<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-1A
REGISTRATION STATEMENT (NO. 33-23444) UNDER
THE SECURITIES ACT OF 1933
Pre-Effective Amendment No. [X]
Post-Effective Amendment No. 15 [X]
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
Amendment No. 18 [X]
VANGUARD ASSET ALLOCATION FUND
(Exact Name of Registrant as Specified in Declaration of Trust)
P.O. Box 2600, Valley Forge, PA 19482
(Address of Principal Executive Office)
Registrant's Telephone Number (610) 669-1000
R. Gregory Barton, Esquire
P.O. Box 876
Valley Forge, PA 19482
It is proposed that this filing become effective
on January 29, 1999 pursuant to paragraph (b) of Rule 485.
Approximate Date of Proposed Public Offering:
As soon as practicable after this Registration Statement becomes effective.
We have elected to register an indefinite number of shares pursuant to
Regulation 24f-2 under the Investment Company Act of 1940. We filed our Rule
24f-2 for the year ended September 30, 1998 on December 24, 1998.
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<PAGE>
VANGUARD ASSET ALLOCATION FUND
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
Form N-1A
Item Number Location in Prospectus
<S> <C> <C>
Item 1. Front and Back Cover Pages .......................... Front and Back Cover Pages
Item 2. Risk/Return Summary; Investments, Risks,
and Performance ..................................... Fund Profile
Item 3. Risk/Return Summary; Fee Table ...................... Fee Table
Item 4. Investment Objectives, Principal Investment
Strategies, and Related Risks ....................... A Word About Risk; Who Should Invest;
Primary Investment Strategies
Item 5. Management's Discussion of Fund
Performance ......................................... Herein incorporated by reference to
Registrant's Annual Report to Shareholders
dated September 30, 1998 filed with the
Securities & Exchange Commission's
EDGAR system on November 19, 1998
Item 6. Management, Organization and
Capital Structure ................................... The Fund and Vanguard; Investment Adviser
Item 7. Shareholder Information ............................. Share Price; Dividends, Capital Gains, and
Taxes; Investing with Vanguard
Item 8. Distribution Arrangements ........................... Not Applicable
Item 9. Financial Highlights Information .................... Financial Highlights
Form N-1A Location in Statement
Item Number of Additional Information
Item 10. Cover Page and Table of Contents .................... Cover Page; Table of Contents
Item 11. Fund History ........................................ Description of the Trust
Item 12. Description of the Fund and its Investments
and Risks ........................................... Description of the Trust; Investment
Policies; Fundamental Investment Limitations
Item 13. Management of the Fund .............................. Management of the Trust
Item 14. Control Persons and Principal Holders of
Securities .......................................... Management of the Trust
Item 15. Investment Advisory and Other Services .............. Investment Advisory Services
Item 16. Brokerage Allocation and Other Practices ............ Portfolio Transactions
Item 17. Capital Stock and Other Securities .................. Description of the Trust
Item 18. Purchase, Redemption and Pricing of Shares .......... Purchase of Shares; Redemption of Shares;
Share Price
Item 19. Taxation of the Fund ................................ Description of the Trust
Item 20. Underwriters ........................................ Not Applicable
Item 21. Calculation of Performance Data ..................... Yield and Total Return
Item 22. Financial Statements ................................ Financial Statements
</TABLE>
<PAGE>
Vanguard Asset Allocation Fund
Prospectus
January 29, 1999
An Asset Allocation Mutual Fund
Contents
1 Fund Profile
2 Additional Information
3 A Word About Risk
3 Who Should Invest
3 Primary Investment Strategies
7 The Fund and Vanguard
7 Investment Adviser
8 Year 2000 Challenge
8 Dividends, Capital Gains, and Taxes
9 Share Price
10 Financial Highlights
11 Investing with Vanguard
11 Services and Account Features
12 Types of Accounts
12 Buying Shares
14 Redeeming Shares
17 Transferring Registration
17 Fund and Account Updates
Glossary (inside back cover)
- --------------------------------------------------------------------------------
Why Reading This Prospectus Is Important
This prospectus explains the objective, risks, and strategies of Vanguard
Asset Allocation Fund. To highlight terms and concepts important to mutual
fund investors, we have provided "Plain Talk(R)" explanations along the way.
Reading the prospectus will help you to decide whether the Fund is the right
investment for you. We suggest that you keep it for future reference.
- --------------------------------------------------------------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
<PAGE>
1
Fund Profile
The following profile summarizes key features of Vanguard Asset Allocation Fund.
INVESTMENT OBJECTIVE
The Fund seeks to provide maximum long-term total return (capital change plus
income) while incurring less stock market risk than a fund made up entirely of
stocks.
INVESTMENT STRATEGIES
The Fund invests in common stocks, bonds, and money market instruments in
proportions consistent with their expected returns and risks as evaluated by the
Fund's adviser. These proportions are changed from time to time as market
expectations shift. The Fund is permitted to be 100% invested in any one of the
three asset classes.
PRIMARY RISKS
The Fund's total return, like stock and bond prices generally, will fluctuate
within a wide range, so an investor could lose money over short or even long
periods. The Fund is also subject to:
o Interest rate risk, which is the chance that bond prices overall will decline
over short or even long periods due to rising interest rates.
o Manager risk, which is the chance that poor security selection will cause the
Fund to underperform other funds with similar investment objectives.
PERFORMANCE/RISK INFORMATION
The bar chart and table below provide an indication of the risk of investing in
the Fund. The bar chart shows the Fund's performance in each calendar year over
a ten-year period. The table shows how the Fund's average annual returns for
one, five, and ten calendar years compare with those of a broad based market
index and a composite index. Keep in mind that the Fund's past performance does
not indicate how it will perform in the future.
<TABLE>
<CAPTION>
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Annual Total Returns
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<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
23.68% 0.89% 25.59% 7.51% 13.49% -2.32% 35.46% 15.73% 27.32% 25.40%
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------
</TABLE>
During the period shown in the bar chart, the highest return for a calendar
quarter was 14.31% (quarter ending December 1998) and the lowest return for a
quarter was -8.31% (quarter ending September 1990).
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Average Annual Total Returns for Years Ended December 31, 1998
- --------------------------------------------------------------------------------
1 Year 5 Years 10 Years
- --------------------------------------------------------------------------------
Vanguard Asset Allocation Fund 25.40% 19.58% 16.67%
Composite Index* 24.01 18.98 16.65
S&P 500 Index 28.58 24.06 19.21
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*Weighted 65% in the S&P 500 Index, 35% in the Lehman Brothers Long U.S.
Treasury Bond Index.
- --------------------------------------------------------------------------------
<PAGE>
2
PLAIN TALK ABOUT
The Costs of Investing
Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with the fund's buying and selling of securities. These costs
can erode a substantial portion of the gross income or capital appreciation a
fund achieves. Even seemingly small differences in expenses can, over time, have
a dramatic effect on a fund's performance.
PLAIN TALK ABOUT
Fund Expenses
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. Vanguard Asset Allocation Fund's expense ratio in fiscal year 1998 was
0.49%, or $4.90 per $1,000 of average net assets. The average flexible mutual
fund currently has expenses of 1.44%, or $14.40 per $1,000 of average net
assets, according to Lipper, Inc., which reports on the mutual fund industry.
FEES AND EXPENSES
The following table describes the fees and expenses you would pay if
you buy and hold shares of the Fund. The expenses shown under Annual Fund
Operating Expenses are based upon those incurred in the fiscal year ended
September 30, 1998.
Shareholder Fees (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
Annual Fund Operating Expenses (expenses deducted from the
Fund's assets)
Management Expenses: 0.46%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
Total Annual Operating Expenses: 0.49%
The following example is intended to help you compare the cost of investing
in the Fund with the cost of investing in other mutual funds. It illustrates the
hypothetical expenses that you would incur over various periods if you invest
$10,000 in the Fund. This example assumes that the Fund provides a return of 5%
a year, and that operating expenses remain the same. The results apply whether
or not you redeem your investment at the end of each period.
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
$50 $157 $274 $616
- --------------------------------------------------------------------------------
This example should not be considered to represent actual performance from
the past or for the future. Actual future expenses may be higher or lower than
those shown.
Additional Information
Dividends and Capital Gains
Dividends are paid in June and December; capital gains, if any, are paid in
December
Investment Adviser
Mellon Capital Management Corporation, San Francisco, Calif., since inception
Inception Date
November 3, 1988
Net Assets as of September 30, 1998
$5.64 billion
Suitable for IRAs
Yes
Minimum Initial Investment
$3,000; $1,000 for IRAs and custodial accounts for minors
Newspaper Abbreviation
AssetA
Vanguard Fund Number
078
Cusip Number
922020102
Ticker Symbol
VAAPX
<PAGE>
3
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A Word About Risk
This prospectus describes the risks you would face as an investor in Vanguard
Asset Allocation Fund. It is important to keep in mind one of the main axioms of
investing: The higher the risk of losing money, the higher the potential reward.
The reverse, also, is generally true: The lower the risk, the lower the
potential reward. As you consider an investment in Vanguard Asset Allocation
Fund, you should also take into account your personal tolerance for the daily
fluctuations of the securities markets.
Look for this [FLAG GRAPHIC] symbol throughout the prospectus. It is used to
mark detailed information about each type of risk that you would confront as a
shareholder of the Fund.
================================================================================
Who Should Invest
The Fund may be a suitable investment for you if:
o You wish to invest in a fund that actively manages a mix of U.S. common
stocks, bonds, and money market instruments.
o You are seeking growth of capital over the long term--at least five years.
o You are not looking for current income.
The Vanguard funds do not permit market-timing. Do not invest in this Fund if
you are a market-timer.
The Fund has adopted the following policies, among others, to discourage
short-term trading:
o The Fund reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it regards as disruptive to the
efficient management of the Fund. This could be because of the timing of the
investment or because of a history of excessive trading by the investor.
o There is a limit on the number of times you can exchange into and out of the
Fund (see "Redeeming Shares" in the Investing with Vanguard section).
o The Fund reserves the right to stop offering shares at any time.
Primary Investment Strategies
This section explains the strategies that the investment adviser uses in pursuit
of the Fund's objective, long-term growth of capital and income. It also
explains how the adviser implements these strategies. In addition, this section
discusses several important risks--market risk, interest rate risk, and manager
risk--faced by investors in the Fund. The Fund's Board of Trustees oversees the
management of the Fund and may change the investment strategies in the interest
of shareholders.
Market Exposure
The adviser, Mellon Capital Management Corporation, allocates the Fund's assets
among stocks, bonds, and money market instruments in proportions that depend on
projected returns and risks for each asset class.
PLAIN TALK ABOUT
Costs and Market-Timing
Some investors try to profit from market-timing -- switching money into
investments when they expect prices to rise, and taking money out when they
expect the market to fall. As money is shifted in and out, a fund incurs
expenses for buying and selling securities. These costs are borne by all fund
shareholders, including the long-term investors who do not generate the costs.
Therefore, the Fund discourages short-term trading by, among other things,
limiting the number of exchanges it permits.
<PAGE>
4
Stocks
A portion of the Fund's assets is typically invested in common stocks.
[FLAG GRAPHIC]
The Fund is subject to stock market risk, which is the possibility that
stock prices overall will decline over short or even long periods. Stock
markets tend to move in cycles, with periods of rising prices and periods
of falling prices.
The Fund will typically hold a diversified combination of common stocks
intended to parallel the performance of the S&P 500 Index, which is dominated by
large-capitalization stocks. The stocks are evaluated using a "dividend
discount" model. This model provides an estimate of the total return of the S&P
500 Index, based upon the expected earnings of each of the companies in the
index.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns for the U.S. stock market over various
periods as measured by the Standard & Poor's 500 Composite Stock Price Index, a
widely used barometer of market activity. (Total returns consist of dividend
income plus change in market price.) Note that the returns shown do not include
the costs of buying and selling stocks or other expenses that a real-world
investment portfolio would incur. Note, also, that the gap between best and
worst tends to narrow over the long term.
- --------------------------------------------------------------------------------
U.S. Stock Market Returns (1926-1997)
- --------------------------------------------------------------------------------
1 Year 5 Years 10 Years 20 Years
- --------------------------------------------------------------------------------
Best 53.9% 23.9% 20.1% 16.9%
Worst -43.3 -12.5 -0.9 3.1
Average 13.0 10.5 10.9 10.9
- --------------------------------------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1997. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.5%, returns for individual 5-year periods
ranged from a -12.5% average (from 1928 through 1932) to 23.9% (from 1950
through 1954). These average returns reflect past performance on common stocks;
you should not regard them as an indication of future returns from either the
stock market as a whole or this Fund in particular.
Finally, because Vanguard Asset Allocation Fund invests in a mix of stocks,
bonds, and money market instruments, the Fund's performance will not mirror the
returns of any particular index.
Bonds
A portion of the Fund's assets is typically invested in bonds.
[FLAG GRAPHIC]
The Fund is subject to interest rate risk, which is the possibility that
bond prices overall will decline over short or even long periods due to
rising interest rates.
Although bonds are often thought to be less risky than stocks, there have
been periods when bond prices have fallen significantly due to rising interest
rates. For instance, prices of long-term bonds fell by almost 48% between
December 1976 and September 1981.
PLAIN TALK ABOUT
Bonds and Interest Rates
As a rule, when interest rates rise, bond prices fall. The opposite is also
true: Bond prices go up when interest rates fall. Why do bond prices and
interest rates move in opposite directions? Let's assume that you hold a bond
offering a 5% yield. A year later, interest rates are on the rise and bonds are
offered with a 6% yield. With higher-yielding bonds available, you would have
trouble selling your 5% bond for the price you paid--causing you to lower your
asking price. On the other hand, if interest rates were falling and 4% bonds
were being offered, you would be able to sell your 5% bond for more than you
paid.
<PAGE>
5
To illustrate the relationship between bond prices and interest rates, the
following table shows the effect of a 2% change (both up and down) in interest
rates on three $1,000 bonds, each with a different maturity.
- --------------------------------------------------------------------------------
How Interest Rate Changes Affect Bond Prices*
- --------------------------------------------------------------------------------
Value of a $1,000 Bond Value of a $1,000 Bond
Type of Bond After a 2% Increase After a 2% Decrease
(Maturity) in Interest Rates in Interest Rates
- --------------------------------------------------------------------------------
Short-Term (2.5 years) $956 $1,046
Intermediate-Term (10 years) 870 1,156
Long-Term (20 years) 816 1,251
- --------------------------------------------------------------------------------
*Assuming a 7% yield.
- --------------------------------------------------------------------------------
The Fund will typically invest its allocation to bonds in a pool of long-term
U.S. Treasury bonds, which mature in 10 to 30 years. It may also hold other
"full faith and credit" obligations of the U.S. government.
The U.S. government guarantees the timely payment of interest and principal
for its Treasury bonds, but does not guarantee its bonds' prices. In other
words, while Treasury bonds enjoy the highest credit ratings, their prices--like
the prices of other bonds in the Fund--will fluctuate with changes in interest
rates.
The adviser evaluates bonds' attractiveness based upon their current
yield-to-maturity, which is an estimate of total return that considers a bond's
purchase price, redemption value, time to maturity, yield, and time between
interest payments.
Security Selection
Mellon Capital Management Corporation ("Mellon Capital"), adviser to the Fund,
makes no effort to choose among individual stocks or bonds to identify
attractive securities. Rather, the adviser tries to determine the mix of stocks,
bonds, and money market instruments that offers the best combination of
potential return and risk. The aim is to maximize the long-term total return of
the Fund while incurring less stock market risk than a portfolio made up
entirely of stocks. At any given time, Mellon Capital may allocate all, a
portion, or none of the Fund's assets to large-capitalization U.S. stocks,
long-term U.S. Treasury bonds, or cash reserves.
For the Fund's common stock allocation, the adviser uses a diversified
portfolio of stocks selected to parallel the performance of the S&P 500 Index or
S&P 500 stock index futures. For the Fund's bond allocation, the adviser uses
long-term (10- to 30-year maturities) U.S. Treasury bonds. For the Fund's cash
reserves allocation, the adviser can use a variety of money market instruments,
including U.S. Treasury bills, government agency securities, high-quality
commercial paper, and certificates of deposit.
Mellon Capital uses a computer model to estimate return and risk and to
recommend shifts in allocations. The adviser implements these shifts in a
disciplined manner. The adviser believes that, within the fluctuations of the
financial markets, there are occasional brief periods in which the market values
of the asset classes do not reflect their true value. The Fund attempts to
capitalize on these perceived imbalances by changing the mix of the Fund's
holdings in the three asset classes. There are no limitations on the amount of
the Fund's assets that may be allocated to stocks, bonds, or money market
instruments; it can be 100% invested in any of the three asset classes.
The Fund is generally managed without regard to tax ramifications.
PLAIN TALK ABOUT
Types of Bonds
Bonds are issued (sold) by many sources: corporations issue corporate bonds; the
federal government issues U.S. Treasury bonds; agencies of the federal
government issue agency bonds; and mortgage holders issue "mortgage-backed"
bonds, such as those of the Government National Mortgage Association (GNMA).
Each issuer is responsible for paying back the bond's initial value as well as
periodic interest payments.
PLAIN TALK ABOUT
Bond Maturities
A bond is issued with a specific maturity date--the date when the bond issuer,
or seller, must pay back the bond's initial value (known as its "face value").
Bond maturities generally range from less than one year (short-term) to 30 years
(long-term). The longer a bond's maturity, the more risk you, as a bond
investor, face as interest rates rise--but also the more interest you could
receive. Long-term bonds are more suitable for investors willing to take greater
risks in hope of higher yields; short-term bond investors should be willing to
accept lower yields in return for less fluctuation in the value of their
investment.
<PAGE>
6
PLAIN TALK ABOUT
Turnover Rate
Before investing in a mutual fund, you should review its turnover rate. This
gives an indication of how transaction costs could affect the fund's future
returns. In general, the greater the volume of buying and selling by the fund,
the greater the impact that brokerage commissions and other transaction costs
will have on its return. Also, funds with high turnover rates may be more likely
to generate capital gains that must be distributed to shareholders as income
subject to taxes. The average turnover rate for all asset allocation funds is
approximately 98%, according to Morningstar, Inc.
PLAIN TALK ABOUT
Derivatives
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new types of derivatives. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
[FLAG] The Fund is subject to manager risk, which is the possibility that
GRAPHIC] the adviser may do a poor job allocating the Fund's net assets among
stocks, bonds, and money market instruments.
Since the Fund's asset allocation changes according to the adviser's timely
projection of risk and return, the Fund may exhibit higher volatility than
balanced funds with static allocations.
Historical evidence indicates that correctly timing portfolio allocations
among asset classes has been a difficult strategy to implement successfully on a
consistent basis. Although Mellon Capital has substantial experience in asset
allocation, there can be no assurance that the adviser will consistently
anticipate which asset class will perform best in the future.
The Fund's investment results could suffer, for example, if only a small
portion of the Fund's assets were allocated to stocks during a significant stock
market advance, as if a major portion of its assets were allocated to stocks
during a market decline. Similarly, the Fund's short-term investment results
could also suffer if the Fund were substantially invested in bonds at a time
when interest rates increased.
Turnover Rate
Although the Fund generally seeks to invest for the long term, it retains the
right to sell securities regardless of how long the securities have been held.
The Fund's average turnover rate for the past five years has been about 40%. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its net assets within a one-year period.)
Other Investment Policies and Risks
Besides investing in common stocks, bonds, and money market instruments, the
Fund may make certain other kinds of investments to achieve its objective.
The Fund may invest, to a limited extent, in foreign securities.
The Fund may also invest in stock and bond futures and options contracts,
which are traditional types of derivatives. Under normal circumstances, the
market value of these contracts and options may represent up to 50% of the
Fund's assets. (Under unusual circumstances, the Fund may hold futures equal in
value to 100% of its net assets.)
Losses (or gains) involving futures can sometimes be substantial--in part
because a relatively small price movement in a futures contract may result in an
immediate and substantial loss (or gain) for a fund. This Fund will not use
futures for speculative purposes and, therefore, does not intend to leverage its
net assets. The Fund will keep separate cash reserves or short-term,
cash-equivalent securities in the amount of the obligation underlying the
futures contract.
The reasons for which the Fund will invest in futures and options are:
[ ] To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in stocks or bonds.
<PAGE>
7
[ ] To reduce the Fund's transaction costs or add value when these instruments
are favorably priced.
[ ] To use as an investment tool when reallocating assets among stocks, bonds,
and money market instruments. For example, the adviser may wish to
reallocate 10% of the Fund's assets from stocks to bonds. To implement this
change rapidly and with low transaction costs, the adviser may sell stock
index futures and purchase bond index futures.
The Fund may also invest without limit in cash reserves, including
obligations of the U.S. government and its agencies, commercial paper, bank
certificates of deposit, banker's acceptances, and repurchase agreements
collateralized by these securities.
The Fund and Vanguard
The Fund is a member of The Vanguard Group, a family of more than 35 investment
companies with more than 100 distinct investment portfolios holding assets worth
more than $420 billion. All of the Vanguard funds share in the expenses
associated with business operations, such as personnel, office space, equipment,
and advertising.
Vanguard also provides marketing services to the funds. Although shareholders
do not pay sales commissions or 12b-1 distribution fees, each fund pays its
allocated share of The Vanguard Group's marketing costs.
Investment Adviser
The Fund employs Mellon Capital Management Corporation, 595 Market St., Suite
3000, San Francisco, CA 94105, as its investment adviser. Mellon Capital is a
wholly owned subsidiary of MBC Investment Corporation, which itself is a wholly
owned subsidiary of Mellon Bank Corporation. Mellon Capital manages the Fund
subject to the control of the Trustees and officers of the Fund.
Mellon Capital's advisory fee is paid at the end of each fiscal quarter. This
fee is based on certain annual percentage rates applied to the Fund's average
month-end assets for each quarter. In addition, Mellon Capital's advisory fee is
increased or decreased, based on the cumulative investment performance of the
Fund over a trailing 36 month period as compared with the cumulative total
return of the Asset Allocation Composite Index (65% S&P 500 Index; 35% Lehman
Brothers Long U.S. Treasury Bond Index) over the same period.
For the year ended September 30, 1998, the investment advisory fee paid to
Mellon Capital was $5.47 million, which represented an effective annual rate of
0.12% of the Fund's average net assets before a decrease of 0.03% based on
performance.
The Fund has authorized Mellon Capital to choose brokers or dealers
to handle the purchase and sale of securities for the Fund, and to seek to
obtain the best available price and most favorable execution from these brokers
with respect to all transactions.
PLAIN TALK ABOUT
Vanguard's Unique Corporate Structure
The Vanguard Group is truly a mutual mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most other mutual funds are operated by for-profit management companies that may
be owned by one person, by a group of individuals, or by investors who own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.
PLAIN TALK ABOUT
The Fund's Adviser
Mellon Capital Management Corporation is an investment advisory firm founded in
1983. As of September 30, 1998, Mellon Capital managed more than $63 billion in
assets. The managers responsible for overseeing the implementation of Mellon
Capital's strategy for the Fund are:
William L. Fouse, CFA, Chairman of Executive Committee for Mellon Capital;
has worked in investment management since 1953; with Mellon Capital since its
founding in 1983; B.A. and M.B.A., University of Kentucky. Mr. Fouse has
managed the Fund since its inception in 1988.
Thomas F. Loeb, Chairman, Chief Executive Officer of Mellon Capital; has
worked in investment management since 1970; with Mellon Capital since its
founding in 1983; B.A., Fairleigh Dickinson University, M.B.A., University of
Pennsylvania. Mr. Loeb has managed the Fund since its inception in 1988.
<PAGE>
8
In the interest of obtaining better execution of a transaction, Mellon
Capital may choose brokers who charge higher commissions. If more than one
broker can obtain the best available price and favorable execution of a
transaction, then Mellon Capital is authorized to choose a broker who, in
addition to executing the transaction, will provide research services to Mellon
Capital or the Fund. Also, the Fund may direct Mellon Capital to use a
particular broker for certain transactions in exchange for commission rebates or
research services provided to the Fund.
The Board of Trustees may, without prior approval from shareholders, change
the terms of the advisory agreement or hire a new investment adviser, either as
a replacement for Mellon Capital or as an additional adviser. However, any such
change will be communicated to shareholders in writing.
Year 2000 Challenge
The common practice in computer programming of using just two digits to identify
a year has resulted in the Year 2000 challenge throughout the information
technology industry. If unchanged, many computer applications and systems could
misinterpret dates occurring after December 31, 1999, leading to errors or
failure. Such failure could adversely affect a fund's operations, including
pricing, securities trading, and the servicing of shareholder accounts.
The Vanguard Group is dedicated to providing uninterrupted, high-quality
performance from our computer systems before, during, and after 2000. In July
1998, we completed the renovation and initial testing of our internal systems.
Vanguard is diligently working with external partners, suppliers, and vendors,
including fund managers and other service providers, to assure that the systems
with which we interact remain operational at all times.
In addition to taking every reasonable step to secure our internal systems
and external relationships, Vanguard is further developing contingency plans
intended to assure that unexpected systems failures will not adversely affect
the Fund's operations. Vanguard intends to monitor these processes through the
rollover of 1999 into 2000 and to quickly implement alternate solutions if
necessary.
However, despite Vanguard's efforts and contingency plans, noncompliant
computer systems could have a material adverse effect on the Fund's business,
operations, or financial condition. Additionally, the Fund's performance could
be hurt if a computer-system failure at a company or governmental unit affects
the price of securities the Fund owns.
Dividends, Capital Gains, and Taxes
The Fund distributes to shareholders virtually all of its net income (interest
and dividends less expenses) as well as any capital gains realized from the sale
of its holdings. Income distributions generally occur in June and December;
capital gains distributions generally occur in December. You can receive
distributions of income or capital gains in cash, or you can have them
automatically invested in more shares of the Fund. In either case, these
distributions are taxable to you. It is important to note that distributions of
dividends and capital gains that are declared in December--if paid to you by the
end of January--are taxed as if they had been paid to you in December.
Vanguard will send you a statement each year showing the tax status of all
your distributions. If you have chosen to receive dividend and/or capital gains
distributions in cash, and the postal or other delivery service is unable to
deliver checks to your address of record, we will change the distribution option
so that all dividends and other distributions are automatically invested in
additional shares. We will not pay interest on uncashed distribution checks.
PLAIN TALK ABOUT
Distributions
As a shareholder, you are entitled to your share of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or a capital gains distribution. Income
dividends come from both the dividends that the fund earns from its holdings and
the interest it receives from its money market and bond investments. Capital
gains are realized whenever the fund sells securities for higher prices than it
paid for them. The capital gains are either short-term or long-term depending on
whether the fund held the securities for less than or more than one year.
<PAGE>
9
[ ] The dividends and short-term capital gains that you receive are considered
ordinary income for tax purposes.
[ ] Any distributions of net long-term capital gains by the Fund are taxable to
you as long-term capital gains, no matter how long you've owned shares in
the Fund.
[ ] Although the Fund does not seek to realize any particular amount of capital
gains during a year, such gains are realized from time to time as
by-products of its ordinary investment activities. Consequently,
distributions may vary considerably from year to year.
[ ] If you sell or exchange shares, any gain or loss you have is a taxable
event. This means that you may have a capital gain to report as income, or a
capital loss to report as a deduction, when you complete your federal income
tax return.
[ ] Distributions of dividends or capital gains, and capital gains or losses
from your sale or exchange of Fund shares, may be subject to state and local
income taxes as well.
The tax information in this prospectus is provided as general information and
will not apply to you if you are investing through a tax-deferred account such
as an IRA or a qualified employee benefit plan. You should consult your tax
adviser about the tax consequences of an investment in the Fund.
Share Price
The Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of trading on the New York Stock Exchange (the NAV
is not calculated on holidays or other days the Exchange is closed). Net asset
value per share is computed by adding up the total value of the Fund's
investments and other assets, subtracting any of its liabilities (debts), and
then dividing by the number of Fund shares outstanding:
Total Assets - Liabilities
Net Asset Value = ------------------------------
Number of Shares Outstanding
Knowing the daily net asset value is useful to you as a shareholder because
it indicates the current value of your investment. The Fund's NAV, multiplied by
the number of shares you own, gives you the dollar amount you would have
received had you sold all of your shares back to the Fund that day.
A Note on Pricing: The Fund's investments will be priced at their market
value when market quotations are readily available. When these quotations are
not readily available, investments will be priced at their fair value,
calculated according to procedures adopted by the Fund's Board of Trustees.
The Fund's share price can be found daily in the mutual fund listings of most
major newspapers under the heading "Vanguard Funds." Different newspapers use
different abbreviations of the Fund's name, but the most common is AssetA.
PLAIN TALK ABOUT
"Buying a Dividend"
Unless you are investing through a tax-deferred retirement account (such as an
IRA), it is not to your advantage to buy shares of a fund shortly before it
makes a distribution, because doing so can cost you money in taxes. This is
known as "buying a dividend." For example: on December 15, you invest $5,000,
buying 250 shares for $20 each. If the fund pays a distribution of $1 per share
on December 16, its share price would drop to $19 (not counting market change).
You still have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250
shares x $1 = $250 in distributions), but you owe tax on the $250 distribution
you received--even if you reinvest it in more shares. To avoid "buying a
dividend," check a fund's distribution schedule before you invest.
<PAGE>
10
PLAIN TALK ABOUT
How to Read the Financial Highlights Table
The Fund began fiscal 1998 with a net asset value (price) of $21.53 per share.
During the year, the Fund earned $.79 per share from investment income (interest
and dividends) and $2.33 per share from investments that had appreciated in
value or that were sold for higher prices than the Fund paid for them.
Shareholders received $1.75 per share in the form of dividend and capital
gains distributions. A portion of each year's distributions may come from the
prior year's income or capital gains.
The earnings ($3.12 per share) minus the distributions ($1.75 per share)
resulted in a share price of $22.90 at the end of the year. This was an increase
of $1.37 per share (from $21.53 at the beginning of the year to $22.90 at the
end of the year). For a shareholder who reinvested the distributions in the
purchase of more shares, the total return from the Fund was 15.24% for the year.
As of September 30, 1998, the Fund had $5.64 billion in net assets. For the
year, its expense ratio was 0.49% ($4.90 per $1,000 of net assets); and its net
investment income amounted to 3.80% of its average net assets. It sold and
replaced securities valued at 60% of its net assets.
Financial Highlights
The following financial highlights table is intended to help you understand the
Fund's financial performance for the past five years, and certain information
reflects financial results for a single Fund share. The total returns in the
table represent the rate that an investor would have earned or lost each year on
an investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been derived from the financial statements
audited by PricewaterhouseCoopers LLP, independent accountants, whose
report--along with the Fund's financial statements--is included in the Fund's
most recent annual report to shareholders. You may have the annual report sent
to you without charge by contacting Vanguard.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
Vanguard Asset Allocation Fund
Year Ended September 30,
-----------------------------------------
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $21.53 $18.27 $17.03 $13.78 $15.08
- ------------------------------------------------------------------------------------------
Investment Operations
Net Investment Income .79 .74 .69 .64 .52
Net Realized and Unrealized Gain (Loss)
on Investments 2.33 4.29 1.82 3.18 (.81)
-------------------------------------------
Total from Investment Operations 3.12 5.03 2.51 3.82 (.29)
-------------------------------------------
Distributions
Dividends from Net Investment Income (.74) (.72) (.66) (.57) (.48)
Distributions from Realized Capital Gains (1.01) (1.05) (.61) -- (.53)
-------------------------------------------
Total Distributions (1.75) (1.77) (1.27) (.57) (1.01)
- -------------------------------------------------------------------------------------------
Net Asset Value, End of Year $22.90 $21.5 $18.27 $17.03 $13.78
===========================================================================================
Total Return 15.24% 29.42% 15.27% 28.57% -2.05%
===========================================================================================
Ratios/Supplemental Data
Net Assets, End of Year (Millions) $5,637 $3,738 $2,341 $1,593 $1,120
Ratio of Total Expenses to
Average Net Assets 0.49% 0.49% 0.47% 0.49% 0.50%
Ratio of Net Investment Income to
Average Net Assets 3.80% 3.96% 4.17% 4.41% 3.68%
Turnover Rate 60% 10% 47% 34% 51%
===========================================================================================
</TABLE>
From time to time, the Vanguard funds advertise yield and total return figures.
Yield is a measure of past dividend income. Total return includes both past
dividend income (assuming that it has been reinvested) plus realized and
unrealized capital appreciation (or depreciation). Neither yield nor total
return should be used to predict the future performance of a fund.
"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.
<PAGE>
11
Investing with Vanguard
Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information? Establish an account for a
minor child or for your retirement savings?
Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.
The following sections of the prospectus briefly explain the many services we
offer. Booklets providing detailed information are available on the services
marked with a [GRAPHIC OMITTED]. Please call us to request copies.
Services and Account Features
Vanguard offers many services that make it convenient to buy, sell, or exchange
shares, or to obtain fund or account information.
- --------------------------------------------------------------------------------
Telephone Redemptions (Sales and Exchanges)
Automatically set up for this Fund unless you notify us otherwise.
- --------------------------------------------------------------------------------
Vanguard Direct Deposit Service(TM) [BOOK GRAPHIC]
Automatic method for depositing your paycheck or U.S. government payment
(including Social Security and government pension checks) into your account.
- --------------------------------------------------------------------------------
Vanguard Automatic Exchange Service(TM) [BOOK GRAPHIC]
Automatic method for moving a fixed amount of money from one Vanguard fund
account to another.
- --------------------------------------------------------------------------------
Vanguard Fund Express(R) [BOOK GRAPHIC]
Electronic method for buying or selling shares. You can transfer money between
your Vanguard fund account and an account at your bank, savings and loan, or
credit union on a systematic schedule or whenever you wish.
- --------------------------------------------------------------------------------
Vanguard Dividend Express(TM) [BOOK GRAPHIC]
Electronic method for transferring dividend and/or capital gains distributions
directly from your Vanguard fund account to your bank, savings and loan, or
credit union account.
- --------------------------------------------------------------------------------
Vanguard Tele-Account(R) 1-800-662-6273 (ON-BOARD) [BOOK GRAPHIC]
Toll-free 24-hour access to Vanguard fund and account information--as well as
some transactions--by using any touch-tone phone. Tele-Account provides total
return, share price, price change, and yield quotations for all Vanguard funds;
gives your account balances and history (e.g., last transaction, latest dividend
distribution); and allows you to sell or exchange fund shares.
- --------------------------------------------------------------------------------
Access Vanguard(TM) www.vanguard.com [COMPUTER GRAPHIC]
You can use your personal computer to perform certain transactions for most
Vanguard funds by accessing our website. To establish this service, you must
register through the website. We will then send to you, by mail, an account
access password that allows you to process the following financial and
administrative transactions online:
[ ] open a new account*.
[ ] buy, sell or exchange shares of most funds.
[ ] change your name/address.
[ ] add/change fund options (including dividend options, Vanguard Fund Express,
bank instructions, checkwriting, and Vanguard Automatic Exchange Service).
*Only current Vanguard shareholders can open a new account online, by exchanging
shares from other existing Vanguard accounts.
- --------------------------------------------------------------------------------
Investor Information Department: 1-800-662-7447 (SHIP) Text Telephone:
1-800-952-3335 Call Vanguard for information on our funds, fund services, and
retirement accounts, and to request literature.
- --------------------------------------------------------------------------------
Client Services Department: 1-800-662-2739 (CREW) Text Telephone: 1-800-662-2738
Call Vanguard for information on your account, account transactions, and account
statements.
- --------------------------------------------------------------------------------
Services for Clients of Vanguard's Institutional Division: 1-888-809-8102
Vanguard's Institutional Division offers a variety of specialized services for
large institutional investors, including the ability to effect account
transactions through private electronic networks and third-party recordkeepers.
- --------------------------------------------------------------------------------
<PAGE>
12
Types of Accounts
Individuals and institutions can establish a variety of accounts with Vanguard.
- --------------------------------------------------------------------------------
For One or More People
Open an account in the name of one (individual) or more (joint tenants) people.
- --------------------------------------------------------------------------------
For Holding Personal Trust Assets [BOOK GRAPHIC]
Invest assets held in an existing personal trust.
- --------------------------------------------------------------------------------
For Individual Retirement Accounts [BOOK GRAPHIC]
Open a traditional IRA account or a Roth IRA account. Eligibility and other
requirements are established by federal law and Vanguard custodial account
agreements. For more information, please call 1-800-662-7447 (SHIP).
- --------------------------------------------------------------------------------
For an Organization [BOOK GRAPHIC]
Open an account as a corporation, partnership, endowment, foundation, or other
entity.
- --------------------------------------------------------------------------------
For Third-Party Trustee Retirement Investments
Open an account as a retirement trust or plan based on an existing corporate or
institutional plan. These accounts are established by the trustee of the
existing plan.
- --------------------------------------------------------------------------------
Vanguard Prototype Plans
Open a variety of retirement accounts using Vanguard prototype plans for
individuals, sole proprietorships, and small businesses. For more information,
please call 1-800-662-2003.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
A Note on Investing with Vanguard Through Other Firms
You may purchase or sell Fund shares through a financial intermediary such as a
bank, broker, or investment adviser. If you invest with Vanguard through an
intermediary, please read that firm's program materials carefully to learn of
any special rules that may apply. For example, special terms may apply to
additional service features, fees, or other policies. Consult your intermediary
to determine when your order will be priced.
- --------------------------------------------------------------------------------
Buying Shares
You buy your shares at the Fund's next-determined net asset value after Vanguard
receives your request. As long as your request is received before the close of
trading on the New York Stock Exchange, generally 4 p.m. Eastern time, you will
buy your shares at that day's net asset value.
- --------------------------------------------------------------------------------
Minimum Investment to...
open a new account
$3,000 (regular account); $1,000 (Traditional IRAs and Roth IRAs).
add to an existing account
$100 by mail or exchange; $1,000 by wire.
- --------------------------------------------------------------------------------
A Note on Low Balances
The Fund reserves the right to close any nonretirement account whose balance
falls below the minimum initial investment. The Fund will deduct a $10 annual
fee in June if your nonretirement account balance falls below $2,500. The fee is
waived if your total Vanguard account assets are $50,000 or more.
- --------------------------------------------------------------------------------
By Mail to... [ENVELOPE GRAPHIC]
open a new account
Complete and sign the application form and enclose your check.
add to an existing account
Mail your check with an Invest-By-Mail form detached from your confirmation
statement to the address listed on the form.
<PAGE>
13
Make your check payable to: The Vanguard Group-78
All purchases must be made in U.S. dollars, and checks must be drawn on U.S.
banks.
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2600 455 Devon Park Drive
Valley Forge, PA 19482-2600 Wayne, PA 19087-1815
For clients of Vanguard's Institutional Division...
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
- --------------------------------------------------------------------------------
IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.
- --------------------------------------------------------------------------------
By Telephone to... [TELEPHONE GRAPHIC]
open a new account
Call Vanguard Tele-Account* 24 hours a day--or Client Services during business
hours--to exchange from another Vanguard fund account with the same registration
(name, address, taxpayer identification number, and account type).
add to an existing account
Call Vanguard Tele-Account* 24 hours a day--or Client Services during business
hours--to exchange from another Vanguard fund account with the same registration
(name, address, taxpayer identification number, and account type). Use Vanguard
Fund Express (see "Services and Account Features") to transfer assets from your
bank account. Call Client Services before your first use to verify that this
option is in place.
Vanguard Tele-Account Client Services
1-800-662-6273 1-800-662-2739
*You must obtain a Personal Identification Number through Tele-Account at least
seven days before you request your first exchange.
- --------------------------------------------------------------------------------
IMPORTANT NOTE: Once you've requested a telephone transaction and a confirmation
number has been assigned, the transaction cannot be revoked. We reserve the
right to refuse any purchase request.
- --------------------------------------------------------------------------------
By Wire to Open a New Account or Add to an Existing Account [Graphic Omitted]
Call Client Services to arrange your wire transaction. Wire transactions are not
available for retirement accounts, except for asset transfers and direct
rollovers.
Wire to:
FRB ABA 021001088
Marine Midland Bank, New York
For credit to:
Account: 000112046
Vanguard Incoming Wire Account
In favor of:
Vanguard Asset Allocation Fund-78
[Account number, or temporary number for a new account]
[Registered account owner/s]
[Registered address]
- --------------------------------------------------------------------------------
<PAGE>
14
Buying Shares (continued)
You can redeem (that is, sell or exchange) shares purchased by check or
Vanguard Fund Express at any time. However, while your redemption request will
be processed at the next-determined net asset value after it is received, your
redemption proceeds will not be available until payment for your purchase is
collected, which may take up to ten calendar days.
Keep in mind that if you buy or sell Fund shares through a registered
broker/dealer or investment adviser, the broker/dealer or adviser may charge you
a service fee.
- --------------------------------------------------------------------------------
A Note on Large Purchases
It is important that you call Vanguard before you invest a large dollar amount.
We must consider the interests of all Fund shareholders and so reserve the right
to refuse any purchase that will disrupt the Fund's operation or performance.
- --------------------------------------------------------------------------------
Redeeming Shares
This section describes how you can redeem--that is, sell or exchange--the Fund's
shares.
When Selling Shares:
o Vanguard sends the redemption proceeds to you or a designated third party.*
o You can sell all or part of your Fund shares at any time.
*Proceeds sent to third parties require a signature guarantee; see footnote on
page 16.
When Exchanging Shares:
o The redemption proceeds are used to purchase shares of a different Vanguard
fund.
o You must meet the receiving fund's minimum investment requirements.
o Vanguard reserves the right to revise or terminate the exchange privilege,
limit the amount of an exchange, or reject an exchange at any time, without
notice.
In both cases, your transaction will be based on the Fund's next-determined
share price, subject to any special rules discussed in this prospectus. For
exchanges, the purchase side of the transaction will be based on the receiving
fund's next-determined share price, again subject to any special rules discussed
in this prospectus.
- --------------------------------------------------------------------------------
Note: Once a redemption is processed and a confirmation number given, the
transaction cannot be canceled.
- --------------------------------------------------------------------------------
HOW TO REQUEST A REDEMPTION
You can request a redemption (that is, either a sale or exchange of shares) from
your Fund account in any one of three ways: online, by telephone, or by mail.
- --------------------------------------------------------------------------------
Online Requests [COMPUTER GRAPHIC]
Access Vanguard at www.vanguard.com
You can use your personal computer to sell or exchange shares of most Vanguard
funds by accessing our website. To establish this service, you must register
through the website. We will then send you, by mail, an account access password
that will enable you to sell or exchange shares online (as well as perform other
transactions).
Note: The Vanguard funds whose shares you cannot exchange online or by
telephone are Vanguard U.S. Stock Index Funds, Vanguard Balanced Index Fund,
Vanguard International Stock Index Funds, Vanguard REIT Index Fund, Vanguard
Total International Stock Index Fund, and Vanguard Growth and Income Fund. These
funds do, however, permit online and telephone exchanges within IRAs and other
retirement accounts. If you sell shares of these funds online, you will receive
a redemption check at your address of record.
- --------------------------------------------------------------------------------
Telephone Requests [TELEPHONE GRAPHIC]
All Account Types Except Retirement:
Call Vanguard Tele-Account 24 hours a day--or Client Services during business
hours--to sell or exchange shares. You can exchange shares from this Fund to
open an account in another Vanguard fund or to add to an existing Vanguard fund
account with an identical registration.
<PAGE>
15
Retirement Accounts:
You can exchange--but not sell--shares by calling Tele-Account or Client
Services.
Vanguard Tele-Account Client Services
1-800-662-6273 1-800-662-2739
- --------------------------------------------------------------------------------
SPECIAL INFORMATION: We will automatically establish the telephone redemption
option for your account, unless you instruct us otherwise in writing. While
telephone redemption is easy and convenient, this account feature involves a
risk of loss from unauthorized or fraudulent transactions. Vanguard will take
reasonable precautions to protect your account from fraud. You should do the
same by keeping your account information private and immediately reviewing any
account statements that we send to you. Make sure to contact Vanguard
immediately about any transaction you believe to be unauthorized.
- --------------------------------------------------------------------------------
We reserve the right to refuse a telephone redemption if the caller is unable to
provide:
(CHECKMARK) The ten-digit account number.
(CHECKMARK) The name and address exactly as registered on the account.
(CHECKMARK) The primary Social Security or employer identification number as
registered on the account.
(CHECKMARK) The Personal Identification Number, if applicable.
Please note that Vanguard will not be responsible for any account losses due
to telephone fraud, so long as we have taken reasonable steps to verify the
caller's identity. If you wish to remove the telephone redemption feature from
your account, please notify us in writing.
- --------------------------------------------------------------------------------
A Note on Unusual Circumstances
Vanguard reserves the right to revise or terminate the redemption privilege at
any time, without notice. In addition, Vanguard can stop selling shares or
postpone payment at times when the New York Stock Exchange is closed or under
any emergency circumstances as determined by the U.S. Securities and Exchange
Commission. If you experience difficulty making a telephone redemption during
periods of drastic economic or market change, you can send us your request by
regular or express mail. Follow the instructions on selling or exchanging shares
by mail in this section.
- --------------------------------------------------------------------------------
Mail Requests [ENVELOPE GRAPHIC]
All Account Types Except Retirement:
Send a letter of instruction signed by all registered account holders. Include
the fund name and account number and (if you are selling) a dollar amount or
number of shares OR (if you are exchanging) the name of the fund you want to
exchange into and a dollar amount or number of shares. To exchange into an
account with a different registration (including a different name, address,
taxpayer identification number, or account type), you must provide Vanguard with
written instructions that include the guaranteed signatures of all current
owners of the fund from which you wish to redeem.
Vanguard Retirement Accounts:
For information on how to request distributions from:
o Traditional IRAs and Roth IRAs--call Client Services.
o SEP-IRAs, SIMPLE IRAs, 403(b)(7) custodial accounts, and Profit-Sharing and
Money Purchase Pension (Keogh) Plans--call Individual Retirement Plans at
1-800-662-2003.
Depending on your account registration type, additional documentation may be
required.
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 1120 455 Devon Park Drive
Valley Forge, PA 19482-1120 Wayne, PA 19087-1815
<PAGE>
16
Redeeming Shares (continued)
For clients of Vanguard's Institutional Division...
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
- --------------------------------------------------------------------------------
A Note on Large Redemptions
It is important that you call Vanguard before you redeem a large dollar amount.
We must consider the interests of all fund shareholders and so reserve the right
to delay delivery of your redemption proceeds--up to seven days--if the amount
will disrupt the Fund's operation or performance.
If you redeem more than $250,000 worth of Fund shares within any 90-day
period, the Fund reserves the right to pay part or all of the redemption
proceeds above $250,000 in kind, i.e., in securities, rather than in cash. If
payment is made in kind, you may incur brokerage commissions if you elect to
sell the securities for cash.
- --------------------------------------------------------------------------------
Options for Redemption Proceeds
You may receive your redemption proceeds in one of two ways: check, or exchange
to another Vanguard fund.
- --------------------------------------------------------------------------------
Check Redemptions
Normally, Vanguard will mail your check within two business days of a
redemption.
- --------------------------------------------------------------------------------
Exchange Redemptions
As described above, an exchange involves using the proceeds of your redemption
to purchase shares of another Vanguard fund.
- --------------------------------------------------------------------------------
For Our Mutual Protection
For your best interests and ours, Vanguard applies these additional requirements
to redemptions:
Request in "Good Order"
All redemption requests must be received by Vanguard in "good order." This means
that your request must include:
(CHECKMARK) The Fund name and account number.
(CHECKMARK) The amount of the transaction (in dollars or shares).
(CHECKMARK) Signatures of all owners exactly as registered on the account
(for mail requests).
(CHECKMARK) Signature guarantees (if required).*
(CHECKMARK) Any supporting legal documentation that may be required.
(CHECKMARK) Any outstanding certificates representing shares to be redeemed.
*For instance, a signature guarantee must be provided by all registered account
shareholders when redemption proceeds are to be sent to a different person or
address. A signature guarantee can be obtained from most banks, credit unions,
and licensed brokers.
Transactions are processed at the next-determined share price after Vanguard has
received all required information.
- --------------------------------------------------------------------------------
Limits on Account Activity
Because excessive account transactions can disrupt management of the Fund and
increase the Fund's costs for all shareholders, Vanguard limits account activity
as follows:
o You may make no more than two substantive "round trips" through the Fund
during any 12-month period.
o Your round trips through the Fund must be at least 30 days apart.
o The Fund may refuse a share purchase at any time, for any reason.
o Vanguard may revoke an investor's telephone exchange privilege at any time,
for any reason.
A "round trip" is a redemption from the Fund followed by a purchase back into
the Fund. Also, "round trip" covers transactions accomplished by any combination
of methods, including transactions conducted by check, wire, or exchange to/from
another Vanguard fund. "Substantive" means a dollar amount that Vanguard
determines, in its sole discretion, could adversely affect management of the
Fund.
- --------------------------------------------------------------------------------
<PAGE>
17
- --------------------------------------------------------------------------------
Return Your Share Certificates
Any portion of your account represented by share certificates cannot be redeemed
until you return the certificates to Vanguard. Certificates must be returned
(unsigned), along with a letter requesting the sale or exchange you wish to
process, via certified mail to:
The Vanguard Group
455 Devon Park Drive
Wayne, PA 19087-1815
- --------------------------------------------------------------------------------
All Trades Final
Vanguard will not cancel any transaction request (including any purchase or
redemption) that we believe to be authentic once the request has been received
and a confirmation number assigned.
- --------------------------------------------------------------------------------
Transferring Registration
You can transfer the registration of your Fund shares to another owner by
completing a transfer form and sending it to Vanguard.
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 1110 455 Devon Park Drive
Valley Forge, PA 19482-1110 Wayne, PA 19087-1815
For clients of Vanguard's Institutional Division...
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
- --------------------------------------------------------------------------------
Fund and Account Updates
STATEMENTS AND REPORTS
We will send you account and tax statements to help you keep track of your Fund
account throughout the year as well as when you are preparing your income tax
returns.
In addition, you will receive financial reports about the Fund twice a year.
These comprehensive reports include an assessment of the Fund's performance (and
a comparison to its industry benchmark), an overview of the markets, a report
from the advisers, and the Fund's financial statements which include a listing
of the Fund's holdings.
To keep the Fund's costs as low as possible (so that you and other
shareholders can keep more of the Fund's investment earnings), Vanguard attempts
to eliminate duplicate mailings to the same address. When we find that two or
more Fund shareholders have the same last name and address, we send just one
Fund report to that address--instead of mailing separate reports to each
shareholder. If you want us to send separate reports, however, you may notify
our Investor Information Department at 1-800-662-7447.
- --------------------------------------------------------------------------------
Confirmation Statement
Sent each time you buy, sell, or exchange shares; confirms the trade date and
the amount of your transaction.
- --------------------------------------------------------------------------------
Portfolio Summary
Mailed quarterly for most accounts; shows the market value of your account at
the close of the statement period, as well as distributions, purchases, sales,
and exchanges for the current calendar year.
- --------------------------------------------------------------------------------
Fund Financial Reports
Mailed in December and June for this Fund.
- --------------------------------------------------------------------------------
<PAGE>
18
Fund and Account Updates (continued)
- --------------------------------------------------------------------------------
Tax Statements
Generally mailed in January; report previous year's dividend and capital gains
distributions, proceeds from the sale of shares, and distributions from IRAs or
other retirement accounts.
- --------------------------------------------------------------------------------
Average Cost Review Statement [BOOK GRAPHIC]
Issued quarterly for most taxable accounts (accompanies your Portfolio Summary);
shows the average cost of shares that you redeemed during the calendar year,
using the average cost single category method.
<PAGE>
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<PAGE>
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<PAGE>
Glossary of Investment Terms
Active Management
An investment approach that seeks to exceed the average returns of the financial
markets. Active managers rely on research, market forecasts, and their own
judgment and experience in selecting securities to buy and sell.
Bond
A debt security (IOU) issued by a corporation, government, or government agency
in exchange for the money you lend it. In most instances, the issuer agrees to
pay back the loan by a specific date and to make regular interest payments until
that date.
Capital Gains Distribution
Payment to mutual fund shareholders of gains realized on securities that the
fund has sold at a profit, minus any realized losses.
Cash Reserves
Cash deposits, short-term bank deposits, and money market instruments which
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's acceptances.
Common Stock
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.
Dividend Income
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
Expense Ratio
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
distribution fees.
Fund Diversification
Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.
Index
An unmanaged group of securities whose overall performance is used as a standard
to measure investment performance.
Investment Adviser
An organization that makes the day-to-day decisions regarding a fund's
investments.
Net Asset Value (NAV)
The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.
Passive Management
A low-cost investment strategy in which a mutual fund attempts to match--rather
than outperform-- a particular stock or bond market index. Also known as
indexing.
Total Return
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
Volatility
The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
Yield
Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE>
The Vanguard Group
Post Office Box 2600
Valley Forge, PA 19482-2600
For More Information
If you'd like more information about Vanguard Asset Allocation Fund, the
following documents are available free upon request:
Annual/Semiannual Report to Shareholders
Additional information about the Fund's investments is available in the Fund's
annual and semiannual reports to shareholders. In these reports, you will find a
discussion of the market conditions and investment strategies that significantly
affected the Fund's performance during the most recent fiscal year.
Statement of Additional Information (SAI) The SAI provides more detailed
information about the Fund.
The current annual and semiannual reports and the SAI are incorporated by
reference into (and are thus legally a part of) this prospectus.
To receive a free copy of the latest annual or semiannual report or the SAI, or
to request additional information about the Fund or other Vanguard funds, please
contact us as follows:
The Vanguard Group
Investor Information Department
P.O. Box 2600
Valley Forge, PA 19482-2600
Telephone:
1-800-662-7447(SHIP)
Text Telephone:
1-800-952-3335
World Wide Web:
www.vanguard.com
E-mail:
[email protected]
If you are a current Fund shareholder and would like information about your
account, account transactions, and/or account statements, please call:
Client Services Department
Telephone:
1-800-662-2739(CREW)
Text Telephone:
1-800-662-2738
Information provided by the Securities and Exchange Commission (SEC)
You can review and copy information about the Fund (including the SAI) at the
SEC's Public Reference Room in Washington, D.C. To find out more about this
public service, call the SEC at 1-800-SEC-0330. Reports and other information
about the Fund are also available on the SEC's website (www.sec.gov), or you can
receive copies of this information, for a fee, by writing the Public Reference
Section, Securities and Exchange Commission, Washington, DC 20549-6009.
Fund's Investment Company Act
file number: 811-5628
(C) 1999 Vanguard Marketing
Corporation, Distributor.
All rights reserved.
<PAGE>
Vanguard Asset Allocation Fund
Participant Prospectus
January 29, 1999
An Asset Allocation Mutual Fund
Contents
1 Fund Profile
2 Additional Information
3 A Word About Risk
3 Who Should Invest
3 Primary Investment Strategies
7 The Fund and Vanguard
7 Investment Adviser
8 Year 2000 Challenge
8 Dividends, Capital Gains, and Taxes
9 Share Price
10 Financial Highlights
11 Investing with Vanguard
11 Accessing Fund Information by Computer
Glossary (inside back cover)
Why Reading This Prospectus Is Important
This prospectus explains the objective, risks, and strategies of Vanguard Asset
Allocation Fund. To highlight terms and concepts important to mutual fund
investors, we have provided "Plain Talk(R)" explanations along the way. Reading
the prospectus will help you to decide whether the Fund is the right investment
for you. We suggest that you keep it for future reference.
Important Note
This prospectus is intended for participants in employer-sponsored retirement or
savings plans. Another version--for investors who would like to open a personal
investment account--can be obtained by calling Vanguard at 1-800-662-7447.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
<PAGE>
1
Fund Profile
The following profile summarizes key features of Vanguard Asset Allocation Fund.
INVESTMENT OBJECTIVE
The Fund seeks to provide maximum long-term total return (capital change plus
income) while incurring less stock market risk than a fund made up entirely of
stocks.
INVESTMENT STRATEGIES
The Fund invests in common stocks, bonds, and money market instruments in
proportions consistent with their expected returns and risks as evaluated by the
Fund's adviser. These proportions are changed from time to time as market
expectations shift. The Fund is permitted to be 100% invested in any one of the
three asset classes.
PRIMARY RISKS
The Fund's total return, like stock and bond prices generally, will fluctuate
within a wide range, so an investor could lose money over short or even long
periods. The Fund is also subject to:
[ ] Interest rate risk, which is the chance that bond prices overall will
decline over short or even long periods due to rising interest rates.
[ ] Manager risk, which is the chance that poor security selection will cause
the Fund to underperform other funds with similar investment objectives.
PERFORMANCE/RISK INFORMATION
The bar chart and table below provide an indication of the risk of investing in
the Fund. The bar chart shows the Fund's performance in each calendar year over
a ten-year period. The table shows how the Fund's average annual returns for
one, five, and ten calendar years compare with those of a broad based market
index and a composite index. Keep in mind that the Fund's past performance does
not indicate how it will perform in the future.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
Annual Total Returns
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
23.68% 0.89% 25.59% 7.51% 13.49% -2.32% 35.46% 15.73% 27.32% 25.40%
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------
</TABLE>
During the period shown in the bar chart, the highest return for a calendar
quarter was 14.31% (quarter ending December 1998) and the lowest return for a
quarter was -8.31% (quarter ending September 1990).
- --------------------------------------------------------------------------------
Average Annual Total Returns for Years Ended December 31, 1998
- --------------------------------------------------------------------------------
1 Year 5 Years 10 Years
- --------------------------------------------------------------------------------
Vanguard Asset Allocation Fund 25.40% 19.58% 16.67%
Composite Index* 24.01 18.98 16.65
S&P 500 Index 28.58 24.06 19.21
- --------------------------------------------------------------------------------
*Weighted 65% in the S&P 500 Index, 35% in the Lehman Brothers Long U.S.
Treasury Bond Index.
- --------------------------------------------------------------------------------
<PAGE>
2
PLAIN TALK ABOUT
The Costs of Investing
Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with the fund's buying and selling of securities. These costs
can erode a substantial portion of the gross income or capital appreciation a
fund achieves. Even seemingly small differences in expenses can, over time, have
a dramatic effect on a fund's performance.
PLAIN TALK ABOUT
Fund Expenses
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. Vanguard Asset Allocation Fund's expense ratio in fiscal year 1998 was
0.49%, or $4.90 per $1,000 of average net assets. The average flexible mutual
fund currently has expenses of 1.44%, or $14.40 per $1,000 of average net
assets, according to Lipper, Inc., which reports on the mutual fund industry.
FEES AND EXPENSES
The following table describes the fees and expenses you would pay if
you buy and hold shares of the Fund. The expenses shown under Annual Fund
Operating Expenses are based upon those incurred in the fiscal year ended
September 30, 1998.
Shareholder Fees (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
Annual Fund Operating Expenses (expenses deducted from the
Fund's assets)
Management Expenses: 0.46%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
Total Annual Operating Expenses: 0.49%
The following example is intended to help you compare the cost of investing
in the Fund with the cost of investing in other mutual funds. It illustrates the
hypothetical expenses that you would incur over various periods if you invest
$10,000 in the Fund. This example assumes that the Fund provides a return of 5%
a year, and that operating expenses remain the same. The results apply whether
or not you redeem your investment at the end of each period.
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
$50 $157 $274 $616
- --------------------------------------------------------------------------------
This example should not be considered to represent actual performance from
the past or for the future. Actual future expenses may be higher or lower than
those shown.
Additional Information
Dividends and Capital Gains
Dividends are paid in June and December; capital gains, if any, are paid
in December
Investment Adviser
Mellon Capital Management Corporation, San Francisco, Calif., since inception
Inception Date
November 3, 1988
Net Assets as of September 30, 1998
$5.64 billion
Newspaper Abbreviation
AssetA
Vanguard Fund Number
078
Cusip Number
922020102
Ticker Symbol
VAAPX
<PAGE>
3
================================================================================
A Word About Risk
This prospectus describes the risks you would face as an investor in Vanguard
Asset Allocation Fund. It is important to keep in mind one of the main axioms of
investing: The higher the risk of losing money, the higher the potential reward.
The reverse, also, is generally true: The lower the risk, the lower the
potential reward. As you consider an investment in Vanguard Asset Allocation
Fund, you should also take into account your personal tolerance for the daily
fluctuations of the securities markets.
Look for this [FLAG GRAPHIC] symbol throughout the prospectus. It is used to
mark detailed information about each type of risk that you would confront as a
shareholder of the Fund.
================================================================================
Who Should Invest
The Fund may be a suitable investment for you if:
[ ] You wish to invest in a fund that actively manages a mix of U.S. common
stocks, bonds, and money market instruments.
[ ] You are seeking growth of capital over the long term--at least five years.
[ ] You are not looking for current income.
The Vanguard funds do not permit market-timing. Do not invest in this Fund if
you are a market-timer.
The Fund has adopted the following policies, among others, to discourage
short-term trading:
[ ] The Fund reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it regards as disruptive to the
efficient management of the Fund. This could be because of the timing of the
investment or because of a history of excessive trading by the investor.
[ ] There is a limit on the number of times you can exchange into and out of the
Fund (see "Exchanges" in the Investing with Vanguard section).
[ ] The Fund reserves the right to stop offering shares at any time.
PLAIN TALK ABOUT
Costs and Market-Timing
Some investors try to profit from market-timing--switching money into
investments when they expect prices to rise, and taking money out when they
expect the market to fall. As money is shifted in and out, a fund incurs
expenses for buying and selling securities. These costs are borne by all fund
shareholders, including the long-term investors who do not generate the costs.
Therefore, the Fund discourages short-term trading by, among other things,
limiting the number of exchanges it permits.
Primary Investment Strategies
This section explains the strategies that the investment adviser uses in pursuit
of the Fund's objective, long-term growth of capital and income. It also
explains how the adviser implements these strategies. In addition, this section
discusses several important risks--market risk, interest rate risk, and manager
risk--faced by investors in the Fund. The Fund's Board of Trustees oversees the
management of the Fund and may change the investment strategies in the interest
of shareholders.
Market Exposure
The adviser, Mellon Capital Management Corporation, allocates the Fund's assets
among stocks, bonds, and money market instruments in proportions that depend on
projected returns and risks for each asset class.
<PAGE>
4
Stocks
A portion of the Fund's assets is typically invested in common stocks.
[FLAG The Fund is subject to stock market risk, which is the possibility that
GRAPHIC] stock prices overall will decline over short or even long periods.
Stock markets tend to move in cycles, with periods of rising prices
and periods of falling prices.
The Fund will typically hold a diversified combination of common stocks
intended to parallel the performance of the S&P 500 Index, which is dominated by
large-capitalization stocks. The stocks are evaluated using a "dividend
discount" model. This model provides an estimate of the total return of the S&P
500 Index, based upon the expected earnings of each of the companies in the
index.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns for the U.S. stock market over various
periods as measured by the Standard & Poor's 500 Composite Stock Price Index, a
widely used barometer of market activity. (Total returns consist of dividend
income plus change in market price.) Note that the returns shown do not include
the costs of buying and selling stocks or other expenses that a real-world
investment portfolio would incur. Note, also, that the gap between best and
worst tends to narrow over the long term.
- --------------------------------------------------------------------------------
U.S. Stock Market Returns (1926-1997)
- --------------------------------------------------------------------------------
1 Year 5 Years 10 Years 20 Years
- --------------------------------------------------------------------------------
Best 53.9% 23.9% 20.1% 16.9%
Worst -43.3 -12.5 -0.9 3.1
Average 13.0 10.5 10.9 10.9
- --------------------------------------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1997. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.5%, returns for individual 5-year periods
ranged from a -12.5% average (from 1928 through 1932) to 23.9% (from 1950
through 1954). These average returns reflect past performance on common stocks;
you should not regard them as an indication of future returns from either the
stock market as a whole or this Fund in particular.
Finally, because Vanguard Asset Allocation Fund invests in a mix of stocks,
bonds, and money market instruments, the Fund's performance will not mirror the
returns of any particular index.
Bonds
A portion of the Fund's assets is typically invested in bonds.
[FLAG The Fund is subject to interest rate risk, which is the possibility
GRAPHIC] that bond prices overall will decline over short or even long periods
due to rising interest rates.
Although bonds are often thought to be less risky than stocks, there have
been periods when bond prices have fallen significantly due to rising interest
rates. For instance, prices of long-term bonds fell by almost 48% between
December 1976 and September 1981.
PLAIN TALK ABOUT
Bonds and Interest Rates
As a rule, when interest rates rise, bond prices fall. The opposite is also
true: Bond prices go up when interest rates fall. Why do bond prices and
interest rates move in opposite directions? Let's assume that you hold a bond
offering a 5% yield. A year later, interest rates are on the rise and bonds are
offered with a 6% yield. With higher-yielding bonds available, you would have
trouble selling your 5% bond for the price you paid--causing you to lower your
asking price. On the other hand, if interest rates were falling and 4% bonds
were being offered, you would be able to sell your 5% bond for more than you
paid.
<PAGE>
5
To illustrate the relationship between bond prices and interest rates, the
following table shows the effect of a 2% change (both up and down) in interest
rates on three $1,000 bonds, each with a different maturity.
- --------------------------------------------------------------------------------
How Interest Rate Changes Affect Bond Prices*
- --------------------------------------------------------------------------------
Value of a $1,000 Bond Value of a $1,000 Bond
After a 2% Increase After a 2% Decrease
Type of Bond (Maturity) in Interest Rates in Interest Rates
- --------------------------------------------------------------------------------
Short-Term (2.5 years) $956 $1,046
Intermediate-Term (10 years) 870 1,156
Long-Term (20 years) 816 1,251
- --------------------------------------------------------------------------------
*Assuming a 7% yield.
- --------------------------------------------------------------------------------
The Fund will typically invest its allocation to bonds in a pool of long-term
U.S. Treasury bonds, which mature in 10 to 30 years. It may also hold other
"full faith and credit" obligations of the U.S. government.
The U.S. government guarantees the timely payment of interest and
principal for its Treasury bonds, but does not guarantee its bonds' prices. In
other words, while Treasury bonds enjoy the highest credit ratings, their
prices--like the prices of other bonds in the Fund--will fluctuate with changes
in interest rates.
The adviser evaluates bonds' attractiveness based upon their current
yield-to-maturity, which is an estimate of total return that considers a bond's
purchase price, redemption value, time to maturity, yield, and time between
interest payments.
PLAIN TALK ABOUT
Types of Bonds
Bonds are issued (sold) by many sources: corporations issue corporate bonds; the
federal government issues U.S. Treasury bonds; agencies of the federal
government issue agency bonds; and mortgage holders issue "mortgage-backed"
bonds, such as those of the Government National Mortgage Association (GNMA).
Each issuer is responsible for paying back the bond's initial value as well as
periodic interest payments.
PLAIN TALK ABOUT
Bond Maturities
A bond is issued with a specific maturity date--the date when the bond issuer,
or seller, must pay back the bond's initial value (known as its "face value").
Bond maturities generally range from less than one year (short-term) to 30 years
(long-term). The longer a bond's maturity, the more risk you, as a bond
investor, face as interest rates rise--but also the more interest you could
receive. Long-term bonds are more suitable for investors willing to take greater
risks in hope of higher yields; short-term bond investors should be willing to
accept lower yields in return for less fluctuation in the value of their
investment.
Security Selection
Mellon Capital Management Corporation ("Mellon Capital"), adviser to the Fund,
makes no effort to choose among individual stocks or bonds to identify
attractive securities. Rather, the adviser tries to determine the mix of stocks,
bonds, and money market instruments that offers the best combination of
potential return and risk. The aim is to maximize the long-term total return of
the Fund while incurring less stock market risk than a portfolio made up
entirely of stocks. At any given time, Mellon Capital may allocate all, a
portion, or none of the Fund's assets to large-capitalization U.S. stocks,
long-term U.S. Treasury bonds, or cash reserves.
For the Fund's common stock allocation, the adviser uses a diversified
portfolio of stocks selected to parallel the performance of the S&P 500 Index or
S&P 500 stock index futures. For the Fund's bond allocation, the adviser uses
long-term (10- to 30-year maturities) U.S. Treasury bonds. For the Fund's cash
reserves allocation, the adviser can use a variety of money market instruments,
including U.S. Treasury bills, government agency securities, high-quality
commercial paper, and certificates of deposit.
Mellon Capital uses a computer model to estimate return and risk and to
recommend shifts in allocations. The adviser implements these shifts in a
disciplined manner. The adviser believes that, within the fluctuations of the
financial markets, there are occasional brief periods in which the market values
of the asset classes do not reflect their true value. The Fund attempts to
capitalize on these perceived imbalances by changing the mix of the Fund's
holdings in the three asset classes. There are no limitations on the amount of
the Fund's assets that may be allocated to stocks, bonds, or money market
instruments; it can be 100% invested in any of the three asset classes.
The Fund is generally managed without regard to tax ramifications.
<PAGE>
6
PLAIN TALK ABOUT
Turnover Rate
Before investing in a mutual fund, you should review its turnover rate. This
gives an indication of how transaction costs could affect the fund's future
returns. In general, the greater the volume of buying and selling by the fund,
the greater the impact that brokerage commissions and other transaction costs
will have on its return. Also, funds with high turnover rates may be more likely
to generate capital gains that must be distributed to shareholders as income
subject to taxes. The average turnover rate for all asset allocation funds is
approximately 98%, according to Morningstar, Inc.
[FLAG GRAPHIC] The Fund is subject to manager risk, which is the possibility
that the adviser may do a poor job allocating the Fund's net
assets among stocks, bonds, and money market instruments.
Since the Fund's asset allocation changes according to the adviser's timely
projection of risk and return, the Fund may exhibit higher volatility than
balanced funds with static allocations.
Historical evidence indicates that correctly timing portfolio allocations
among asset classes has been a difficult strategy to implement successfully on a
consistent basis. Although Mellon Capital has substantial experience in asset
allocation, there can be no assurance that the adviser will consistently
anticipate which asset class will perform best in the future.
The Fund's investment results could suffer, for example, if only a small
portion of the Fund's assets were allocated to stocks during a significant stock
market advance, as if a major portion of its assets were allocated to stocks
during a market decline. Similarly, the Fund's short-term investment results
could also suffer if the Fund were substantially invested in bonds at a time
when interest rates increased.
Turnover Rate
Although the Fund generally seeks to invest for the long term, it retains the
right to sell securities regardless of how long the securities have been held.
The Fund's average turnover rate for the past five years has been about 40%. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its net assets within a one-year period.)
PLAIN TALK ABOUT
Derivatives
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new types of derivatives. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
Other Investment Policies and Risks
Besides investing in common stocks, bonds, and money market instruments, the
Fund may make certain other kinds of investments to achieve its objective.
The Fund may invest, to a limited extent, in foreign securities.
The Fund may also invest in stock and bond futures and options contracts,
which are traditional types of derivatives. Under normal circumstances, the
market value of these contracts and options may represent up to 50% of the
Fund's assets. (Under unusual circumstances, the Fund may hold futures equal in
value to 100% of its net assets.)
Losses (or gains) involving futures can sometimes be substantial--in part
because a relatively small price movement in a futures contract may result in an
immediate and substantial loss (or gain) for a fund. This Fund will not use
futures for speculative purposes and, therefore, does not intend to leverage its
net assets. The Fund will keep separate cash reserves or short-term,
cash-equivalent securities in the amount of the obligation underlying the
futures contract.
The reasons for which the Fund will invest in futures and options are:
[ ] To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in stocks or bonds.
<PAGE>
7
[ ] To reduce the Fund's transaction costs or add value when these instruments
are favorably priced.
[ ] To use as an investment tool when reallocating assets among stocks, bonds,
and money market instruments. For example, the adviser may wish to
reallocate 10% of the Fund's assets from stocks to bonds. To implement
this change rapidly and with low transaction costs, the adviser may sell
stock index futures and purchase bond index futures.
The Fund may also invest without limit in cash reserves, including
obligations of the U.S. government and its agencies, commercial paper, bank
certificates of deposit, banker's acceptances, and repurchase agreements
collateralized by these securities.
The Fund and Vanguard
The Fund is a member of The Vanguard Group, a family of more than 35 investment
companies with more than 100 distinct investment portfolios holding assets worth
more than $420 billion. All of the Vanguard funds share in the expenses
associated with business operations, such as personnel, office space, equipment,
and advertising.
Vanguard also provides marketing services to the funds. Although shareholders
do not pay sales commissions or 12b-1 distribution fees, each fund pays its
allocated share of The Vanguard Group's marketing costs.
PLAIN TALK ABOUT
Vanguard's Unique Corporate Structure
The Vanguard Group is truly a mutual mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most other mutual funds are operated by for-profit management companies that may
be owned by one person, by a group of individuals, or by investors who own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.
PLAIN TALK ABOUT
The Fund's Adviser
Mellon Capital Management Corporation is an investment advisory firm founded in
1983. As of September 30, 1998, Mellon Capital managed more than $63 billion in
assets. The managers responsible for overseeing the implementation of Mellon
Capital's strategy for the Fund are:
William L. Fouse, CFA, Chairman of Executive Committee for Mellon Capital;
has worked in investment management since 1953; with Mellon Capital since its
founding in 1983; B.A. and M.B.A., University of Kentucky. Mr. Fouse has managed
the Fund since its inception in 1988.
Thomas F. Loeb, Chairman, Chief Executive Officer of Mellon Capital; has
worked in investment management since 1970; with Mellon Capital since its
founding in 1983; B.A., Fairleigh Dickinson University, M.B.A., University of
Pennsylvania. Mr. Loeb has managed the Fund since its inception in 1988.
Investment Adviser
The Fund employs Mellon Capital Management Corporation, 595 Market St., Suite
3000, San Francisco, CA 94105, as its investment adviser. Mellon Capital is a
wholly owned subsidiary of MBC Investment Corporation, which itself is a wholly
owned subsidiary of Mellon Bank Corporation. Mellon Capital manages the Fund
subject to the control of the Trustees and officers of the Fund.
Mellon Capital's advisory fee is paid at the end of each fiscal quarter. This
fee is based on certain annual percentage rates applied to the Fund's average
month-end assets for each quarter. In addition, Mellon Capital's advisory fee is
increased or decreased, based on the cumulative investment performance of the
Fund over a trailing 36 month period as compared with the cumulative total
return of the Asset Allocation Composite Index (65% S&P 500 Index; 35% Lehman
Brothers Long U.S. Treasury Bond Index) over the same period.
For the year ended September 30, 1998, the investment advisory fee paid to
Mellon Capital was $5.47 million, which represented an effective annual rate of
0.12% of the Fund's average net assets before a decrease of 0.03% based on
performance.
The Fund has authorized Mellon Capital to choose brokers or dealers
to handle the purchase and sale of securities for the Fund, and to seek to
obtain the best available price and most favorable execution from these brokers
with respect to all transactions.
<PAGE>
8
In the interest of obtaining better execution of a transaction, Mellon
Capital may choose brokers who charge higher commissions. If more than one
broker can obtain the best available price and favorable execution of a
transaction, then Mellon Capital is authorized to choose a broker who, in
addition to executing the transaction, will provide research services to Mellon
Capital or the Fund. Also, the Fund may direct Mellon Capital to use a
particular broker for certain transactions in exchange for commission rebates or
research services provided to the Fund.
The Board of Trustees may, without prior approval from shareholders, change
the terms of the advisory agreement or hire a new investment adviser, either as
a replacement for Mellon Capital or as an additional adviser. However, any such
change will be communicated to shareholders in writing.
Year 2000 Challenge
The common practice in computer programming of using just two digits to identify
a year has resulted in the Year 2000 challenge throughout the information
technology industry. If unchanged, many computer applications and systems could
misinterpret dates occurring after December 31, 1999, leading to errors or
failure. Such failure could adversely affect a fund's operations, including
pricing, securities trading, and the servicing of shareholder accounts.
The Vanguard Group is dedicated to providing uninterrupted, high-quality
performance from our computer systems before, during, and after 2000. In July
1998, we completed the renovation and initial testing of our internal systems.
Vanguard is diligently working with external partners, suppliers, and vendors,
including fund managers and other service providers, to assure that the systems
with which we interact remain operational at all times.
In addition to taking every reasonable step to secure our internal systems
and external relationships, Vanguard is further developing contingency plans
intended to assure that unexpected systems failures will not adversely affect
the Fund's operations. Vanguard intends to monitor these processes through the
rollover of 1999 into 2000 and to quickly implement alternate solutions if
necessary.
However, despite Vanguard's efforts and contingency plans, noncompliant
computer systems could have a material adverse effect on the Fund's business,
operations, or financial condition. Additionally, the Fund's performance could
be hurt if a computer-system failure at a company or governmental unit affects
the price of securities the Fund owns.
Dividends, Capital Gains, and Taxes
The Fund distributes to shareholders virtually all of its net income (interest
and dividends less expenses) as well as any capital gains realized from the sale
of its holdings. Income distributions generally occur in June and December;
capital gains distributions generally occur in December.
Dividend and capital gains distributions of Fund shares that are held as an
investment option in an employer-sponsored retirement or savings plan will be
reinvested in additional Fund shares and accumulate on a tax-deferred basis. You
will not owe taxes on these distributions until you begin withdrawals. You
should consult your plan administrator, your plan's Summary Plan Document, or
your own tax adviser about the tax consequences of an investment in the Fund and
of any plan withdrawals.
PLAIN TALK ABOUT
Distributions
As a shareholder, you are entitled to your share of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or a capital gains distribution. Income
dividends come from both the dividends that the fund earns from its holdings and
the interest it receives from its money market and bond investments. Capital
gains are realized whenever the fund sells securities for higher prices than it
paid for them. The capital gains are either short-term or long-term depending on
whether the fund held the securities for less than or more than one year.
<PAGE>
9
Share Price
The Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of trading on the New York Stock Exchange (the NAV
is not calculated on holidays or other days the Exchange is closed). Net asset
value per share is computed by adding up the total value of the Fund's
investments and other assets, subtracting any of its liabilities (debts), and
then dividing by the number of Fund shares outstanding:
Total Assets - Liabilities
Net Asset Value = ------------------------------
Number of Shares Outstanding
Knowing the daily net asset value is useful to you as a shareholder because
it indicates the current value of your investment. The Fund's NAV, multiplied by
the number of shares you own, gives you the dollar amount you would have
received had you sold all of your shares back to the Fund that day.
A Note on Pricing: The Fund's investments will be priced at their market
value when market quotations are readily available. When these quotations are
not readily available, investments will be priced at their fair value,
calculated according to procedures adopted by the Fund's Board of Trustees.
The Fund's share price can be found daily in the mutual fund listings of most
major newspapers under the heading "Vanguard Funds." Different newspapers use
different abbreviations of the Fund's name, but the most common is AssetA.
<PAGE>
10
PLAIN TALK ABOUT
How to Read the Financial Highlights Table
The Fund began fiscal 1998 with a net asset value (price) of $21.53 per share.
During the year, the Fund earned $.79 per share from investment income (interest
and dividends) and $2.33 per share from investments that had appreciated in
value or that were sold for higher prices than the Fund paid for them.
Shareholders received $1.75 per share in the form of dividend and capital
gains distributions. A portion of each year's distributions may come from the
prior year's income or capital gains.
The earnings ($3.12 per share) minus the distributions ($1.75 per share)
resulted in a share price of $22.90 at the end of the year. This was an increase
of $1.37 per share (from $21.53 at the beginning of the year to $22.90 at the
end of the year). For a shareholder who reinvested the distributions in the
purchase of more shares, the total return from the Fund was 15.24% for the year.
As of September 30, 1998, the Fund had $5.64 billion in net assets. For the
year, its expense ratio was 0.49% ($4.90 per $1,000 of net assets); and its net
investment income amounted to 3.80% of its average net assets. It sold and
replaced securities valued at 60% of its net assets.
Financial Highlights
The following financial highlights table is intended to help you understand the
Fund's financial performance for the past five years, and certain information
reflects financial results for a single Fund share. The total returns in the
table represent the rate that an investor would have earned or lost each year on
an investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been derived from the financial statements
audited by PricewaterhouseCoopers LLP, independent accountants, whose
report--along with the Fund's financial statements--is included in the Fund's
most recent annual report to shareholders. You may have the annual report sent
to you without charge by contacting Vanguard.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Vanguard Asset Allocation Fund
Year Ended September 30,
----------------------------------------------
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $21.53 $18.27 $17.03 $13.78 $15.08
- ---------------------------------------------------------------------------------------------
Investment Operations
Net Investment Income .79 .74 .69 .64 .52
Net Realized and Unrealized Gain (Loss)
on Investments 2.33 4.29 1.82 3.18 (.81)
----------------------------------------------
Total from Investment Operations 3.12 5.03 2.51 3.82 (.29)
----------------------------------------------
Distributions
Dividends from Net Investment Income (.74) (.72) (.66) (.57) (.48)
Distributions from Realized Capital Gains (1.01) (1.05) (.61) -- (.53)
----------------------------------------------
Total Distributions (1.75) (1.77) (1.27) (.57) (1.01)
- ---------------------------------------------------------------------------------------------
Net Asset Value, End of Year $22.90 $21.53 $18.27 $17.03 $13.78
=============================================================================================
Total Return 15.24% 29.42% 15.27% 28.57% -2.05%
=============================================================================================
Ratios/Supplemental Data
Net Assets, End of Year (Millions) $5,637 $3,738 $2,341 $1,593 $1,120
Ratio of Total Expenses to
Average Net Assets 0.49% 0.49% 0.47% 0.49% 0.50%
Ratio of Net Investment Income to
Average Net Assets 3.80% 3.96% 4.17% 4.41% 3.68%
Turnover Rate 60% 10% 47% 34% 51%
=============================================================================================
</TABLE>
From time to time, the Vanguard funds advertise yield and total return
figures. Yield is a measure of past dividend income. Total return includes both
past dividend income (assuming that it has been reinvested) plus realized and
unrealized capital appreciation (or depreciation). Neither yield nor total
return should be used to predict the future performance of a fund.
"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.
<PAGE>
11
Investing with Vanguard
The Fund is an investment option in your retirement or savings plan. Your plan
administrator or your employee benefits office can provide you with detailed
information on how to participate in your plan and how to elect the Fund as an
investment option.
[ ] If you have any questions about the Fund or Vanguard, including the Fund's
investment objective, strategies, or risks, contact Vanguard's Participant
Services Center, toll-free, at 1-800-523-1188.
[ ] If you have questions about your account, contact your plan administrator or
the organization that provides recordkeeping services for your plan.
Investment Options and Allocations
Your plan's specific provisions may allow you to change your investment
selections, the amount of your contributions, or how your contributions are
allocated among the investment choices available to you. Contact your plan
administrator or employee benefits office for more details.
Transactions
Contributions, exchanges, or redemptions of the Fund's shares are processed as
soon as they have been received by Vanguard in good order. Good order means that
your request includes complete information on your contribution, exchange, or
redemption, and that Vanguard has received the appropriate assets.
Exchanges
The exchange privilege (your ability to redeem shares from one fund to purchase
shares of another fund) may be available to you through your plan. Although we
make every effort to maintain the exchange privilege, Vanguard reserves the
right to revise or terminate this privilege, limit the amount of an exchange or
reject any exchange, at any time, without notice. Because excessive exchanges
can potentially disrupt the management of the Fund and increase its transaction
costs, Vanguard limits exchange activity to no more than four substantive "round
trips" through the Fund (at least 90 days apart) during any 12-month period. A
"round trip" is a redemption from the Fund followed by a purchase back into the
Fund. "Substantive" means a dollar amount that Vanguard determines, in its sole
discretion, could adversely affect the management of the Fund.
Before making an exchange to or from another fund available in your plan,
consider the following:
[ ] Certain investment options, particularly funds made up of company stock or
investment contracts, may be subject to unique restrictions.
[ ] Make sure to read that fund's prospectus. Contact Participant Services,
toll-free, at 1-800-523-1188 for a copy.
[ ] Vanguard can accept exchanges only as permitted by your plan. Contact your
plan administrator for details on the exchange policies that apply to your
plan.
Accessing Fund Information by Computer
- --------------------------------------------------------------------------------
Vanguard on the World Wide Web www.vanguard.com
Use your personal computer to visit Vanguard's education-oriented website, which
provides timely news and information about Vanguard funds and services; an
online "university" that offers a variety of mutual fund classes; and
easy-to-use, interactive tools to help you create your own investment and
retirement strategies.
- --------------------------------------------------------------------------------
<PAGE>
(This page intentionally left blank.)
<PAGE>
Glossary of Investment Terms
Active Management
An investment approach that seeks to exceed the average returns of the financial
markets. Active managers rely on research, market forecasts, and their own
judgment and experience in selecting securities to buy and sell.
Bond
A debt security (IOU) issued by a corporation, government, or government agency
in exchange for the money you lend it. In most instances, the issuer agrees to
pay back the loan by a specific date and to make regular interest payments until
that date.
Capital Gains Distribution
Payment to mutual fund shareholders of gains realized on securities that the
fund has sold at a profit, minus any realized losses.
Cash Reserves
Cash deposits, short-term bank deposits, and money market instruments which
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's acceptances.
Common Stock
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.
Dividend Income
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
Expense Ratio
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
distribution fees.
Fund Diversification
Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.
Index
An unmanaged group of securities whose overall performance is used as a standard
to measure investment performance.
Investment Adviser
An organization that makes the day-to-day decisions regarding a fund's
investments.
Net Asset Value (NAV)
The market value of a mutual fund's total assets, minus liabilities, divided by
the number of sharesoutstanding. The value of a single share is called its share
value or share price.
Passive Management
A low-cost investment strategy in which a mutual fund attempts to match--rather
than outperform-- a particular stock or bond market index. Also known as
indexing.
Total Return
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
Volatility
The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
Yield
Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE>
The Vanguard Group
Institutional Division
Post Office Box 2900
Valley Forge, PA 19482-2900
For More Information
If you'd like more information about Vanguard Asset Allocation Fund, the
following documents are available free upon request:
Annual/Semiannual Report to Shareholders
Additional information about the Fund's investments is available in the Fund's
annual and semiannual reports to shareholders. In these reports, you will find a
discussion of the market conditions and investment strategies that significantly
affected the Fund's performance during the most recent fiscal year.
Statement of Additional Information (SAI)
The SAI provides more detailed
information about the Fund.
The current annual and semiannual reports and the SAI are incorporated by
reference into (and are thus legally a part of) this prospectus.
To receive a free copy of the latest annual or semiannual report or the SAI, or
to request additional information about the Fund or other Vanguard funds, please
contact us as follows:
The Vanguard Group
Participant Services Center
P.O. Box 2900
Valley Forge, PA 19482-2900
Telephone:
1-800-523-1188
Text Telephone:
1-800-523-8004
World Wide Web:
www.vanguard.com
E-mail:
[email protected]
Information provided by the Securities and Exchange Commission (SEC)
You can review and copy information about the Fund (including the SAI) at the
SEC's Public Reference Room in Washington, D.C. To find out more about this
public service, call the SEC at 1-800-SEC-0330. Reports and other information
about the Fund are also available on the SEC's website (www.sec.gov), or you can
receive copies of this information, for a fee, by writing the Public Reference
Section, Securities and Exchange Commission, Washington, DC 20549-6009.
Fund's Investment Company Act
file number: 811-5628
(C) 1999 Vanguard Marketing
Corporation, Distributor.
All rights reserved.
I078N-01/29/1999
<PAGE>
PART B
VANGUARD ASSET ALLOCATION FUND
(the "Trust")
STATEMENT OF ADDITIONAL INFORMATION
January 29, 1999
This Statement is not a prospectus but should be read in conjunction with
the Trust's current Prospectus (dated January 29, 1999). To obtain the
Prospectus and the Annual Report to Shareholders, containing the Fund's
Financial Statements, which are hereby incorporated by reference, please call:
Investor Information Department
1-800-662-7447 (SHIP)
TABLE OF CONTENTS
Page
------
Description of the Trust ........................... B-1
Futures Contracts and Options ...................... B-3
Portfolio Transactions ............................. B-8
Description of U.S. Government Securities .......... B-9
Description of Repurchase Agreements ............... B-9
Fundamental Investment Limitations ................. B-10
Share Price ........................................ B-11
Purchase of Shares ................................. B-11
Redemption of Shares ............................... B-11
Management of the Trust ............................ B-12
Performance Measures ............................... B-16
Total Return ....................................... B-17
Investment Advisory Services ....................... B-19
Glossary ........................................... B-22
Financial Statements ............................... B-22
DESCRIPTION OF THE TRUST
Organization
The Trust was organized as a Maryland corporation in 1988, and was
reorganized as a Delaware business trust in May, 1998. Prior to its
reorganization as a Delaware business trust, the Trust was known as Vanguard
Asset Allocation Fund, Inc. The Trust is registered with the United States
Securities and Exchange Commission under the Investment Company Act of 1940
(the "1940 Act") as an open-end, diversified management investment company. It
currently offers the following fund and class of shares: Vanguard Asset
Allocation Fund (the "Fund").
The Trust has the ability to offer additional funds or classes of shares.
There is no limit on the number of full and fractional shares that the Trust
may issue for a single fund or class of shares.
Service Providers
Custodian. State Street Bank and Trust Company, 225 Franklin Street,
Boston, Massachusetts 02110, serves as the Trust's custodian. The custodian is
responsible for maintaining the Fund's assets and keeping all necessary
accounts and records.
B-1
<PAGE>
Independent Accountants. PricewaterhouseCoopers LLP, 30 South 17th Street,
Philadelphia, Pennsylvania 19103, serves as the Trust's independent accountants.
The accountants audit financial statements for the Trusts and provide other
related services.
Transfer and Dividend-Paying Agent. The Fund's transfer agent and
dividend-paying agent is The Vanguard Group, Inc., 100 Vanguard Boulevard,
Malvern, Pennsylvania 19355.
Characteristics of the Trust's Shares
Restrictions on Holding or Disposing of Shares. There are no restrictions
on the right of shareholders to retain or dispose of the Trust's shares, other
than the possible future termination of the Trust or any of its funds. The
Trust or any of its funds may be terminated by reorganization into another
mutual fund or by liquidation and distribution of the assets of the affected
fund. Unless terminated by reorganization or liquidation, the Trust and its
funds will continue indefinitely.
Shareholder Liability. The Trust is organized under Delaware law, which
provides that shareholders of a business trust are entitled to the same
limitations of personal liability as shareholders of a corporation organized
under Delaware law. Effectively, this means that a shareholder of the Trust
will not be personally liable for payment of the Trust's debts except by reason
of his or her own conduct or acts. In addition, a shareholder could incur a
financial loss on account of a Trust obligation only if the Trust itself had no
remaining assets with which to meet such obligation. We believe that the
possibility of such a situation arising is extremely remote.
Dividend Rights. The shareholders of a fund are entitled to receive any
dividends or other distributions declared for such fund. No shares have
priority or preference over any other shares of the same fund with respect to
distributions. Distributions will be made from the assets of a fund, and will
be paid ratably to all shareholders of the fund (or class) according to the
number of shares of such fund (or class) held by shareholders on the record
date. The amount of income dividends per share may vary between separate share
classes of the same fund based upon differences in the way that expenses are
allocated between share classes pursuant to a multiple class plan.
Voting Rights. Shareholders are entitled to vote on a matter if: (i) a
shareholder vote is required under the 1940 Act; (ii) the matter concerns an
amendment to the Declaration of Trust that would adversely affect to a material
degree the rights and preferences of the shares of any class or fund; or (iii)
the Trustees determine that it is necessary or desirable to obtain a
shareholder vote. The 1940 Act requires a shareholder vote under various
circumstances, including to elect or remove Trustees upon the written request
of shareholders representing 10% or more of the Trust's net assets, and to
change any fundamental policy of the Trust. Shareholders of the Trust receive
one vote for each dollar of net asset value owned on the record date, and a
fractional vote for each fractional dollar of net asset value owned on the
record date. However, only the shares of the fund affected by a particular
matter are entitled to vote on that matter. Voting rights are non-cumulative
and cannot be modified without a majority vote of shareholders.
Liquidation Rights. In the event of liquidation, shareholders will be
entitled to receive a pro rata share of the net assets of the applicable fund
of the Trust.
Preemptive Rights. There are no preemptive rights associated with the
Trust.
Conversion Rights. There are no conversion rights associated with the
Trust.
Redemption Provisions. The Trust's redemption provisions are described in
its current prospectus and elsewhere in this Statement of Additional
Information.
Sinking Fund Provisions. The Trust has no sinking fund provisions.
Calls or Assessment. The Trust's shares are fully paid and non-assessable.
B-2
<PAGE>
Tax Status of the Trust
The Trust qualifies as a "regulated investment company" under Subchapter M
of the Internal Revenue Code. This special tax status means that a Fund will
not be liable for federal tax or income and capital gains distributed to
shareholders. In order to preserve its tax status, a Fund must comply with
certain requirements. If a Fund fails to meet these requirements in any taxable
year, it will be subject to tax on its taxable income at corporate rates, and
all distributions from earnings and profits, including any distributions of net
tax-exempt income and net long-term capital gains, will be taxable to
shareholders as ordinary income. In addition, a Fund could be required to
recognize unrealized gains, pay substantial taxes and interest, and make
substantial distributions before regaining its tax status as a regulated
investment company.
INVESTMENT POLICIES
The following policies supplement the Trust's investment objectives and
policies set forth in the Prospectus:
Futures Contracts And Options
The Fund may enter into stock index and fixed-income futures contracts,
stock index and fixed income options, and options on such futures contracts to
remain fully invested, or to reduce transactions costs. Futures contracts
provide for the future sale by one party and purchase by another party of a
specified amount of a specific security or index at a specified future time and
at a specified price. Futures contracts which are standardized as to maturity
date and underlying financial instrument are traded on national futures
exchanges. Futures exchanges and trading are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a U.S.
Government Agency. Assets committed to futures contracts will be segregated to
the extent required by law.
Although many fixed-income futures contracts call for actual delivery or
acceptance of the underlying securities at a specified date (stock index
futures contracts do not permit delivery of securities), the contracts are
normally closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold," "selling" a
contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is bought
or sold.
Futures traders are required to make a good faith margin deposit in cash
or government securities with a broker or custodian to initiate and maintain
open positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin which
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
B-3
<PAGE>
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes (anticipated or potential) in the value of securities
currently owned or expected to be acquired by them. Speculators are less
inclined to own the securities underlying the futures contracts which they
trade, and use futures contracts with the expectation of realizing profits from
fluctuations in the value of the underlying securities. The Fund intends to use
futures contracts only for hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions except to the
extent that the aggregate initial margins and premiums required to establish
any non-hedging positions do not exceed five percent of the value of the Fund's
portfolio. The Fund will only sell futures contracts to protect securities it
owns against price declines or purchase contracts to protect against an
increase in the price of securities it intends to purchase. As evidence of this
hedging interest, the Fund expects that approximately 75% of its futures
contract purchases will be "completed," that is, equivalent amounts of related
securities will have been purchased or are being purchased by the Fund upon
sale of open futures contracts.
Restrictions on the Use of Futures Contracts and Options. The Fund will
not enter into futures contract transactions to the extent that, immediately
thereafter, the sum of its initial margin deposits on open contracts exceeds 5%
of the Fund's total assets; however, because only a small margin deposit is
required to trade in futures and options, the Fund may have up to 50% of the
value of its assets exposed to futures and options.
Risk Factors in Futures Transactions. Positions in futures may be closed
out only on an Exchange which provides a secondary market for such futures.
However, there can be no assurance that a liquid secondary market will exist
for any particular futures contract at any specific time. Thus, it may not be
possible to close a futures position. In the event of adverse price movements,
the Fund would continue to be required to make daily cash payments to maintain
its required margin. In such situations, if the Fund has insufficient cash, it
may have to sell portfolio securities to meet daily margin requirements at a
time when it may be disadvantageous to do so. The inability to close options
and futures positions also could have an adverse impact on the ability to hedge
effectively.
The Fund will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures contracts. As a result, a
relatively small price movement in a futures contract may result in immediate
and substantial loss (or gain) to the investor. For example, if at the time of
purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. The Fund also bears the risk
that the Adviser will incorrectly predict future market trends. However,
because the futures strategies of the Fund are engaged in only for hedging
purposes, the adviser does not believe that the Fund is subject to the risks of
loss frequently associated with futures transactions. The Fund would presumably
have sustained comparable losses if, instead of the futures contract, it had
invested in the underlying financial instrument and sold it after the decline.
B-4
<PAGE>
Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is
also possible that the Fund could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a futures contract or related
option.
Most futures exchanges limit the amount of fluctuation permitted in some
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of future positions and
subjecting some futures traders to substantial losses.
Federal Tax Treatment of Futures Contracts. The Fund is required for
Federal income tax purposes to recognize as income for each taxable year its
net unrealized gains and losses on futures contracts as of the end of the year
as well as those actually realized during the year. In most cases, any gain or
loss recognized with respect to a futures contract is considered to be 60%
long-term capital gain or loss and 40% short-term capital gain or loss, without
regard to the holding period of the contract. Furthermore, sales of futures
contracts which are intended to hedge against a change in the value of
securities held by the Fund may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. The Fund may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Fund.
In order for the Fund to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest income derived from loans of securities, and gains from the sale of
securities or foreign currencies, or other income derived with respect to its
business of investing in such securities or currencies. It is anticipated that
any net gain realized from the closing out of futures contracts will be
considered qualifying income for purposes of the 90% requirement.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes including unrealized
gains at the end of the Fund's fiscal year on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Fund's other investments and shareholders will be advised on the nature of
the payments.
Illiquid Securities
The Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are securities that may not be sold or disposed of in the
ordinary course of business within seven business days at approximately the
value at which they are being carried on the Fund's books.
The Fund may invest in restricted, privately placed securities that, under
SEC rules, may be sold only to qualified institutional buyers. Because these
securities can be resold only to qualified institutional buyers, they may be
considered illiquid securities -- meaning that they could be difficult for the
Fund to convert to cash if needed.
If a substantial market develops for a restricted security held by the
Fund, it will be treated as a liquid security, in accordance with procedures
and guidelines approved by the Fund's Board of Trustees. This generally
includes securities that are unregistered that can be sold to qualified
institutional buyers in accordance
B-5
<PAGE>
with Rule 144A under the 1933 Act. While the Fund's investment adviser
determines the liquidity of restricted securities on a daily basis, the Board
oversees and retains ultimate responsibility for the adviser's decisions.
Several factors the Board considers in monitoring these decisions include the
valuation of a security, the availability of qualified institutional buyers,
and the availability of information about the security's issuer.
Lending of Securities
The Fund may lend its investment securities to qualified institutional
investors (typically brokers, dealers, banks or other financial institutions)
who need to borrow securities in order to complete certain transactions, such
as covering short sales, avoiding failures to deliver securities or completing
arbitrage operations. By lending its investment securities, the Fund attempts
to increase its net investment income through the receipt of interest on the
loan. Any gain or loss in the market price of the securities loaned that might
occur during the term of the loan would be for the account of the Fund. The
terms and the structure and the aggregate amount of such loans must be
consistent with the Investment Company Act of 1940, and the Rules and
Regulations or interpretations of the Securities and Exchange Commission (the
"Commission") thereunder. These provisions limit the amount of securities a
fund may lend to 33 1/3% of the Fund's total assets, and require that (a) the
borrower pledge and maintain with the Fund collateral consisting of cash, an
irrevocable letter of credit or securities issued or guaranteed by the United
States Government having at all times not less than 100% of the value of the
securities loaned, (b) the borrower add to such collateral whenever the price
of the securities loaned rises (i.e., the borrower "marks to the market" on a
daily basis), (c) the loan be made subject to termination by the Fund at any
time, and (d) the Fund receive reasonable interest on the loan (which may
include the Fund's investing any cash collateral in interest bearing short-term
investments), any distribution on the loaned securities and any increase in
their market value. Loan arrangements made by the Fund will comply with all
other applicable regulatory requirements, including the rules of the New York
Stock Exchange, which presently require the borrower, after notice, to
redeliver the securities within the normal settlement time of three business
days. All relevant facts and circumstances, including the creditworthiness of
the broker, dealer or institution, will be considered in making decisions with
respect to the lending of securities, subject to review by the Trust's Board of
Trustees.
Vanguard Interfund Lending Program
The SEC has issued an exemptive order permitting the Fund to participate
in Vanguard's interfund lending program. This program allows the Vanguard funds
to borrow money from and loan money to each other for temporary or emergency
purposes. The program is subject to a number of conditions, including the
requirement that no fund may borrow or lend money through the program unless it
receives a more favorable interest rate than is available from a typical bank
for a comparable transaction. In addition, a fund may participate in the
program only if and to the extent that such participation is consistent with
the fund's investment objective and other investment policies. The Boards of
Trustees of the Vanguard funds are responsible for ensuring that the interfund
lending program operates in compliance with all conditions of the SEC's
exemptive order.
Temporary Investments
The Fund may take temporary defensive measures that are inconsistent with
the Fund's normal investment strategies in response to adverse market,
economic, political or other conditions. Such measures could include
investments in (a) highly liquid short-term fixed income securities issued by
or on behalf of municipal or corporate issuers, obligations of the U.S.
Government and its agencies, commercial paper, and bank certificates of
deposit; (b) shares of other investment companies which have investment
objectives consistent
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with those of the Fund; (c) repurchase agreements involving any such
securities; and (d) other money market instruments. There is no limit on the
extent to which the Fund may take temporary defensive measures. In taking such
measures, the Fund may fail to achieve its investment objective.
Foreign Investments
Vanguard Asset Allocation Fund may invest up to 20% of its assets in
securities of foreign companies. Investors should recognize that investing in
foreign companies involves certain special considerations which are not
typically associated with investing in U.S. companies.
Currency Risk. Since the stocks of foreign companies are frequently
denominated in foreign currencies, and since the Fund may temporarily hold
uninvested reserves in bank deposits in foreign currencies, the Fund will be
affected favorably or unfavorably by changes in currency rates and in exchange
control regulations, and may incur costs in connection with conversions between
various currencies. The investment policies of Vanguard Asset Allocation Fund
permit it to enter into forward foreign currency exchange contracts in order to
hedge the Fund's holdings and commitments against changes in the level of
future currency rates. Such contracts involve an obligation to purchase or sell
a specific currency at a future date at a price set at the time of the
contract.
Federal Tax Treatment of Non-U.S. Transactions. Special rules govern the
Federal income tax treatment of certain transactions denominated in terms of a
currency other than the U.S. dollar or determined by reference to the value of
one or more currencies other than the U.S. dollar. The types of transactions
covered by the special rules include the following: (i) the acquisition of, or
becoming the obligor under, a bond or other debt instrument (including, to the
extent provided in Treasury regulations, preferred stock); (ii) the accruing of
certain trade receivables and payables; and (iii) the entering into or
acquisition of any forward contract, futures contract, option and similar
financial instrument if such instrument is not marked to market. The
disposition of a currency other than the U.S. dollar by a U.S. taxpayer is also
treated as a transaction subject to the special currency rules. However,
foreign currency-related regulated futures contracts and non-equity options are
generally not subject to the special currency rules if they are or would be
treated as sold for their fair market value at year-end under the
marking-to-market rules applicable to other futures contracts unless an
election is made to have such currency rules apply. With respect to
transactions covered by the special rules, foreign currency gain or loss is
calculated separately from any gain or loss on the underlying transaction and
is normally taxable as ordinary gain or loss. A taxpayer may elect to treat as
capital gain or loss foreign currency gain or loss arising from certain
identified forward contracts, futures contracts and options that are capital
assets in the hands of the taxpayer and which are not part of a straddle. The
Treasury Department issued regulations under which certain transactions subject
to the special currency rules that are part of a "section 988 hedging
transaction" (as defined in the Internal Revenue Code of 1986, as amended, and
the Treasury regulations) will be integrated and treated as a single
transaction or otherwise treated consistently for purposes of the Code. Any
gain or loss attributable to the foreign currency component of a transaction
engaged in by a Fund which is not subject to the special currency rules (such
as foreign equity investments other than certain preferred stocks) will be
treated as capital gain or loss and will not be segregated from the gain or
loss on the underlying transaction. It is anticipated that some of the non-U.S.
dollar-denominated investments and foreign currency contracts Vanguard Asset
Allocation Fund may make or enter into will be subject to the special currency
rules described above.
Country Risk. As foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards and practices comparable
to those applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more
volatile than securities of comparable
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domestic companies. There is generally less government supervision and
regulation of stock exchanges, brokers and listed companies than in the U.S. In
addition, with respect to certain foreign countries, there is the possibility
of expropriation or confiscatory taxation, political or social instability, or
diplomatic developments which could affect U.S. investments in those countries.
Although the Fund will endeavor to achieve most favorable execution costs
in their portfolio transactions, fixed commissions on many foreign stock
exchanges are generally higher than negotiated commissions on U.S. exchanges.
In addition, it is expected that the expenses for custodian arrangements of the
Fund's foreign securities will be somewhat greater than the expenses for the
custodian arrangements for handling U.S. securities of equal value.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income received from foreign companies held by the Fund.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the Adviser (with the
approval of the Trust's Board of Trustees) to select the brokers or dealers
that will execute the purchases and sales of portfolio securities for the Fund
and directs the Adviser to use its best efforts to obtain the best available
price and most favorable execution as to all transactions for the Fund. The
Adviser undertakes to execute each investment transaction at a price and
commission which provides the most favorable total cost or proceeds reasonably
obtainable under the circumstances.
In placing portfolio transactions, the Adviser will use its best judgment
to choose the broker most capable of providing the brokerage services necessary
to obtain best available price and most favorable execution. The full range and
quality of brokerage services available will be considered in making these
determinations. In those instances where it is reasonably determined that more
than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration may be given to
those brokers which supply investment research and statistical information and
provide other services in addition to execution services to the Fund and/or the
Adviser. The Adviser considers such information useful in the performance of
its obligations under the agreement, but is unable to determine the amount by
which such services may reduce its expenses.
The investment advisory agreement also incorporates the concepts of
Section 28(e) of the Securities Exchange Act of 1934 by providing that, subject
to the approval of the Trust's Board of Trustees, the Adviser may cause the
Fund to pay a broker-dealer which furnishes brokerage and research services a
higher commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of the Adviser to the Trust.
Currently, it is the Fund's policy that the Adviser may at times pay
higher commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be in the best interest of the Fund. Some
brokers or dealers who may receive such higher commissions in recognition of
brokerage services related to execution of securities transactions are also
providers of research information to the Adviser and/or the Trust.
The total brokerage commissions paid by the Fund for the fiscal years
ended September 30, 1996, 1997, and 1998, totaled $127,528, $113,938, and
$96,955, respectively.
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Some securities considered for investment by the Fund may also be
appropriate for other clients served by the Adviser. If purchases or sales of
securities consistent with the investment policies of the Fund and one or more
of these other clients serviced by the Adviser are considered at or about the
same time, transactions in such securities will be allocated among the Trust
and such other clients in a manner deemed equitable by the Adviser.
Description of U.S. Government Securities
As used in this Statement of Additional Information, the term "U.S.
Government Securities" refers to a variety of securities which are issued or
guaranteed by the United States Treasury, by various agencies of the United
States Government, and by various instrumentalities which have been established
or sponsored by the United States Government. The term also refers to
"repurchase agreements" collateralized by such securities.
U.S. Treasury Securities are backed by the "full faith and credit" of the
United States. Securities issued or guaranteed by Federal agencies and U.S.
Government sponsored instrumentalities may or may not be backed by the full
faith and credit of the United States. In the case of securities not backed by
the full faith and credit of the United States, the investor must look
principally to the agency or instrumentality issuing or guaranteeing the
obligation for ultimate repayment, and may not be able to assert a claim
against the United States itself in the event the agency or instrumentality
does not meet its commitment.
Some of the U.S. Government agencies that issue or guarantee securities
include the Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Maritime Administration, Small
Business Administration, and The Tennessee Valley Authority.
An instrumentality of the U.S. Government is a government agency organized
under Federal charter with government supervision. Instrumentalities issuing or
guaranteeing securities include, among others, Federal Home Loan Banks, the
Federal Land Banks, Central Bank for Cooperatives, Federal Intermediate Credit
Banks, and the Federal National Mortgage Association.
Description of Repurchase Agreements
Repurchase agreements are transactions by which a person purchases a
security and simultaneously commits to resell that security to the seller (a
member bank of the Federal Reserve System or recognized securities dealer) at
an agreed upon price on an agreed upon date within a number of days (usually
not more than seven) from the date of purchase. The resale price reflects the
purchase price plus an agreed upon market rate of interest which is unrelated
to the coupon rate or maturity of the purchased security. A repurchase
agreement involves the obligation of the seller to pay the agreed upon price,
which obligation is in effect secured by the value of the underlying security.
The use of repurchase agreements involves certain risks. For example, if
the seller of the agreement defaults on its obligation to repurchase the
underlying securities at a time when the value of these securities has
declined, the Trust may incur a loss upon disposition of them. If the seller of
the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a bankruptcy court may determine that
the underlying securities are collateral not within the control of the Trust
and therefore subject to sale by the trustee in bankruptcy. Finally, it is
possible that the Trust may not be able to substantiate its interest in the
underlying securities. While the Trust's management acknowledges these risks,
it is expected that they can be controlled through stringent security selection
criteria and careful monitoring procedures.
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FUNDAMENTAL INVESTMENT LIMITATIONS
The Fund is subject to the following fundamental investment limitations,
which cannot be changed in any material way without the approval of the holders
of a majority of the Fund's shares. For these purposes, a "majority" of the
Fund's shares means shares representing the lesser of: (i) 67% of the Fund's
net asset value, so long as shares representing more than 50% of the Fund's net
asset value are present or represented by proxy; or (ii) more than 50% of the
Fund's net asset value.
Borrowing. The Fund may not borrow money, except for temporary or
emergency purposes in an amount not exceeding 15% of the Fund's net assets. The
Fund may borrow money through banks, reverse repurchase agreements, or
Vanguard's interfund lending program only, and must comply with all applicable
regulatory conditions. The Fund may not make any additional investments
whenever its outstanding borrowings exceed 5% of net assets.
Commodities. The Fund may not invest in commodities, except that it may
invest in bond or stock futures contracts, bond or stock options and options on
bond or stock futures contracts. No more than 5% of the Fund's total assets may
be used as initial margin deposit for futures contracts, and no more than 50%
of the Fund's total assets may be invested in futures contracts or options at
any time.
Diversification. With respect to 75% of its total assets, the Fund may
not: (i) purchase more than 10% of the outstanding voting securities of any one
issuer; or (ii) purchase securities of any issuer if, as a result, more than 5%
of the Fund's total assets would be invested in that issuer's securities. This
limitation does not apply to obligations of the United States Government, its
agencies, or instrumentalities.
Industry Concentration. The Fund may not invest more than 25% of its total
assets in any one industry.
Investing for Control. The Fund may not invest in a company for purposes
of controlling its management.
Investment Companies. The Fund may not invest in any other investment
company, except through a merger, consolidation or acquisition of assets, or to
the extent permitted by Section 12 of the 1940 Act. Investment companies whose
shares the Fund acquires pursuant to Section 12 must have investment objectives
and investment policies consistent with those of the Fund.
Loans. The Fund may not lend money to any person except by purchasing
fixed income securities that are publicly distributed, lending its portfolio
securities, or through Vanguard's interfund lending program.
Margin. The Fund may not purchase securities on margin or sell securities
short, except as permitted by the Fund's investment policies relating to
commodities.
Pledging assets. The Fund may not pledge, mortgage or hypothecate more
than 15% of its net assets.
Real Estate. The Fund may not invest directly in real estate, although it
may invest in securities of companies that deal in real estate and bonds
secured by real estate.
Senior securities. The Fund may not issue senior securities, except in
compliance with the 1940 Act.
Underwriting. The Fund may not engage in the business of underwriting
securities issued by other persons. The Fund will not be considered an
underwriter when disposing of its investment securities.
The investment limitations above are considered at the time that
investment securities are purchased.
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None of these limitations prevents the Trust from participating in The
Vanguard Group ("Vanguard"). Because the Trust is a member of the Group, the
Fund may own securities issued by Vanguard, make loans to Vanguard, and
contribute to Vanguard's costs or other financial requirement. See "Management
of the Trust" for more information.
SHARE PRICE
The Fund's share price, or "net asset value" per share, is calculated by
dividing the total assets of the Fund, less all liabilities, by the total
number of shares outstanding. The net asset value is determined as of the close
of the New York Stock Exchange (generally 4:00 p.m. Eastern time) on each day
that the Exchange is open for trading.
Portfolio securities for which market quotations are readily available
(includes those securities listed on national securities exchanges, as well as
those quoted on the NASDAQ Stock Market) will be valued at the last quoted
sales price on the day the valuation is made. Such securities which are not
traded on the valuation date are valued at the mean of the bid and ask prices.
Price information on exchange-listed securities is taken from the exchange
where the security is primarily traded. Any foreign securities are valued at
the latest quoted sales price available before the time when assets are valued.
Securities may be valued on the basis of prices provided by a pricing service
when such prices are believed to reflect the fair market value of such
securities.
Short-term instruments (those acquired with remaining maturities of 60
days or less) may be valued at cost, plus or minus any amortized discount or
premium, which approximates market value.
Bonds and other fixed income securities may be valued on the basis of
prices provided by a pricing service when such prices are believed to reflect
the fair market value of such securities. The prices provided by a pricing
service may be determined without regard to bid or last sale prices of each
security, but take into account institutional-size transactions in similar
groups of securities as well as any developments related to specific
securities.
Other assets and securities for which no quotations are readily available
or which are restricted as to sale (or resale) are valued by such methods as
the Board of Trustees deems in good faith to reflect fair value.
The share price for the Fund can be found daily in the mutual fund
listings of most major newspapers under the heading of "Vanguard Funds."
PURCHASE OF SHARES
The Trust reserves the right in its sole discretion (i) to suspend the
offerings of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Trust, and (iii) to
reduce or waive the minimum investment for or any other restrictions on initial
and subsequent investments for certain fiduciary accounts or under
circumstances where certain economies can be achieved in sales of the Trust's
shares.
REDEMPTION OF SHARES
The Trust may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange is closed, or
trading on the Exchange is restricted as determined by the Securities and
Exchange Commission (the "Commission"), (ii) during any period when an
emergency exists as defined by the rules of the Commission as a result of which
it is not reasonably practicable for the Trust to dispose of securities owned
by it, or fairly to determine the value of its assets, and (iii) for such other
periods as the Commission may permit.
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No charge is made by the Fund for redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the
securities held by the Trust.
Trading Shares through Charles Schwab
The Trust has authorized Charles Schwab & Co., Inc. ("Schwab") to accept
on its behalf purchase and redemption orders under certain terms and
conditions. Schwab is also authorized to designate other intermediaries to
accept purchase and redemption orders on the Trust's behalf subject to those
terms and conditions. Under this arrangement, the Trust will be deemed to have
received a purchase or redemption order when Schwab or, if applicable, Schwab's
authorized designee, accepts the order in accordance with the Trust's
instructions. Customer orders that are properly transmitted to the Trust by
Schwab, or if applicable, Schwab's authorized designee, will be priced as
follows:
Orders received by Schwab before 3 p.m. Eastern time on any business day,
will be sent to Vanguard that day and your share price will be based on the
Trust's net asset value calculated at the close of trading that day. Orders
received by Schwab after 3 p.m. Eastern time, will be sent to Vanguard on the
following business day and your share price will be based on the Trust's net
asset value calculated at the close of trading that day.
MANAGEMENT OF THE TRUST
Trustees and Officers
The Officers of the Trust manage its day-to-day operations and are
responsible to the Trust's Board of Trustees. The Trustees set broad policies
for the Trust and choose its Officers. The following is a list of Trustees and
Officers of the Trust and a statement of their present positions and principal
occupations during the past five years. As a group, the Trust's Trustees and
Officers own less than 1% of the outstanding shares of the Trust. Each Trustee
also serves as a Director of The Vanguard Group, Inc., and as a Trustee of each
of the 36 investment companies administered by Vanguard (35 in the case of Mr.
Malkiel and 28 in the case of Mr. MacLaury). The mailing address of the
Trustees and Officers of the Trust is Post Office Box 876, Valley Forge, PA
19482.
JOHN C. BOGLE, (DOB: 5/8/1929) Senior Chairman and Trustee*
Senior Chairman and Director of The Vanguard Group, Inc., and Trustee of each
of the investment companies in The Vanguard Group. Director of The Mead Corp.
(Paper Products), General Accident Insurance, and Chris-Craft Industries, Inc.
(Broadcasting & Plastics Manufacturer).
JOHN J. BRENNAN, (DOB: 7/29/1954) Chairman, Chief Executive Officer & Trustee*
Chairman, Chief Executive Officer and Director of The Vanguard Group, Inc.,
and Trustee of each of the investment companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN, (DOB: 1/25/1950) Trustee
Vice President, Chief Information Officer, and member of the Executive
Committee of Johnson and Johnson (Pharmaceuticals/Consumer Products), Director
of Johnson & Johnson*MERCK Consumer Pharmaceuticals Co., Women First
HealthCare, Inc. (Research and Education Institution), Recording for the Blind
and Dyslexic, The Medical Center at Princeton, and Women's Research and
Education Institute.
BRUCE K. MACLAURY, (DOB: 5/7/1931) Trustee
President Emeritus of The Brookings Institution (Independent Non-Partisan
Research Organization); Director of American Express Bank Ltd., The St. Paul
Companies, Inc. (Insurance and Financial Services), and National Steel Corp.
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BURTON G. MALKIEL, (DOB: 8/28/1932) Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress
& Co. (Investment Management), The Jeffrey Co. (Holding Company), and Southern
New England Telecommunications Co.
ALFRED M. RANKIN, Jr., (DOB: 10/8/1941) Trustee
Chairman, President, Chief Executive Officer, and Director of NACCO Industries
(Machinery/Coal/ Appliances); Director of The BFGoodrich Co. (Aircraft
Systems/Manufacturing/Chemicals), and The Standard Products Co. (Rubber
Products Company).
JOHN C. SAWHILL, (DOB: 6/12/1936) Trustee
President and Chief Executive Officer of The Nature Conservancy (Non-Profit
Conservation Group); Director of Pacific Gas and Electric Co., Procter & Gamble
Co., NACCO Industries (Machinery/Coal/Appliances), and Newfield Exploration Co.
(Energy); formerly, Director and Senior Partner of McKinsey & Co., and
President of New York University.
JAMES O. WELCH, JR., (DOB: 5/13/1931) Trustee
Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman
and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO
Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON, (DOB: 3/2/1936) Trustee
Chairman and Chief Executive Officer of Rohm & Haas Co. (Chemicals); Director
of Cummins Engine Co. (Diesel Engine Company), and The Mead Corp. (Paper
Products); and Trustee of Vanderbilt University.
RAYMOND J. KLAPINSKY, (DOB: 12/7/1938) Secretary*
Managing Director of The Vanguard Group, Inc.; Secretary of The Vanguard Group,
Inc. and of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS, (DOB: 5/21/1957) Treasurer*
Principal of The Vanguard Group, Inc.; Treasurer of each of the investment
companies in The Vanguard Group.
ROBERT D. SNOWDEN, (DOB: 9/4/1961) Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
------------
* Officers of the Trust are "interested persons" as defined in the Investment
Company Act of 1940.
The Trust is a member of The Vanguard Group of Investment Companies, which
consists of more than 35 investment companies (the "Trusts"). Through their
jointly-owned subsidiary, The Vanguard Group, Inc. ("Vanguard"), the Trust and
the other Trusts in Vanguard obtain at cost virtually all of their corporate
management, administrative and distribution services. Vanguard also provides
investment advisory services on an at-cost basis to certain of the Vanguard
Trusts.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Trusts and also
furnishes the Trusts with necessary office space, furnishings and equipment.
Each Trust pays its share of Vanguard's total expenses which are allocated
among the Trusts under methods approved by the Board of Trustees of each Trust.
In addition, each Trust bears its own direct expenses such as legal, auditing
and custodian fees.
The Trust's officers are also officers and employees of Vanguard. No
officer or employee owns, or is permitted to own, any securities of any
external adviser for the Trusts.
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Vanguard adheres to a Code of Ethics established pursuant to Rule 17j-1
under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines similar to, and in many
cases more restrictive than, those recommended by a blue ribbon panel of mutual
fund industry executives.
Vanguard was established and operates under an Amended and Restated Funds'
Service Agreement which was approved by the shareholders of each of the Trusts.
The amounts which each of the Trusts have invested are adjusted from time to
time in order to maintain the proportionate relationship between each Trust's
relative net assets and its contribution to Vanguard's capital. The Amended and
Restated Funds' Service Agreement provides that: (a) each Vanguard Trust may
invest up to .40% of its current assets in Vanguard, and (b) there is no limit
on the dollar amount that each Vanguard Trust may contribute to Vanguard's
capitalization. At September 30, 1998, the Trust had contributed capital of
$1,071,000, representing 1.5% of Vanguard's capitalization.
Management
Corporate management and administrative services include: (1) executive
staff; (2) accounting and financial; (3) legal and regulatory; (4) shareholder
account maintenance; (5) monitoring and control of custodian relationships; (6)
shareholder reporting; and (7) review and evaluation of advisory and other
services provided to the Trusts by third parties. During the fiscal year ended
September 30, 1998, the Trust's allocated share of Vanguard's actual net costs
of operations relating to management and administrative services (including
transfer agency) totaled approximately $17,431,000.
Distribution
Vanguard Marketing Corporation, a wholly-owned subsidiary of The Vanguard
Group, Inc. provides all distribution and marketing activities for the Trusts
in the Group. The principal distribution expenses are for advertising,
promotional materials and marketing personnel. Distribution services may also
include organizing and offering to the public, from time to time, one or more
new investment companies which will become members of The Vanguard Group. The
Trustees and Officers of Vanguard determine the amount to be spent annually on
distribution activities, the manner and amount to be spent on each Trust, and
whether to organize new investment companies.
One-half of the distribution expenses of a marketing and promotional
nature is allocated among the Trusts based upon relative net assets. The
remaining one-half of those expenses is allocated among the Trusts based upon
each Trust's sales for the preceding 24 months relative to the total sales of
the Trusts as a Group, provided, however, that no Trust's aggregate quarterly
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of average distribution expense rate for The Vanguard
Group, and that no Trust shall incur annual distribution expenses in excess of
20/100 of 1% of its average month-end net assets. During the fiscal year ended
September 30, 1998, the Trust incurred approximately $1,124,000 of The Vanguard
Group's distribution and marketing expenses, which represented an effective
annual rate of .02 of 1% of the Trust's average net assets.
Investment Advisory Services
Vanguard provides investment advisory services to several Vanguard Trusts.
These services are provided on an at-cost basis from a money management staff
employed directly by Vanguard. The compensation and other expenses of this
staff are paid by the funds and Trusts utilizing these services.
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Trustee Compensation
The individuals in the following table serve as Trustees of all Vanguard
Trusts, and each Trust pays a proportionate share of the Trustees'
compensation. The Trusts employ their officers on a shared basis, as well.
However, officers are compensated by The Vanguard Group, Inc., not the Trusts.
Independent Trustees. The Trusts compensate their independent Trustees --
that is, the ones who are not also officers of the Trust in three ways:
o The independent Trustees receive an annual fee for their service to the
Trusts, which is subject to reduction based on absences from scheduled
Board meetings.
o The independent Trustees are reimbursed for the travel and other expenses
that they incur in attending Board meetings.
o Upon retirement, the independent Trustees receive an aggregate annual fee
of $1,000 for each year served on the Board, up to fifteen years of
service. This annual fee is paid for ten years following retirement, or
until each Trustee's death.
"Interested" Trustees. The Trusts' interested Trustees -- Messrs. Bogle
and Brennan -- receive no compensation for their service in that capacity.
However, they are paid in their role as officers of The Vanguard Group, Inc.
Compensation Table. The following table provides compensation details for
each of the Trustees. For the Trust, we list the amounts paid as compensation
and accrued as retirement benefits by the Trust for each Trustee. In addition,
the table shows the total amount of benefits that we expect each Trustee to
receive from all Vanguard Trusts upon retirement, and the total amount of
compensation paid to each Trustee by all Vanguard Trusts. All information shown
is for the fiscal year ended September 30, 1998.
VANGUARD ASSET ALLOCATION FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
Pension or Retirement Estimated
Aggregate Benefits Accrued as Annual Benefits Total Compensation
Compensation Part of Trust Upon From All Vanguard Trusts
Names of Trustees From Trust Expenses Retirement Paid to Trustees(1)
- ------------------------------- -------------- ----------------------- ----------------- -------------------------
<S> <C> <C> <C> <C>
John C. Bogle -- -- -- --
John J. Brennan -- -- -- --
Barbara Barnes Hauptfuhrer(2) $1,000 $135 $15,000 $75,000
JoAnn Heffernan Heisen $ 250 $ 59 $15,000 $18,750
Robert E. Cawthorn(2) $ 667 $ 90 $ 6,000 $50,000
Bruce K. MacLaury $1,047 $102 $12,000 $70,000
Burton G. Malkiel $1,007 $ 97 $15,000 $75,000
Alfred M. Rankin, Jr. $1,000 $ 71 $15,000 $75,000
John C. Sawhill $1,000 $ 90 $15,000 $75,000
James O. Welch, Jr. $1,000 $104 $15,000 $75,000
J. Lawrence Wilson $1,000 $ 75 $15,000 $75,000
</TABLE>
- ------------
(1) The amounts reported in this column reflect the total compensation paid to
each Trustee for their service as Trustee of 36 Vanguard Trusts (35 in the
case of Mr. Malkiel; 28 in the case of Mr. MacLaury).
(2) Mr. Cawthorn and Mrs. Hauptfuhrer have retired from the Trust's Board,
effective May 31, 1998 and December 31, 1998, respectively.
B-15
<PAGE>
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member trusts of The Vanguard Group of Investment Companies.
Each of the investment company members of The Vanguard Group, including
Vanguard Asset Allocation Fund, may, from time to time, use one or more of the
following unmanaged indices for comparative performance purposes.
Standard & Poor's 500 Composite Stock Price Index -- contains the stocks of 500
of the largest domestic companies.
Standard & Poor's MidCap 400 Index -- is composed of 400 medium sized domestic
stocks.
Standard & Poor's SmallCap 600/BARRA Value Index -- contains stocks of the S&P
SmallCap 600 Index which have a lower than average price-to-book ratio.
Standard & Poor's SmallCap 600/BARRA Growth Index -- contains stocks of the S&P
SmallCap 600 Index which have a higher than average price-to-book ratio.
Russell 1000 Value Index -- consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the lowest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000.
Wilshire 5000 Equity Index -- consists of nearly 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
Wilshire 4500 Equity Index -- consists of all stocks in the Wilshire 5000
except for the 500 stocks in the Standard and Poor's 500 Index.
Morgan Stanley Capital International EAFE Index -- is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia, Asia and the Far East.
Goldman Sachs 100 Convertible Bond Index -- currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
Salomon Brothers GNMA Index -- includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government National
Mortgage Association.
Salomon Brothers High-Grade Corporate Bond Index -- consists of publicly
issued, non-convertible corporate bonds rated AA or AAA. It is a
value-weighted, total return index, including approximately 800 issues with
maturities of 12 years or greater.
Lehman Brothers Aggregate Bond Index -- is a market weighted index that
contains over 4,000 individually priced U.S. Treasury, agency, corporate, and
mortgage pass-through securities corporate rated BBB - or better. The Index has
a market value of over $4 trillion.
Lehman Brothers Mutual Fund Short (1-5) Government/Corporate Index -- is a
market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate investment grade bonds rated BBB - or better
with maturities between 1 and 5 years. The index has a market value of over
$1.6 trillion.
B-16
<PAGE>
Lehman Brothers Mutual Fund Intermediate (5-10) Government/Corporate Index --
is a market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate securities rated BBB - or better with
maturities between 5 and 10 years. The index has a market value of over $700
billion.
Lehman Brothers Long (10+) Government/Corporate Index -- is a market weighted
index that contains over 1,900 individually priced U.S. Treasury, agency, and
corporate securities rated BBB - or better with maturities greater than 10
years. The index has a market value of over $900 billion.
Lehman Long-Term Treasury Bond Index -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
Merrill Lynch Corporate & Government Bond Index -- consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index -- all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
Lehman Brothers Long-Term Corporate Bond Index -- is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Bond Index -- is a yield index on current coupon high
grade general obligation municipal bonds.
Standard & Poor's Preferred Index -- is a yield index based upon the average
yield of four high grade, noncallable preferred stock issues.
NASDAQ Industrial Index -- is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
Composite Index -- 70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
Composite Index -- 65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
Composite Index -- 65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index, 12.5% Standard & Poor's Utilities Index and 12.5% Standard & Poor's
Telephone Index).
Lehman Long-Term Corporate AA or Better Bond Index -- consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
TOTAL RETURN
The average annual total return for the Fund for one and five years ended
September 30, 1998 and for the period from inception (November 3, 1988) to
September 30, 1998 was +15.24%, +16.71% and +15.64%, respectively.
B-17
<PAGE>
Total return is computed by determining the average compounded rates of
return over the periods set forth above that would equate an initial amount
invested at the beginning of the periods to the ending redeemable value of the
investment.
Average Annual Total Return
Average annual total return is the average annual compounded rate of
return for the periods of one year, five years, ten years or the life of the
Fund, all ended on the last day of a recent month. Average annual total return
quotations will reflect changes in the price of the Fund's shares and assume
that all dividends and capital gains distributions during the respective
periods were reinvested in Fund shares. Average annual total return is
calculated by finding the average annual compounded rates of return of a
hypothetical investment over such periods according to the following formula
(average annual total return is then expressed as a percentage):
T = (ERV/P)1/n-1
Where:
T = average annual total return
P = a hypothetical initial investment of $1,000
n = number of years
ERV = ending redeemable value: ERV is the value, at the end of the
applicable period, of a hypothetical $1,000 investment made at
the beginning of the applicable period.
Cumulative Total Return
Cumulative total return is the cumulative rate of return on a hypothetical
initial investment of $1,000 for a specified period. Cumulative total return
quotations reflect changes in the price of the Fund's shares and assume that
all dividends and capital gains distributions during the period were reinvested
in Fund shares. Cumulative total return is calculated by finding the cumulative
rates of a return of a hypothetical investment over such periods, according to
the following formula (cumulative total return is then expressed as a
percentage):
C = (ERV/P)-1
Where:
C = cumulative total return
P = a hypothetical initial investment of $1,000
ERV = ending redeemable value: ERV is the value, at the end of the
applicable period, of a hypothetical $1,000 investment made at
the beginning of the applicable period.
B-18
<PAGE>
SEC Yields
Yield is the net annualized yield based on a specified 30-day (or one
month) period assuming semiannual compounding of income. Yield is calculated by
dividing the net investment income per share earned during the period by the
maximum offering price per share on the last day of the period, according to
the following formula:
YIELD = 2[((a-b)/cd+1)6-1]
Where:
a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
INVESTMENT ADVISORY SERVICES
The Trust employs Mellon Capital Management Corporation ("Mellon
Capital"), 595 Market St., Suite 3000, San Francisco, California (the
"Adviser") under an investment advisory agreement to manage the investment and
reinvestment of the assets of the Fund and to continuously review, supervise
and administer the Trust's investment program. The Adviser discharges its
responsibilities subject to the control of the Officers and Board of Trustees
of the Trust.
The Fund pays the Adviser a Basic fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on the following annual
percentage rates, to the Fund's average month-end net assets for the quarter:
Net Assets Rate
---------- ----
First $100 million .......... .200%
Next $900 million ........... .150%
Next $500 million ........... .125%
Over $1.5 billion ........... .100%
This fee may be increased or decreased by applying an adjustment formula
based on the performance of the Fund's portfolio relative to the investment
record of a "Combined Index", 65% of which shall be comprised of the Standard &
Poor's 500 Composite Price Index and 35% of which shall be comprised of the
Lehman Brothers Long-Term U.S. Treasury Index. The fee payment will be
increased (decreased) by an incentive (penalty) of 0.05% of average net assets,
if the Fund's cumulative investment performance for the thirty-six months
preceding the end of the quarter is at least six percentage points above
(below) the cumulative investment record of the Combined Index for the same
period. For the purpose of determining the fee adjustment for investment
performance, as described above, the net assets of the Fund will be averaged
over the same period as the performance of the Fund and the investment record
of the Combined Index are computed.
Under the rules of the Securities and Exchange Commission, the new
incentive/penalty fee will not be fully operable until the quarter ending March
31, 2000. Until that date, a "blended" fee rate consisting of varying
percentages of (i) the performance adjustment based on the schedule set forth
above (the "New Rate"1), and (ii) the performance adjustment based on the
schedule set forth in the Fund's previous investment advisory agreement with
the adviser2 (the "Previous Rate") shall be used as follows:
B-19
<PAGE>
1. Quarter Ending June 30, 1997. The incentive/penalty fee was calculated
as the sum of 8.3% (e.g., one of 12 quarters) of the fee payable under the New
Rate plus 91.7% (e.g., 11 of 12 quarters) of the fee payable under the Previous
Rate.
2. Quarter Ending September 30, 1997. The incentive/penalty fee was
calculated as the sum of 16.6% of the fee payable under the New Rate plus 83.4%
of the fee payable under the Previous Rate.
3. Quarter Ending December 31, 1997. The incentive/penalty fee was
calculated as the sum of 25% of the fee payable under the New Rate plus 75% of
the fee payable under the Previous Rate.
4. Quarter Ending March 31, 1998. The incentive/penalty fee was calculated
as the sum of 33.3% of the fee payable under the New Rate plus 66.7% of the fee
payable under the Previous Rate.
5. Quarter Ending June 30, 1998. The incentive/penalty fee was calculated
as the sum of 41.6% of the fee payable under the New Rate plus 58.4% of the fee
payable under the Previous Rate.
6. Quarter Ending September 30, 1998. The incentive/penalty fee was
calculated as the sum of 50% of the fee payable under the New Rate plus 50% of
the fee payable under the Previous Rate.
7. Quarter Ending December 31, 1998. The incentive/penalty fee was
calculated as the sum of 58.4% of the fee payable under the New Rate plus 41.6%
of the fee payable under the Previous Rate.
8. Quarter Ending March 31, 1999. The incentive/penalty fee shall be
calculated as the sum of 66.7% of the fee payable under the New Rate plus 33.3%
of the fee payable under the Previous Rate.
9. Quarter Ending June 30, 1999. The incentive/penalty fee shall be
calculated as the sum of 75% of the fee payable under the New Rate plus 25% of
the fee payable under the Previous Rate.
10. Quarter Ending September 30, 1999. The incentive/penalty fee shall be
calculated as the sum of 83.4% of the fee payable under the New Rate plus 16.6%
of the fee payable under the Previous Rate.
11. Quarter Ending December 31, 1999. The incentive/penalty fee shall be
calculated as the sum of 91.7% of the fee payable under the New Rate plus 8.3%
of the fee payable under the Previous Rate.
12. Quarter Ending March 31, 2000. New Rate fully operable.
For the purpose of determining the fee adjustment for investment
performance, as described above, the net assets of the Fund shall be averaged
over the same period as the investment performance of the Fund and the
investment record of the Combined Index are computed. The "investment
performance" of the Fund for the period, expressed as a percentage of the
Fund's net asset value per share at the beginning of the period
- ------------
NOTES (Continued)
(1) The benchmark used for the new rate calculation will consist of linking the
return of the "new" benchmark (a "Combined Index", 65% of which is comprised
of the Standard & Poor's 500 Composite Price Index and 35% of which is
comprised of the Lehman Brothers Long-Term U.S. Treasury Index) to the
return of the "previous" benchmark (Standard & Poor's 500 Composite Price
Index) in the same varying percentages that are listed below.
(2) The previous incentive/penalty fee structure provided that the Basic Fee be
increased or decreased by an amount equal to .05% of the average month-end
assets of the Fund if the Fund's investment performance for the thirty-six
months preceding the end of the quarter was six percentage points or more
above or below, respectively, the investment record of the Standard & Poor's
500 Composite Price Index.
B-20
<PAGE>
shall be the sum of: (i) the change in the Fund's net asset value per share
during such period; (ii) the value of the Fund's cash distributions per share
having an ex-dividend date occurring within the period; and (iii) the per share
amount of capital gains taxes paid or accrued during such period by the Fund
for undistributed realized long-term capital gains.
The "investment record" of the Stock Index for the period, expressed as a
percentage of the Stock Index level at the beginning of the period, shall be
the sum of (i) the change in the level of the Stock Index during the period and
(ii) the value, computed consistently with the Stock Index, of cash
distributions having an ex-dividend date occurring within the period made by
companies whose securities comprise the Stock Index. The "investment record" of
the Bond Index for the period, expressed as a percentage of the Bond Index
level at the beginning of such period shall be the sum of (i) the change in the
level of the Bond Index during the period and (ii) the value of the interest
accrued or paid on the bonds included in the Bond Index, assuming the
reinvestment of such interest on a monthly basis. Computation of these two
components as the Combined Index shall be made on the basis of 65% in the Stock
Index and 35% in the Bond Index at the beginning of each quarter.
The investment advisory agreement will be renewable for successive
one-year periods, only if each renewal is specifically approved by a vote of
the Fund's Board of Trustees, including the affirmative votes of a majority of
the Trustees who are not parties to the contract or "interested persons" (as
defined in the Investment Company Act of 1940) of any such party, cast in
person at a meeting called for the purpose of considering such approval. The
agreement is automatically terminated if assigned, and may be terminated
without penalty at any time (1) either by vote of the Board of Trustees of the
Trust or by vote of its outstanding voting securities on 60 days' written
notice to the Adviser, or (2) by the Adviser upon 90 days' written notice to
the Trust.
The Trust's Board of Trustees may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of a
new advisory agreement, either as a replacement for an existing adviser or as
an additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same advisory
contract terms where a contract has been assigned because of a change in
control of the adviser.
Any such change will be communicated to shareholders in writing.
Description of the Adviser. The Adviser is an investment management firm
which manages well diversified stock and bond portfolios for institutional
clients. As of September 30, 1998 the Adviser provided investment advisory
services to 252 clients and managed assets with an approximate value of $63
billion. The Adviser's asset allocation strategy was developed by the Adviser's
co-founder, William Fouse, in 1972, and is used by 120 of its clients and
accounts for approximately $24 billion of the assets that it manages. The
Adviser is a wholly-owned subsidiary of MBC Investment Corporation, which
itself is a wholly-owned subsidiary of Mellon Bank Corporation. For the fiscal
years ended September 30, 1996, 1997, and 1998, the Fund incurred approximately
$2,691,000 (before a decrease of $515,000 based on performance), $3,723,000
(before a decrease of $921,000 based on performance), and $5,466,000 (before a
decrease of $1,404,000 based on performance) respectively, for investment
advisory services. The basic fee paid to the Adviser for the fiscal year ended
September 30, 1996 reflects a fee waiver of $146,000 during the period October
1, 1995 to March 31, 1996.
B-21
<PAGE>
Glossary
a. Historical Market Returns -- Total returns of broad asset class benchmarks.
As examples, the returns of well-known benchmarks for domestic stocks,
bonds, and money market instruments are given below.
<TABLE>
<CAPTION>
Money Market
Asset Class Common Stocks Bonds Instruments
Standard & Poor's
500 Composite Stock Lehman Brothers 90 Day
Benchmark Price Index Long Treasury Index U.S. Treasury Bills
- ------------------- --------------------- --------------------- --------------------
<S> <C> <C> <C>
1989 31.6% 18.9% 8.6%
1990 -3.1 6.3 7.9
1991 30.4 18.5 5.8
1992 7.6 8.0 3.6
1993 10.1 17.3 3.1
1994 1.3 -7.6 4.2
1995 37.6 30.7 5.8
1996 23.0 -0.9 5.2
1997 29.6 8.1 3.9
1998(9/30) 9.1 22.1 5.2
</TABLE>
b. Asset Allocation -- Asset allocation -- in its most generic sense -- is the
allotment of an investor's monies to broad asset classes such as stocks or
bonds. Investors establish percentage allocation guidelines for stocks,
bonds, and money market instruments which are consistent with their
particular long-term investment needs. These needs will include current
income, potential growth in capital, and willingness to accept risk.
In implementing their asset allocation targets, some investors attempt to
maintain a stable mix -- such as 50% stocks and 50% bonds -- while others will
actively manage the stock/bond mix in pursuit of higher returns, lower risk, or
other investment objectives. The key difference between investors who maintain
a stable mix and those who actively change allocations is their willingness to
forecast the risks and returns of individual asset classes, their forecasting
abilities, and their comfort in making investment decisions based upon such
forecasts. Historically, investors who actively managed the mix based upon
conjecture have often underperformed both investors with relatively stable
allocations and investors with logical, disciplined methods for assessing
relative value and risk. Institutional investors commonly refer to active asset
allocation approaches which are based upon disciplined methodologies as
tactical asset allocation.
FINANCIAL STATEMENTS
The Trust's financial statements, including the financial highlights for
each of the five fiscal years in the period ended September 30, 1998, appearing
in the Trust's 1998 Annual Report to Shareholders and the report thereon of
PricewaterhouseCoopers LLP, independent accountants, also appearing therein,
are incorporated by reference into this Statement of Additional Information.
For a more complete discussion of the performance, please see the Trust's
Annual Report to Shareholders, which may be obtained without charge.
B-22
<PAGE>
PART C
VANGUARD ASSET ALLOCATION FUND
OTHER INFORMATION
Item 23. Exhibits
Exhibit Description
- ------- -----------
(a) Declaration of Trust*
(b) By-Laws*
(c) Not Applicable
(d) Investment Advisory Contract*
(e) Not Applicable
(f) Reference is made to the section entitled "Management of the Trust"
in the Registrant's Statement of Additional Information
(g) Custodian Agreement*
(h) Amended and Restated Funds' Service Agreement*
(i) Legal Opinion*
(j) Consent of Independent Accountants+
(k) Not Applicable
(l) Not Applicable
(m) Not Applicable
(n) Financial Data Schedule+
(o) Not Applicable
- ------------
*Filed Prevously
+Filed Herewith
Item 24. Persons Controlled by or Under Common Control with Registrant
Registrant is not controlled by or under common control with any person.
Item 25. Indemnification
The Registrant's organizational documents contain provisions indemnifying
Trustees and Officers against liability incurred in their official capacity.
Article VII, Section 2 of the Declaration of Trust provides that the Registrant
may indemnify and hold harmless each and every Trustee and Officer from and
against any and all claims, demands, costs, losses, expenses, and damages
whatsoever arising out of or related to the performance of his or her duties as
a Trustee or Officer. However, this provision does not cover any liability to
which a Trustee or Officer would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office. Article VI of the By-Laws
generally provides that the Registrant shall indemnify its Trustees and
Officers from any liability arising out of their past or present service in
that capacity. Among other things, this provision excludes any liability
arising by reason of willful misfeasance, bad faith, gross negligence, or the
reckless disregard of the duties involved in the conduct of the Trustee's or
Officer's office with the Registrant.
Item 26. Business and Other Connections of the Investment Adviser
Mellon Capital Management Corporation is an investment adviser registered
under the Investment Advisers Act of 1940, as amended (the "Advisers Act"). The
list required by this Item 26 of officers and directors of Mellon Capital
Management Corporation, together with any information as to any business
profession,
C-1
<PAGE>
vocation or employment of a substantial nature engaged in by such officers and
directors during the past two years, is incorporated herein by reference from
Schedules B and D of Form ADV filed by Mellon Capital Management Corporation
pursuant to the Advisers Act (SEC File No. 801-19785).
Item 27. Principal Underwriters
(a) Not Applicable
(b) Not Applicable
(c) Not Applicable
Item 28. Location of Accounts and Records
The books, accounts and other documents required by Section 31(a) under
the Investment Company Act and the rules promulgated thereunder will be
maintained in the physical possession of Registrant; Registrant's Transfer
Agent, The Vanguard Group, Inc., Valley Forge, Pennsylvania 19482; and the
Registrant's Custodian, State Street Bank and Trust Company, 225 Franklin
Street, Boston, Massachusetts 02110.
Item 29. Management Services
Other than as set forth under the description of The Vanguard Group in
Part B of this Registration Statement, the Registrant is not a party to any
management-related service contract.
Item 30. Undertakings
Not Applicable
C-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant hereby certifies that it meets
all the requirements for effectiveness of this Registration Statement pursuant
to Rule 485(b) under the Securities Act of 1933 and has duly caused this
Post-Effective Amendment to this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the Town of Valley
Forge and the Commonwealth of Pennsylvania on the 15th day of January, 1999.
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
(Signature)
BY:___________________________ John C. Bogle*, Senior Chairman January 15, 1999
(Heidi Stam) of the Board and Trustee
(Signature) John J. Brennan*, January 15, 1999
BY:___________________________ Chairman, Chief Executive
(Heidi Stam) Officer and Trustee
(Signature) JoAnn Heffernan Heisen*, January 15, 1999
BY:___________________________ Trustee
(Heidi Stam)
(Signature) Burton G. Malkiel*, Trustee January 15, 1999
BY:___________________________
(Heidi Stam)
(Signature) Bruce K. MacLaury,* Trustee January 15, 1999
BY:___________________________
(Heidi Stam)
(Signature) Alfred M. Rankin, Jr.*, Trustee January 15, 1999
BY:___________________________
(Heidi Stam)
(Signature) John C. Sawhill*, Trustee January 15, 1999
BY:___________________________
(Heidi Stam)
(Signature) James O. Welch, Jr.*, Trustee January 15, 1999
BY: ___________________________
(Heidi Stam)
(Signature) J. Lawrence Wilson*, Trustee January 15, 1999
BY:___________________________
(Heidi Stam)
(Signature) Thomas J. Higgins*, Treasurer January 15, 1999
BY:___________________________ and Principal Financial
(Heidi Stam) Officer and Accounting
Officer
</TABLE>
- --------
*By Power of Attorney. See 1933 Act File No. 333-63579, filed on December 4,
1998. Incorporated by Reference.
<PAGE>
VANGUARD ASSET ALLOCATION FUND
INDEX TO EXHIBITS
Consent of Independent Accountants.................................. EX-99.BJ
Financial Data Schedule............................................. EX-99.BN
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectuses and
the Statement of Additional Information constituting parts of this
Post-Effective Amendment No. 15 to the registration statement on Form N-1A (the
"Registration Statement") of our report dated October 30, 1998, relating to the
financial statements and financial highlights appearing in the September 30,
1998 Annual Report to Shareholders of Vanguard Asset Allocation Fund, which are
also incorporated by reference into the Registration Statement. We also consent
to the references to us under the heading "Financial Highlights" in the
Prospectuses and under the headings "Financial Statements" and "Service
Providers--Independent Accountants" in the Statement of Additional Information.
PricewaterhouseCoopers LLP
Philadelphia, PA
January 14, 1999
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000836906
<NAME> VANGUARD ASSET ALLOCATION FUND
<MULTIPLIER> 1,000
<CURRENCY> US
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<INVESTMENTS-AT-COST> 4,905,725
<INVESTMENTS-AT-VALUE> 5,855,544
<RECEIVABLES> 133,409
<ASSETS-OTHER> 1,071
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 5,990,024
<PAYABLE-FOR-SECURITIES> 195,248
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 158,261
<TOTAL-LIABILITIES> 353,509
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 4,394,259
<SHARES-COMMON-STOCK> 246,189
<SHARES-COMMON-PRIOR> 173,603
<ACCUMULATED-NII-CURRENT> 94,543
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 137,081
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 1,010,632
<NET-ASSETS> 5,636,515
<DIVIDEND-INCOME> 27,410
<INTEREST-INCOME> 174,270
<OTHER-INCOME> 433
<EXPENSES-NET> 23,057
<NET-INVESTMENT-INCOME> 179,056
<REALIZED-GAINS-CURRENT> 163,880
<APPREC-INCREASE-CURRENT> 242,715
<NET-CHANGE-FROM-OPS> 585,651
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 141,316
<DISTRIBUTIONS-OF-GAINS> 181,623
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 85,659
<NUMBER-OF-SHARES-REDEEMED> 27,756
<SHARES-REINVESTED> 14,684
<NET-CHANGE-IN-ASSETS> 1,898,122
<ACCUMULATED-NII-PRIOR> 56,803
<ACCUMULATED-GAINS-PRIOR> 154,824
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 4,062
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 23,057
<AVERAGE-NET-ASSETS> 4,717,065
<PER-SHARE-NAV-BEGIN> 21.53
<PER-SHARE-NII> 0.79
<PER-SHARE-GAIN-APPREC> 2.33
<PER-SHARE-DIVIDEND> 0.74
<PER-SHARE-DISTRIBUTIONS> 1.01
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 22.90
<EXPENSE-RATIO> 0.49
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
