- --------
Net Asset Value, End of Period .... $18.27 $17.03 $13.78 $15.08 $13.79 $13.06 $10.93 $12.11
======== ======== ======== ======== ======== ======== ======== ========
Total Return ...................... 15.27% 28.57% (2.05)% 15.41% 12.16% 27.32% (4.57)% 23.93%
======== ======== ======== ======== ======== ======== ======== ========
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $2,341 $1,593 $1,120 $1,003 $ 502 $ 265 $ 160 $ 107
Ratio of Expenses to Average Net
Assets .......................... 0.47% 0.49% 0.50% 0.49% 0.52% 0.44% 0.50% 0.49%*
Ratio of Net Investment Income to
Average Net Assets .............. 4.17% 4.41% 3.68% 4.07% 4.95% 5.28% 5.53% 5.53%*
Portfolio Turnover Rate ........... 47% 34% 51% 31% 18% 44% 12% 52%
Average Commission Rate Paid ...... $.0160 N/A N/A N/A N/A N/A N/A N/A
</TABLE>
* Annualized.
+Commencement of operations.
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YIELD AND From time to time the Fund may advertise its yield and total
TOTAL RETURN return. Both yield and total return figures are based on
historical earnings and are not intended to indicate future
performance. The "total return" of the Fund refers to the average
annual compounded rates of return over one-, five- and ten-year
periods or for the life of the Fund (which periods will be stated
in the advertisement) that would equate an initial amount
invested at the beginning of a stated period to the ending
redeemable value of the investment, assuming the reinvestment of
all dividend and capital gains distributions.
Inaccordance with industry guidelines set forth by the U.S.
Securities and Exchange Commission, the "30-day yield" of the
Fund is calculated by dividing the net investment income per
share earned during a 30-day period by the net asset value per
share on the last day of the period. Net investment income
includes interest and dividend income earned on the Fund's
securities; it is net of all expenses and all recurring and
nonrecurring charges that have been applied to all shareholder
accounts. The yield calculation assumes that the net investment
income earned over thirty days is compounded monthly for six
months and then annualized. Methods used to calculate advertised
yields are standardized for all stock and bond mutual funds.
However, these methods differ from the accounting methods used by
the Fund to maintain its books and records, and so the advertised
thirty-day yield may not fully reflect the income paid to an
investor's account. Additionally, the Fund may compare its
performance to that of the Standard & Poor's 500 Composite Stock
Price Index.
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3
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INVESTMENT The objective of the Fund is to maximize total return
OBJECTIVE (i.e., capital change plus income) while exhibiting
The Fund seeks to less investment risk than a portfolio consisting
maximize total return entirely of common stocks. There is no assurance that
the Fund will achieve its stated objective.
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INVESTMENT The Fund will allocate its assets among a common stock
POLICIES portfolio, a bond portfolio, and money market
instruments. The Fund's adviser, Mellon Capital
The Fund invests in Management, allocates the Fund's assets among stocks,
stocks, bonds and bonds and money market instruments in proportions
money market which reflect the anticipated returns and risks of
instruments in each asset class. The estimates of return and risk are
varying proportions developed based upon the adviser's disciplined
valuation methodology. There are no limitations on the
amount of the Fund's assets which may be allocated to
each of the three asset classes (stocks, bonds and
money market instruments). The Fund is managed without
regard to tax ramifications.
Inestimating the relative attractiveness of each asset
class, the adviser takes into account various factors.
Common stocks are evaluated using a "dividend-
discount" model. This model provides an estimate of
the expected return of the Standard & Poor's 500
Composite Stock Price Index (the "S&P 500 Index")
based upon earnings forecasts for companies whose
stocks are included in the S&P 500 Index. The expected
bond return is the current yield-to-maturity of
long-term U.S. Treasury bonds, while the return on
money market instruments reflects the current yield on
three-month U.S. Treasury bills and long-term
inflation forecasts.
Once expected return and volatility (risk) estimates
are developed for each asset class, the adviser
attempts to identify apparent imbalances in the
relative pricing of common stocks, bonds and money
market instruments, using a computer model. Implicit
in the adviser's approach is the belief that such
short-term imbalances occur periodically but tend to
be corrected fairly quickly. The Fund's allocation
among the three asset classes is then structured to
take advantage of these perceived imbalances.
To implement a particular allocation strategy, the
Fund may invest in the following securities: a
diversified portfolio of common stocks selected by the
adviser to parallel the performance of the S&P 500
Index; long-term U.S. Treasury bonds with maturities
generally in excess of 20 years; and selected money
market instruments, including repurchase agreements.
The Fund may also invest in futures contracts on stock
indexes and bonds. See "Implementation of Policies"
for a description of the securities in which the Fund
invests and other investment practices of the Fund.
The Fund is responsible for voting the shares of all
securities it holds.
The investment objective and policies of the Fund are
not fundamental and so may be changed by the Board of
Directors without shareholder approval. However,
shareholders would be notified prior to a material
change in either.
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4
<PAGE>
INVESTMENT RISKS Depending on the adviser's allocation of the Fund's
The Fund is subject to assets among stocks, bonds and cash reserves,
stock and bond market investors in the Fund may be exposed to the market
risk risk of common stocks and bonds.
Stock market risk is the possibility that stock prices
in general will decline over short or even extended
periods. The stock market tends to be cyclical, with
periods when stock prices generally rise and periods
when stock prices generally decline. To illustrate the
volatility of domestic stock prices, the following
table sets forth the extremes for U.S. stock market
returns as well as the average return for the period
from 1926 to 1996, as measured by the Standard &
Poor's 500 Composite Stock Price Index:
AVERAGE ANNUAL U.S. STOCK MARKET RETURNS (1926-1996)
OVER VARIOUS TIME HORIZONS
1 Year 5 Years 10 Years 20 Years
-------- --------- ---------- ----------
Best +53.9% +23.9% +20.1% +16.9%
Worst -43.3 -12.5 -0.9 +3.1
Average +12.7 +10.4 +10.8 +10.8
As shown, from 1926 to 1996, U.S. common stocks as
measured by the Index provided an average annual total
return (capital appreciation plus dividend income) for
10 years, of +10.8%. Average return may not be useful
for forecasting future returns in any particular
period, as stock returns are quite volatile from year
to year
Bond market risk is . the potential for fluctuations
in the market value of bonds. Bond prices vary
inversely with changes in the level of interest rates.
When interest rates rise, the prices of bonds fall;
conversely, when interest rates fall, bond prices
rise. While bonds normally fluctuate less in price
than stocks, there have been extended periods of
cyclical increases in interest rates that have caused
significant declines in bond prices. For example,
long-term bond prices fell 48% from December 1976 to
September 1981. The risk of bonds declining in value,
however, may be offset in whole or in part by the
higher level of income that bonds provide.
While the Fund invests in stocks, bonds and money
market instruments in varying proportions, investors
should not construe the Fund as a balanced investment
program offering relatively stable allocations among
these asset classes. Because the allocation strategy
of the adviser may, at certain times, result in a
portfolio with a primary emphasis on common stocks,
the Fund may from time to time exhibit a level of
volatility which is more consistent with a common
stock portfolio than a balanced portfolio. However,
under normal circumstances, the volatility of the
Fund's total return is expected to be less than that
of a common stock portfolio, as represented, for
example, by the S&P 500 Index.
5
<PAGE>
The adviser may fail
to anticipate market
advances or declines
Investors should also be aware that the investment
results of the Fund depend upon the adviser's ability
to anticipate correctly the relative performance and
risk of stocks, bonds and money market instruments.
Historical evidence indicates that correctly timing
portfolio allocations among these asset classes has
been an extremely difficult strategy to implement
successfully. While the adviser has substantial
experience in asset allocation, there can be no
assurance that the adviser will correctly anticipate
relative asset class performance in the future on a
consistent basis. The Fund's short-term investment
results would suffer, for example, if only a small
portion of the Fund's assets were allocated to stocks
during a significant stock market advance, or if a
major portion of its assets were allocated to stocks
during a market decline. Similarly, the Fund's
short-term investment results would also suffer if the
Fund were substantially invested in bonds at a time
when interest rates increased.
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WHO SHOULD The Fund is designed for investors seeking maximum
INVEST total return through an investment vehicle which
Long-term investors provides an actively managed mix of stocks, bonds and
seeking maximum money market instruments. Because the Fund can and may
total return have a large percentage of its portfolio invested in
common stocks, investors in the Fund should be willing
to accept the risk of an all-stock portfolio,
including the potential for sudden, sometimes
substantial declines in market value.
Due to the risks associated with common stock and bond
investments, the Fund is intended to be a long-term
investment vehicle and is not designed to provide
investors with a means of speculating on short-term
stock and bond market movements. Investors who engage
in excessive account activity generate additional
costs which are borne by all of the Fund's
shareholders. In order to minimize such costs the Fund
has adopted the following policies. The Fund reserves
the right to reject any purchase request (including
exchange purchases from other Vanguard portfolios)
that is reasonably deemed to be disruptive to
efficient portfolio management, either because of the
timing of the investment or previous excessive trading
by the investor. Additionally, the Fund has adopted
exchange privilege limitations as described in the
section "Exchange Privilege Limitations." Finally, the
Fund reserves the right to suspend the offering of its
shares.
No assurance can be given that the Fund will achieve
its objective or that shareholders will be protected
from the risk of loss that is inherent in equity
investing. Also, there can be no guarantee that the
adviser will correctly anticipate fluctuations in the
stock and bond markets in its effort to maximize total
return while minimizing risk.
The Fund should be considered part of a well-rounded
investment program and not its sole component.
Investors may wish to reduce the potential risk of
investing in the Fund by purchasing shares on a
regular, periodic basis (dollar-cost averaging) rather
than making an investment in one lump sum.
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6
<PAGE>
IMPLEMENTATION In an effort to maximize its total investment return,
OF the Fund utilizes a number of investment practices.
POLICIES
The Fund may invest The Fund invests in stocks, bonds and money market
in stocks, bonds and instruments in varying proportions. For common stocks,
money market the Fund will invest in a diversified portfolio of
instruments common stocks selected to parallel the investment
performance of the S&P 500 Index. The Fund may also
invest in stock index futures and options to a limited
extent, as described below.
Bond investments for the Fund will consist of
long-term U.S. Treasury bonds (those with maturities
generally in excess of 20 years) and, as described
below, futures contracts and options on such bonds. As
part of its bond portfolio, the Fund may also invest
in other long-term "full faith and credit" obligations
of the U.S. Government.
The money market instruments held by the Fund will
have an average weighted maturity of less than 90
days. Money market instruments may include obligations
of the United States Government and its agencies and
instrumentalities; commercial paper, bank certificates
of deposit, and bankers' acceptances; and repurchase
agreements collateralized by these securities.
A repurchase agreement is a means of investing monies
for a short period. In a repurchase agreement, a
seller -- a U.S. commercial bank or recognized U.S.
securities dealer -- sells securities to the Fund and
agrees to repurchase the securities at the Fund's cost
plus interest within a specified period (normally one
day). In these transactions, the securities purchased
by the Fund will have a total value equal to, or in
excess of, the value of the repurchase agreement, and
will be held by the Fund's Custodian Bank until
repurchased.
The Fund may lend The Fund may lend its investment securities to
its securities qualified institutional investors for either
short-term or long-term purposes of realizing
additional income. Loans of securities by the Fund
will be collateralized by cash, letters of credit, or
securities issued or guaranteed by the U.S. Government
or its agencies. The collateral will equal at least
100% of the current market value of the loaned
securities.
The Fund may borrow The Fund may borrow money, subject to the limitations
money under unusual set forth below, for temporary or emergency purposes,
circumstances including the meeting of redemption requests which
might otherwise require selling securities at a loss.
Portfolio turnover Due to the active asset allocation approach employed
may be high by the Fund, the Fund's portfolio turnover rate may be
high, approximately 100% per year. A 100% portfolio
turnover rate would occur, for example, if all of the
Fund's securities were replaced within one year.
Further, in order to comply with the "short-short"
test under the Internal Revenue Code, it may be
necessary for the Fund to modify its investment
strategy and refrain from securities sales that it
would otherwise make. The "short-short" test provides
that a mutual fund must not receive more than 30% of
its gross income from gains realized on securities
held for less than 90 days.
7
<PAGE>
Derivative Investing Derivatives are instruments whose values are linked to
or derived from an underlying security or index. The
most common and conventional types of derivative
securities are futures and options.
The Fund may use The Fund may utilize stock and bond futures contracts
futures contracts and options to a limited extent. Specifically, the
and options Fund may enter into futures contracts provided that
not more than 5% of its assets are required as a
futures contract deposit; in addition, the Fund may
enter into futures contracts and options only to the
extent that obligations under such contracts or
transactions represent not more than 50% of the Fund's
assets. However, under unusual circumstances, the Fund
may maintain futures positions that are equivalent in
value to up to 100% of the Fund's assets, so that the
Fund may remain effectively fully invested in
proportions consistent with the adviser's current
asset allocation strategy.
Futures contracts and options may be used for several
reasons: to reallocate the Fund's assets among stocks,
bonds and money market instruments while minimizing
transaction costs; to maintain cash reserves while
simulating full investment; to facilitate trading; or
to seek higher investment returns when a futures
contract is priced more attractively than the
underlying security or index.
For example, in order to reallocate 10% of the Fund's
assets from stocks to bonds while minimizing
transaction costs, the adviser may sell stock index
futures and purchase bond futures. Because the
transaction costs of futures contracts and options may
be lower than the costs of investing in stocks or
bonds directly, it is expected that the use of futures
contracts and options may reduce the Fund's total
transaction costs. Also, because futures contracts
only require a small initial margin deposit, the Fund
would then be able to simultaneously maintain a cash
reserve for potential redemptions and simulate full
investment. In the event of net redemptions from the
Fund, sufficient futures contracts would be sold to
avoid any leveraging of the Fund's assets.
Futures contracts The primary risks associated with the use of futures
and options pose contracts and options are: (i) imperfect correlation
certain risks between the change in market value of the securities
held by the Fund and the prices of futures contracts
and options; and (ii) possible lack of a liquid
secondary market for a futures contract and the
resulting inability to close a futures position prior
to its maturity date. The risk of imperfect
correlation will be minimized by investing only in
those contracts whose behavior is expected to resemble
that of the Fund's underlying securities. The risk
that the Fund will be unable to close out a futures
position will be minimized by entering into such
transactions on a national exchange with an active and
liquid secondary market. While futures contracts and
options can be used as leveraged instruments, the Fund
may not use futures contracts or options to leverage
its net assets.
The risk of loss in trading futures contracts in some
strategies can be substantial, due both to the low
margin deposits required and the extremely high degree
of leverage involved in futures pricing. As a result,
a relatively small price movement
8
<PAGE>
in a futures contract may result in immediate and
substantial loss (or gain) to the investor. When
investing in futures contracts, the Fund will
segregate cash or other liquid portfolio securities in
the amount of the underlying obligation.
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INVESTMENT The Fund has adopted certain limitations in an attempt
LIMITATIONS to reduce its exposure to specific situations. Some of
these limitations are that the Fund will not:
The Fund has adopted (a) with respect to 75% of the value of its total
certain fundamental assets, purchase the securities of any issuer (except
limitations obligations of the United States government and its
instrumentalities) if as a result the Fund would hold
more than 10% of the outstanding voting securities of
the issuer, or more than 5% of the value of the Fund's
total assets would be invested in the securities of
such issuer;
=
(b) invest more than 25% of its assets in any one
industry; (c) borrow money except from banks (or
through reverse repurchase agreements) for temporary
or emergency purposes (not leveraging), and then only
in an amount not in excess of 15% of the value of the
Fund's net assets at the time the borrowing is made.
Whenever borrowing exceeds 5% of the value of the
Fund's assets, the Fund will not make any additional
investments; and
(d) pledge, mortgage or hypothecate any of its assets
to an extent greater than 5% of its total assets.
These investment limitations are considered at the
time investment securities are purchased. The
investment limitations described here and in the
Statement of Additional Information may be changed
only with the approval of a majority of the Fund's
shareholders.
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MANAGEMENT OF The Fund is a member of The Vanguard Group of
THE FUND Investment Companies, a family of more than 30
Vanguard investment companies with more than 90 distinct
administers and investment portfolios and total assets in excess of
distributes the Fund $230 billion. Through their jointly-owned subsidiary,
The Vanguard Group, Inc. ("Vanguard"), the Fund and
the other funds in the Group obtain at cost virtually
all of their corporate management, administrative and
distribution services. Vanguard also provides
investment advisory services on an at-cost basis to
certain Vanguard funds. As a result of Vanguard's
unique corporate structure, the Vanguard funds have
costs substantially lower than those of most competing
mutual funds. In 1995, the average expense ratio
(annual costs including advisory fees divided by
average net assets) for the Vanguard funds amounted to
approximately .31% compared to an average of 1.11% for
the mutual fund industry (data provided by Lipper
Analytical Services).
Vanguard employs a supporting staff of management and
administrative personnel needed to provide the
requisite services to the funds and also furnishes the
funds with necessary office space, furnishings and
equipment. Each fund pays a share of Vanguard's total
expenses, which are allocated among the funds under
methods approved by the Board of Directors (Trustees)
of each fund. In addition, each fund bears its own
direct expenses, such as legal, auditing and custodian
fees.
9
<PAGE>
The Officers of the Fund manage its day-to-day
operations and are responsible to the Fund's Board of
Directors. The Directors set broad policies for the
Fund and choose its Officers. A list of Directors and
Officers of the Fund and a statement of their present
positions and principal occupations during the past
five years can be found in the Statement of Additional
Information.
Vanguard provides distribution and marketing services
to the funds. However, each fund bears its share of
the Group's distribution costs.
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INVESTMENT The Fund employs Mellon Capital Management
ADVISER Corporation, 595 Market St., Suite 3000, San
Mellon Capital Francisco, CA 94105, as its investment adviser. Under
Management an investment advisory agreement dated January 15,
manages the Fund's 1996, the adviser manages the investment and
investments reinvestment of the assets of the Fund and
continuously reviews, supervises and administers the
Fund's investment program. The adviser discharges its
responsibilities subject to the control of the
Officers and Directors of the Fund.
The adviser is a professional counseling firm which
manages well-diversified stock and bond portfolios for
institutional clients. As of September 30, 1996 the
adviser provided investment advisory services to 212
clients and managed assets with an approximate value
of $46.4 billion. The adviser's asset allocation
strategy was developed by the adviser's co-founder,
William Fouse, in 1972, and is used by 84 of its
clients and accounts for approximately $13.6 billion
of the assets that it manages. For its asset
allocation clients, including the Fund, the adviser
employs a proprietary asset allocation model in
managing client investment portfolios and an indexing
approach in selecting individual equity securities.
The Fund is one of the adviser's two investment
company clients.
The adviser was founded in October 1983 by William
Fouse and Thomas Loeb. They have been responsible for
overseeing the implementation of the firm's strategy
for the Fund since the Fund's inception in 1988. The
adviser is a wholly-owned subsidiary of MBC Investment
Corporation, which itself is a subsidiary of Mellon
Bank Corporation.
The Fund pays the adviser a basic fee at the end of
each fiscal quarter, calculated by applying a
quarterly rate, based on the following annual
percentage rates, to the Fund's average month-end net
assets for the quarter:
Net Assets Rate
---------- ------
First $100 million .200%
Next $900 million .150%
Next $500 million .125%
Over $1.5 billion .100%
This fee may be increased or decreased by applying an
adjustment formula based on the performance of the
Fund relative to the investment record of the S&P 500
Index. The fee payment will be increased (decreased)
by an incentive (penalty) of 0.05% of average net
assets if the Fund's cumulative investment performance
for the thirty-six months preceding the end of the
quarter is at least six percentage
10
<PAGE>
points above (below) the cumulative investment record
of the S&P 500 Index for the same period. For the year
ended September 30, 1996, the investment advisory fee
paid by the Fund represented an effective annual rate
of .14 of 1% of average net assets, before a decrease
of .03 of 1% based on performance.
The investment advisory agreement authorizes the adviser to select brokers or
dealers to execute purchases and sales of the Fund's portfolio securities, and
directs the adviser to use its best efforts to obtain the best available price
and most favorable execution with respect to all transactions. The full range
and quality of brokerage services available are considered in making these
determinations.
The Fund has authorized the adviser to pay higher commissions in recognition of
brokerage services felt necessary for the achievement of better execution,
provided the adviser believes this to be in the best interest of the Fund.
Although the Fund does not market its shares through intermediary brokers or
dealers, the Fund may place orders with qualified broker-dealers who recommend
the Fund to clients if the Officers of the Fund believe that the quality of the
transaction and the commission are comparable to what they would be with other
qualified brokerage firms.
The Fund's Board of Directors may, without the approval of shareholders, provide
for: (a) the employment of a new investment adviser pursuant to the terms of a
new advisory agreement, either as a replacement for an existing adviser or as an
additional adviser; (b) a change in the terms of an advisory agreement; and (c)
the continued employment of an existing adviser on the same advisory contract
terms where a contract has been assigned because of a change in control of the
adviser. Any such change will only be made upon not less than 30 days prior
written notice to shareholders of the Fund which shall include substantially the
information concerning the adviser that would have normally been included in a
proxy statement.
- -------------------------------------------------------------------------------
PERFORMANCE The table on page 12 provides investment results for
RECORD the Fund for several periods throughout the Fund's
lifetime. The results shown represent "total return"
investment performance, which assumes the reinvestment
of all capital gains and income dividends for the
indicated periods. Also included is comparative
information with respect to the unmanaged Standard &
Poor's 500 Composite Stock Price Index, a widely-used
barometer of stock market activity, and the Consumer
Price Index, a statistical measure of changes in the
prices of goods and services. The tables do not make
any allowance for federal, state or local income
taxes, which shareholders must pay on a current basis.
The results should not be considered a representation
of the total return from an investment made in the
Fund today. This information is provided to help
investors better understand the Fund and may not
provide a basis for comparison with other investments
or mutual funds which use a different method to
calculate performance.
11
<PAGE>
AVERAGE ANNUAL RETURN FOR VANGUARD ASSET ALLOCATION
FUND
Fiscal Periods Vanguard Asset S&P 500 Consumer
Ended 9/30/96 Allocation Fund Index Price Index
- -------------- --------------- --------- -------------
1 Year +15.3% +20.3% +2.8%
5 Years +13.4 +15.2 +2.8
Lifetime* +14.1 +15.5 --
* November 3, 1988, to September 30, 1996.
- -------------------------------------------------------------------------------
DIVIDENDS, The Fund expects to pay dividends semi-annually from
CAPITAL GAINS ordinary income. Net capital gains distributions, if
AND TAXES any, will be distributed annually.
The Fund pays semi- In addition, in order to satisfy certain distribution
annual dividends and requirements of the Tax Reform Act of 1986, the Fund
any capital gains may declare special year-end dividend and capital
annually gains distributions during December. Such
distributions, if received by shareholders by January
31, are deemed to have been paid by the Fund and
received by shareholders on December 31 of the prior
year.
Dividend and capital gains distributions may be
automatically reinvested or received in cash. See
"Choosing a Distribution Option" for a description of
these distribution methods.
The Fund intends to continue to qualify for taxation
as a "regulated investment company" under the Internal
Revenue Code so that it will not be subject to federal
income tax to the extent its income is distributed to
shareholders. Dividends paid by the Fund from net
investment income and net short-term capital gains,
whether received in cash or reinvested in additional
shares, will be taxable to shareholders as ordinary
income. For corporate investors, dividends from net
investment income and net short-term capital gains
will generally qualify in part for the intercorporate
dividends-received deduction. However, the portion of
the dividends so qualified depends on the aggregate
taxable qualifying dividend income received by the
Fund from domestic (U.S.) sources.
Distributions paid by the Fund from long-term capital
gains, whether received in cash or reinvested in
additional shares, are taxable as long-term capital
gains, regardless of the length of time you have owned
shares in the Fund. Capital gains distributions are
made when the Fund realizes net capital gains on sales
of portfolio securities during the year. The Fund does
not seek to realize any particular amount of capital
gains during a year; rather, realized gains are a
by-product of portfolio management activities.
Consequently, capital gains distributions may be
expected to vary considerably from year to year; there
will be no capital gains distributions in years when
the Fund realizes net capital losses.
Note that if you accept capital gains distributions in
cash, instead of reinvesting them in additional
shares, you are in effect reducing the capital at work
for you in the Fund. Also, keep in mind that if you
purchase shares in the Fund shortly
12
<PAGE>
before the record date for a dividend or capital gains
distribution, a portion of your investment will be
returned to you as a taxable distribution, regardless
of whether you are reinvesting your distributions or
receiving them in cash.
The Fund will notify you annually as to the tax status
of dividend and capital gains distributions paid by
the Fund.
A capital gain or loss A sale of shares of the Fund is a taxable event and
may be realized upon may result in a capital gain or loss. A capital gain
exchange or or loss may be realized from an ordinary redemption of
redemption shares or an exchange of shares between two mutual
funds (or two portfolios of a mutual fund).
Dividend distributions, capital gains distributions,
and capital gains or losses from redemptions and
exchanges may be subject to state and local taxes.
The Fund is required to withhold 31% of taxable
dividends, capital gains distributions, and
redemptions paid to shareholders who have not complied
with IRS taxpayer identification regulations. You may
avoid this withholding requirement by certifying on
your Account Registration Form your proper Social
Security or Taxpayer Identification Number and by
certifying that you are not subject to backup
withholding.
The Fund has obtained a Certificate of Authority to do
business as a foreign corporation in Pennsylvania and
does business and maintains an office in that state.
In the opinion of counsel, the shares of the Fund are
exempt from Pennsylvania personal property taxes.
The tax discussion set forth above is included for
general information only. Prospective investors should
consult their own tax advisers concerning the tax
consequences of an investment in the Fund. The Fund is
managed without regard to tax ramifications.
- -------------------------------------------------------------------------------
THE SHARE PRICE The Fund's share price or "net asset value" per share
OF THE FUND is calculated by dividing the total assets of the
Fund, less any liabilities, by the total number of
outstanding shares. The net asset value is determined
as of the close of the New York Stock Exchange
(generally, 4:00 p.m. Eastern time) on each day that
the Exchange is open for trading.
Common stocks that are listed on a securities exchange
are valued at the last quoted sales price on the day
the valuation is made. Price information on listed
stocks is taken from the exchange where the security
is primarily traded. Securities which are listed on an
exchange but which are not traded on the valuation
date are valued at the mean of the bid and ask prices.
Unlisted securities for which market quotations are
readily available are valued at the latest quoted bid
price. Bonds are valued at the latest bid prices and
on the basis of a matrix system (which considers such
factors as security prices, yields, maturities and
ratings), both as furnished by independent pricing
services. Other assets and securities for which no
quotations are readily available are valued at fair
value as determined in good faith by the Directors.
Securities may be valued on the basis
13
<PAGE>
of prices provided by a pricing service when such
prices are believed to reflect the fair market value
of such securities. Pricing services do not always
consider each security's bid or last sale price when
providing prices. However, prices reflect significant
(that is, institutional-sized) transactions of similar
securities as well as any developments involving
specific securities. Instruments with remaining
maturities of 60 days or less may be valued at cost
(that is, after adding or subtracting any amortized
discount or premium), which approximates market value.
The Fund's share price can be found daily in the
mutual fund listings of most major newspapers under
the heading of Vanguard.
- -------------------------------------------------------------------------------
GENERAL The Fund is a Maryland corporation. The Articles of
INFORMATION Incorporation permit the Directors to issue
1,000,000,000 shares of common stock, with a $.001 par
value. The Board of Directors has the power to
designate one or more classes ("series") of shares of
common stock and to classify or reclassify any
unissued shares with respect to such series. Currently
the Fund is offering one class of shares.
The shares of the Fund are fully paid and
non-assessable; have no preference as to conversion,
exchange, dividends, retirement or other features; and
have no pre-emptive rights. Such shares have
non-cumulative voting rights, meaning that the holders
of more than 50% of the shares voting for the election
of Directors can elect 100% of the Directors if they
so choose.
Annual meetings of shareholders will not be held
except as required by the Investment Company Act of
1940 and other applicable law. An annual meeting will
be held to vote on the removal of a Director or
Directors of the Fund if requested in writing by the
holders of not less than 10% of the outstanding shares
of the Fund.
All securities and cash are held by State Street Bank
and Trust Company, Boston, MA. The Vanguard Group,
Inc., Valley Forge, PA, serves as the Fund's Transfer
and Dividend Disbursing Agent. Price Waterhouse LLP,
serves as independent accountants for the Fund and
audits its financial statements annually. The Fund is
not involved in any litigation.
- -------------------------------------------------------------------------------
14
<PAGE>
SHAREHOLDER GUIDE
OPENING AN You may open a regular (non-retirement) account,
ACCOUNT AND either by mail or wire. Simply complete and return an
PURCHASING Account Registration Form and any required legal
SHARES documentation, indicating the amount you wish to
invest. Your purchase must be equal to or greater than
the $3,000 minimum initial investment requirement
($1,000 for Uniform Gifts/Transfers to Minors Act
accounts). You must open a new Individual Retirement
Account by mail (IRAs may not be opened by wire) using
a Vanguard IRA Adoption Agreement. Your purchase must
be equal to or greater than the $1,000 minimum initial
investment requirement for IRAs, but no more than
$2,000 if you are making a regular IRA contribution.
Rollover contributions are generally limited to the
amount withdrawn within the past 60 days from an IRA
or other qualified Retirement Plan. If you need
assistance with the forms or have any questions about
the Fund, please call our Investor Information
Department at 1-800-662-7447. Note: For other types of
account registrations (e.g. corporations,
associations, other organizations, trusts or powers of
attorney), please call us to determine which
additional forms you may need.
The Fund's shares are purchased at the next-determined
net asset value after your investment has been
received. The Fund is offered on a no-load basis
(i.e., there are no sales commissions or 12b-1 fees).
Purchase 1) Because of the risks associated with common stock
Restrictions and bond investments, the Fund is intended to be a
long-term investment vehicle and is not designed to
provide investors with a means of speculating on
short-term market movements. Consequently, the Fund
reserves the right to reject any specific purchase
(and exchange purchase) request. The Fund also
reserves the right to suspend the offering of
shares for a period of time.
2) Vanguard will not accept third-party checks to
purchase shares of the Fund. Please be sure your
purchase check is made payable to the Vanguard
Group.
Additional
Investments
Subsequent investments to regular accounts may be made
by mail ($100 minimum), wire ($1,000 minimum),
exchange from another Vanguard Fund account, or
Vanguard Fund Express. Subsequent investments to
Individual Retirement Accounts may be made by mail
($100 minimum) or exchange from another Vanguard Fund
account. In some instances, contributions may be made
by wire or Vanguard Fund Express. Please call us for
more information on these options.
-----------------------------------------------------
15
<PAGE>
<TABLE>
<CAPTION>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING
<S> <C> <C>
Purchasing By Mail Please include the amount of your Additional investments should
Complete and sign the initial investment on the registration include the Invest-by-Mail
enclosed Account form, make your check payable to remittance form remittance
Registration Form The Vanguard Group-78 and form attached to your Fund
mail to: confirmation statements.
Please make your check payable
Vanguard Financial Center to The Vanguard Group-78,
P.O. Box 2600 write your account number on
Valley Forge, PA 19487 your check and, using the
return envelope provided, mail
to the address indicated on
the Invest-by-Mail Form.
For express Vanguard Financial Center All written request should be
or registered mail, 455 Devon Park Drive mailed to one of the addresses
send to: Wayne, PA 19087 indicated for new accounts. Do not
send registered or express mail to
the post office box address.
---------------------------------------------------------------------------------------
</TABLE>
Purchasing By Wire CORESTATES BANK, N.A.
Money should be ABA 031000011
wired to: CORESTATES NO. 0101 9897
ATTN VANGUARD
Before Wiring VANGUARD ASSET ALLOCATION FUND
ACCOUNT NUMBER
Please contact ACCOUNT REGISTRATION
Client Services
(1-800-662-2739)
To ensure proper receipt, please be sure your bank
includes the name of the Fund, the account number
Vanguard has assigned to you and the eight-digit
CoreStates number. If you are opening a new account,
please complete the Account Registration Form and mail
it to the "New Account" address after completing your
wire arrangement. Note: Federal Funds wire purchase
orders will be accepted only when the Fund and
Custodian Bank are open for business.
- --------------------------------------------------------------------------------
Purchasing By You may open an account or purchase additional shares
Exchange (from a by making an exchange from another Vanguard Fund
Vanguard account) account. However, the Fund reserves the right to
refuse any exchange purchase request. Call our Client
Services Department toll- free at 1-800-662-2739. The
new account will have the same registration as the
existing account.
- --------------------------------------------------------------------------------
Purchasing By The Fund Express Special Purchase option lets you move
Fund Express money from your bank account to your Vanguard account
at your request. Or if you choose the Automatic
Special Purchase and Investment option, money will be moved from your bank
Automatic Investment account to your Vanguard account on the schedule
(monthly, bimonthly [every other month],
16
<PAGE>
quarterly, semiannually or yearly) you select. To
establish these Fund Express options, please provide
the appropriate information on the Account
Registration Form. We will send you a confirmation of
your Fund Express service; please wait two weeks
before using the service.
- --------------------------------------------------------------------------------
CHOOSING A You must select one of three distribution options:
DISTRIBUTION
OPTION 1. Automatic Reinvestment Option -- Both dividends and
capital gains distributions will be reinvested in
additional Fund shares. This option will be
selected for you unless you specify one of the
other options.
2. Cash Dividend Option -- Your dividends will be paid
in cash and your capital gains will be reinvested
in additional Fund shares.
3. All Cash Option -- Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client
Services Department (1-800- 662-2739).
In addition, an option to invest your cash dividends
and/or capital gains distributions in another Vanguard
Fund account is available. Please call our Client
Services Department (1-800-662-2739) for information.
You may also elect Vanguard Dividend Express which
allows you to transfer your cash dividends and/or
capital gains distributions automatically to your bank
account. Please see "Other Vanguard Services" for more
information.
- --------------------------------------------------------------------------------
TAX CAUTION Under Federal tax laws, the Fund is required to
distribute net capital gains and dividend income to
Investors should ask Fund shareholders. These distributions are made to all
about the timing of shareholders who own Fund shares as of the
capital gains and distribution's record date, regardless of how long the
dividend shares have been owned. Purchasing shares just prior
distributions to the record date could have a significant impact on
before investing your tax liability for the year. For example, if you
purchase shares immediately prior to the record date
of a sizable capital gain or income dividend
distribution, you will be assessed taxes on the amount
of the capital gain and/or dividend distribution later
paid even though you owned the Fund shares for just a
short period of time. (Taxes are due on the
distributions even if the dividend or gain is
reinvested in additional Fund shares.) While the total
value of your investment will be the same after the
distribution -- the amount of the distribution will
offset the drop in the net asset value of the shares
-- you should be aware of the tax implications the
timing of your purchase may have.
Prospective investors should, therefore, inquire about
potential distributions before investing. The Fund's
annual capital gains distributions normally occur in
December, while income dividends are generally paid
semi-annually in June and December. For additional
information on distributions and taxes, see the
section titled "Dividends, Capital Gains and Taxes."
- -------------------------------------------------------------------------------
17
<PAGE>
IMPORTANT The easiest way to establish optional Vanguard
INFORMATION services on your account is to select the options you
Optional Services desire when you complete your Account Registration
Form. If you wish to add shareholder options later,
you may need to provide Vanguard with additional
information and a signature guarantee. Please call our
Client Services Department (1-800-662-2739) for
further assistance.
Signature For our mutual protection, we may require a signature
Guarantees guarantee on certain written transaction requests. A
signature guarantee verifies the authenticity of your
signature and may be obtained from banks, brokers and
any other guarantor that Vanguard deems acceptable. A
signature guarantee cannot be provided by a notary
public.
Certificates Share certificates will be issued upon request. If a
certificate is lost, you may incur an expense to
replace it.
Broker-Dealer If you purchase shares in Vanguard Funds through a
Purchases registered broker-dealer or investment adviser, the
broker-dealer or adviser may charge a service fee.
Cancelling Trades The Fund will not cancel any trade (e.g., a purchase,
exchange, or redemption) believed to be authentic,
received in writing or by telephone, once the trade
has been received.
Electronic You may receive a prospectus for the Fund or any of
Prospectus the Vanguard Funds in an electronic format. Please
Delivery call 1-800-231-7870 for additional information, or see
"Other Vanguard Services-Computer Access." You may
also receive a paper copy of the prospectus, by
calling 1-800-662-7447.
- -------------------------------------------------------------------------------
WHEN YOUR Your trade date is the date on which your account is
ACCOUNT WILL BE credited. If your purchase is made by check, Federal
CREDITED Funds wire, or exchange, and is received by the close
of regular trading on the New York Stock Exchange,
(generally 4:00 p.m. Eastern time), your trade date is
the day of receipt. If your purchase is received after
the close of the Exchange, your trade date is the next
business day. Your shares are purchased at the net
asset value determined on your trade date.
In order to prevent lengthy processing delays caused
by the clearing of foreign checks, Vanguard will only
accept a foreign check which has been drawn in U.S.
dollars and has been issued by a foreign bank with a
U.S. correspondent bank. The name of the U.S.
correspondent bank must be printed on the face of the
foreign check.
- -------------------------------------------------------------------------------
SELLING YOUR You may withdraw any portion of the funds in your
SHARES account by redeeming shares at any time (please see
"Important Redemption Information"). You generally may
initiate a request by writing or by telephoning. Your
redemption proceeds are normally mailed within two
business days after the receipt of the request in Good
Order.
------------------------------------------------------
Selling By Mail Requests should be mailed to Vanguard Financial
Center, Vanguard Asset Allocation Fund, P.O. Box 1120,
Valley Forge, PA 19482. (For express or
18
<PAGE>
registered mail, send your request to Vanguard
Financial Center, Vanguard Asset Allocation Fund, 455
Devon Park Drive, Wayne, PA 19087.)
The redemption price of shares will be the Fund's net
asset value next determined after Vanguard has
received all required documents in Good Order.
------------------------------------------------------
Definition of
Good Order
Good Order means that the request includes the
following:
1. The account number and Fund name.
2. The amount of the transaction (specified in dollars
or shares).
3. Signatures of all owners exactly as they are
registered on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that might be
required in the case of estates, corporations, trusts
and certain other accounts.
6. Any certificates you hold for the account.
If you have questions about this definition as it
pertains to your request, please call our Client
Services Department at 1-800-662-2739.
------------------------------------------------------
Selling By Telephone To sell shares by telephone, you or your
pre-authorized representative may call our Client
Services Department at 1-800-662-2739. The proceeds
will be sent to you by mail. Please Note: As a
protection against fraud, your telephone mail
redemption privilege will be suspended for 15 calendar
days following any expedited address change to your
account. An expedited address change is one that is
made by telephone, by Vanguard Online or, in writing,
without the signatures of all account owners. Please
see "Important Information About Telephone
Transactions."
------------------------------------------------------
Selling By Fund If you select the Fund Express Automatic Withdrawal
Express option, money will be automatically moved from your
Vanguard Fund account to your bank account according
to the schedule you have selected. The Special
Automatic Redemption option lets you move money from your
Withdrawal Vanguard account to your bank account on your request.
& Special Redemption You may elect Fund Express on the Account Registration
Form or call our Investor Information Department at
1-800-662-7447 for a Fund Express application.
-----------------------------------------------------
Selling By Exchange You may sell shares by making an exchange to another
Vanguard Fund account. Please see "Exchanging Your
Shares" for details.
-----------------------------------------------------
Important Shares purchased by check or Fund Express may be
Redemption redeemed at any time. However, your redemption
Information proceeds will not be paid until payment for the
purchase is collected, which may take up to ten
calendar days.
-----------------------------------------------------
Delivery of Redemption requests received by telephone prior to the
Redemption Proceeds close of regular trading on the New York Stock
Exchange (generally, 4:00 p.m. Eastern time) are
processed on the day of receipt and the redemption
proceeds are normally sent on the following business
day.
19
<PAGE>
Redemption requests received by telephone after the
close of the Exchange are processed on the business
day following receipt and the proceeds are normally
sent on the second business day following receipt. The
Fund reserves the right to revise or terminate the
telephone redemption privilege at any time.
Redemption proceeds must be sent to you within seven
days of receipt of your request in Good Order except
as described in "Important Redemption Information."
If you experience difficulty in making a telephone
redemption during periods of drastic economic or
market changes, your redemption request may be made by
regular or express mail. It will be implemented at the
net asset value next determined after your request has
been received by Vanguard in Good Order.
The Fund may suspend the redemption right or postpone
payment at times when the New York Stock Exchange is
closed or under any emergency circumstances as
determined by the United States Securities and
Exchange Commission.
If the Board of Directors determines that it would be
detrimental to the best interests of the Fund's
remaining shareholders to make payment in cash, the
Fund may pay redemption proceeds in whole or in part
by a distribution in kind of readily marketable
securities.
-----------------------------------------------------
Vanguard's Average If you make a redemption from a qualifying account,
Cost Statement Vanguard will send you an Average Cost Statement which
provides you with the cost and tax basis of the shares
you redeemed. Please see "Statements and Reports" for
additional information.
-----------------------------------------------------
Low Balance Fee Due to the relatively high cost of maintaining smaller
and Minimum accounts, the Fund will automatically deduct a $10
Account Balance annual fee from non-retirement accounts with balances
Requirement falling below $2,500 ($500 for Uniform Gifts/Transfers
to Minors Act accounts). The fee generally will be
waived for investors whose aggregate Vanguard assets
exceed $50,000. In addition, the Fund reserves the
right to liquidate any non-retirement account that is
below the minimum initial investment. In such a case,
you may be notified that the value of your account is
below the Fund's minimum account balance requirement.
You would then be allowed 60 days to make an
additional investment before the account is
liquidated. Proceeds would be promptly paid to the
registered shareholder.
Vanguard will not liquidate your account if it has
fallen below $3,000 solely as a result of declining
markets (i.e., a decline in the Fund's net asset
value).
- -------------------------------------------------------------------------------
EXCHANGING YOUR Should your investment goals change, you may exchange
SHARES your shares of Vanguard Asset Allocation Fund for
those of other available Vanguard Funds.
Exchanging by
Telephone In addition to the details below, please see
"Important Information About Telephone Transactions."
Call Client Services
(1-800-662-2739) When exchanging shares by telephone, please have ready
the Fund name, account number, Social Security number
or Employer Identification number listed
20
<PAGE>
on the account, and the exact name and address in
which the account is registered. Only the registered
shareowner (or his or her preauthorized
representative) may complete such an exchange.
Requests for telephone exchanges received prior to the
close of the New York Stock Exchange (generally, 4:00
p.m. Eastern time) are processed at the close of
business that same day. Requests received after the
close of the Exchange are processed the next business
day. Telephone exchanges are not accepted into or from
Vanguard Balanced Index Fund, Vanguard Index Trust,
Vanguard International Equity Index Fund and Vanguard
Quantitative Portfolios. If you experience difficulty
in making a telephone exchange, your exchange request
may be made by regular or express mail, and it will be
implemented at the closing net asset value on the date
received by Vanguard provided the request is received
in Good Order. Neither the Fund nor Vanguard is
responsible for the authenticity of exchange
instructions received by telephone. Investors bear the
full risk of any loss arising from unauthorized
telephone exchanges. To prohibit telephone exchanges
on your account, please notify the Fund in writing.
Otherwise, the telephone exchange privilege will be
automatically established for your account.
------------------------------------------------------
Exchanging By Mail Please be sure to include on your exchange request the
name and account number of your current Fund, the name
of the Fund you wish to exchange into, the amount you
wish to exchange, and the signatures of all registered
account holders. Send your request to Vanguard
Financial Center, Vanguard Asset Allocation Fund, P.O.
Box 1120, Valley Forge, PA 19482. (For express or
registered mail, send your request to Vanguard
Financial Center, Vanguard Asset Allocation Fund, 455
Devon Park Drive, Wayne, PA 19087.)
------------------------------------------------------
Important Exchange Before you make an exchange, you should consider the
Information following:
o Please read the Fund's prospectus before making an
exchange. For a copy and for answers to any
questions you may have, call our Investor
Information Department (1-800-662-7447).
o An exchange is treated as a redemption and a
purchase. Therefore, you could realize a taxable
gain or loss on the transaction.
o Exchanges are accepted only if the registrations
and the Taxpayer Identification numbers of the two
accounts are identical.
o The shares to be exchanged must be on deposit and
not held in certificate form.
o New accounts are not currently accepted in
Vanguard/Windsor Fund.
o The redemption price of shares redeemed by exchange
is the net asset value next determined after
Vanguard has received the required documentation in
Good Order.
o When opening a new account by exchange, you must
meet the minimum investment requirement of the new
Fund.
21
<PAGE>
Every effort will be made to maintain the exchange
privilege. However, the Fund reserves the right to
revise or terminate its provisions, limit the amount
of or reject any exchange, as deemed necessary, at any
time.
The exchange privilege is only available in states in
which the shares of the Fund are registered for sale.
The Fund's shares are currently registered for sale in
all 50 states and the Fund intends to maintain such
registration.
- -------------------------------------------------------------------------------
EXCHANGE The Fund's exchange privilege is not intended to
PRIVILEGE afford shareholders a way to speculate on short-term
LIMITATIONS movements in the market. Accordingly, in order to
prevent excessive use of the exchange privilege that
may potentially disrupt the management of the Fund and
increase transaction costs, the Fund has established a
policy of limiting excessive exchange activity.
Exchange activity generally will not be deemed
excessive if limited to two substantive exchange
redemptions (at least 30 days apart) from the Fund
during any twelve month period. "Substantive" means
either a dollar amount large enough to have a negative
impact on the Fund or a series of movements between
Vanguard portfolios. Notwithstanding these
limitations, the Fund reserves the right to reject any
purchase request (including exchange purchases from
other Vanguard portfolios) that is reasonably deemed
to be disruptive to efficient portfolio management.
- --------------------------------------------------------------------------------
IMPORTANT The ability to initiate redemptions (except wire
INFORMATION redemptions) and exchanges by telephone is
ABOUT TELEPHONE automatically established on your account unless you
TRANSACTIONS request in writing that telephone transactions on your
account not be permitted.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions,
Vanguard adheres to the following security procedures:
1. Security Check. To request a transaction by
telephone, the caller must know (i) the name of the
Portfolio; (ii) the 10-digit account number; (iii)
the exact name and address used in the
registration; and (iv) the Social Security or
Employer Identification number listed on the
account.
2. Payment Policy. The proceeds of any telephone
redemption by mail will be made payable to the
registered shareowner and mailed to the address of
record, only.
Neither the Fund nor Vanguard will be responsible for
the authenticity of transaction instructions received
by telephone, provided that reasonable security
procedures have been followed. Vanguard believes that
the security procedures described above are reasonable
and that if such procedures are followed, you will
bear the risk of any losses resulting from
unauthorized or fraudulent telephone transactions on
your account.
- --------------------------------------------------------------------------------
22
<PAGE>
TRANSFERRING You may transfer the registration of any of your Fund
REGISTRATION shares to another person by completing a transfer form
and sending it to: Vanguard Financial Center, P.O. Box
1110, Valley Forge, PA 19482, Attention: Transfers
Department. The request must be in Good Order. To
receive a transfer form and full instructions, please
call our Client Services Department (1-800-662-2739).
- --------------------------------------------------------------------------------
STATEMENTS AND Vanguard will send you a confirmation statement each
REPORTS time you initiate a transaction in your account,
except for checkwriting redemptions from Vanguard
money market accounts. You will also receive a
comprehensive account statement at the end of each
calendar quarter. The fourth-quarter statement will be
a year- end statement, listing all transaction
activity for the entire calendar year.
Vanguard's Average Cost Statement provides you with
the average cost of shares redeemed from your account
during the calendar year, using the average cost
single category method. This service is available for
most taxable accounts opened since January 1, 1986. In
general, investors who redeemed shares from a
qualifying Vanguard account may expect to receive
their Average Cost Statement along with their Fund
Summary Statement. Please call our Client Services
Department (1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you
semi-annually, according to the Fund's fiscal
year-end.
- --------------------------------------------------------------------------------
OTHER VANGUARD For more information about any of these services,
SERVICES please call our Investor Information Department at
1-800-662-7447.
Vanguard Direct With Vanguard's Direct Deposit Service, most U.S.
Deposit Service Government checks (including Social Security and
military pension checks) and private payroll checks
may be automatically deposited into your Vanguard Fund
account. Separate brochures and forms are available
for direct deposit of U.S. Government and private
payroll checks.
Vanguard Automatic Vanguard's Automatic Exchange Service allows you to
Exchange Service move money automatically among your Vanguard Fund
accounts. For instance, the service can be used to
"dollar cost average" from a money market portfolio
into a stock or bond fund or to contribute to an IRA
or other retirement plan. Please contact our Client
Services Department at 1-800-662-2739 for additional
Vanguard Fund Vanguard's Fund Express allows you to transfer money
Express between your Fund account and your account at a bank,
savings and loan association, or a credit union that
is a member of the Automated Clearing House (ACH)
system. You may elect this service on the Account
Registration Form or call our Investor Information
Department (1-800-662-7447) for a Fund Express
application.
Special rules govern how your Fund Express purchases
or redemptions are credited to your account. In
addition, some services of Fund Express cannot be used
with specific Vanguard Funds. For more information,
please refer to the Vanguard Fund Express brochure.
23
<PAGE>
Vanguard Dividend Vanguard's Dividend Express allows you to transfer
Express your dividends and/or capital gains distributions
automatically from your Fund account, one business day
after the Fund's payable date, to your account at a
bank, savings and loan association, or credit union
that is a member of the Automated Clearing House (ACH)
network. You may elect this service on the Account
Registration Form or call our Investor Information
Department (1-800-662-7447) for a Vanguard Dividend
Express application.
Vanguard Vanguard's Tele-Account is a convenient, automated
Tele-Account service that provides share price, price change and
yield quotations on Vanguard Funds through any
TouchTone(TM) telephone. This service also lets you
obtain information about your account balance, your
last transaction, and your most recent dividend or
capital gains payment. In addition, you may perform
investment exchanges of Vanguard Fund shares and
redemptions by check using Tele-Account. To contact
Vanguard's Tele-Account service, dial 1-800-ON-BOARD
(1-800-662-6273). A brochure offering detailed
operating instructions is available from our Investor
Information Department (1-800-662-7447).
Computer Access
Vanguard Online Vanguard Online allows you to obtain information via
Keyword: vanguard your personal computer on Fund share price, yield, and
total return. Vanguard Online is offered through
America Online (AOL). To establish an AOL account,
call 1-800-238-6336.
Vanguard on the Vanguard sponsors an education-oriented website
World Wide Web offering news and information about Vanguard Funds and
http://www.vanguard.com services, as well as interactive, easy-to-use
investment planning tools.
- -------------------------------------------------------------------------------
24
<PAGE>
(This page intentionally left blank.)
<PAGE>
Vanguard
Asset
Allocation
Fund
The Vanguard Group
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
Investor Information
Department:
1-800-662-7447 (SHIP)
Client Services
Department:
1-800-662-2739 (CREW)
Tele-Account for
24-Hour Access:
1-800-662-6273 (ON-BOARD)
Telecommunication Service
for the Hearing-impaired:
1-800-662-2738
Transfer Agent:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
<PAGE>
Vanguard
Asset
Allocation
Fund
P R O S P E C T U S
JANUARY 17, 1997
A member of
THE VANGUARD GROUP(R)
P078
<PAGE>
PART B
VANGUARD ASSET ALLOCATION FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
JANUARY 17, 1997
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated January 17, 1997). To obtain the
Prospectus please call:
INVESTOR INFORMATION DEPARTMENT
1-800-662-7447 (SHIP)
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
--------
<S> <C> <C>
Investment Limitations ....................... B-1
Purchase of Shares ........................... B-2
Redemption of Shares ......................... B-3
Management of the Fund ....................... B-4
Performance Measures ......................... B-7
Total Return ................................. B-9
Investment Advisory Services ................. B-9
Portfolio Transactions ....................... B-10
Description of U.S. Government Securities .... B-11
Description of Repurchase Agreements ......... B-11
Futures Contracts ............................ B-12
Glossary ..................................... B-15
Financial Statements ......................... B-15
</TABLE>
INVESTMENT LIMITATIONS
The following restrictions are fundamental policies and cannot be changed
without approval of the holders of a majority of the outstanding shares of
the Fund, as defined in the Investment Company Act of 1940 (the "1940 Act").
The Fund may not under any circumstances:
1) Borrow money, except from banks (or through reverse repurchase
agreements) for temporary or emergency purposes (not leveraging), and
then only in an amount not in excess of 15% of the value of the Fund's
net assets at the time the borrowing is made. Whenever borrowing
exceeds 5% of the value of the Fund's assets, the Fund will not make
any additional investments;
2) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if as a result the Fund would
hold more than 10% of the outstanding voting securities of the issuer,
or more than 5% of the value of the Fund's total assets would be
invested in the securities of such issuer;
3) Invest for the purpose of exercising control of management of any
company;
4) Purchase the securities of any other investment company, except as they
may be acquired as part of a merger, consolidation or acquisition of
assets or otherwise to the extent permitted by Section 12 of the 1940
Act. The Fund will invest only in investment companies which have
investment objectives consistent with those of the Fund;
B-1
<PAGE>
5) The Fund will not engage in the business of underwriting securities
issued by other persons except to the extent that the Fund may
technically be deemed to be an underwriter under the Securities Act of
1933 in disposing of portfolio securities. Additionally, the Fund will
not purchase or otherwise acquire any security if, as a result, more
than 15% of its net assets would be invested in securities that are
illiquid (included in this limitation is the Fund's investment in The
Vanguard Group, Inc.);
6) Invest in commodities, except that the Fund may invest in futures
contracts, options and options on futures contracts to the extent that
not more than 5% of the Fund's assets are required as margin deposit
for futures contracts;
7) Invest in real estate or real estate limited partnership interests
although the Fund may purchase and sell securities of companies which
invest in real estate, or interests therein;
8) Purchase securities on margin or sell any securities short except as
specified in investment limitation No. 6 above;
9) Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements) which are either
publicly distributed or customarily purchased by institutional
investors, and (ii) by lending its securities to banks, brokers,
dealers and other financial institutions so long as such loans are not
inconsistent with the Investment Company Act or the Rules and
Regulations or interpretations of the Securities and Exchange
Commission thereunder. No loan of securities will be made if, as a
result the aggregate of such loans in the Fund would exceed 33 1/3 %
of the value of the Fund's total assets;
10) Pledge, mortgage, or hypothecate any of its assets to an extent
greater than 5% of its total assets; and
11) Invest more than 25% of the value of its total assets in any one
industry.
These investment limitations are considered at the time Fund securities
are purchased.
Notwithstanding these limitations, the Fund may own all or any portion of
the securities of, or make loans to, or contribute to the costs or other
financial requirements of any company which will be wholly- owned by the Fund
and one or more other investment companies and is primarily engaged in the
business of providing, at-cost, management, administrative, distribution or
related services to the Fund and other investment companies. See "Management
of the Fund."
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offerings of its shares, (ii) to reject purchase orders when in the judgment
of management such rejection is in the best interest of the Fund, and (iii)
to reduce or waive the minimum investment for or any other restrictions on
initial and subsequent investments for certain fiduciary accounts or under
circumstances where certain economies can be achieved in sales of the Fund's
shares.
B-2
<PAGE>
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading
on the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency
exists as defined by the rules of the Commission as a result of which it is
not reasonably practicable for the Fund to dispose of securities owned by it,
or fairly to determine the value of its assets, and (iii) for such other
periods as the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during
any 90-day period to the lesser of $250,000 or 1% of the net assets of the
Fund at the beginning of such period. Such commitment is irrevocable without
the prior approval of the Commission. Redemptions in excess of the above
limits may be paid in whole or in part, in investment securities or in cash,
as the Directors may deem advisable; however, payment will be made wholly in
cash unless the Directors believe that economic or market conditions exist
which would make such a practice detrimental to the best interests of the
Fund. If redemptions are paid in investment securities, such securities will
be valued as set forth in the Prospectus under "The Fund's Share Price" and a
redeeming shareholder would normally incur brokerage expenses if he converted
these securities to cash.
No charge is made by the Fund for redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the
securities held by the Fund.
B-3
<PAGE>
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Directors. The Directors set broad
policies for the Fund and choose its Officers. The following is a list of
Directors and Officers of the Fund and a statement of their present positions
and principal occupations during the past five years. The mailing address of
the Directors and Officers of the Fund is Post Office Box 876, Valley Forge,
PA 19482.
JOHN C. BOGLE, Chairman and Director*
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group; Director of the Mead
Corporation, General Accident Insurance and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive Officer & Director*
President, Chief Executive Officer and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Director
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc; Director of Sun
Company, Inc. and Westinghouse Electric Corporation.
BARBARA BARNES HAUPTFUHRER, Director
Director of The Great Atlantic and Pacific Tea Company, Alco Standard Corp.,
Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Co. and Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY, Director
President Emeritus of The Brookings Institution; Director of American
Express Bank Ltd., The St. Paul Companies, Inc., and National Steel
Corporation.
BURTON G. MALKIEL, Director
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co., and Southern New England Communications
Company.
<PAGE>
ALFRED M. RANKIN, Jr., Director
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company and The Standard Products Company.
JOHN C. SAWHILL, Director
President and Chief Executive Officer, The Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co.; and President, New York
University; Director of Pacific Gas and Electric Company, Procter & Gamble
Company and NACCO Industries.
JAMES O. WELCH, JR., Director
Retired Chairman of Nabisco Brands, Inc., retired Vice Chairman and Director
of RJR Nabisco; Director of TECO Energy, Inc. and Kmart Corporation.
J. LAWRENCE WILSON, Director
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company; and Trustee of Vanderbilt University.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary
of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc., and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
------
* Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
B-4
<PAGE>
The Fund is a member of The Vanguard Group of Investment Companies.
Through their jointly-owned subsidiary, The Vanguard Group, Inc.
("Vanguard"), the Fund and the other Funds in the Group obtain at cost
virtually all of their corporate management, administrative and distribution
services. Vanguard also provides investment advisory services on an at-cost
basis to certain of the Vanguard Funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment.
Each Fund pays its share of Vanguard's total expenses which are allocated
among the Funds under methods approved by the Board of Directors (Trustees)
of each Fund. In addition, each Fund bears its own direct expenses such as
legal, auditing and custodian fees.
The Fund's officers are also officers and employees of Vanguard. No
officer or employee owns, or is permitted to own, any securities of any
external adviser for the Funds.
The Vanguard Group adheres to a Code of Ethics established pursuant to
Rule 17j-1 under the Investment Company Act of 1940. The Code is designed to
prevent unlawful practices in connection with the purchase or sale of
securities by persons associated with Vanguard. Under Vanguard's Code of
Ethics certain officers and employees of Vanguard who are considered access
persons are permitted to engage in personal securities transactions. However,
such transactions are subject to procedures and guidelines substantially
similar to those recommended by the mutual fund industry and approved by the
U.S. Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds have invested are adjusted from time to time
in order to maintain the proportionate relationship between each Fund's
relative net assets and its contribution to Vanguard's capital. The Fund's
Service Agreement provides that: (a) each Vanguard Fund may invest up to .40%
of its current assets in Vanguard, and (b) there is no limit on the amount
that each Vanguard Fund may contribute to Vanguard's capitalization. At
September 30, 1996, the Fund had contributed capital of $219,000,
representing 1.1% of Vanguard's capitalization.
MANAGEMENT
Corporate management and administrative services include: (1) executive
staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During
the fiscal year ended September 30, 1996, the Fund's allocated share of
Vanguard's actual net costs of operations relating to management and
administrative services (including transfer agency) totaled approximately
$6,402,000.
DISTRIBUTION
Vanguard provides all distribution and marketing activities for the Funds
in the Group. Vanguard Marketing Corporation, a wholly-owned subsidiary of
Vanguard, acts as Sales Agent for the shares of the Funds in connection with
any sales made directly to investors in the states of Florida, Missouri, New
York, Ohio, Texas and such other states as it may be required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Directors
and Officers of Vanguard determine the amount to be spent annually on
distribution activities, the manner and amount to be spent on each Fund, and
whether to organize new investment companies.
B-5
<PAGE>
One-half of the distribution expenses of a marketing and promotional
nature is allocated among the Funds based upon relative net assets. The
remaining one-half of those expenses is allocated among the Funds based upon
each Fund's sales for the preceding 24 months relative to the total sales of
the Funds as a Group, provided, however, that no Fund's aggregate quarterly
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of 20/100
of 1% of its average month-end net assets. During the fiscal year ended
September 30, 1996, the Fund paid approximately $421,000 of the Group's
distribution and marketing expenses, which represented an effective annual
rate of .02 of 1% of the Fund's average net assets.
INVESTMENT ADVISORY SERVICES
Vanguard provides investment advisory services to Vanguard Money Market
Reserves, Vanguard Municipal Bond Fund, several Portfolios of Vanguard Fixed
Income Securities Fund, Vanguard California Tax- Free Fund, Vanguard Florida
Insured Tax-Free Fund, Vanguard New Jersey Tax-Free Fund, Vanguard New York
Insured Tax-Free Fund, Vanguard Pennsylvania Tax-Free Fund, Vanguard Ohio
Tax-Free Fund, Vanguard Admiral Funds, Vanguard Tax-Managed Fund, Vanguard
Balanced Index Fund, Vanguard Bond Index Fund, Vanguard Index Trust, Vanguard
International Equity Index Fund, Total International Portfolio of Vanguard
STAR Fund, Aggressive Growth Portfolio of Vanguard Horizon Fund, several
Portfolios of Vanguard Variable Insurance Fund, a portion of Vanguard/Windsor
II, Vanguard Institutional Index Fund, Vanguard REIT Index Portfolio of
Vanguard Specialized Portfolios, and a portion of Vanguard/Morgan Growth Fund
as well as several indexed separate accounts. These services are provided on
an at-cost basis from a money management staff employed directly by Vanguard.
The compensation and other expenses of this staff are paid by the Funds
utilizing these services.
REMUNERATION OF DIRECTORS AND OFFICERS
The Fund pays each Director who is not also an Officer, an annual fee plus
travel and other expenses incurred in attending Board meetings. The Fund's
Officers and employees are paid by Vanguard which, in turn, is reimbursed by
the Fund, and each other Fund in the Group, for its proportionate share of
Officers' and employees' salaries and retirement benefits. During the year
ended September 30, 1996 the Fund's proportionate share of remuneration paid
to all Officers of the Fund, as a group, was approximately $60,746 including
Directors.
Retired Directors who are not officers are paid an annual fee based on the
number of years of service. The fee is equal to $1,000 for each year of
service and each investment company member of The Vanguard Group contributes
a proportionate amount to this fee based on its relative net assets. Under
its retirement plan, Vanguard contributes annually an amount equal to 10% of
each eligible officer's annual compensation plus 5.7% of that part of an
eligible officer's compensation during the year, if any, that exceeds the
Social Security Taxable Wage Base then in effect. Under its thrift plan, all
eligible officers are permitted to make pre- tax contributions in an amount
up to 4% of total compensation, subject to federal tax limitations, which are
matched by Vanguard on a 100% basis. The Fund's proportionate share of
retirement contributions made by Vanguard under its retirement and thrift
plans on behalf of all Officers of the Fund, as a group, during the 1996
fiscal year was approximately $1,650.
B-6
<PAGE>
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors for the fiscal year ended September
30, 1996.
VANGUARD ASSET ALLOCATION FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
Pension or Retirement Estimated
Aggregate Benefits Accrued as Annual Benefits Total Compensation
Compensation Part of Fund Upon From All Vanguard Funds
Names of Directors From Fund Expenses Retirement Paid to Directors(2)
-------------------------- -------------- --------------------- --------------- -----------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) -- -- -- --
John J. Brennan(1) -- -- -- --
Barbara Barnes Hauptfuhrer $677 $105 $15,000 $65,000
Robert E. Cawthorn $677 $ 88 $13,000 $65,000
Bruce K. MacLaury $734 $103 $12,000 $60,000
Burton G. Malkiel $677 $ 70 $15,000 $65,000
Alfred M. Rankin, Jr. $677 $ 55 $15,000 $65,000
John C. Sawhill $677 $ 66 $15,000 $65,000
James O. Welch, Jr. $677 $ 81 $15,000 $65,000
J. Lawrence Wilson $677 $ 58 $15,000 $65,000
</TABLE>
- ------
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no
compensation for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid
to each Director for their service as Director or Trustee of 34 Vanguard
Funds (33 in the case of Mr. Malkiel; 27 in the case of Mr. MacLaury).
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of The Vanguard Group, including
Vanguard Asset Allocation Fund, may, from time to time, use one or more of
the following unmanaged indices for comparative performance purposes.
Standard and Poor's 500 Composite Stock Price Index -- is a well diversified
list of 500 companies representing the U.S. Stock Market.
Wilshire 5000 Equity Index -- consists of nearly 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
Wilshire 4500 Equity Index -- consists of all stocks in the Wilshire 5000
except for the 500 stocks in the Standard and Poor's 500 Index.
Morgan Stanley Capital International EAFE Index -- is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on
the stock exchanges of countries in Europe, Australia and the Far East.
Goldman Sachs 100 Convertible Bond Index -- currently includes 71 bonds and
29 preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
Salomon Brothers GNMA Index -- includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government
National Mortgage Association.
B-7
<PAGE>
Salomon Brothers High-Grade Corporate Bond Index -- consists of publicly
issued, non-convertible corporate bonds rated AA or AAA. It is a
value-weighted, total return index, including approximately 800 issues with
maturities of 12 years or greater.
Lehman Brothers Aggregate Bond Index -- is a market weighted index that
contains over 4,000 individually priced U.S. Treasury, agency, corporate, and
mortgage pass-through securities corporate rated BBB - or better. The Index
has a market value of over $4 trillion.
Lehman Brothers Mutual Fund Short (1-5) Government/Corporate Index -- is a
market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate investment grade bonds rated BBB - or better
with maturities between 1 and 5 years. The index has a market value of over
$1.3 trillion.
Lehman Brothers Mutual Fund Intermediate (5-10) Government/Corporate Index --
is a market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate securities rated BBB - or better with
maturities between 5 and 10 years. The index has a market value of over $600
billion.
Lehman Brothers Mutual Fund Long (10+) Government/Corporate Index -- is a
market weighted index that contains over 1,900 individually priced U.S.
Treasury, agency, and corporate securities rated BBB - or better with
maturities greater than 10 years. The index has a market value of over $900
billion.
Lehman Long-Term Treasury Bond -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
Merrill Lynch Corporate & Government Bond -- consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index -- all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
Lehman Brothers Long-Term Corporate Bond Index -- is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Index (20 year) Bond -- is a yield index on current
coupon high grade general obligation municipal bonds.
Standard & Poor's Preferred Index -- is a yield index based upon the average
yield of four high grade, noncallable preferred stock issues.
NASDAQ Industrial Index -- is composed of more than 3,000 industrial issues.
It is a value-weighted index calculated on price change only and does not
include income.
Composite Index -- 70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
Composite Index -- 65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
Composite Index -- 65% Lehman Long-Term Corporate AA or Better Bond Index and
a 35% weighting in a blended equity composite (75% Standard & Poor's/BARRA
Value Index, 25% Standard & Poor's Utilities Index.)
B-8
<PAGE>
Lehman Long-Term Corporate AA or Better Bond Index -- consists of all
publicly issued, fixed rate, nonconvertible investment grade,
dollar-denominated, SEC-registered corporate debt rated AA or AAA.
TOTAL RETURN
The average annual total return for the Fund for one and five years ended
September 30, 1996 and for the period from inception (November 3, 1988) to
September 30, 1996 was +15.27%, +13.45% and +14.06%, respectively.
Total return is computed by determining the average compounded rates of
return over the periods set forth above that would equate an initial amount
invested at the beginning of the periods to the ending redeemable value of
the investment.
INVESTMENT ADVISORY SERVICES
The Fund employs Mellon Capital Management Corporation ("MCM"), 595 Market
St., Suite 3000, San Francisco, California (the "Adviser") under an
investment advisory agreement dated as of January 15, 1996 to manage the
investment and reinvestment of the assets of the Fund and to continuously
review, supervise and administer the Fund's investment program. The Adviser
discharges its responsibilities subject to the control of the Officers and
Directors of the Fund.
The Fund pays the Adviser a Basic fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on the following annual
percentage rates, to the Fund's average month-end net assets for the quarter:
<TABLE>
<CAPTION>
Net Assets Rate
------------------- -------
<S> <C>
First $100 million . .200%
Next $900 million . .150%
Next $500 million . .125%
Over $1.5 billion . .100%
</TABLE>
This fee may be increased or decreased by applying an adjustment formula
based on the performance of the Fund's portfolio relative to the investment
record of the S&P 500 Index. The fee payment will be increased (decreased) by
an incentive (penalty) of 0.05% of average net assets, if the Fund's
cumulative investment performance for the thirty-six months preceding the end
of the quarter is at least six percentage points above (below) the cumulative
investment record of the S&P 500 Index for the same period.
The agreement will continue until March 31, 1998 and will be renewable
thereafter for successive one-year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Directors, including
the affirmative votes of a majority of the Directors who are not parties to
the contract or "interested persons" (as defined in the Investment Company
Act of 1940) of any such party, cast in person at a meeting called for the
purpose of considering such approval. In addition, the question of
continuance shall be effected only if approved by the affirmative vote of a
majority of the outstanding voting securities of the Fund. The agreement is
automatically terminated if assigned, and may be terminated without penalty
at any time (1) either by vote of the Board of Directors of the Fund or by
vote of its outstanding voting securities on 60 days' written notice to the
Adviser, or (2) by the Adviser upon 90 days' written notice to the Fund.
The Fund's Board of Directors may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of a
new advisory agreement, either as a replacement for an existing adviser or as
an additional adviser.
B. A change in the terms of an advisory agreement.
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<PAGE>
C. The continued employment of an existing adviser on the same advisory
contract terms where a contract has been assigned because of a change in
control of the adviser.
Any such change will only be made upon not less than 30 days' prior
written notice to shareholders, which shall include the information
concerning the adviser that would have normally been included in a proxy
statement.
Because the Adviser provides only investment advisory services to the Fund
and has no control over the Fund's expenses, the Adviser has not undertaken
to guarantee expenses of the Fund. The Officers of the Fund have worked out
alternative arrangements with state authorities which do require an expense
guarantee.
Description of the Adviser. The Adviser is a professional counseling firm
which manages well diversified stock and bond portfolios for institutional
clients. As of September 30, 1996 the Adviser provided investment advisory
services to 212 clients and managed assets with an approximate value of $46.4
billion. The Adviser's asset allocation strategy was developed by the
Adviser's co-founder, William Fouse, in 1972, and is used by 84 of its
clients and accounts for approximately $13.6 billion of the assets that it
manages. The Adviser is a wholly-owned subsidiary of MBC Investment
Corporation, which itself is a wholly-owned subsidiary of Mellon Bank
Corporation. For the fiscal years ended September 30, 1994, September 30,
1995 and September 30, 1996, the Fund paid approximately $1,785,000,
$1,954,000 (before a decrease of $131,000 based on performance), and
$2,691,000 (before a decrease of $515,000 based on performance) respectively,
to the Adviser for investment advisory services. The basic fee paid to the
Adviser for the fiscal year ended September 30, 1996 reflects a fee waiver of
$146,000 during the period October 1, 1995 to March 31, 1996.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the Adviser (with the
approval of the Fund's Board of Directors) to select the brokers or dealers
that will execute the purchases and sales of portfolio securities for the
Fund and directs the Adviser to use its best efforts to obtain the best
available price and most favorable execution as to all transactions for the
Fund. The Adviser undertakes to execute each investment transaction at a
price and commission which provides the most favorable total cost or proceeds
reasonably obtainable under the circumstances.
In placing portfolio transactions, the Adviser will use its best judgment
to choose the broker most capable of providing the brokerage services
necessary to obtain best available price and most favorable execution. The
full range and quality of brokerage services available will be considered in
making these determinations. In those instances where it is reasonably
determined that more than one broker can offer the brokerage services needed
to obtain the best available price and most favorable execution,
consideration may be given to those brokers which supply investment research
and statistical information and provide other services in addition to
execution services to the Fund and/or the Adviser. The Adviser considers such
information useful in the performance of its obligations under the agreement,
but is unable to determine the amount by which such services may reduce its
expenses.
The investment advisory agreement also incorporates the concepts of
Section 28(e) of the Securities Exchange Act of 1934 by providing that,
subject to the approval of the Fund's Board of Directors, the Adviser may
cause the Fund to pay a broker-dealer which furnishes brokerage and research
services a higher commission than that which might be charged by another
broker-dealer for effecting the same transaction; provided that such
commission is deemed reasonable in terms of either that particular
transaction or the overall responsibilities of the Adviser to the Fund.
Currently, it is the Fund's policy that the Adviser may at times pay
higher commissions in recognition of brokerage services felt necessary for
the achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be
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<PAGE>
in the best interest of the Fund. Some brokers or dealers who may receive
such higher commissions in recognition of brokerage services related to
execution of securities transactions are also providers of research
information to the Adviser and/or the Fund. However, the Adviser has informed
the Fund that it will not pay higher commission rates specifically for the
purpose of obtaining research services.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified broker-dealers
who recommend the Fund to other clients, or who act as agent in the purchase
of the Fund's shares for their clients, and may, when a number of brokers and
dealers can provide comparable best price and execution on a particular
transaction, consider the sale of Fund shares by a broker or dealer in
selecting among qualified broker-dealers.
The total brokerage commissions paid by the Fund for the fiscal years
ended September 30, 1994, September 30, 1995 and September 30, 1996, totaled
$482,595, $92,177 and $127,528 respectively.
Some securities considered for investment by the Fund may also be
appropriate for other clients served by the Adviser. If purchases or sales of
securities consistent with the investment policies of the Fund and one or
more of these other clients serviced by the Adviser are considered at or
about the same time, transactions in such securities will be allocated among
the Fund and such other clients in a manner deemed equitable by the Adviser.
DESCRIPTION OF U.S. GOVERNMENT SECURITIES
As used in this prospectus, the term "U.S. Government Securities" refers
to a variety of securities which are issued or guaranteed by the United
States Treasury, by various agencies of the United States Government, and by
various instrumentalities which have been established or sponsored by the
United States Government. The term also refers to "repurchase agreements"
collateralized by such securities.
U.S. Treasury Securities are backed by the "full faith and credit" of the
United States. Securities issued or guaranteed by Federal agencies and U.S.
Government sponsored instrumentalities may or may not be backed by the full
faith and credit of the United States. In the case of securities not backed
by the full faith and credit of the United States, the investor must look
principally to the agency or instrumentality issuing or guaranteeing the
obligation for ultimate repayment, and may not be able to assert a claim
against the United States itself in the event the agency or instrumentality
does not meet its commitment.
Some of the U.S. Government agencies that issue or guarantee securities
include the Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Maritime Administration,
Small Business Administration, and The Tennessee Valley Authority.
An instrumentality of the U.S. Government is a government agency organized
under Federal charter with government supervision. Instrumentalities issuing
or guaranteeing securities include, among others, Federal Home Loan Banks,
the Federal Land Banks, Central Bank for Cooperatives, Federal Intermediate
Credit Banks, and the Federal National Mortgage Association.
DESCRIPTION OF REPURCHASE AGREEMENTS
Repurchase agreements are transactions by which a person purchases a
security and simultaneously commits to resell that security to the seller (a
member bank of the Federal Reserve System or recognized securities dealer) at
an agreed upon price on an agreed upon date within a number of days (usually
not more
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<PAGE>
than seven) from the date of purchase. The resale price reflects the purchase
price plus an agreed upon market rate of interest which is unrelated to the
coupon rate or maturity of the purchased security. A repurchase agreement
involves the obligation of the seller to pay the agreed upon price, which
obligation is in effect secured by the value of the underlying security.
The use of repurchase agreements involves certain risks. For example, if
the seller of the agreement defaults on its obligation to repurchase the
underlying securities at a time when the value of these securities has
declined, the Portfolio may incur a loss upon disposition of them. If the
seller of the agreement becomes insolvent and subject to liquidation or
reorganization under the Bankruptcy Code or other laws, a bankruptcy court
may determine that the underlying securities are collateral not within the
control of the Portfolio and therefore subject to sale by the trustee in
bankruptcy. Finally, it is possible that the Portfolio may not be able to
substantiate its interest in the underlying securities. While the Fund's
management acknowledges these risks, it is expected that they can be
controlled through stringent security selection criteria and careful
monitoring procedures.
FUTURES CONTRACTS
The Fund may enter into stock index and fixed-income futures contracts,
stock index and fixed income options, and options on such futures contracts
to remain fully invested, to reduce transactions costs. Futures contracts
provide for the future sale by one party and purchase by another party of a
specified amount of a specific security or index at a specified future time
and at a specified price. Futures contracts which are standardized as to
maturity date and underlying financial instrument are traded on national
futures exchanges. Futures exchanges and trading are regulated under the
Commodity Exchange Act by the Commodity Futures Trading Commission ("CFTC"),
a U.S. Government Agency. Assets committed to futures contracts will be
segregated at the Fund's custodian bank to the extent required by law.
Although many fixed-income futures contracts call for actual delivery or
acceptance of the underlying securities at a specified date (stock index
futures contracts do not permit delivery of securities), the contracts are
normally closed out before the settlement date without the making or taking
of delivery. Closing out an open futures position is done by taking an
opposite position ("buying" a contract which has previously been "sold,"
"selling" a contract previously "purchased") in an identical contract to
terminate the position. Brokerage commissions are incurred when a futures
contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash
or government securities with a broker or custodian to initiate and maintain
open positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying
security) if it is not terminated prior to the specified delivery date.
Minimal initial margin requirements are established by the futures exchange
and may be changed. Brokers may establish deposit requirements which are
higher than the exchange minimums.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to
and from the futures broker for as long as the contract remains open. The
Fund expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes (anticipated or potential) in the value of securities
currently owned or expected to be acquired by them. Speculators are less
inclined to own the securities underlying the futures contracts which they
trade, and use futures contracts with the expectation of realizing profits
from fluctuations in the value of the underlying securities. The Fund intends
to use futures contracts only for bona fide hedging purposes.
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<PAGE>
Regulations of the CFTC applicable to the Portfolio require that all of
its futures transactions constitute bona fide hedging transactions. The
Portfolio will only sell futures contracts to protect securities it owns
against price declines or purchase contracts to protect against an increase
in the price of securities it intends to purchase. As evidence of this
hedging interest, the Portfolio expects that approximately 75% of its futures
contract purchases will be "completed," that is, equivalent amounts of
related securities will have been purchased or are being purchased by the
Fund upon sale of open futures contracts.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
The Fund will not enter into futures contract transactions to the extent
that, immediately thereafter, the sum of its initial margin deposits on open
contracts exceeds 5% of the market value of the Portfolio's total assets.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures may be closed out only on an Exchange which provides
a secondary market for such futures. However, there can be no assurance that
a liquid secondary market will exist for any particular futures contract at
any specific time. Thus, it may not be possible to close a futures position.
In the event of adverse price movements, the Fund would continue to be
required to make daily cash payments to maintain its required margin. In such
situations, if the Fund has insufficient cash, it may have to sell portfolio
securities to meet daily margin requirements at a time when it may be
disadvantageous to do so. The inability to close options and futures
positions also could have an adverse impact on the ability to hedge
effectively.
A Fund will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary
market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures contracts. As a result, a
relatively small price movement in a futures contract may result in immediate
and substantial loss (or gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin,
a subsequent 10% decrease in the value of the futures contract would result
in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit if the contract
were closed out. Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the contract. The Fund also bears
the risk that the Adviser will incorrectly predict future market trends.
However, because the futures strategies of the Portfolio are engaged in only
for hedging purposes, the adviser does not believe that the Fund is subject
to the risks of loss frequently associated with futures transactions. The
Fund would presumably have sustained comparable losses if, instead of the
futures contract, it had invested in the underlying financial instrument and
sold it after the decline.
Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is
also possible that the Fund could both lose money on futures contracts and
also experience a decline in value of its portfolio securities. There is also
the risk of loss by the Fund of margin deposits in the event of bankruptcy of
a broker with whom the Fund has an open position in a futures contract or
related option.
Most futures exchanges limit the amount of fluctuation permitted in some
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type
of contract, no trades may be made on that day at a price beyond
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<PAGE>
that limit. The daily limit governs only price movement during a particular
trading day and therefore does not limit potential losses, because the limit
may prevent the liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several consecutive trading
days with little or no trading, thereby preventing prompt liquidation of
future positions and subjecting some futures traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS
The Fund is required for Federal income tax purposes to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts as of the end of the year as well as those actually realized during
the year. In most cases, any gain or loss recognized with respect to a
futures contract is considered to be 60% long-term capital gain or loss and
40% short-term capital gain or loss, without regard to the holding period of
the contract. Furthermore, sales of futures contracts which are intended to
hedge against a change in the value of securities held by the Fund may affect
the holding period of such securities and, consequently, the nature of the
gain or loss on such securities upon disposition. The Fund may be required to
defer the recognition of losses on futures contracts to the extent of any
unrecognized gains on related positions held by the Fund.
In order for the Fund to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest income derived from loans of securities, and gains from the sale of
securities or foreign currencies, or other income derived with respect to its
business of investing in such securities or currencies. In addition, gains
realized on the sale or other disposition of securities held for less than
three months must be limited to less than 30% of the Fund's annual gross
income. It is anticipated that any net gain realized from the closing out of
futures contracts will be considered gain from the sale of securities and
therefore be qualifying income for purposes of the 90% requirement. In order
to avoid realizing excessive gains on securities held less than three months,
the Fund may be required to defer the closing out of futures contracts beyond
the time when it would otherwise be advantageous to do so. It is anticipated
that unrealized gains on futures contracts, which have been open for less
than three months as of the end of the Fund's fiscal year and which are
recognized for tax purposes, will not be considered gains on securities held
less than three months for the purpose of the 30% test.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes including
unrealized gains at the end of the Fund's fiscal year on futures
transactions. Such distributions will be combined with distributions of
capital gains realized on the Fund's other investments and shareholders will
be advised on the nature of the payments.
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<PAGE>
GLOSSARY
a. Historical Market Returns -- Total returns of broad asset class
benchmarks. As examples, the returns of well-known benchmarks for domestic
stocks, bonds, and money market instruments are given below.
<TABLE>
<CAPTION>
Money Market
Asset Class Common Stocks Bonds Instruments
Standard & Poor's
500 Composite Stock Lehman Brothers 90 Day
Benchmark Price Index Long Treasury Index U.S. Treasury Bills
------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
1979 18.4 -0.5 10.0
1980 32.4 -2.9 11.4
1981 -4.9 0.4 14.7
1982 21.5 41.8 10.9
1983 22.5 2.0 9.0
1984 6.2 14.8 10.0
1985 31.6 31.6 7.8
1986 18.6 24.1 6.2
1987 5.2 -2.7 5.9
1988 16.5 9.2 6.8
1989 31.6 18.9 8.6
1990 -3.1 6.3 7.9
1991 30.4 18.5 5.8
1992 7.6 8.0 3.6
1993 10.1 17.3 3.1
1994 1.3 -7.6 4.2
1995 37.6 30.7 5.8
1996(9/30) 13.5 -5.4 3.9
</TABLE>
b. Asset Allocation -- Asset allocation -- in its most generic sense -- is
the allotment of an investor's monies to broad asset classes such as
stocks or bonds. Investors establish percentage allocation guidelines for
stocks, bonds, and money market instruments which are consistent with
their particular long-term investment needs. These needs will include
current income, potential growth in capital, and willingness to accept
risk.
In implementing their asset allocation targets, some investors attempt to
maintain a stable mix -- such as 50% stocks and 50% bonds -- while others
will actively manage the stock/bond mix in pursuit of higher returns, lower
risk, or other investment objectives. The key difference between investors
who maintain a stable mix and those who actively change allocations is their
willingness to forecast the risks and returns of individual asset classes,
their forecasting abilities, and their comfort in making investment decisions
based upon such forecasts. Historically, investors who actively managed the
mix based upon conjecture have often underperformed both investors with
relatively stable allocations and investors with logical, disciplined methods
for assessing relative value and risk. Institutional investors commonly refer
to active asset allocation approaches which are based upon disciplined
methodologies as tactical asset allocation.
FINANCIAL STATEMENTS
The Fund's financial statements, including the financial highlights for
each of the five fiscal years in the period ended September 30, 1996,
appearing in the Fund's 1996 Annual Report to Shareholders and the report
thereon of Price Waterhouse LLP, independent accountants, also appearing
therein, are incorporated by reference into this Statement of Additional
Information. The Fund's 1996 Annual Report to Shareholders is enclosed with
this Statement of Additional Information.
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