VANGUARD
ASSET ALLOCATION
FUND
Annual Report
September 30, 1999
[GRAPHIC OF SHIP]
[LOGO A member of The Vanguard Group(R)]
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[PHOTO]
John C. Bogle
FELLOW SHAREHOLDERS:
TWO ROADS DIVERGED IN A WOOD, AND I-I TOOK THE ONE LESS TRAVELED BY, AND
THAT HAS MADE ALL THE DIFFERENCE.
I can think of no better words than those of Robert Frost to begin this special
letter to our shareholders, who have placed such extraordinary trust in me and
in Vanguard over the past quarter century.
When the firm was founded 25 years ago, we deliberately took a new road to
managing a mutual fund enterprise. Instead of having the funds controlled by an
outside management company with its own financial interests, the Vanguard
funds-there were only 11 of them then-would be controlled by their own
shareholders and operate solely in their financial interests. The outcome of our
unprecedented decision was by no means certain. We described it then as "The
Vanguard Experiment."
Well, I guess it's fair to say it's an experiment no more. During the past
25 years, the assets we hold in stewardship for investors have grown from $1
billion to more than $500 billion, and I believe that our reputation for
integrity, fair-dealing, and sound investment principles is second to none in
this industry. Our staggering growth-which I never sought-has come in important
part as a result of the simple investment ideas and basic human values that are
the foundation of my personal philosophy. I have every confidence that they will
long endure at Vanguard, for they are the right ideas and right values,
unshakable and eternal.
While Emerson believed that "an institution is the lengthened shadow of one
man," Vanguard today is far greater than any individual. The Vanguard crew has
splendidly implemented and enthusiastically supported our founding ideas and
values, and deserves the credit for a vital role in forging our success over the
years. It is a dedicated crew of fine human beings, working together in an
organization that is well prepared to press on regardless long after I am gone.
Creating and leading this enterprise has been an exhilarating run. Through it
all, I've taken the kudos and the blows alike, enjoying every moment to the
fullest, and even getting a second chance at life with a heart transplant three
years ago. What more could a man ask?
While I shall no longer be serving on the Vanguard Board, I want to assure
you that I will remain vigorous and active in a newly created Vanguard unit,
researching the financial markets, writing, and speaking. I'll continue to focus
whatever intellectual power and ethical strength I possess on my mission to
assure that mutual fund investors everywhere receive a fair shake. In the spirit
of Robert Frost:
BUT I HAVE PROMISES TO KEEP, AND MILES TO GO BEFORE I SLEEP, AND MILES TO
GO BEFORE I SLEEP.
You have given me your loyalty and friendship over these long years, and I
deeply appreciate your thousands of letters of support. For my part, I will
continue to keep an eagle eye on your interests, for you deserve no less. May
God bless you all, always.
/S/
JCB
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CONTENTS
REPORT FROM THE CHAIRMAN ..........1 PERFORMANCE SUMMARY ................9
AFTER-TAX RETURNS REPORT ..........4 FUND PROFILE ......................10
THE MARKETS IN PERSPECTIVE ........5 FINANCIAL STATEMENTS ..............14
REPORT FROM THE ADVISER ...........7 REPORT OF INDEPENDENT ACCOUNTANTS .25
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[PHOTO]
John J. Brennan
REPORT FROM THE CHAIRMAN
Vanguard Asset Allocation Fund provided a strong 14.7% return for the fiscal
year ended September 30, 1999, a period during which stocks provided big gains
but bond prices slumped. The fund's performance was slightly behind that of the
average flexible portfolio but a bit ahead of the return of our composite index
of stocks and bonds.
As you know, the fund's assets may be split among common stocks (as
repre-sented by the Standard & Poor's 500 Index), long-term U.S. Treasury bonds,
and cash equivalents. The table at right presents our fiscal-year total return
(capital change plus reinvested dividends) with those of the average competing
fund and our composite index. We also show returns for indexes representing the
three asset classes in which the fund invests.
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TOTAL RETURNS
FISCAL YEAR ENDED
SEPTEMBER 30, 1999
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Vanguard Asset Allocation Fund 14.7%
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Average Flexible Portfolio* 15.5%
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Asset Allocation Composite Index** 14.4%
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S&P 500 Index 27.8%
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Lehman Brothers Long U.S. Treasury
Bond Index -7.7
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Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 4.6
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*Based on data from Lipper Inc.
**65% S&P 500 Index, 35% Lehman Long Treasury Index.
The fund's total return is based on an increase in net asset value from
$22.90 per share on September 30, 1998, to $24.11 on September 30, 1999, with
the latter figure adjusted for dividends totaling $0.91 per share paid from net
investment income and a distribution of $1.18 per share paid from net capital
gains realized during 1998. We anticipate making a distribution of roughly $0.75
per share from net realized capital gains in December 1999.
FINANCIAL MARKETS IN REVIEW
At first blush, the performance of U.S. stocks during the 12 months ended
September 30 appeared to be the latest chapter in the story of an ongoing bull
market. The Wilshire 5000 Total Market Index, a measure of the entire U.S. stock
market, returned an impressive 27.0% against a backdrop of strong economic
growth and low inflation. But that bountiful return masked significant weakness
during the second half of the period. Nearly all of the Wilshire 5000's gain
came from October 1998 through March 1999, when the index advanced 26.1%. From
April through September, the index returned just 0.7%, and it recorded negative
returns during four of the period's final six months.
When the fiscal year began, stocks were in the early stages of a swift,
impressive recovery from the swoon of late-summer 1998, and bonds were basking
in an environment that featured declining interest rates and nary a hint of
inflation. The U.S. economy was growing and international markets were getting
back on their feet. But around the period's halfway point, investors seemed to
focus on the possibility that the U.S. economy's expansion would engender higher
inflation. The nation's record trade deficits, due in part to the economy's
strength, became worrisome as the U.S. dollar weakened against the Japanese yen.
Interest rates began to rise and were a burden on both stocks and bonds.
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The shift in sentiment was felt among all stock market segments, even in
the large-capitalization stocks that for several years have driven the
performance of the overall market. The S&P 500 Index, which gained 27.3% from
October through March, returned just 0.4% during the next six months. Gains made
by growth stocks outstripped those of value stocks by a wide margin. The growth
component of the S&P 500 Index returned 33.4% during the 12 months, while the
index's value shares-those issues characterized by below-average prices in
relation to such measures as earnings and book value-returned 21.5%.
Bond prices slid during the fiscal year amid inflation fears. The yield of
the 30-year U.S. Treasury bond, which moves in the opposite direction from its
price, rose more than 1 percentage point on balance. The 30-year Treasury's
yield stood at 6.05% on September 30, up 107 basis points (1.07 percentage
points) from its level a year earlier and up 133 basis points from the low of
4.72% reached in October 1998. The Lehman Aggregate Bond Index, a measure of the
entire U.S. bond market, provided a total return for the year of -0.4%. As
usual, long-term Treasuries were hardest hit by rising interest rates, suffering
a price decline of nearly -14% and recording a 12-month total return of -7.7%.
FISCAL 1999 PERFORMANCE OVERVIEW
The Asset Allocation Fund's 14.7% return during fiscal 1999 trailed the 15.5%
gain of the average flexible portfolio and represented a slight edge over the
14.4% theoretical return of a portfolio invested in our "neutral allocation" of
65% stocks and 35% bonds. The fund's gains were front-loaded with a total return
of 15.5% for the first half of fiscal 1999. During the second half, the fund
essentially stayed put amidst choppy markets, recording a slightly negative
return of -0.7%.
As stock prices rose and bond prices fell, our holdings changed in
increments from 80% stocks/20% bonds at the start of the year to 50% stocks/50%
bonds at the end. These shifts were driven by our investment adviser's asset
allocation model, which is designed to take advantage of perceived imbalances in
the relative prices and expected returns of stocks, bonds, and cash investments.
Our adviser, Mellon Capital Management Corporation, made only three changes in
the fund's allocation during the entire year, as detailed in the report starting
on page 7.
LONG-TERM PERFORMANCE OVERVIEW
For more than a decade now, Vanguard Asset Allocation Fund has sought to provide
returns that are competitive with those of the unmanaged S&P 500 Index while
exhibiting less total volatility than the index. This is a lofty goal, but our
investment adviser's disciplined approach has come remarkably close, especially
in light of the astonishing performance of the index and its large-cap stocks
during this decade. Over the ten years ended September 30, a shareholder in the
Asset Allocation Fund would have received 87% of the average annual return of
the S&P 500 Index while enduring only 73% of the volatility, as measured by
standard deviation.
As the chart on page 3 illustrates, the fund's returns over the past ten
years have averaged 14.6% per year, just 2.2 percentage points short of the S&P
500 Index's incredible performance and far above the 11.0% annual advance of our
average competitor.
An initial investment of $10,000 in the Asset Allocation Fund, with
dividends and capital gains reinvested, would have grown during the decade to
$39,055, or about $10,700 more than would have accumulated in the average
flexible portfolio over the same period. This advantage amounts to more than the
original investment. The adviser
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also beat our composite index, a theoretical construct that does not incur the
expenses that mutual funds must bear.
Our margin over our average peer is due in part to our much lower expenses.
The fund's expense ratio (expenses as a percentage of average net assets) is
0.49%, considerably less than the 1.41% charged by our average competitor. This
difference-we call it the "Vanguard advantage"-gives our fund a head start year
after year.
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TOTAL RETURNS
10 YEARS ENDED SEPTEMBER 30, 1999
---------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
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Vanguard Asset Allocation Fund 14.6% $39,055
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Average Flexible Portfolio 11.0% $28,338
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Asset Allocation Composite Index 14.3% $38,181
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S&P 500 Index 16.8% $47,334
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While investors can certainly be thankful for the soaring markets of the
past decade, it would be unwise to consider such performance the norm. It's
important to keep in mind that large-cap stocks have historically returned about
11% annually. Of course, there have been wide year-to-year fluctuations in
returns. The future is unpredictable, but I believe that investors should count
on no more from common stocks than the long-term historical average and should
be prepared for periods-maybe extended periods-of returns that are far lower.
IN SUMMARY
Compared with the outsized returns on large-cap stocks during fiscal 1999, the
Asset Allocation Fund's gain may seem modest. But even though our bond holdings
detracted from returns this year, they have in other periods provided a strong
lift. Just last fiscal year, in fact, when the S&P 500 Index recorded a 9.0%
advance, the Lehman Long Treasury Index soared 22.1%.
It is precisely because stocks and bonds do not move in lockstep that we
believe most investors should hold a balanced portfolio of stocks and bonds,
along with cash investments, in accordance with their own investment goals, time
horizon, and tolerance for risk. Creating such a balanced plan and sticking with
it through both the good times and the inevitable bad times is a time-tested
approach to long-term investment success.
/S/
John J. Brennan
Chairman and Chief Executive Officer October 15, 1999
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A NOTE OF THANKS TO OUR FOUNDER
================================================================================
As you may have read on the inside cover of our report, our founder, John C.
Bogle, is retiring December 31, 1999, as Senior Chairman of our Board after
nearly 25 years of devoted service to Vanguard and our shareholders. Vanguard
investors have Jack to thank for creating a truly mutual mutual fund company
that operates solely in the interest of its fund shareholders. And mutual fund
investors everywhere have benefited from his energetic efforts to improve this
industry. Finally, on a personal note, I am forever grateful to Jack for giving
me the opportunity to join this great company in 1982.
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A REPORT OF YOUR FUND'S AFTER-TAX RETURNS
Beginning with this annual report, Vanguard is pleased to provide a review of
the Asset Allocation Fund's after-tax performance. The figures on this page
demonstrate the considerable impact that federal income taxes can have on a
fund's return-an important consideration for investors who own mutual funds in
taxable accounts. While the pretax return is most often used to tally a fund's
performance, the fund's after-tax return, which accounts for taxes on
distributions of capital gains and income dividends, is a better representation
of the return that many investors actually received. If you own the Asset
Allocation Fund in a tax-deferred account such as an individual retirement
account or a 401(k), this information does not apply to you. Such accounts are
not subject to current taxes.
The table below presents the pretax and after-tax returns for your fund and
an appropriate peer group of mutual funds. Two things to keep in mind:
o The after-tax return calculations use the top federal income tax rates in
effect at the time of each distribution. The tax burden, therefore, would be
somewhat less, and the after-tax return somewhat more, for those in lower tax
brackets.
o The peer funds' returns are provided by Morningstar, Inc. (Elsewhere in
this report, returns for comparable mutual funds are based on data from Lipper
Inc. and may differ somewhat.)
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AVERAGE ANNUAL RETURNS: PRETAX AND AFTER-TAX
PERIODS ENDED SEPTEMBER 30, 1999
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1 YEAR 5 YEARS 10 YEARS
------------------ ----------------- -----------------
PRETAX AFTER-TAX PRETAX AFTER-TAX PRETAX AFTER-TAX
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Asset Allocation Fund 14.7% 11.5% 20.4% 17.4% 14.6% 12.0%
Average Domestic
Hybrid Fund* 11.5 9.1 13.7 10.9 10.8 8.2
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*Based on data from Morningstar, Inc.
As you can see, the Asset Allocation Fund's pretax total return of 14.7%
for the 12 months ended September 30, 1999, was reduced by taxes to 11.5%. In
other words, for investors in the highest tax bracket, the fund's pretax return
was cut by 3.2 percentage points. In comparison, the average comparable fund
earned a pretax return of 11.5% and an after-tax return of 9.1%, a difference of
2.4 percentage points.
Over longer periods, the Asset Allocation Fund's performance, both before
and after taxes, compares favorably with that of its average peer. Over the ten
years ended September 30, 1999, both your fund and its average peer lost 2.6
percentage points to taxes, but the Asset Allocation Fund generated a higher
return-before and after taxes.
We must stress that because many interrelated factors affect how
tax-friendly a fund may be, it's very difficult to predict tax efficiency. A
fund's tax efficiency can be influenced by its turnover rate, the types of
securities it holds, the accounting practices it uses when selling shares, and
the net cash flow it receives.
Finally, it's important to understand that our calculation does not reflect
the tax effect of your own investment activities. Specifically, you may incur
additional capital gains taxes-thereby lowering your after-tax return-if you
decide to sell all or some of your shares.
A NOTE ABOUT OUR CALCULATIONS: Pretax total returns assume that all
distributions received (income dividends, short-term capital gains, and
long-term capital gains) are reinvested in new shares, while our after-tax
returns assume that distributions are reduced by any taxes owed on them before
reinvestment. When calculating the taxes due, we used the highest individual
federal income tax rates at the time of the distributions. Those rates are
currently 39.6% for dividends and short-term capital gains and 20% for long-term
capital gains. State and local income taxes were not considered. The competitive
group returns provided by Morningstar are calculated in a manner consistent with
that used for Vanguard funds.
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THE MARKETS IN PERSPECTIVE
YEAR ENDED SEPTEMBER 30, 1999
The fiscal year ended September 30, 1999, was, in a sense, two distinctly
different periods. During the first half of the year, stock markets rebounded
sharply from the crisis of confidence that had shaken investors during the
summer of 1998. Then, during the second half, fears of a global economic slump
gave way to optimism about improving business activity. Indeed, a new
concern-that economic growth might be getting out of hand-came to the fore,
causing interest rates to rise and bond prices to fall, depressing the total
returns on bonds and cooling off the hot U.S. stock market.
U.S. STOCK MARKETS
A robust U.S. economy and rising expectations for corporate earnings buoyed the
U.S. stock market, especially during the first half of the fiscal year.
Consumers, whose spending accounts for roughly two-thirds of economic activity,
spent like never before, encouraged by rising wealth from a long bull market, a
bright employment picture (unemployment was at a slim 4.2% of the workforce in
September), and rising incomes (after-tax personal income in August was up 5.2%
from a year earlier). Indeed, on average, U.S. households in August spent just
above $1.01 for every $1.00 of after-tax income, dipping into savings or
borrowing to finance some of their purchases.
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AVERAGE ANNUAL RETURNS
PERIODS ENDED SEPTEMBER 30, 1999
-------------------------------------
1 YEAR 3 YEARS 5 YEARS
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STOCKS
S&P 500 Index 27.8% 25.1% 25.0%
Russell 2000 Index 19.1 8.7 12.4
Wilshire 5000 Index 27.0 21.9 22.7
MSCI EAFE Index 31.3 10.7 9.4
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BONDS
Lehman Aggregate Bond Index -0.4% 6.8% 7.8%
Lehman 10 Year Municipal Bond Index -0.5 5.9 6.8
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 4.6 5.0 5.2
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OTHER
Consumer Price Index 2.6% 2.1% 2.4%
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During the first half of the period, the stock market rose 26.1%, as
measured by the Wilshire 5000 Total Market Index. Investor confidence, already
high due to the booming economy, was bolstered by easier monetary policy-the
Federal Reserve's Open Market Committee cut short-term interest rates a total of
0.75 percentage point during autumn 1998. However, stock returns were muted
during the second half of the fiscal year, when the Fed acted to boost
short-term rates to slow the economy and reduce inflationary pressures. Higher
rates tend to hurt stock prices because many investors use current interest
rates to discount the value of a stock's projected earnings and dividends. And
the higher the rate, the more future earnings are discounted, and the less
investors are willing to pay for the stock now. After a second-half gain of just
0.7%, the Wilshire 5000 Index recorded a 27.0% return for the full fiscal year.
A rise in corporate profits helped stock investors overcome their worries about
higher interest rates.
Big stocks outperformed small stocks during the fiscal year, and growth
stocks outpaced value stocks. The S&P 500 Index, which is made up largely of
large-capitalization
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stocks, gained 27.8%, while the small-cap Russell 2000 Index posted a 19.1%
return. Large and small growth stocks-whose high prices in relation to earnings,
book value, and dividends indicate high expectations for future
growth-outdistanced value stocks, posting gains of roughly 33%. Value stocks
within the S&P 500 Index gained 21.5%, while the value stocks in the Russell
2000 recorded a meager 5.8% return.
The market's leaders were large-cap technology stocks, which as a group
posted a gain of 77% during the year. Big gains also were posted by retailers
and other members of the consumer-discretionary sector (up 34%) and by the
producer-durables sector (up 45%), which includes engine, machinery, and
aircraft makers. The weakest sectors were consumer staples (a -1% return), where
food and beverage company stocks were hurt by disappointing earnings, and health
care (up 1%), where stocks suffered from weaker-than-expected earnings and
concerns about government efforts to limit health-care spending.
U.S. BOND MARKETS
The powerful economic growth that helped stocks was seen as a negative for
bonds. Investors and Federal Reserve policymakers alike worried that growth was
so strong it was bound to push up inflation. However, the Consumer Price Index
rose a relatively modest 2.6% during the 12-month period.
The Fed, having lowered interest rates late in 1998 to help fuel the
economy, reversed its stance and tapped on the monetary brakes with
quarter-point rate increases on June 30 and again on August 24. The Fed said it
sought to "diminish the risk of rising inflation."
Yields of long-term U.S. Treasury bonds rose by 1 to 1.5 percentage points
during the fiscal year. The yield of the 30-year Treasury bond increased 1.07
percentage points (107 basis points), from 4.98% on September 30, 1998, to 6.05%
a year later. The yield of the 10-year Treasury, a key benchmark for mortgage
loans, rose 146 basis points, from 4.42% to 5.88%. Three-month Treasury bills
rose on balance by 49 basis points, from 4.36% to 4.85%.
The Lehman Brothers Aggregate Bond Index, a benchmark for the entire
taxable bond market, posted a negative -0.4% return, as interest income of 6.1%
from bonds was more than offset by an average price decline of -6.5%. Returns
were somewhat higher for high-yield (junk) bonds and mortgage-backed securities
such as GNMAs.
INTERNATIONAL STOCK MARKETS
International markets recorded big gains during the 12 months ended September
30. The Morgan Stanley Capital International Europe, Australasia, Far East
(EAFE) Index provided a 31.3% return for U.S. investors. Gains were especially
large in the Pacific region, where the MSCI Pacific Free Index posted a 70.2%
return for the fiscal year. Currency fluctuations, principally the U.S. dollar's
slide versus the Japanese yen, accounted for more than 30 percentage points of
the gain in the Pacific region. Emerging markets, as measured by the Select
Emerging Markets Free Index, gained 47.9% for U.S. investors. Returns from
Europe were 17.4%, as measured by the MSCI Europe Index. European currencies
generally declined versus the U.S. dollar, which for U.S. investors reduced the
26.2% gains made in local currencies.
Stocks benefited from a general brightening of the world economic outlook.
When the fiscal year began, markets were still reacting to economic weakness in
Japan and upheavals elsewhere in Asia, Russia, and Latin America. But business
rebounded in many nations around the world, aided by the efforts of central
banks to spur economic growth with lower interest rates.
6
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REPORT FROM THE ADVISER
Vanguard Asset Allocation Fund had a total return of 14.7% for the 12 months
ended September 30, 1999. The S&P 500 Index rose 27.8% and the Lehman Long
Treasury Index returned -7.7% during the same period.
The stock market's strong performance early in the fiscal year occurred
during a period of high volatility prompted in part by the financial crises in
emerging markets. The Federal Reserve Board, then seeing little risk of an
overheating economy, acted to steady the markets and to reassure lenders by
lowering its target for short-term interest rates in increments. The stock
market reacted favorably-the S&P 500 Index rose 8.1% in October, its highest
monthly return since December 1991-but bond prices began declining and yields
began rising. Stocks rose sharply again in November, while the bond market
posted marginal gains. The Fed lowered its target rate by another quarter-point
to 4.75% on November 17.
During the January-March quarter, uniformly strong economic reports
confirmed that the foreign financial crises had not significantly affected U.S.
growth. Labor markets remained tight; the nation's unemployment rate fell in
March to 4.2%, a 29-year low. Moreover, inflation showed no signs of
accelerating.
However, by the third fiscal quarter which began in April, the Fed became
concerned about the strength of the economy's expansion and reversed monetary
policy, acting to boost interest rates. Economic growth remained robust during
the quarter and, for the first time in this expansion, inflation showed signs of
accelerating. Consumer prices rose 0.7% in April, the biggest monthly gain for
the Consumer Price Index in nine years, suggesting that inflation may finally
have bottomed. With unemployment remaining low and wage gains growing, the Fed
on June 30 increased the target federal funds rate from 4.75% to 5.00%.
Although stocks reached record highs early in the final three months of the
fiscal year, for the quarter as a whole stocks underperformed bonds; the S&P 500
Index declined -6.2% and the Lehman Long Treasury Index returned -0.1%. Economic
growth moderated during the period, and inflation remained subdued. Consumers
continued to be the economy's driving force, and the consumer-spending component
of gross domestic product increased at a 4.8% annual rate during the
July-September period. It was the fourth consecutive quarter during which
spending grew faster than 4%. Manufacturing orders in September hit a four-year
high. Although inflation reports remained low after April's surge, the financial
markets were still worried that tight labor markets would eventually lead to
accelerating inflation. The Fed was concerned, too: On August 24, it tightened
monetary policy a second time by raising the target federal funds rate by 0.25%
to 5.25%.
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INVESTMENT PHILOSOPHY
The adviser believes that, although the financial markets are very efficient,
imbalances can be identified in the relative pricing of stocks, bonds, and money
market instruments. Implicit in this approach is a belief that such imbalances
occur only periodically and do not persist for long periods. The adviser
attempts to identify these windows of opportunity and to structure the portfolio
to take advantage of them.
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Vanguard Asset Allocation Fund began the fiscal year with an allocation of
80% stocks and 20% bonds. Market volatility during the first fiscal quarter
provided two opportunities for our tactical asset allocation (TAA)
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model to signal shifts in the fund's asset mix. The sharp rise in stock prices
through October 22, 1998, reduced the expected return on equities, while bond
yields were rising substantially. These trends narrowed the spread between the
expected returns on stocks and bonds and prompted the model to call for a 10%
shift from stocks to bonds. This step was taken October 23, changing the fund's
allocation to 70% stocks/30% bonds. Stocks kept rising during November, further
reducing their expected returns. Meanwhile, bond yields sharply increased during
early November. The result was a further narrowing in the spread between
expected returns on stocks and bonds and another call by our TAA model to shift
10% of fund assets from stocks to bonds. We implemented this on November 9,
making the fund's asset mix 60% equities/40% bonds.
Our asset mix remained there for six months, despite considerable market
volatility during that time. For example, in January both stock and bond prices
rose, and in February the prices of both fell. The net result in these periods
was little change in the spread between expected returns on the two asset
classes. During March, stock prices rose again, reducing the expected return on
stocks while bond yields and prices were stable. This narrowed the spread
between expected returns for the asset classes, but not by enough to prompt the
TAA model to recommend a new allocation.
However, the sharp rise in stock prices through May 7 lowered the expected
return on equities, while bond yields rose substantially. Consequently, the
spread between the expected returns on stocks and bonds narrowed, and our model
called for a 10% shift from stocks to bonds. We took this step on May 10, making
the fund's asset allocation 50% stocks/50% bonds. Further increases in stock
prices lowered the expected return on stocks, while rising bond yields raised
the expected return on bonds. On balance, this narrowed the spread between
expected returns on stocks and bonds, but not sufficiently to trigger a shift in
the fund's asset mix.
After mid-July, a steady decline in prices raised the expected return on
stocks. Bond yields drifted slightly lower, decreasing the expected return on
bonds. Although these changes reduced the spread between stocks' and bonds'
expected returns, the gap didn't narrow enough to prompt a change in the fund's
50%/50% allocation.
Higher forecasts for corporate earnings boosted our forecasts of the
expected return for stocks, and our long-run expected annual return for stocks
is nearly 10%. However, with long-term U.S. Treasury bond yields above 6%, our
TAA model finds bonds relatively attractive. This is why the fund is
underweighted in stocks and overweighted in bonds compared with our neutral
stance of 65% stocks/35% bonds.
William L. Fouse, CFA
Mellon Capital Management Corporation
October 8, 1999
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PERFORMANCE SUMMARY
ASSET ALLOCATION FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely. An investor's shares, when
redeemed, could be worth more or less than their original cost.
TOTAL INVESTMENT RETURNS: NOVEMBER 3, 1988-SEPTEMBER 30, 1999
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ASSET ALLOCATION FUND COMPOSITE
INDEX*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
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1989 21.1% 2.8% 23.9% 27.8%
1990 -8.6 4.0 -4.6 -5.1
1991 20.9 6.4 27.3 27.5
1992 7.2 5.0 12.2 12.2
1993 10.7 4.7 15.4 15.5
1994 -5.2 3.1 -2.1 -1.5
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ASSET ALLOCATION FUND COMPOSITE
INDEX*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
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1995 23.6% 5.0% 28.6% 27.4%
1996 11.1 4.2 15.3 13.9
1997 24.7 4.7 29.4 30.4
1998 11.5 3.7 15.2 14.2
1999 10.5 4.2 14.7 14.4
- --------------------------------------------------------------------------------
*65% S&P 500 Index, 35% Lehman Long Treasury Index.
See Financial Highlights table on page 22 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: SEPTEMBER 30, 1989-SEPTEMBER 30, 1999
- --------------------------------------------------------------------------------
[GRAPH]
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED SEPTEMBER 30, 1999
---------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Asset Allocation Fund 14.68% 20.45% 14.60% $39,055
Average Flexible Portfolio* 15.51 14.41 10.98 28,338
Asset Allocation Composite Index** 14.37 19.83 14.34 38,181
S&P 500 Index 27.80 25.03 16.82 47,334
- -------------------------------------------------------------------------------------------------
*Based on data from Lipper Inc.
**65% S&P 500 Index, 35% Lehman Long Treasury Index.
</TABLE>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1999
- --------------------------------------------------------------------------------
10 YEARS
INCEPTION ------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Asset Allocation Fund 11/3/1988 14.68% 20.45% 10.12% 4.48% 14.60%
- --------------------------------------------------------------------------------
9
<PAGE>
FUND PROFILE
ASSET ALLOCATION FUND
This Profile provides a snapshot of the fund's characteristics as of September
30, 1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on pages 12 and 13.
TOTAL FUND CHARACTERISTICS
- ----------------------------------------------
Turnover Rate 11%
Expense Ratio 0.49%
Cash Reserves 1.4%
FUND ASSET ALLOCATION*
- ----------------------------------------------
[PIE CHART]
CASH RESERVES.....1%
STOCKS...........49%
BONDS............50%
*Actual allocation may vary slightly from target allocation because of
day-to-day market fluctuations.
TOTAL FUND VOLATILITY MEASURES
- ----------------------------------------------
ASSET ALLOCATION S&P 500
- ----------------------------------------------
R-Squared 0.94 1.00
Beta 0.67 1.00
TEN LARGEST STOCKS
(% OF EQUITIES)
- ----------------------------------------------
Microsoft Corp. 4.4%
General Electric Co. 3.7
Intel Corp. 2.3
Cisco Systems, Inc. 2.1
International Business Machines Corp. 2.1
Wal-Mart Stores, Inc. 2.0
Lucent Technologies, Inc. 1.9
Exxon Corp. 1.7
Merck & Co., Inc. 1.5
Citigroup, Inc. 1.4
- ----------------------------------------------
Top Ten 23.1%
- ----------------------------------------------
Top Ten as % of Total Net Assets 8.1%
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- --------------------------------------------------------------------------------
SEPTEMBER 30, 1998 SEPTEMBER 30, 1999
----------------------------------------------------------
ASSET ALLOCATION ASSET ALLOCATION S&P 500
----------------------------------------------------------
Auto & Transportation ....... 3.0% 2.3% 2.2%
Consumer Discretionary ......10.3 12.2 12.2
Consumer Staples ............ 9.5 7.2 7.2
Financial Services ..........16.3 14.8 14.7
Health Care .................13.4 10.5 10.5
Integrated Oils ............. 7.0 5.6 5.5
Other Energy ................ 1.1 1.5 1.5
Materials & Processing ...... 4.4 3.4 3.4
Producer Durables ........... 3.2 3.5 3.5
Technology ..................14.7 21.6 21.8
Utilities ...................11.7 11.2 11.2
Other ....................... 5.4 6.2 6.3
- --------------------------------------------------------------------------------
10
<PAGE>
EQUITY CHARACTERISTICS
- ----------------------------------------------
ASSET ALLOCATION S&P 500
- ----------------------------------------------
Number of Stocks 505 500
Median Market Cap $65.4B $65.4B
Price/Earnings Ratio 27.1x 27.1x
Price/Book Ratio 4.9x 4.9x
Dividend Yield 1.3% 1.3%
Return on Equity 23.0% 23.0%
Earnings Growth Rate 14.8% 14.8%
Foreign Holdings 1.6% 1.6%
EQUITY INVESTMENT FOCUS
- ----------------------------------------------
[GRID]
STYLE.........BLEND
MARKET CAP....LARGE
FIXED-INCOME CHARACTERISTICS
- ----------------------------------------------
LEHMAN
ASSET ALLOCATION INDEX*
- ----------------------------------------------
Number of Bonds 29 5,392
Average Coupon 8.1% 6.7%
Average Duration 10.5 years 5.0 years
Average Maturity 21.2 years 9.0 years
Average Quality Treasury Aaa
*Lehman Aggregate Bond Index.
FIXED-INCOME INVESTMENT FOCUS
- ----------------------------------------------
[GRID]
AVERAGE MATURITY....LONG
CREDIT QUALITY......TREASURY/AGENCY
11
<PAGE>
AVERAGE COUPON. The average interest rate paid on the securities held by a fund.
It is expressed as a percentage of face value.
AVERAGE DURATION. An estimate of how much a bond fund's share price will
fluctuate in response to a change in interest rates. To see how the price could
shift, multiply the fund's duration by the change in rates. If interest rates
rise by one percentage point, the share price of a fund with an average duration
of five years would decline by about 5%. If rates decrease by a percentage
point, the fund's share price would rise by 5%.
AVERAGE MATURITY. The average length of time until bonds held by a fund reach
maturity (or are called) and are repaid. In general, the longer the average
maturity, the more a fund's share price will fluctuate in response to changes in
market interest rates.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
ratings assigned to a fund's securities holdings by credit-rating agencies. The
agencies make their judgment after appraising an issuer's ability to meet its
obligations. Quality is graded on a scale, with Aaa or AAA indicating the most
creditworthy bond issuers and A-1 or MIG-1 indicating the most creditworthy
issuers of money market securities. U.S. Treasury securities are considered to
have the highest credit quality.
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"-highly liquid, short-term, interest-bearing securities. This figure
does not include cash invested in futures contracts to simulate stock or bond
investment.
DIVIDEND YIELD. The current, annualized rate of dividends paid on a share of
stock, divided by its current share price. For a fund, the weighted average
yield for stocks it holds.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
EQUITY INVESTMENT FOCUS. This grid indicates the focus of a fund's equity
holdings in terms of two attributes: market capitalization (large, medium, or
small) and relative valuation (growth, value, or a blend).
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FIXED-INCOME INVESTMENT FOCUS. This grid indicates the focus of a fund's
fixed-income holdings in terms of two attributes: average maturity (short,
medium, or long) and average credit quality (Treasury/agency, investment-grade
corporate, or below investment-grade).
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
FUND ASSET ALLOCATION. This chart shows the proportion of a fund's holdings
allocated to different types of assets.
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
12
<PAGE>
NUMBER OF BONDS. An indicator of diversification. The more separate issues a
fund holds, the less susceptible it is to a price decline stemming from the
problems of a particular bond issuer.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come from
each of the major industry groups that compose the stock market.
TEN LARGEST STOCKS. The percentage of equity assets that a fund has invested in
its ten largest stocks. As this percentage rises, a fund's returns are likely to
be more volatile because they are more dependent on the fortunes of a few
companies.
TURNOVER RATE. An indication of trading activity during the past year. Funds
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
13
<PAGE>
FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.), with the
fund's S&P 500 Index common stocks listed in descending market value order.
Other assets are added to, and liabilities are subtracted from, the value of
Total Investments to calculate the fund's Net Assets. Finally, Net Assets are
divided by the outstanding shares of the fund to arrive at its share price, or
Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the fund's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the fund had available to distribute to shareholders as income dividends or
capital gains as of the statement date, but may differ because certain
investments or transactions may be treated differently for financial statement
and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess
of distributions over net income or net realized gains, will appear as negative
balances. Unrealized Appreciation (Depreciation) is the difference between the
market value of the fund's investments and their cost, and reflects the gains
(losses) that would be realized if the fund were to sell all of its investments
at their statement-date values.
- --------------------------------------------------------------------------------
MARKET
VALUE*
ASSET ALLOCATION FUND SHARES (000)
- --------------------------------------------------------------------------------
COMMON STOCKS (35.4%)(1)
- --------------------------------------------------------------------------------
o Microsoft Corp. 1,397,400 126,552
General Electric Co. 894,700 106,078
Intel Corp. 910,300 67,647
o Cisco Systems, Inc. 889,500 60,986
International Business
Machines Corp. 495,100 60,093
Wal-Mart Stores, Inc. 1,218,600 57,960
Lucent Technologies, Inc. 832,271 53,994
Exxon Corp. 663,800 50,407
Merck & Co., Inc. 651,800 42,245
Citigroup, Inc. 924,691 40,686
Pfizer, Inc. 1,062,900 38,197
AT&T Corp. 869,521 37,824
American International
Group, Inc. 423,168 36,789
Bristol-Myers Squibb Co. 544,560 36,758
o MCI WorldCom, Inc. 507,611 36,485
Royal Dutch Petroleum Co. ADR 586,800 34,658
Procter & Gamble Co. 362,544 33,989
Johnson & Johnson 368,000 33,810
The Coca-Cola Co. 674,900 32,437
o America Online, Inc. 296,400 30,826
o Dell Computer Corp. 698,300 29,198
Bell Atlantic Corp. 425,230 28,623
Home Depot, Inc. 404,600 27,766
SBC Communications Inc. 534,846 27,311
Bank of America Corp. 477,689 26,600
Hewlett-Packard Co. 277,100 25,493
BellSouth Corp. 516,700 23,252
Tyco International Ltd. 224,685 23,199
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
Philip Morris Cos., Inc. 665,300 22,745
Mobil Corp. 213,400 21,500
Time Warner, Inc. 353,900 21,499
Ameritech Corp. 263,700 20,272
o EMC Corp. 277,500 19,824
o Sun Microsystems, Inc. 211,400 19,660
Eli Lilly & Co. 301,000 19,263
Nortel Networks Corp. 364,120 18,570
o Oracle Corp. 396,500 18,041
Wells Fargo Co. 453,010 17,951
Fannie Mae 283,100 17,747
Schering-Plough Corp. 401,600 17,520
Texas Instruments, Inc. 212,000 17,437
The Chase Manhattan Corp. 230,922 17,406
Ford Motor Co. 331,500 16,637
American Express Co. 123,545 16,632
E.I. du Pont de Nemours & Co. 268,634 16,353
McDonald's Corp. 373,400 16,056
Chevron Corp. 178,500 15,842
Warner-Lambert Co. 232,400 15,425
Abbott Laboratories 414,400 15,229
American Home Products Corp. 359,900 14,936
The Walt Disney Co. 560,200 14,495
Motorola, Inc. 163,600 14,397
Morgan Stanley Dean
Witter & Co. 158,600 14,145
Sprint Corp. 245,400 13,313
PepsiCo, Inc. 405,000 12,251
o Amgen, Inc. 140,500 11,451
General Motors Corp. 180,731 11,375
14
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
o MediaOne Group, Inc. 166,430 11,369
Medtronic, Inc. 320,200 11,367
The Boeing Co. 266,086 11,342
Bank One Corp. 320,535 11,159
Minnesota Mining &
Manufacturing Co. 111,600 10,721
Compaq Computer Corp. 466,848 10,708
Unilever NV ADR 156,342 10,650
Gillette Co. 302,900 10,280
Freddie Mac 190,300 9,896
First Union Corp. 271,832 9,667
Texaco Inc. 148,400 9,368
Schlumberger Ltd. 148,800 9,272
Anheuser-Busch Cos., Inc. 132,214 9,263
AlliedSignal Inc. 153,500 9,200
o CBS Corp. 196,200 9,074
Computer Associates
International, Inc. 147,100 9,010
o Sprint PCS 120,400 8,977
o Viacom Inc. Class B 189,900 8,023
Comcast Corp. Class A Special 200,100 7,979
Enron Corp. 193,200 7,970
Kimberly-Clark Corp. 150,292 7,890
U S WEST, Inc. 137,082 7,822
United Technologies Corp. 131,800 7,817
Atlantic Richfield Co. 87,700 7,772
o QUALCOMM, Inc. 41,000 7,756
o Applied Materials, Inc. 98,800 7,694
Emerson Electric Co. 119,700 7,564
Automatic Data Processing, Inc. 169,400 7,559
Xerox Corp. 179,696 7,536
Charles Schwab Corp. 223,450 7,527
The Gap, Inc. 233,437 7,470
Colgate-Palmolive Co. 160,800 7,357
Carnival Corp. 167,800 7,299
Associates First Capital Corp. 198,012 7,128
Dayton Hudson Corp. 118,618 7,124
o Clear Channel
Communications, Inc. 88,800 7,093
Electronic Data Systems Corp. 133,300 7,057
Firstar Corp. 274,049 7,023
Pharmacia & Upjohn, Inc. 138,990 6,897
Dow Chemical Co. 60,450 6,868
The Bank of New York Co., Inc. 205,000 6,855
Walgreen Co. 269,300 6,833
Merrill Lynch & Co., Inc. 100,500 6,752
Eastman Kodak Co. 89,300 6,737
Alcoa Inc. 102,300 6,349
U.S. Bancorp 204,903 6,186
NEXTEL Communications, Inc. 90,700 6,151
Monsanto Co. 171,800 6,131
Tellabs, Inc. 105,700 6,018
ALLTEL Corp. 83,500 5,876
Sara Lee Corp. 249,000 5,836
SunTrust Banks, Inc. 86,700 5,701
Fleet Financial Group, Inc. 154,054 5,641
o Global Crossing Ltd. 211,715 5,610
Allstate Corp. 224,054 5,587
J.P. Morgan & Co., Inc. 47,742 5,455
Conoco Inc. 198,839 5,443
Household International, Inc. 135,188 5,424
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
Duke Energy Corp. 97,981 5,401
Caterpillar, Inc. 97,900 5,366
Gannett Co., Inc. 77,300 5,348
The Seagram Co. Ltd. 117,000 5,324
International Paper Co. 109,889 5,282
o Solectron Corp. 73,500 5,278
First Data Corp. 119,800 5,256
o Safeway, Inc. 133,000 5,062
Illinois Tool Works, Inc. 67,500 5,033
MBNA Corp. 219,950 5,018
Lowe's Cos., Inc. 101,600 4,953
Marsh & McLennan Cos., Inc. 72,150 4,942
o The Kroger Co. 223,600 4,933
Southern Co. 190,900 4,916
Halliburton Co. 119,000 4,879
Campbell Soup Co. 123,600 4,836
Mellon Bank Corp. 142,600 4,813
Washington Mutual, Inc. 163,041 4,769
National City Corp. 178,582 4,766
Baxter International, Inc. 78,000 4,700
o BMC Software, Inc. 64,400 4,609
Albertson's, Inc. 115,836 4,583
Corning, Inc. 66,800 4,580
Raytheon Co. Class B 92,000 4,566
Pitney Bowes, Inc. 74,400 4,534
o Micron Technology, Inc. 67,900 4,520
NIKE, Inc. Class B 78,600 4,470
Fifth Third Bancorp 73,250 4,457
Guidant Corp. 82,400 4,419
CIGNA Corp. 56,400 4,385
Wachovia Corp. 55,700 4,379
PNC Bank Corp. 82,700 4,357
American General Corp. 68,895 4,353
CVS Corp. 106,500 4,347
Williams Cos., Inc. 116,100 4,346
o Costco Wholesale Corp. 59,156 4,259
H.J. Heinz Co. 98,500 4,236
Kellogg Co. 112,400 4,208
Cardinal Health, Inc. 74,250 4,047
Honeywell, Inc. 34,000 3,785
Columbia/HCA Healthcare Corp. 178,145 3,774
Masco Corp. 121,300 3,760
Bestfoods 77,400 3,754
o Gateway, Inc. 84,200 3,742
o Cendant Corp. 209,734 3,723
Omnicom Group Inc. 46,500 3,682
May Department Stores Co. 98,600 3,593
Burlington Northern Santa
Fe Corp. 129,796 3,569
BankBoston Corp. 80,702 3,500
Lockheed Martin Corp. 106,382 3,477
Textron, Inc. 44,800 3,466
o Best Buy Co., Inc. 55,800 3,463
General Mills, Inc. 42,400 3,440
Phillips Petroleum Co. 70,300 3,427
Sysco Corp. 95,900 3,362
Sears, Roebuck & Co. 106,700 3,348
o Unisys Corp. 73,800 3,330
Tribune Co. 65,800 3,274
General Dynamics Corp. 52,100 3,253
Union Pacific Corp. 66,800 3,211
15
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
ASSET ALLOCATION FUND SHARES (000)
- --------------------------------------------------------------------------------
Waste Management, Inc. 164,110 3,159
KeyCorp 121,300 3,131
o AES Corp. 52,200 3,080
Weyerhaeuser Co. 53,100 3,060
Interpublic Group of Cos., Inc. 74,300 3,056
o FDX Corp. 78,520 3,043
AFLAC, Inc. 72,300 3,028
ConAgra, Inc. 133,400 3,010
Providian Financial Corp. 37,800 2,993
PPG Industries, Inc. 49,400 2,964
o Computer Sciences Corp. 42,100 2,960
Texas Utilities Co. 76,041 2,837
o Lexmark International Group, Inc.
Class A 35,200 2,834
o Kohl's Corp. 42,700 2,824
State Street Corp. 43,600 2,818
o Staples, Inc. 128,400 2,801
Tandy Corp. 54,128 2,798
o 3Com Corp. 96,800 2,783
BB&T Corp. 85,300 2,762
o Apple Computer, Inc. 43,400 2,748
o AMR Corp. 50,000 2,725
Rockwell International Corp. 51,800 2,720
PG&E Corp. 103,800 2,686
Deere & Co. 68,600 2,654
Pioneer Hi-Bred
International, Inc. 66,340 2,641
The Hartford Financial Services
Group Inc. 64,400 2,632
o Compuware Corp. 100,400 2,617
Consolidated Edison Inc. 62,700 2,602
The McGraw-Hill Cos., Inc. 53,400 2,583
o Boston Scientific Corp. 104,300 2,575
Norfolk Southern Corp. 103,800 2,543
Northern Trust Corp. 30,300 2,530
United Healthcare Corp. 51,700 2,517
Public Service Enterprise
Group, Inc. 64,900 2,507
CSX Corp. 58,700 2,487
Dover Corp. 60,700 2,481
Delphi Automotive Systems Corp. 154,018 2,474
USX-Marathon Group 84,500 2,472
Baker Hughes, Inc. 85,160 2,470
TJX Cos., Inc. 87,700 2,461
Coca-Cola Enterprises, Inc. 109,000 2,459
FPL Group, Inc. 48,800 2,458
The Clorox Co. 64,200 2,456
Unocal Corp. 66,039 2,448
o Federated Department Stores, Inc. 55,800 2,438
Dominion Resources, Inc. 53,650 2,421
Ingersoll-Rand Co. 43,850 2,409
Edison International 98,300 2,390
Coastal Corp. 58,200 2,383
Ralston-Ralston Purina Group 84,200 2,342
J.C. Penney Co., Inc. 67,600 2,324
The Chubb Corp. 46,300 2,306
Occidental Petroleum Corp. 99,100 2,292
o General Instrument Corp. 47,200 2,272
Circuit City Stores, Inc. 53,800 2,270
Comerica, Inc. 44,750 2,265
The Quaker Oats Co. 36,500 2,258
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
Paychex, Inc. 66,000 2,252
Marriott International, Inc.
Class A 68,600 2,242
PECO Energy Corp. 59,500 2,231
Reliant Energy, Inc. 81,422 2,203
Barrick Gold Corp. 100,600 2,188
Adobe Systems, Inc. 19,200 2,179
Mattel, Inc. 114,487 2,175
The Limited, Inc. 56,588 2,164
Rohm & Haas Co. 59,739 2,158
Loews Corp. 30,700 2,155
McKesson HBOC, Inc. 74,165 2,151
Wrigley, (Wm.) Jr. Co. 31,100 2,140
Unicom Corp. 57,700 2,131
Newell Rubbermaid, Inc. 74,109 2,117
Franklin Resources Corp. 68,500 2,106
Southwest Airlines Co. 137,700 2,091
Lincoln National Corp. 55,400 2,081
IMS Health, Inc. 90,800 2,071
Capital One Financial Corp. 53,100 2,071
Archer-Daniels-Midland Co. 169,235 2,063
o Seagate Technology Inc. 66,100 2,037
Delta Air Lines, Inc. 41,900 2,032
PE Corp.-PE Biosystems Group 28,000 2,023
Aon Corp. 68,325 2,020
The Goodyear Tire & Rubber Co. 41,800 2,012
Georgia Pacific Group 49,400 2,001
Union Carbide Corp. 35,000 1,988
Aetna Inc. 40,206 1,980
SLM Holding Corp. 46,000 1,978
Hershey Foods Corp. 40,500 1,972
o Novell, Inc. 95,000 1,965
o LSI Logic Corp. 38,100 1,962
New York Times Co. Class A 52,200 1,958
Allergan, Inc. 17,700 1,947
Praxair, Inc. 42,000 1,932
UnumProvident Corp. 65,491 1,928
Entergy Corp. 36,500 1,923
Dollar General Corp. 61,531 1,900
Alcan Aluminium Ltd. 60,750 1,898
Lehman Brothers Holdings, Inc. 32,200 1,878
Becton, Dickinson & Co. 66,100 1,855
Air Products & Chemicals, Inc. 63,400 1,843
Republic New York Corp. 29,500 1,812
Jefferson-Pilot Corp. 28,500 1,801
American Electric Power Co., Inc. 52,100 1,778
Avon Products, Inc. 71,000 1,762
Eaton Corp. 20,400 1,761
Burlington Resources, Inc. 47,785 1,756
Regions Financial Corp. 57,900 1,737
St. Paul Cos., Inc. 63,056 1,734
o Tricon Global Restaurants, Inc. 41,800 1,711
TRW, Inc. 34,100 1,696
Cincinnati Financial Corp. 44,700 1,678
Huntington Bancshares Inc. 63,107 1,676
Avery Dennison Corp. 31,700 1,672
Conseco Inc. 84,345 1,629
SouthTrust Corp. 45,300 1,625
Consolidated Natural Gas Co. 25,900 1,616
Fort James Corp. 60,300 1,609
16
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
FirstEnergy Corp. 63,000 1,607
Dana Corp. 42,959 1,595
PacifiCorp 79,100 1,592
Union Planters Corp. 39,000 1,589
Progressive Corp. of Ohio 19,400 1,585
o ADC Telecommunications, Inc. 36,900 1,547
Summit Bancorp 47,700 1,547
CenturyTel, Inc. 37,750 1,534
Amerada Hess Corp. 25,000 1,531
o Kmart Corp. 130,500 1,525
Johnson Controls, Inc. 22,900 1,519
Golden West Financial Corp. 15,400 1,513
UST, Inc. 50,100 1,512
MGIC Investment Corp. 31,400 1,499
Fortune Brands, Inc. 45,900 1,480
o KLA-Tencor Corp. 22,600 1,469
o Tenet Healthcare Corp. 82,900 1,456
Carolina Power & Light Co. 40,600 1,436
Kansas City Southern Industries,
Inc. 30,500 1,416
PaineWebber Group, Inc. 39,000 1,414
Ameren Corp. 37,200 1,407
DTE Energy Co. 38,900 1,405
o Network Appliance, Inc. 19,600 1,404
Dow Jones & Co., Inc. 25,900 1,382
Parker Hannifin Corp. 30,625 1,372
Dun & Bradstreet Corp. 45,900 1,371
Knight Ridder 24,700 1,355
Sempra Energy 65,020 1,353
W.W. Grainger, Inc. 28,000 1,346
Whirlpool Corp. 20,600 1,345
o Bed Bath & Beyond, Inc. 38,300 1,338
o National Semiconductor Corp. 43,700 1,333
Placer Dome, Inc. 89,200 1,327
Synovus Financial Corp. 70,950 1,326
Apache Corp. 30,600 1,322
Champion International Corp. 25,700 1,320
The Times Mirror Co. Class A 19,700 1,297
Nabisco Group Holdings Corp. 86,000 1,290
Genuine Parts Co. 48,350 1,284
Kerr-McGee Corp. 23,297 1,283
Willamette Industries, Inc. 29,700 1,281
Bear Stearns Co., Inc. 32,750 1,259
MBIA, Inc. 26,600 1,240
Columbia Energy Group 22,200 1,229
Florida Progress Corp. 26,500 1,226
H & R Block, Inc. 28,200 1,225
Nordstrom, Inc. 44,900 1,212
Ecolab, Inc. 35,300 1,205
PP&L Resources Inc. 44,500 1,204
Cooper Industries, Inc. 25,757 1,204
Winn-Dixie Stores, Inc. 40,500 1,202
Reynolds Metals Co. 19,900 1,201
Cinergy Corp. 42,318 1,198
Central & South West Corp. 56,400 1,191
Black & Decker Corp. 26,000 1,188
Sonat, Inc. 29,900 1,187
Brown-Forman Corp. Class B 19,000 1,185
o ALZA Corp. 27,600 1,182
R.R. Donnelley & Sons Co. 40,400 1,167
o Toys R Us, Inc. 77,400 1,161
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
Northrop Grumman Corp. 18,200 1,157
Constellation Energy Group 40,850 1,149
AmSouth Bancorp 48,900 1,146
o Sealed Air Corp. 22,315 1,145
GPU, Inc. 35,000 1,142
o AutoZone Inc. 40,500 1,137
Equifax, Inc. 40,400 1,136
o Adaptec, Inc. 28,300 1,123
Nucor Corp. 23,500 1,119
Hasbro, Inc. 52,150 1,118
PACCAR, Inc. 21,640 1,101
Newmont Mining Corp. 42,046 1,088
SAFECO Corp. 38,500 1,078
Union Pacific Resources
Group, Inc. 67,022 1,077
Scientific-Atlanta, Inc. 21,400 1,061
o Ceridian Corp. 42,600 1,060
Bausch & Lomb, Inc. 16,000 1,055
Tosco Corp. 41,700 1,053
o Wellpoint Health Networks Inc.
Class A 18,400 1,049
VF Corp. 33,528 1,039
o Office Depot, Inc. 102,000 1,039
o PeopleSoft, Inc. 60,600 1,026
Torchmark Corp. 39,600 1,025
International Flavors &
Fragrances, Inc. 29,500 1,018
New Century Energies, Inc. 30,300 1,013
Vulcan Materials Co. 27,500 1,007
Sherwin-Williams Co. 47,500 995
Countrywide Credit Industries, Inc. 30,600 987
Anadarko Petroleum Corp. 32,100 981
Rite Aid Corp. 70,100 968
Case Corp. 19,400 966
The Mead Corp. 27,900 959
Nalco Chemical Co. 18,900 954
Phelps Dodge Corp. 17,300 953
Inco Ltd. 44,298 947
CMS Energy Corp. 27,900 947
o Navistar International Corp. 20,280 943
Wendy's International, Inc. 35,600 939
Temple-Inland Inc. 15,500 938
o Parametric Technology Corp. 69,300 936
Allegheny Teledyne Inc. 53,910 910
Fluor Corp. 22,400 902
Sigma-Aldrich Corp. 27,600 876
Northern States Power Co. 40,600 875
The BFGoodrich Co. 30,100 873
ITT Industries, Inc. 26,900 856
Darden Restaurants Inc. 43,200 845
Eastman Chemical Co. 21,050 842
o Owens-Illinois, Inc. 42,000 832
Crown Cork & Seal Co., Inc. 34,300 832
Biomet, Inc. 31,600 831
SuperValu Inc. 37,700 822
Maytag Corp. 24,600 819
Freeport-McMoRan Copper &
Gold Inc. Class B 52,100 811
Harcourt General, Inc. 19,363 806
o Watson Pharmaceuticals, Inc. 26,100 798
Hercules, Inc. 27,700 793
17
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
ASSET ALLOCATION FUND SHARES (000)
- --------------------------------------------------------------------------------
o Niagara Mohawk Holdings Inc. 50,900 786
Tenneco, Inc. 45,700 777
o King World Productions, Inc. 20,700 776
Deluxe Corp. 22,600 768
o St. Jude Medical, Inc. 24,200 762
o Harrah's Entertainment, Inc. 27,300 758
C.R. Bard, Inc. 15,900 748
Pall Corp. 32,266 748
Thomas & Betts Corp. 14,600 745
Engelhard Corp. 40,150 730
Westvaco Corp. 28,100 720
Service Corp. International 67,800 716
o US Airways Group, Inc. 27,200 714
Sunoco, Inc. 25,567 700
o HEALTHSOUTH Corp. 115,300 699
Ashland, Inc. 20,300 683
Brunswick Corp. 27,100 674
o Advanced Micro Devices, Inc. 38,800 667
o Mirage Resorts, Inc. 47,300 665
Hilton Hotels Corp. 65,500 647
o Consolidated Stores, Inc. 29,300 646
o Cabletron Systems, Inc. 41,200 646
Great Lakes Chemical Corp. 16,800 639
Dillard's Inc. 31,300 636
The Stanley Works 24,800 625
USX-U.S. Steel Group 23,740 611
Harris Corp. 21,900 605
o Allied Waste Industries, Inc. 51,400 601
Mallinckrodt, Inc. 19,900 601
Liz Claiborne, Inc. 19,300 598
Laidlaw, Inc. 85,900 580
Adolph Coors Co. Class B 10,400 563
Meredith Corp. 15,300 556
Snap-On Inc. 17,050 554
o Thermo Electron Corp. 41,000 551
Cummins Engine Co., Inc. 11,000 548
o Silicon Graphics, Inc. 48,546 531
American Greetings Corp. Class A 20,400 525
NICOR, Inc. 14,100 524
o Manor Care, Inc. 30,400 523
Homestake Mining Co. 55,600 511
Cyprus Amax Minerals Co. 26,011 510
Boise Cascade Corp. 13,800 503
Centex Corp. 17,000 503
EG&G, Inc. 12,500 498
Bemis Co., Inc. 14,500 491
o FMC Corp. 10,100 487
Armstrong World Industries Inc. 10,800 485
Tektronix, Inc. 14,450 484
Louisiana-Pacific Corp. 29,100 455
Briggs & Stratton Corp. 7,600 444
Ryder System, Inc. 21,600 440
Worthington Industries, Inc. 25,650 436
Millipore Corp. 11,500 432
Crane Co. 19,137 429
o Andrew Corp. 23,975 417
National Service Industries, Inc. 13,200 416
Cooper Tire & Rubber Co. 22,600 398
o Rowan Cos., Inc. 23,500 382
IKON Office Solutions, Inc. 34,700 371
Ball Corp. 8,300 366
- --------------------------------------------------------------------------------
MARKET
VALUE*
(000)
- --------------------------------------------------------------------------------
Alberto-Culver Co. Class B 15,500 358
Helmerich & Payne, Inc. 13,800 349
Peoples Energy Corp. 9,600 338
Longs Drug Stores, Inc. 11,200 335
Tupperware Corp. 16,400 332
Polaroid Corp. 12,762 332
Potlatch Corp. 8,000 330
Great Atlantic & Pacific Tea
Co., Inc. 10,600 321
o W.R. Grace & Co. 19,900 320
ASARCO, Inc. 11,600 311
Pulte Corp. 14,100 307
McDermott International, Inc. 15,100 306
Shared Medical Systems Corp. 6,500 304
Owens Corning 13,900 301
o Humana, Inc. 43,600 300
The Timken Co. 17,200 277
Autodesk, Inc. 12,500 273
The Pep Boys (Manny, Moe
& Jack) 17,600 262
Eastern Enterprises 5,600 260
o Data General Corp. 12,200 257
ONEOK, Inc. 7,700 233
o Bethlehem Steel Corp. 31,400 232
Jostens Inc. 11,700 224
Kaufman & Broad Home Corp. 9,500 196
Fleetwood Enterprises, Inc. 9,675 195
Milacron Inc. 9,900 176
Springs Industries Inc. Class A 5,100 173
o Reebok International Ltd. 15,300 164
NACCO Industries, Inc. Class A 2,260 158
Russell Corp. 10,900 155
Foster Wheeler Corp. 11,000 133
o Siebel Systems, Inc. 102 7
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,490,013) 2,897,036
- --------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
U.S. GOVERNMENT OBLIGATIONS (49.9%)
- --------------------------------------------------------------------------------
U.S. TREASURY BONDS
5.25%, 11/15/2028 50,000 43,340
5.50%, 8/15/2028 236,900 211,985
6.125%, 11/15/2027 163,410 158,710
6.375%, 8/15/2027 178,270 178,539
6.50%, 11/15/2026 212,160 215,470
6.875%, 8/15/2025 123,415 131,014
7.125%, 2/15/2023 162,435 176,281
7.25%, 5/15/2016 146,525 158,429
7.50%, 11/15/2016 124,270 137,644
7.50%, 11/15/2024 109,240 124,228
7.625%, 11/15/2022 103,420 118,217
7.625%, 2/15/2025 79,585 91,909
(2)8.00%, 11/15/2021 179,420 211,958
8.125%, 8/15/2019 103,820 122,897
(2)8.125%, 5/15/2021 155,115 185,037
8.125%, 8/15/2021 151,830 181,303
8.50%, 2/15/2020 91,634 112,521
8.75%, 5/15/2017 102,830 127,328
8.75%, 5/15/2020 84,400 106,230
18
<PAGE>
- --------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- --------------------------------------------------------------------------------
8.75%, 8/15/2020 126,400 159,208
8.875%, 8/15/2017 127,540 159,787
8.875%, 2/15/2019 190,910 241,177
10.375%, 11/15/2012 88,958 111,485
10.625%, 8/15/2015 92,610 130,656
11.25%, 2/15/2015 45,890 67,284
11.75%, 11/15/2014 72,775 101,895
12.00%, 8/15/2013 206,650 285,127
12.75%, 11/15/2010 7,220 9,588
14.00%, 11/15/2011 17,300 24,893
- --------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT OBLIGATIONS
(COST $4,326,098) 4,084,140
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (16.5%)(1)
- --------------------------------------------------------------------------------
COMMERCIAL PAPER ( 10.1%)
A.I. Credit Corp.
5.26%, 11/18/1999 50,000 49,649
Abbey National North America Corp.
5.35%, 12/15/1999 30,000 29,666
Alcoa Inc.
5.30%, 12/3/1999 28,000 27,740
Associates First Capital Corp.
5.31%, 11/22/1999 50,000 49,616
BP America
5.23%, 11/19/1999 27,500 27,304
5.23%, 11/23/1999 30,000 29,769
Bank of Scotland Treasury
Services PLC
5.35%, 12/8/1999 50,000 49,495
Ciesco LP
5.30%, 11/23/1999 25,000 24,805
Daimler-Chrysler Benz Corp.
5.28%, 12/10/1999 25,000 24,740
E. I. du Pont de Nemours & Co.
5.20%, 10/7/1999 24,000 23,979
5.22%, 10/8/1999 25,000 24,975
Ford Motor Credit Co.
5.28%, 12/16/1999 30,000 29,661
5.28%, 12/22/1999 30,000 29,634
General Electric Capital Corp.
5.29%, 12/13/1999 25,000 24,730
General Electric Co.
5.29%, 12/10/1999 30,000 29,691
General Motors Acceptance Corp.
5.26%, 12/17/1999 50,000 49,428
Halifax PLC
5.33%, 12/8/1999 45,000 44,547
Household Finance Corp.
5.23%, 10/6/1999 50,000 49,964
International Lease Finance Corp.
5.26%, 11/18/1999 40,000 39,719
Procter & Gamble Co.
5.31%, 12/17/1999 50,000 49,431
Toyota Motor Credit Corp.
5.25%, 11/12/1999 45,000 44,724
Transamerica Financial Corp.
5.32%, 11/16/1999 25,000 24,830
Xerox Capital Corp. LLC
5.25%, 11/10/1999 47,500 47,221
-----------
825,318
- --------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENTS (6.4%)
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.25%-5.29%, 10/1/1999-Note G $258,053 258,053
5.30%, 10/1/1999 261,079 261,079
-----------
519,132
-----------
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $1,344,477) 1,344,450
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (101.8%)
(COST $7,160,588) 8,325,626
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-1.8%)
- --------------------------------------------------------------------------------
Other Assets-Note C 137,872
Security Lending Collateral Payable
to Brokers-Note G (258,053)
Other Liabilities (23,324)
-----------
(143,505)
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 339,384,627 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $8,182,121
================================================================================
NET ASSET VALUE PER SHARE $24.11
================================================================================
*See Note A in Notes to Financial Statements.
oNon-Income-Producing Security.
(1) The fund invests a portion of its cash reserves in equity markets through
the use of index futures contracts. After giving effect to futures
investments, the fund's effective common stock and temporary cash
investment positions represent 48.6% and 3.2%, respectively, of net assets.
See Note F in Notes to Financial Statements.
(2) Securities with an aggregate value of $95,086,000 have been segregated as
initial margin for open futures contracts.
ADR-American Depositary Receipt.
- --------------------------------------------------------------------------------
AT SEPTEMBER 30, 1999, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
Paid in Capital $6,670,005 $19.66
Undistributed Net
Investment Income 92,326 .27
Accumulated Net
Realized Gains 306,160 .90
Unrealized Appreciation
(Depreciation)-Note F
Investment Securities 1,165,038 3.43
Futures Contracts (51,408) (.15)
- --------------------------------------------------------------------------------
NET ASSETS $8,182,121 $24.11
- --------------------------------------------------------------------------------
19
<PAGE>
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period. If the
fund invested in futures contracts during the period, the results of these
investments are shown separately.
- --------------------------------------------------------------------------------
ASSET ALLOCATION FUND
YEAR ENDED SEPTEMBER 30, 1999
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends 41,203
Interest 256,579
Security Lending 389
-----------
Total Income 298,171
-----------
EXPENSES
Investment Advisory Fees-Note B
Basic Fee 8,336
Performance Adjustment (1,564)
The Vanguard Group-Note C
Management and Administrative 28,548
Marketing and Distribution 1,322
Custodian Fees 63
Auditing Fees 29
Shareholders' Reports 114
Trustees' Fees and Expenses 11
-----------
Total Expenses 36,859
Expenses Paid Indirectly-Note D (3)
-----------
Net Expenses 36,856
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 261,315
- --------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 88,726
Futures Contract 389,038
- --------------------------------------------------------------------------------
REALIZED NET GAIN 477,764
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 215,219
Futures Contracts (112,221)
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 102,998
- --------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $842,077
================================================================================
20
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
- -------------------------------------------------------------------------------
ASSET ALLOCATION FUND
YEAR ENDED SEPTEMBER 30,
------------------------------
1999 1998
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income 261,315 179,056
Realized Net Gain 477,764 163,880
Change in Unrealized Appreciation
(Depreciation) 102,998 242,715
Net Increase in Net Assets
-----------------------------------
Resulting from Operations 842,077 585,651
-----------------------------------
DISTRIBUTIONS
Net Investment Income (263,532) (141,316)
Realized Capital Gain (308,685) (181,623)
-----------------------------------
Total Distributions (572,217) (322,939)
-----------------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 3,038,828 1,956,353
Issued in Lieu of Cash Distributions 550,958 310,969
Redeemed (1,314,040) (631,912)
-----------------------------------
Net Increase from Capital Share
Transactions 2,275,746 1,635,410
- --------------------------------------------------------------------------------
Total Increase 2,545,606 1,898,122
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 5,636,515 3,738,393
-----------------------------------
End of Year $8,182,121 $5,636,515
================================================================================
1Shares Issued (Redeemed)
Issued 123,320 85,659
Issued in Lieu of Cash Distributions 23,236 14,684
Redeemed (53,361) (27,756)
-----------------------------------
Net Increase in Shares Outstanding 93,195 72,587
================================================================================
21
<PAGE>
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
ASSET ALLOCATION FUND
YEAR ENDED SEPTEMBER 30,
---------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $22.90 $21.53 $18.27 $17.03 $13.78
- ---------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .80 .79 .74 .69 .64
Net Realized and Unrealized Gain (Loss) on Investments 2.50 2.33 4.29 1.82 3.18
---------------------------------------------
Total from Investment Operations 3.30 3.12 5.03 2.51 3.82
---------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.91) (.74) (.72) (.66) (.57)
Distributions from Realized Capital Gains (1.18) (1.01) (1.05) (.61) -
---------------------------------------------
Total Distributions (2.09) (1.75) (1.77) (1.27) (.57)
- ---------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $24.11 $22.90 $21.53 $18.27 $17.03
=========================================================================================================
TOTAL RETURN 14.68% 15.24% 29.42% 15.27% 28.57%
=========================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $8,182 $5,637 $3,738 $2,341 $1,593
Ratio of Total Expenses to Average Net Assets 0.49% 0.49% 0.49% 0.47% 0.49%
Ratio of Net Investment Income to Average Net Assets 3.49% 3.80% 3.96% 4.17% 4.41%
Portfolio Turnover Rate 11% 60% 10% 47% 34%
=========================================================================================================
</TABLE>
22
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Vanguard Asset Allocation Fund is registered under the Investment Company Act of
1940 as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid and
asked prices. Prices are taken from the primary market in which each security
trades. Bonds, and temporary cash investments acquired over 60 days to maturity,
are valued using the latest bid prices or using valuations based on a matrix
system (which considers such factors as security prices, yields, maturities, and
ratings), both as furnished by independent pricing services. Other temporary
cash investments are valued at amortized cost, which approximates market value.
Securities for which market quotations are not readily available are valued by
methods deemed by the Board of Trustees to represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
4. FUTURES: The fund uses S&P 500 Index futures contracts, with the
objectives of maintaining full exposure to the stock market, enhancing returns,
maintaining liquidity, and minimizing transaction costs. The fund may purchase
futures contracts to immediately invest incoming cash in the market, or sell
futures in response to cash outflows, thereby simulating a fully invested
position in the underlying index while maintaining a cash balance for liquidity.
The fund may seek to enhance returns by using futures contracts instead of the
underlying securities when futures are believed to be priced more attractively
than the underlying securities. The primary risks associated with the use of
futures contracts are imperfect correlation between changes in market values of
stocks held by the fund and the prices of futures contracts, and the possibility
of an illiquid market.
Futures contracts are valued at their quoted daily settlement prices. The
aggregate principal amounts of the contracts are not recorded in the financial
statements. Fluctuations in the value of the contracts are recorded in the
Statement of Net Assets as an asset (liability) and in the Statement of
Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized futures gains (losses).
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold. Premiums and discounts on debt
securities purchased are amortized and accreted, respectively, to interest
income over the lives of the respective securities.
23
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
B. Mellon Capital Management Corporation provides investment advisory services
to the fund for a fee calculated at an annual percentage rate of average net
assets. The basic fee is subject to quarterly adjustments based on performance
for the preceding three years relative to a combined index comprising the S&P
500 Index and the Lehman Brothers Long U.S. Treasury Bond Index. For the year
ended September 30, 1999, the advisory fee represented an effective annual basic
rate of 0.11% of the fund's average net assets before a decrease of $1,564,000
(0.02%) based on performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At September 30, 1999, the fund had contributed capital of $1,770,000
to Vanguard (included in Other Assets), representing 0.02% of the fund's net
assets and 1.8% of Vanguard's capitalization. The fund's Trustees and officers
are also Directors and officers of Vanguard.
D. The fund's custodian bank has agreed to reduce its fees when the fund
maintains cash on deposit in the non-interest-bearing custody account. For the
year ended September 30, 1999, custodian fee offset arrangements reduced
expenses by $3,000.
E. During the year ended September 30, 1999, the fund purchased $816,429,000 of
investment securities and sold $487,325,000 of investment securities, other than
U.S. government securities and temporary cash investments. Purchases and sales
of U.S. government securities were $3,545,856,000 and $173,881,000,
respectively.
F. At September 30, 1999, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $1,165,038,000,
consisting of unrealized gains of $1,450,459,000 on securities that had risen in
value since their purchase and $285,421,000 in unrealized losses on securities
that had fallen in value since their purchase.
At September 30, 1999, the aggregate settlement value of open futures
contracts expiring in December 1999 and the related unrealized depreciation
were:
- --------------------------------------------------------------------------------
(000)
-------------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE DEPRECIATION
- --------------------------------------------------------------------------------
S&P 500 Index 3,338 $1,083,348 $(51,408)
- --------------------------------------------------------------------------------
Unrealized depreciation on open futures contracts is required to be treated as
realized loss for federal income tax purposes.
G. The market value of securities on loan to broker/dealers at September 30,
1999, was $465,150,000, for which the fund had received as collateral cash of
$258,053,000 and U.S. Treasury securities with a market value of $215,525,000.
Cash collateral received is invested in repurchase agreements. Security loans
are required to be secured at all times by collateral at least equal to the
market value of securities loaned; however, in the event of default or
bankruptcy by the other party to the agreement, retention of the collateral may
be subject to legal proceedings.
24
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Asset Allocation Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Asset Allocation Fund (the "Fund") at September 30, 1999, the results
of its operations for the year then ended, the changes in its net assets for
each of the two years in the period then ended and the financial highlights for
each of the five years in the period then ended, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at September 30, 1999 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
October 29, 1999
25
<PAGE>
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SPECIAL 1999 TAX INFORMATION (UNAUDITED) FOR
VANGUARD ASSET ALLOCATION FUND
This information for the fiscal year ended September 30, 1999, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $154,343,000 as capital gain dividends (from net
long-term capital gains) to shareholders in December 1998, all of which is
designated as a 20% rate gain distribution.
For corporate shareholders, 8.9% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
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26
<PAGE>
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NOTICE TO SHAREHOLDERS ABOUT Y2K
As is well known by now, the approaching calendar change to 2000 has posed a
challenge to many computer systems worldwide. Computers that are not modified
could interpret "00" as 1900 rather than 2000 and produce errors in
date-dependent calculations, including bond interest payments, stock trade
settlements, retirement benefits, and other financial transactions.
OUR APPROACH
Vanguard has taken this challenge seriously. We have had a Year 2000 Project
under way since 1996 to fulfill our responsibility to safeguard our business
relationships and the security of our investors' accounts.
Our internal systems are Year 2000-compliant. They have been renovated and
thoroughly tested and are ready for the date change. As for the external systems
that connect with ours, we have been working for many months with clients,
business partners, and providers of products and services to assess their
compliance. We have analyzed the external services we require and have developed
contingency plans-including provision for alternative providers where
appropriate.
On New Year's Day, our telephone centers will be staffed and ready for
shareholder calls. However, we expect the volume of inquiries over the New
Year's weekend to be high, and we encourage shareholders to check their accounts
via our website or automated telephone systems, which offer much greater service
capacity and efficiency. This will also help our live representatives to provide
a higher level of service to those with specific transaction or other
service-related needs.
WHAT YOU CAN DO
We assure you we will protect our shareholders' records, so account records will
not be lost. Nevertheless, keeping copies of current records is always
advisable. You should keep at least your third-quarter statement and any
confirmations you receive from us between October 1, 1999, and year-end.
If you are a registered user of Access Vanguard(tm) (www.vanguard.com), you
can retrieve this information through the secure "Your Accounts" section and
print copies for your files. If you are not registered for Access Vanguard and
wish to have this flexibility, you should register as soon as possible so that
you can receive your password and become familiar with this service before the
New Year's weekend. Likewise, you may need personal identification numbers to
use our automated telephone services: Vanguard Tele-Account(r) for individual
investors (1-800-662-6273) and The VOICE(tm) Network for participants in
employer-sponsored retirement plans (1-800-523-1188).
Our Year 2000 Project's primary goal from the start has been to prepare our
systems for business as usual on behalf of our shareholders into 2000 and
beyond. We remain confident we will meet that goal, and we look forward to
serving you in the years to come.
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27
<PAGE>
THE VANGUARD FAMILY OF FUNDS
STOCK FUNDS
- --------------------------------------------------------------------------------
500 Index Fund
Aggressive Growth Fund
Capital Opportunity Fund
Convertible Securities Fund
Emerging Markets Stock Index Fund
Energy Fund
Equity Income Fund
European Stock Index Fund
Explorer Fund
Extended Market Index Fund*
Global Equity Fund
Gold and Precious Metals Fund
Growth and Income Fund
Growth Index Fund*
Health Care Fund
Institutional Index Fund*
International Growth Fund
International Value Fund
Mid-Cap Index Fund*
Morgan Growth Fund
Pacific Stock Index Fund
PRIMECAP Fund
REIT Index Fund
Selected Value Fund
Small-Cap Growth Index Fund*
Small-Cap Index Fund*
Small-Cap Value Index Fund*
Tax-Managed Capital Appreciation Fund*
Tax-Managed Growth and Income Fund*
Tax-Managed International Fund Tax-Managed
Small-Cap Fund*
Total International Stock Index Fund
Total Stock Market Index Fund*
U.S. Growth Fund
Utilities Income Fund
Value Index Fund*
Windsor Fund
Windsor II Fund
BALANCED FUNDS
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Asset Allocation Fund
Balanced Index Fund
Global Asset Allocation Fund
LifeStrategy Conservative Growth Fund
LifeStrategy Growth Fund
LifeStrategy Income Fund
LifeStrategy Moderate Growth Fund
STAR Fund
Tax-Managed Balanced Fund
Wellesley Income Fund
Wellington Fund
BOND FUNDS
- --------------------------------------------------------------------------------
Admiral Intermediate-Term Treasury Fund
Admiral Long-Term Treasury Fund
Admiral Short-Term Treasury Fund
GNMA Fund
High-Yield Corporate Fund
High-Yield Tax-Exempt Fund
Insured Long-Term Tax-Exempt Fund
Intermediate-Term Bond Index Fund
Intermediate-Term Corporate Fund
Intermediate-Term Tax-Exempt Fund
Intermediate-Term Treasury Fund
Limited-Term Tax-Exempt Fund
Long-Term Bond Index Fund
Long-Term Corporate Fund
Long-Term Tax-Exempt Fund
Long-Term Treasury Fund
Preferred Stock Fund
Short-Term Bond Index Fund
Short-Term Corporate Fund*
Short-Term Federal Fund
Short-Term Tax-Exempt Fund
Short-Term Treasury Fund
State Tax-Exempt Bond Funds (California, Florida, Massachusetts,
New Jersey, New York, Ohio, Pennsylvania)
Total Bond Market Index Fund*
MONEY MARKET FUNDS
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Admiral Treasury Money Market Fund
Federal Money Market Fund
Prime Money Market Fund*
State Tax-Exempt Money Market Funds
(California, New Jersey, New York, Ohio, Pennsylvania)
Tax-Exempt Money Market Fund
Treasury Money Market Fund
VARIABLE ANNUITY PLAN
- --------------------------------------------------------------------------------
Balanced Portfolio
Diversified Value Portfolio
Equity Income Portfolio
Equity Index Portfolio
Growth Portfolio
High-Grade Bond Portfolio
High Yield Bond Portfolio
International Portfolio
Mid-Cap Index Portfolio
Money Market Portfolio
REIT Index Portfolio
Short-Term Corporate Portfolio
Small Company Growth Portfolio
*Offers Institutional Shares.
For information about Vanguard funds, including charges and expenses, obtain a
prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482-2600.
Read it carefully before you invest or send money.
<PAGE>
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THE PEOPLE WHO GOVERN YOUR FUND
The Trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund Trustees also serve on the Board of Directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
Seven of Vanguard's nine board members are independent, meaning that they
have no affiliation with Vanguard or the funds they oversee, apart from the
sizable personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers for
the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new Trustees/Directors; and electing
Vanguard officers.
The list below provides a brief description of each Trustee's professional
affiliations. Noted in parentheses is the year in which the Trustee joined the
Vanguard Board.
TRUSTEES
JOHN C. BOGLE * (1967) Founder, Senior Chairman of the Board, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOHN J. BRENNAN * (1987) Chairman of the Board, Chief Executive Officer, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN * (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
Johnson*Merck Consumer Pharmaceuticals Co., The Medical Center at Princeton,
and Women's Research and Education Institute.
BRUCE K. MACLAURY * (1990) President Emeritus of The Brookings Institution;
Director of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL * (1977) Chemical Bank Chairman's Professor of Economics,
Princeton University; Director of Prudential Insurance Co. of America, Banco
Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR
Trust.
ALFRED M. RANKIN, JR. * (1993) Chairman, President, and Chief Executive Officer
of NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co., and
The Standard Products Co.
JOHN C. SAWHILL * (1991) President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Co.,
Procter & Gamble Co., NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR. * (1971) Retired Chairman of Nabisco Brands, Inc.; retired
Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc., and
Kmart Corp.
J. LAWRENCE WILSON * (1985) Director of Cummins Engine Co. and The Mead Corp.;
Trustee of Vanderbilt University.
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OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY * Secretary; Managing Director and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in The
Vanguard Group.
THOMAS J. HIGGINS * Treasurer; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON * Legal Department.
ROBERT A. DISTEFANO * Information Technology.
JAMES H. GATELY * Individual Investor Group.
KATHLEEN C. GUBANICH * Human Resources.
IAN A. MACKINNON * Fixed Income Group.
F. WILLIAM MCNABB, III * Institutional Investor Group.
MICHAEL S. MILLER * Planning and Development.
RALPH K. PACKARD * Chief Financial Officer.
GEORGE U. SAUTER * Core Management Group.
<PAGE>
ABOUT OUR COVER
Our cover art, depicting HMS Vanguard at sea, is a
reproduction of Leading the Way, a 1984 work created
and copyrighted by noted naval artist Tom Freeman,
of Forest Hill, Maryland.
[SHIP LOGO]
[LOGO - THE VANGUARD GROUP (R)]
Post Office Box 2600
Valley Forge, Pennsylvania 19482-2600
All comparative mutual fund data are from Lipper Inc. or Morningstar,
Inc., unless otherwise noted.
"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500,"
and "500" are trademarks of The McGraw-Hill Companies, Inc.
Frank Russell Company is the owner of trademarks and copyrights
relating to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000"
are trademarks of Wilshire Associates.
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
This report is intended for the fund's
shareholders. It may not be distributed
to prospective investors unless it
is preceded or accompanied by the
current fund prospectus.
Q780-11/11/1999
(c) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
