<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 33-48863) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. [X]
POST-EFFECTIVE AMENDMENT NO. 12
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 14
VANGUARD BALANCED INDEX 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 April 19, 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 SECURITIES UNDER THE
SECURITIES ACT OF 1933 PURSUANT TO RULE 24f-2 OF THE INVESTMENT COMPANY ACT OF
1940. REGISTRANT FILED ITS RULE 24f-2 NOTICE FOR ITS FISCAL YEAR ENDED DECEMBER
31, 1998 WITH THE COMMISSION ON FEBRUARY 18, 1999.
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VANGUARD BALANCED INDEX FUND
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
Form N-1A
Item Number Location in Prospectus
<C> <S> <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 December 31, 1998
filed with the Securities & Exchange
Commission's EDGAR system on March 3,
1999.
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
</TABLE>
<TABLE>
<CAPTION>
Form N-1A Location in Statement
Item Number of Additional Information
<C> <S> <C>
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................................................ Investment Policies; Description of the
Trust; and 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; and 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> 3
VANGUARD BALANCED INDEX FUND
Prospectus
April 30, 1999
A Balanced Mutual Fund
CONTENTS
1 AN INTRODUCTION TO INDEX FUNDS
2 FUND PROFILE
4 ADDITIONAL INFORMATION
4 A WORD ABOUT RISK
4 WHO SHOULD INVEST
5 PRIMARY INVESTMENT STRATEGIES
11 THE FUND AND VANGUARD
11 INVESTMENT ADVISERS
11 YEAR 2000 CHALLENGE
12 DIVIDENDS, CAPITAL GAINS, AND TAXES
13 SHARE PRICE
14 FINANCIAL HIGHLIGHTS
15 INVESTING WITH VANGUARD
15 SERVICES AND ACCOUNT FEATURES
16 TYPES OF ACCOUNTS
16 BUYING SHARES
18 REDEEMING SHARES
21 TRANSFERRING REGISTRATION
21 FUND AND ACCOUNT UPDATES
GLOSSARY (inside back cover)
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WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objective, risks, and strategies of Vanguard
Balanced Index 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.
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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> 4
1
FUND PROFILE
The following profile summarizes key features of Vanguard Balanced Index Fund.
INVESTMENT OBJECTIVE
The Fund is a balanced stock and bond index fund that seeks to provide current
income and long-term growth of income and capital.
INVESTMENT STRATEGIES
The Fund typically invests 60% of its assets in common stocks and 40% in bonds.
The stock portion of the Fund seeks to match the total return of the Wilshire
5000 Equity Index, a widely recognized measure for the U.S. stock market. The
Fund's bond portion seeks to replicate the returns of the Lehman Brothers
Aggregate Bond Index, a measure of regularly traded, U.S. investment-grade
bonds. There is no assurance that the Fund will achieve its stated objective.
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:
- - Stock market risk, which is the chance that stock prices in general will
decline over short or even long periods. The stock market tends to be
cyclical, with periods when stock prices generally rise and periods when
stock prices generally decline.
- - Interest rate risk, which is the chance that bond prices overall will
decline over short or even long periods due to rising interest rates.
Interest rate risk should be moderate for the Fund.
- - Income risk, which is the chance that falling interest rates will cause
the Fund's income to decline. Income risk should be moderate for the Fund.
- - Credit risk, which is the chance that a bond issuer will fail to pay
interest and principal in a timely manner, reducing the Fund's return.
Credit risk should be low for the Fund.
- - Prepayment risk, which is the chance that during periods of falling
interest rates, a mortgage-backed bond issuer will repay its high-yielding
bond earlier than scheduled. Forced to reinvest the unanticipated proceeds
at lower rates, the Fund would experience a decline in income and ease the
opportunity for additional price appreciation associated with falling
rates.
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 since
inception. The table shows how the Fund's average annual returns for one and
five calendar years and since inception compare to those of a broad-based
securities market index. Keep in mind that the Fund's past performance does not
necessarily indicate how it will perform in the future.
<TABLE>
<CAPTION>
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ANNUAL TOTAL RETURNS
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<S> <C>
1993 10.00%
1994 -1.56%
1995 28.64%
1996 13.95%
1997 22.24%
1998 17.85%
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</TABLE>
Total return figures do not reflect the annual account maintenance fee of $10.
During the period shown in the bar chart, the highest return for a
calendar quarter was 12.67% (quarter ended December 31, 1998) and the lowest
return for a quarter was - 5.57% (quarter ended September 30, 1998).
<PAGE> 5
2
<TABLE>
<CAPTION>
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AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
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1 YEAR 5 YEARS SINCE INCEPTION*
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<S> <C> <C> <C>
Vanguard Balanced Index Fund** 17.85% 15.76% 15.09%
Balanced Composite Index*** 18.11 16.03 15.46
Wilshire 5000 Index 23.39 21.78 20.46
Lehman Aggregate Bond Index 8.69 7.27 7.83
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</TABLE>
* November 9, 1992.
** Total return figures do not reflect the annual account maintenance fee of
$10.
*** Made up of two unmanaged benchmarks, weighted 60% Wilshire 5000 Index and
40% Lehman Aggregate Bond Index.
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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 December 31, 1998.
<TABLE>
<S> <C>
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
Account Maintenance Fee (For accounts under $10,000): $2.50/quarter*
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
Management Fees: 0.17%
12b-1 Distribution Fees: None
Other Expenses 0.04%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.21%
</TABLE>
* Vanguard will deduct an account maintenance fee from your quarterly
distribution of the Fund's dividends. If your distribution is less than the
fee, fractional shares will be automatically redeemed to make up the
difference.
The Fund reserves the right to deduct a transaction fee of 0.08% from an
investor's cumulative purchases over $100 million. Where it applies, the fee is
retained by the Fund to offset transaction costs of investing large new
contributions into the market. The fee is not paid to Vanguard and is not a
sales charge.
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 Balanced Index Fund's expense ratio in fiscal year
1998 was 0.21%, or $2.10 per $1,000 of average net assets. The average balanced
mutual fund had expenses in 1998 of 1.31%, or $13.10 per $1,000 of average net
assets, according to Lipper Inc., which reports on the mutual fund industry.
The average balanced mutual fund refers predominantly to actively managed
mutual funds.
<PAGE> 6
3
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.
<TABLE>
<CAPTION>
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1 YEAR 3 YEARS 5 YEARS 10 YEARS
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<S> <C> <C> <C>
$ 22 $ 68 $118 $268
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</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
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 quarterly; capital gains are distributed annually in December
INVESTMENT ADVISERS
Vanguard Core Management Group (for common stocks) and Vanguard Fixed Income
Group (for bonds), Valley Forge, Pa., since inception
INCEPTION DATE
November 9, 1992
NET ASSETS AS OF DECEMBER 31, 1998
$2 billion
SUITABLE FOR IRAS
Yes
MINIMUM INITIAL INVESTMENT
$3,000; $1,000 for IRAs and custodial accounts for minors
NEWSPAPER ABBREVIATION
Balanced
VANGUARD FUND NUMBER
02
CUSIP NUMBER
921931101
TICKER SYMBOL
VBINX
AN INTRODUCTION TO INDEX FUNDS
WHAT IS INDEXING?
An index is an unmanaged group of securities whose overall performance is used
as a standard to measure investment performance. An index fund (or "passively
managed" fund) tries to match, as closely as possible, the performance of an
established target index by holding all, or a representative sample, of the
securities in the index.
The target index may be a group of stocks or bonds, or a combination of stocks
and bonds. Balanced index funds hold a mix of stocks and bonds.
Index funds are not actively managed by investment advisers who buy and
sell securities based on research and analysis in an attempt to outperform the
market. Rather, index funds simply mirror what the target index does,
for better or worse.
WHY INVEST IN INDEX FUNDS?
Index funds appeal to many investors for a number of reasons:
- - Diversification. Index funds generally invest in a diversified mix of
companies and industries.
- - Relative consistency. Index funds typically match the performance of
relevant market benchmarks more closely than comparable actively managed
funds do.
- - Low cost. Index funds do not have many of the costs and expenses of an
actively managed fund -- such as research -- and keep trading activity,
and thus brokerage commissions, to a minimum.
- - Low realization of capital gains. Because an index fund typically sells
securities only to respond to redemption requests or to adjust the number
of shares it holds to reflect a change in its target index, the fund's
turnover rate -- and thus its realization of capital gains -- is usually
very low.
<PAGE> 7
4
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.
KEEP IN MIND THAT AN INDEX FUND HAS OPERATING EXPENSES AND TRANSACTION
COSTS; A MARKET INDEX DOES NOT. THEREFORE, AN INDEX FUND -- WHILE EXPECTED TO
TRACK ITS TARGET INDEX AS CLOSELY AS POSSIBLE -- WILL TYPICALLY BE UNABLE TO
MATCH THE PERFORMANCE OF THE INDEX EXACTLY.
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A WORD ABOUT RISK
This prospectus describes the risks you would face as an investor in Vanguard
Balanced Index 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 Balanced Index Fund,
you should also take into account your personal tolerance for the daily
fluctuations of the stock and bond 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.
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WHO SHOULD INVEST
The Fund may be a suitable investment for you if:
- - You are seeking moderate current income and long-term growth of principal
and income.
- - You are seeking a diversified combination of U.S. stocks and bonds.
- - You are willing to invest for the long term -- at least five years.
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.
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> 8
5
- - Telephone and online exchanges are not accepted for non-IRA accounts.
- - 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).
- - 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, current income and long-term growth of capital and
income. It also explains how the adviser implements these strategies. In
addition, this section discusses several important risks -- stock market risk,
interest rate risk, income risk, credit risk, and prepayment 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. The Fund's investment objective is not fundamental, and so may be
changed without a shareholder vote.
MARKET EXPOSURE
STOCKS
About 60% of the Fund's assets are invested in common stocks, in an attempt to
replicate with that portion of the assets the performance of the Wilshire 5000
Index.
[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.
PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are generally "middle-of-the-road" investments that seek to
provide some combination of growth, income, and conservation of capital by
investing in a mix of stocks, bonds, and/or money market instruments. Because
the prices of stocks and bonds often move in different directions, balanced
funds are able to use rewards from one type of investment to help offset the
risks from another.
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. (The S&P 500 Index is shown
here because this benchmark, unlike the Wilshire 5000 Index, has been in
existence for all of the periods shown.)
<TABLE>
<CAPTION>
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U.S. STOCK MARKET RETURNS (1926 - 1998)
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1 YEAR 5 YEARS 10 YEARS 20 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 54.2% 24.1% 19.9% 17.7%
Worst -43.1 -12.4 -0.8 3.1
Average 13.1 10.7 11.0 11.0
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</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1998. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.7%, returns for individual 5-year periods
ranged from a - 12.4% average (from 1928 through 1932) to 24.1% (from 1994
through 1998). 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.
While the Fund's holdings will typically include the 500 largest stocks in
the Wilshire 5000 Index, they will not include all of the securities in the
Index. Instead, the Fund will invest in a representative sample of stocks.
<PAGE> 9
6
PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies -- and mutual funds that hold these stocks
- -- can be classified by the companies' market value, or capitalization.
Generally, Vanguard defines large-capitalization (large-cap) funds as those
holding stocks of companies whose outstanding shares have a market value
exceeding $10 billion. Mid-cap funds hold stocks of companies with a market
value from $1 billion to $10 billion. Small-cap funds typically hold stocks of
companies with a market value of $1 billion or less.
Keep in mind, too, that while the Wilshire 5000 Index is dominated by
large-cap stocks (those contained in the S&P 500 Index), small- and mid-cap
issues are also represented. The Fund's stock holdings are adjusted on a regular
basis to reflect the Wilshire 5000 Index. As of December 31, 1998, about 22% of
the market value of the Wilshire 5000 Index was comprised of securities that
were not in the S&P 500 Index. Stocks of smaller companies have historically
been more volatile than -- and at times have performed quite differently from --
the stocks of larger companies.
Finally, because Vanguard Balanced Index Fund's holdings are not identical
to the Wilshire 5000 Index or any other market index, the performance of the
Fund will not mirror the returns of any particular index.
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 should be able to sell your 5% bond for more than you
paid.
BONDS
About 40% of the Fund's assets are 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. INTEREST RATE
RISK SHOULD BE MODERATE FOR SHORTER-TERM BONDS AND HIGH FOR
LONGER-TERM BONDS. BECAUSE THE FUND INVESTS IN A PORTFOLIO OF
BONDS WITH AN INTERMEDIATE AVERAGE MATURITY (5-10 YEARS),
INTEREST RATE RISK IS MODERATE.
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.
To illustrate the relationship between bond prices and interest rates, the
following table shows the impact of a 2% change (both up and down) in interest
rates on three bonds of different maturities, each with a face value of $1,000.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
<S> <C> <C>
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.
- --------------------------------------------------------------------------------
</TABLE>
<PAGE> 10
7
These figures are for illustration only and should not be regarded as an
indication of future returns from the bond market as a whole or the Fund in
particular.
Changes in interest rates will affect bond income as well as bond prices.
[FLAG GRAPHIC] THE FUND IS SUBJECT TO INCOME RISK, WHICH IS THE CHANCE THAT A
FUND'S DIVIDENDS (INCOME) WILL DECLINE DUE TO FALLING INTEREST
RATES. INCOME RISK IS GENERALLY THE GREATEST FOR SHORT-TERM
BONDS, AND THE LEAST FOR LONG-TERM BONDS.
[FLAG GRAPHIC] BECAUSE IT INVESTS IN MORTGAGE-BACKED BONDS, THE FUND IS SUBJECT
TO PREPAYMENT RISK, WHICH IS THE POSSIBILITY THAT DURING PERIODS
OF FALLING INTEREST RATES, A BOND ISSUER WILL REPAY ITS
HIGH-YIELDING BOND EARLIER THAN SCHEDULED. FORCED TO REINVEST THE
UNANTICIPATED PROCEEDS AT LOWER RATES, THE FUND WOULD EXPERIENCE
A DECLINE IN INCOME AND LOSE THE OPPORTUNITY FOR ADDITIONAL PRICE
APPRECIATION ASSOCIATED WITH FALLING RATES.
Since the Fund invests only a portion of its assets in mortgage-backed
bonds, the risk to the Fund is limited.
[FLAG GRAPHIC] THE FUND IS SUBJECT TO CREDIT RISK, WHICH IS THE POSSIBILITY THAT
A BOND ISSUER WILL FAIL TO PAY INTEREST AND PRINCIPAL IN A TIMELY
MANNER.
The credit quality of the Fund is expected to be very high, and thus
credit risk should be low. The weighted average credit quality of the Fund's
holdings, as rated by Moody's Investors Service, as of December 31, 1998, was
Aa1.
To a limited extent, the Fund is also exposed to event risk, which is the
possibility that corporate fixed-income securities held by the Fund may suffer a
substantial decline in credit quality and market value due to a corporate
restructuring.
Finally, because stock and bond prices often move in different directions,
the Fund's bond holdings help to dampen -- but not eliminate -- some of the
stock market volatility experienced by the Fund. Likewise, changes in interest
rates may not have as dramatic an effect on the Fund as they would on a fund
made up entirely of bonds.
SECURITY SELECTION
INDEXING METHODS
In seeking to track a particular index, a fund may use one of two indexing
methods to select the stocks or bonds it invests in.
Some index funds hold each stock or bond found in their target indexes in
about the same proportions as represented in the indexes themselves. For
example, if 5% of the S&P 500 Index were made up of the stock of a specific
company, a fund tracking that index would invest about 5% of its assets in that
company.
Other index funds may use a different selection process. Because it would
be very expensive to buy and sell all of the securities represented (the
Wilshire 5000 Index, for example, includes more than 7,000 stocks), funds
tracking these larger indexes use a "sampling" technique. Using a sophisticated
computer program, these funds select securities that will recreate their target
indexes in terms of industry, size, and other characteristics. For instance, if
10% of the Wilshire 5000 Index were made up of utility stocks, the Balanced
Index Fund would allocate about 10% of its stock investment to the utility
stocks of the index with similar characteristics.
STOCKS
The Fund's common stock portfolio is designed to have investment characteristics
that parallel those of the Wilshire 5000 Index. The Fund is expected to
replicate approximately 1,000 of the largest securities in the Wilshire 5000
Index as measured by market capitalization, plus a representative sample of the
remainder, which are selected primarily on the basis of market capitalization,
industry weightings, and other fundamental characteristics. Typically, the Fund
holds a total of between 2,500 and 3,000 stocks.
<PAGE> 11
8
PLAIN TALK ABOUT
BOND MATURITIES
A bond is issued with a specific maturity date -- the date when the bond's
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.
BONDS
The Fund's bond portfolio is designed to have investment characteristics that
parallel those of the Lehman Brothers Aggregate Bond Index, a broad
market-weighted index that encompasses five major classes of investment-grade
fixed-income securities in the United States: U.S. Treasury and agency
securities, corporate bonds, mortgage-backed securities, international
dollar-denominated bonds, and asset-backed securities with maturities greater
than one year. The Fund will invest in a representative sample of fixed-income
securities in the index, which, taken together, are expected to perform
similarly to the index. These securities are described further as follows:
- - U.S. government securities include U.S. Treasury and agency bonds, which
represent loans by an investor to the U.S. Treasury Department or a wide
variety of governmental agencies and instrumentalities. Timely payment of
principal and interest on these bonds is guaranteed by the full faith and
credit of the U.S. government.
- - Corporate bonds are IOUs issued by businesses that want to borrow money
for some purpose -- often to develop a new product or service, to expand
into a new market, or to buy another company. As with other types of
bonds, the issuer promises to repay the principal on a specific date and
to make interest payments in the meantime. The amount of interest offered
depends both on market conditions and on the financial health of the
corporation issuing the bonds; a company whose credit rating is not strong
will have to offer a relatively high interest rate to obtain buyers for
its bonds.
- - Mortgage-backed bonds represent interests in underlying pools of
mortgages. Unlike ordinary bonds, which generally pay a fixed rate of
interest at regular intervals and then repay principal upon maturity,
mortgage-backed bonds pay both interest and principal as part of their
regular payments. Because the mortgages underlying the bonds can be
prepaid at any time by homeowners or corporate borrowers, mortgage-backed
bonds are subject to prepayment risk, as discussed earlier in this
prospectus. These types of bonds are issued by a number of government
agencies, including the Government National Mortgage Association (GNMA),
often referred to as "Ginnie Mae," the Federal Home Loan Mortgage
Corporation (FHLMC), the Federal National Mortgage Association (FNMA),
often referred to as "Fannie Mae," and the Federal Housing Authority
(FHA). GNMA bonds are guaranteed by the full faith and credit of the U.S.
government as to the timely payment of principal and interest; bonds
issued by other government agencies are not. (Note: The Balanced Index
Fund may also invest in conventional mortgage securities, which are
packaged by private corporations and are not guaranteed by the U.S.
government.)
- - International dollar-denominated bonds are bonds denominated in U.S.
dollars issued by foreign governments and companies. Because the bond's
value is designated in dollars rather than in the currency of the issuer's
country, the investor is not exposed to currency risk; rather, the issuer
assumes the risk, usually to attract American investors.
- - Asset-backed securities are bonds backed by an underlying pool of assets
such as automobile loans, credit card loans, and home equity loans. These
securities are structured with varying amounts of credit risk, depending
primarily on the quality of the underlying assets. They are generally
issued by private corporations and are not guaranteed by the U.S.
government. Asset-backed bonds are subject to prepayment risk as discussed
earlier in this prospectus.
The Fund may, from time to time, substitute one type of investment-grade
bond for another. For instance, the Fund may hold more short-term corporate
bonds (and fewer short-term U.S. Treasury bonds) than are represented in the
index so as to increase income. This corporate substitution strategy entails the
assumption of additional credit risk;
<PAGE> 12
9
however, substantial diversification within the corporate sector should
moderate issue-specific credit risk. In addition, the Fund's current investment
policy restricts corporate substitutions to issues with less than four years
remaining to maturity and in aggregate to no more than 15% of the assets of the
Fund's bond portfolio. Overall, credit risk is expected to be very low for the
Fund.
The Fund is generally managed without regard to tax ramifications.
FUND CHARACTERISTICS
STOCKS
The following table provides a snapshot of some financial characteristics of the
Fund's stock holdings as of December 31, 1998.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
PRICE/EARNINGS EARNINGS DIVIDEND PRICE/BOOK
RATIO GROWTH RATE YIELD RATIO
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
26.1 17.6% 1.27% 4.28
- --------------------------------------------------------------------------------
</TABLE>
- - Price/earnings ratio is the current price of a stock, divided by its
per-share earnings (profits) from the past year. A stock selling for $20,
with earnings of $2 per share, has a price/earnings ratio of 10.
- - Earnings growth rate is the average annual rate, expressed as a
percentage, of growth in earnings over the past five years for the stocks
now in a fund.
- - Dividend yield is current income (interest or dividends) earned by an
investment, expressed as a percentage of the investment's price.
- - Price/book ratio is the current price of a stock, divided by its net
worth, or book value, per share. For a fund, this ratio is used to mean
the weighted average price/book ratio of the stocks held by the fund.
BONDS
The following table provides a snapshot of the financial characteristics of the
Fund's bond holdings as of December 31, 1998.
<TABLE>
<CAPTION>
- ----------------------------------------------
NUMBER OF AVERAGE AVERAGE AVERAGE
ISSUES MATURITY QUALITY DURATION
- ----------------------------------------------
<S> <C> <C> <C>
379 8.7 years Aa1 4.4 years
- ----------------------------------------------
</TABLE>
- - Number of issues is an indicator of diversification. The more separate
issues a fund holds, the less susceptible it is to a price decline
stemming from the problems of a particular issue.
- - 30-day yield is a snapshot of a fund's income. The yield, expressed as a
percentage of the fund's net asset value, is based on its income, net of
its operating expenses, over the past 30 days and is annualized, or
projected forward for the coming year.
- - Average maturity is the average length of time until bonds held by a fund
reach maturity (or are called) and are repaid. In general, the longer the
average maturity, the more a fund's share price will fluctuate in response
to changes in market interest rates.
- - Weighted Average quality is an indicator of credit risk. This figure is
the average of the ratings assigned to a fund's securities holdings by
credit-rating agencies. The agencies make their judgment after appraising
an issuer's ability to meet its obligations. Quality is graded on a scale,
with Aaa or AAA indicating the most creditworthy bond issuers and A-1 or
MIG-1 indicating the most creditworthy issuers of money market securities.
The Fund's weighted average quality is based on the market value of the
bonds held by the Fund.
- - Average duration is an estimate of how much a bond fund's share price will
fluctuate in response to a change in interest rates. To see how the price
could shift, multiply the fund's duration by the change in rates. If
interest rates rise by one percentage point, the share price of a fund
with an average duration of five years would decline by about 5%. If rates
decrease by a percentage point, the fund's share price would rise by about
5%.
<PAGE> 13
10
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.
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 domestic hybrid funds (a
category that includes balanced funds) is approximately 97%, according to
Morningstar, Inc.
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 22%. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its total net assets within a one-year period.)
ACCOUNT MAINTENANCE FEES
Vanguard assesses an account maintenance fee on index fund shareholders whose
accountant balances are below $10,000 (for any reason, including a decline in
the value of a Fund's shares) on the date a dividend is distributed. This fee
is intended to allocate the costs of maintaining accounts more equitably among
shareholders. The account maintenance fee is $2.50 per quarter,
deducted from the quarterly dividend, which usually is distributed during the
last two weeks of each calendar quarter. If the fee is deducted from your
dividend distribution, you will still be taxed on the full amount of your
dividend (unless you hold your shares through a non-taxable account). If you
are due a dividend that is less than the fee, fractional shares will be
automatically redeemed to make up the difference.
OTHER INVESTMENT POLICIES AND RISKS
Besides investing in U.S. common stocks and bonds, 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, to a limited extent, in stock and bond futures
and options contracts, which are traditional types of derivatives. 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 or as leveraged investments that magnify the gains or
losses of an investment. The value of all futures contracts in which the Fund
acquires an interest cannot exceed 20% of total assets.
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.
- - To reduce the Fund's transaction costs or add value when these instruments
are favorably priced.
<PAGE> 14
11
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 $440 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 ADVISERS
Vanguard's Core Management and Fixed Income Groups provide investment advisory
services to many Vanguard funds. As of December 31, 1998, the Core Management
Group managed more than $147 billion in total stock assets, and the Fixed Income
Group managed more than $127 billion in total fixed-income assets. The
individuals responsible for overseeing the Fund's investments are:
GEORGE U. SAUTER, Managing Director of the Core Management Group; has
worked in investment management since 1985; with Vanguard since 1987; primary
responsibility for Vanguard's stock index investment policy and strategy since
1987; has served as the portfolio manager for the stock portion of the Fund
since 1992; A.B., Dartmouth College; M.B.A., University of Chicago.
IAN A. MACKINNON, Managing Director of the Fixed Income Group; has worked
in investment management since 1974; with Vanguard since 1981; primary
responsibility for Vanguard's internal fixed-income policy and strategy since
1981; has been responsible for overseeing the portfolio management of the bond
portion of the Fund since 1992; B.A., Lafayette College; M.B.A., Pennsylvania
State University.
CHRISTOPHER W. ALWINE, CFA, and (since 1998) portfolio manager of the
bond portion of the Fund; has worked in investment management since 1991; with
Vanguard since 1990; has managed portfolio investments since 1998; B.B.A.,
Temple University; M.S., Drexel University.
INVESTMENT ADVISERS
Vanguard Core Management Group and Vanguard Fixed Income Group, P.O. Box 2600,
Valley Forge, PA 19482, provide advisory services on an at-cost basis to the
Fund. For the fiscal year ended December 31, 1998, the advisory fees represented
an effective annual rate of 0.01%.
The Fund has authorized the Groups to choose brokers or dealers to handle
the purchase and sale of securities for the Fund, and to get the best available
price and most favorable execution from these brokers with respect to all
transactions.
The Fund may direct the Groups to use a particular broker for certain
transactions in exchange for commission rebates or research services provided to
the Fund.
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.
<PAGE> 15
12
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.
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. These 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.
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 had reinvested it in more shares. To avoid "buying a
dividend," check a fund's distribution schedule before you invest.
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 March, June, September,
and December; capital gains distributions generally occur in December. In
addition, the Fund may occasionally be required to make supplemental income or
capital gains distributions at some other time during the year. 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.
- - 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 the Fund's 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.
<PAGE> 16
13
- - 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. (Non-U.S. investors may be
subject to U.S. withholding and estate tax.) You should consult your tax adviser
about the tax consequences of an investment in the Fund.
IMPORTANT NOTE: By law, the Fund must withhold 31% of your taxable
distributions and any redemption proceeds if you do not provide your correct
taxpayer identification number, or certify that it is correct, or if the IRS
instructs the Fund to do so.
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 Index Funds." Different
newspapers use different abbreviations of the Fund's name, but the most common
is BALANCED.
<PAGE> 17
14
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 1998 with a net asset value (price) of $16.29 per share.
During the year, the Fund earned $.54 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 $.68 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 ($2.87 per share) minus the distributions ($.68 per share)
resulted in a share price of $18.48 at the end of the year. This was an increase
of $2.19 per share (from $16.29 at the beginning of the year to $18.48 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 17.85% for the year.
As of December 31, 1998, the Fund had $2 billion in net assets. For the
year, its expense ratio was 0.21% ($2.10 per $1,000 of net assets); and its net
investment income amounted to 3.29% of its average net assets. It sold and
replaced securities valued at 25% 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.
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.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
VANGUARD BALANCED INDEX FUND
YEAR ENDED DECEMBER 31,
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $16.29 $13.92 $12.77 $10.34 $10.91
- --------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .54 .520 .50 .45 .41
Net Realized and Unrealized Gain
(Loss) on Investments 2.33 2.525 1.26 2.48 (.58)
------------------------------------------------
Total from Investment Operations 2.87 3.045 1.76 2.93 (.17)
- --------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.54) (.530) (.49) (.45) (.40)
Distributions from Realized Capital Gains (.14) (.145) (.12) (.05) --
------------------------------------------------
Total Distributions (.68) (.675) (.61) (.50) (.40)
- --------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $18.48 $16.29 $13.92 $12.77 $10.34
============================================================================================
TOTAL RETURN* 17.85% 22.24% 13.95% 28.64% -1.56%
============================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $2,004 $1,260 $826 $ 590 $ 403
Ratio of Total Expenses to
Average Net Assets 0.21% 0.20% 0.20% 0.20% 0.20%
Ratio of Net Investment Income to
Average Net Assets 3.29% 3.56% 3.69% 3.85% 3.86%
Turnover Rate 25% 18% 37%+ 16% 16%
============================================================================================
</TABLE>
* Total return figures do not reflect the annual account maintenance fee of $10.
+ Turnover rate excluding in-kind redemptions was 30%.
"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> 18
15
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 [BOOK GRAPHIC]. 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. Note:
Limitations do apply; see page 18.
- --------------------------------------------------------------------------------
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> 19
16
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 at that time is 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> 20
17
Make your check payable to: The Vanguard Group - 02
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 [WIRE GRAPHIC]
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 Balanced Index Fund - 02
[Account number, or temporary number for a new account]
[Registered account owner/s]
[Registered address]
<PAGE> 21
18
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.
- --------------------------------------------------------------------------------
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:
- - Vanguard sends the redemption proceeds to you or a designated third
party.*
- - You can sell all or part of your Fund shares at any time.
* May require a signature guarantee; see footnote on page 20.
When Exchanging Shares:
- - The redemption proceeds are used to purchase shares of a different
Vanguard fund.
- - You must meet the receiving fund's minimum investment requirements.
- - 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 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.
<PAGE> 22
19
- --------------------------------------------------------------------------------
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 shares.
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 telephone 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:
- - Traditional IRAs and Roth IRAs -- call Client Services.
- - 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> 23
20
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 the management of the Fund
and increase the Fund's costs for all shareholders, Vanguard limits account
activity as follows:
- - You may make no more than TWO SUBSTANTIVE "ROUND TRIPS" THROUGH THE FUND
during any 12-month period.
- - Your round trips through the Fund must be at least 30 days apart.
- - The Fund may refuse a share purchase at any time, for any reason.
- - 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 the management of the
Fund.
<PAGE> 24
21
- --------------------------------------------------------------------------------
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 client services Department at 1-800-662-2739.
- --------------------------------------------------------------------------------
CONFIRMATION STATEMENT
Sent each time you buy, sell, or exchange shares; confirms the trade date and
the amount of your transaction.
- --------------------------------------------------------------------------------
PORTFOLIO SUMMARY [BOOK GRAPHIC]
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.
- --------------------------------------------------------------------------------
<PAGE> 25
22
FUND AND ACCOUNT UPDATES (CONTINUED)
- --------------------------------------------------------------------------------
FUND FINANCIAL REPORTS
Mailed in February and August for this Fund.
- --------------------------------------------------------------------------------
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> 26
(THIS PAGE INTENTIONALLY LEFT BLANK.)
<PAGE> 27
(THIS PAGE INTENTIONALLY LEFT BLANK.)
<PAGE> 28
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.
BALANCED FUND
A mutual fund that seeks to provide some combination of income, capital growth,
and conservation of capital by investing in stocks, bonds, and/or money market
instruments.
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.
CREDIT QUALITY
A measure of a bond issuer's ability to pay interest and principal in a timely
manner.
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.
FACE VALUE
The amount to be paid at maturity of a bond; also known as the par value or
principal.
FIXED-INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
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 or industry.
INVESTMENT GRADE
A bond whose credit quality is considered by independent bond-rating agencies to
be sufficient to ensure timely payment of principal and interest under current
economic circumstances.
MATURITY
The date when a bond issuer agrees to repay the bond's principal, or face value,
to the bond's buyer.
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.
PRICE/EARNINGS (P/E) RATIO
The current share price of a stock, divided by its per-share earnings (profits)
from the past year. A stock selling for $20, with earnings of $2 per share, has
a price/earnings ratio of 10.
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> 29
[THE Vanguard GROUP(R) SHIP GRAPHIC]
Post Office Box 2600
Valley Forge, PA 19482-2600
FOR MORE INFORMATION
If you'd like more information about Vanguard Balanced Index 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
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: 811-7023
(C) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
P002N - 04/30/1999
<PAGE> 30
VANGUARD BALANCED INDEX FUND
Participant Prospectus
April 30, 1999
A Balanced Mutual Fund
CONTENTS
2 FUND PROFILE
4 AN INTRODUCTION TO INDEX FUNDS
4 ADDITIONAL INFORMATION
4 A WORD ABOUT RISK
4 WHO SHOULD INVEST
5 PRIMARY INVESTMENT STRATEGIES
11 THE FUND AND VANGUARD
11 INVESTMENT ADVISERS
12 YEAR 2000 CHALLENGE
12 DIVIDENDS, CAPITAL GAINS, AND TAXES
13 SHARE PRICE
14 FINANCIAL HIGHLIGHTS
15 INVESTING WITH VANGUARD
15 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
Balanced Index 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> 31
1
FUND PROFILE
The following profile summarizes key features of Vanguard Balanced Index Fund.
INVESTMENT OBJECTIVE
The Fund is a balanced stock and bond index fund that seeks to provide current
income and long-term growth of income and capital.
INVESTMENT STRATEGIES
The Fund typically invests 60% of its assets in common stocks and 40% in bonds.
The stock portion of the Fund seeks to match the total return of the Wilshire
5000 Equity Index, a widely recognized measure for the U.S. stock market. The
Fund's bond portion seeks to replicate the returns of the Lehman Brothers
Aggregate Bond Index, a measure of regularly traded, U.S. investment-grade
bonds. There is no assurance that the Fund will achieve its stated objective.
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:
- - Stock market risk, which is the chance that stock prices in general
will decline over short or even long periods. The stock market tends to
be cyclical, with periods when stock prices generally rise and periods
when stock prices generally decline.
- - Interest rate risk, which is the chance that bond prices overall will
decline over short or even long periods due to rising interest rates.
Interest rate risk should be moderate for the Fund.
- - Income risk, which is the chance that falling interest rates will cause
the Fund's income to decline. Income risk should be moderate for the
Fund.
- - Credit risk, which is the chance that a bond issuer will fail to pay
interest and principal in a timely manner, reducing the Fund's return.
Credit risk should be low for the Fund.
- - Prepayment risk, which is the chance that during periods of falling
interest rates, a mortgage-backed bond issuer will repay its
high-yielding bond earlier than scheduled. Forced to reinvest the
unanticipated proceeds at lower rates, the Fund would experience a
decline in income and lose the opportunity for additional price
appreciation associated with falling rates.
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 since
inception. The table shows how the Fund's average annual returns for one and
five calendar years and since inception compare to those of a broad-based
securities market index. Keep in mind that the Fund's past performance does not
necessarily indicate how it will perform in the future.
<TABLE>
<CAPTION>
ANNUAL TOTAL RETURNS
<S> <C>
1993........ 10.00%
1994........ -1.56%
1995........ 28.64%
1996........ 13.95%
1997........ 22.24%
1998........ 17.85%
</TABLE>
During the period shown in the bar chart, the highest return for a
calendar quarter was 12.67% (quarter ended December 31, 1998) and the lowest
return for a quarter was -5.57% (quarter ended September 30, 1998).
<PAGE> 32
2
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
1 YEAR 5 YEARS SINCE INCEPTION*
------ ------- ----------------
<S> <C> <C> <C>
Vanguard Balanced Index Fund 17.85% 15.76% 15.09%
Balanced Composite Index** 18.11 16.03 15.46
Wilshire 5000 Index 23.39 21.78 20.46
Lehman Aggregate Bond Index 8.69 7.27 7.83
</TABLE>
*November 9, 1992.
**Made up of two unmanaged benchmarks, weighted 60% Wilshire 5000 Index and 40%
Lehman Aggregate Bond Index.
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 December 31, 1998.
<TABLE>
<S> <C>
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 Fees: 0.17%
12b-1 Distribution Fees: None
Other Expenses 0.04%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.21%
</TABLE>
The Fund reserves the right to deduct a transaction fee of 0.08% from an
investor's cumulative purchases over $100 million. Where it applies, the fee is
retained by the Fund to offset transaction costs of investing large new
contributions into the market. The fee is not paid to Vanguard and is not a
sales charge.
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 Balanced Index Fund's expense ratio in fiscal year 1998 was
0.21%, or $2.10 per $1,000 of average net assets. The average balanced mutual
fund had expenses in 1998 of 1.31%, or $13.10 per $1,000 of average net assets,
according to Lipper Inc., which reports on the mutual fund industry. The
average balanced mutual fund refers predominantly to actively managed mutual
funds.
<PAGE> 33
3
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.
<TABLE>
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
<S> <C> <C> <C>
$22 $68 $118 $268
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
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 quarterly; capital gains are distributed annually in December
INVESTMENT ADVISERS
Vanguard Core Management Group (for common stocks) and Vanguard Fixed Income
Group (for bonds), Valley Forge, Pa., since inception
INCEPTION DATE
November 9, 1992
NET ASSETS AS OF DECEMBER 31, 1998
$2 billion
NEWSPAPER ABBREVIATION
Balanced
VANGUARD FUND NUMBER
02
CUSIP NUMBER
921931101
TICKER SYMBOL
VBINX
AN INTRODUCTION TO INDEX FUNDS
WHAT IS INDEXING?
An index is an unmanaged group of securities whose overall performance is used
as a standard to measure investment performance. An index fund (or "passively
managed" fund) tries to match, as closely as possible, the performance of an
established target index by holding all, or a representative sample, of the
securities in the index.
The target index may be a group of stocks or bonds, or a combination
of stocks and bonds. Balanced index funds hold a mix of stocks and bonds.
Index funds are not actively managed by investment advisers who buy and
sell securities based on research and analysis in an attempt to outperform the
market. Rather, index funds simply mirror what the target index does,
for better or worse.
WHY INVEST IN INDEX FUNDS?
Index funds appeal to many investors for a number of reasons:
- - Diversification. Index funds generally invest in a diversified mix
companies and industries.
- - Relative consistency. Index funds typically match the performance of
relevant market benchmarks more closely than comparable actively
managed funds do.
- - Low cost. Index funds do not have many of the costs and expenses of an
actively managed fund -- such as research -- and keep trading activity,
and thus brokerage commissions, to a minimum.
- - Low realization of capital gains. Because an index fund typically sells
securities only to respond to redemption requests or to adjust the
number of shares it holds to reflect a change in its target index, the
fund's turnover rate -- and thus its realization of capital gains -- is
usually very low.
<PAGE> 34
4
KEEP IN MIND THAT AN INDEX FUND HAS OPERATING EXPENSES AND TRANSACTION
COSTS; A MARKET INDEX DOES NOT. THEREFORE, AN INDEX FUND -- WHILE EXPECTED TO
TRACK ITS TARGET INDEX AS CLOSELY AS POSSIBLE -- WILL TYPICALLY BE UNABLE TO
MATCH THE PERFORMANCE OF THE INDEX EXACTLY.
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.
A WORD ABOUT RISK
This prospectus describes the risks you would face as an investor in Vanguard
Balanced Index 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 Balanced Index Fund,
you should also take into account your personal tolerance for the daily
fluctuations of the stock and bond 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 are seeking moderate current income and long-term growth of
principal and income.
- - You are seeking a diversified combination of U.S. stocks and bonds.
- - You are willing to invest for the long term -- at least five years.
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> 35
5
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.
PRIMARY INVESTMENT STRATEGIES
This section explains the strategies that the investment adviser uses in pursuit
of the Fund's objective, current income and long-term growth of capital and
income. It also explains how the adviser implements these strategies. In
addition, this section discusses several important risks -- stock market risk,
interest rate risk, income risk, credit risk, and prepayment 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. The Fund's investment objective is not fundamental, and so may be
changed without a shareholder vote.
MARKET EXPOSURE
STOCKS
About 60% of the Fund's assets are invested in common stocks, in an attempt to
replicate with that portion of the assets the performance of the Wilshire 5000
Index.
[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.
PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are generally "middle-of-the-road" investments that seek to
provide some combination of growth, income, and conservation of capital by
investing in a mix of stocks, bonds, and/or money market instruments. Because
the prices of stocks and bonds often move in different directions, balanced
funds are able to use rewards from one type of investment to help offset the
risks from another.
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. (The S&P 500 Index is shown
here because this benchmark, unlike the Wilshire 5000 Index, has been in
existence for all of the periods shown.)
<TABLE>
<CAPTION>
U.S. STOCK MARKET RETURNS (1926 - 1998)
1 YEAR 5 YEARS 10 YEARS 20 YEARS
------ ------- -------- --------
<S> <C> <C> <C> <C>
Best 54.2% 24.1% 19.9% 17.7%
Worst -43.1 -12.4 -0.8 3.1
Average 13.1 10.7 11.0 11.0
</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1998. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.7%, returns for individual 5-year periods
ranged from a -12.4% average (from 1928 through 1932) to 24.1% (from 1994
through 1998). 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.
<PAGE> 36
6
PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies -- and mutual funds that hold these stocks
- -- can be classified by the companies' market value, or capitalization.
Generally, Vanguard defines large-capitalization (large-cap) funds as those
holding stocks of companies whose outstanding shares have a market value
exceeding $10 billion. Mid-cap funds hold stocks of companies with a market
value from $1 billion to $10 billion. Small-cap funds typically hold stocks of
companies with a market value of $1 billion or less.
While the Fund's holdings will typically include the 500 largest stocks
in the Wilshire 5000 Index, they will not include all of the securities in the
Index. Instead, the Fund will invest in a representative sample of stocks.
Keep in mind, too, that while the Wilshire 5000 Index is dominated by
large-cap stocks (those contained in the S&P 500 Index), small- and mid-cap
issues are also represented. The Fund's stock holdings are adjusted on a regular
basis to reflect the Wilshire 5000 Index. As of December 31, 1998, about 22% of
the market value of the Wilshire 5000 Index was comprised of securities that
were not in the S&P 500 Index. Stocks of smaller companies have historically
been more volatile than -- and at times have performed quite differently from --
the stocks of larger companies.
Finally, because Vanguard Balanced Index Fund's holdings are not
identical to the Wilshire 5000 Index or any other market index, the performance
of the Fund will not mirror the returns of any particular index.
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 should be able to sell your 5% bond for more than you
paid.
BONDS
About 40% of the Fund's assets are 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. INTEREST RATE
RISK SHOULD BE MODERATE FOR SHORTER-TERM BONDS AND HIGH FOR
LONGER-TERM BONDS. BECAUSE THE FUND INVESTS IN A PORTFOLIO OF
BONDS WITH AN INTERMEDIATE AVERAGE MATURITY (5-10 YEARS),
INTEREST RATE RISK IS MODERATE.
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.
To illustrate the relationship between bond prices and interest rates,
the following table shows the impact of a 2% change (both up and down) in
interest rates on three bonds of different maturities, each with a face value of
$1,000.
<TABLE>
<CAPTION>
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
- ---------- ----------------- -----------------
<S> <C> <C>
Short-Term (2.5 years) $956 $1,046
Intermediate-Term (10 years) 870 $1,156
Long-Term (20 years) $816 $1,251
</TABLE>
*Assuming a 7% yield.
<PAGE> 37
7
These figures are for illustration only and should not be regarded as
an indication of future returns from the bond market as a whole or the Fund in
particular.
Changes in interest rates will affect bond income as well as bond
prices.
[FLAG GRAPHIC] THE FUND IS SUBJECT TO INCOME RISK, WHICH IS THE CHANCE THAT A
FUND'S DIVIDENDS (INCOME) WILL DECLINE DUE TO FALLING INTEREST
RATES. INCOME RISK IS GENERALLY THE GREATEST FOR SHORT-TERM
BONDS, AND THE LEAST FOR LONG-TERM BONDS.
[FLAG GRAPHIC] BECAUSE IT INVESTS IN MORTGAGE-BACKED BONDS, THE FUND IS SUBJECT
TO PREPAYMENT RISK, WHICH IS THE POSSIBILITY THAT DURING PERIODS
OF FALLING INTEREST RATES, A BOND ISSUER WILL REPAY ITS
HIGH-YIELDING BOND EARLIER THAN SCHEDULED. FORCED TO REINVEST THE
UNANTICIPATED PROCEEDS AT LOWER RATES, THE FUND WOULD EXPERIENCE
A DECLINE IN INCOME AND LOSE THE OPPORTUNITY FOR ADDITIONAL PRICE
APPRECIATION ASSOCIATED WITH FALLING RATES.
Since the Fund invests only a portion of its assets in mortgage-backed
bonds, the risk to the Fund is limited.
[FLAG GRAPHIC] THE FUND IS SUBJECT TO CREDIT RISK, WHICH IS THE POSSIBILITY THAT
A BOND ISSUER WILL FAIL TO PAY INTEREST AND PRINCIPAL IN A TIMELY
MANNER.
The credit quality of the Fund is expected to be very high, and thus
credit risk should be low. The weighted average credit quality of the Fund's
holdings, as rated by Moody's Investors Service, as of December 31, 1998, was
Aa1.
To a limited extent, the Fund is also exposed to event risk, which is
the possibility that corporate fixed-income securities held by the Fund may
suffer a substantial decline in credit quality and market value due to a
corporate restructuring.
Finally, because stock and bond prices often move in different
directions, the Fund's bond holdings help to dampen -- but not eliminate -- some
of the stock market volatility experienced by the Fund. Likewise, changes in
interest rates may not have as dramatic an effect on the Fund as they would on a
fund made up entirely of bonds.
SECURITY SELECTION
INDEXING METHODS
In seeking to track a particular index, a fund may use one of two indexing
methods to select the stocks or bonds it invests in.
Some index funds hold each stock or bond found in their target indexes
in about the same proportions as represented in the indexes themselves. For
example, if 5% of the S&P 500 Index were made up of the stock of a specific
company, a fund tracking that index would invest about 5% of its assets in that
company.
Other index funds may use a different selection process. Because it
would be very expensive to buy and sell all of the securities represented (the
Wilshire 5000 Index, for example, includes more than 7,000 stocks), funds
tracking these larger indexes use a "sampling" technique. Using a sophisticated
computer program, these funds select securities that will recreate their target
indexes in terms of industry, size, and other characteristics. For instance, if
10% of the Wilshire 5000 Index were made up of utility stocks, the Balanced
Index Fund would allocate about 10% of its stock investment to the utility
stocks of the index with similar characteristics.
STOCKS
The Fund's common stock portfolio is designed to have investment characteristics
that parallel those of the Wilshire 5000 Index. The Fund is expected to
replicate approximately 1,000 of the largest securities in the Wilshire 5000
Index as measured by market capitalization, plus a representative sample of the
remainder, which are selected primarily on the basis of market capitalization,
industry weightings, and other fundamental characteristics. Typically, the Fund
holds a total of between 2,500 and 3,000 stocks.
<PAGE> 38
8
PLAIN TALK ABOUT
BOND MATURITIES
A bond is issued with a specific maturity date -- the date when the
bond's 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.
BONDS
The Fund's bond portfolio is designed to have investment characteristics that
parallel those of the Lehman Brothers Aggregate Bond Index, a broad
market-weighted index that encompasses five major classes of investment-grade
fixed-income securities in the United States: U.S. Treasury and agency
securities, corporate bonds, mortgage-backed securities, international
dollar-denominated bonds, and asset-backed securities with maturities greater
than one year. The Fund will invest in a representative sample of fixed-income
securities in the index, which, taken together, are expected to perform
similarly to the index. These securities are described further as follows:
- - U.S. government securities include U.S. Treasury and agency bonds,
which represent loans by an investor to the U.S. Treasury Department or
a wide variety of governmental agencies and instrumentalities. Timely
payment of principal and interest on these bonds is guaranteed by the
full faith and credit of the U.S. government.
- - Corporate bonds are IOUs issued by businesses that want to borrow money
for some purpose -- often to develop a new product or service, to
expand into a new market, or to buy another company. As with other
types of bonds, the issuer promises to repay the principal on a
specific date and to make interest payments in the meantime. The amount
of interest offered depends both on market conditions and on the
financial health of the corporation issuing the bonds; a company whose
credit rating is not strong will have to offer a relatively high
interest rate to obtain buyers for its bonds.
- - Mortgage-backed bonds represent interests in underlying pools of
mortgages. Unlike ordinary bonds, which generally pay a fixed rate of
interest at regular intervals and then repay principal upon maturity,
mortgage-backed bonds pay both interest and principal as part of
their regular payments. Because the mortgages underlying the bonds can
be prepaid at any time by homeowners or corporate borrowers,
mortgage-backed bonds are subject to prepayment risk, as discussed
earlier in this prospectus. These types of bonds are issued by a number
of government agencies, including the Government National Mortgage
Association (GNMA), often referred to as "Ginnie Mae," the Federal Home
Loan Mortgage Corporation (FHLMC), the Federal National Mortgage
Association (FNMA), often referred to as "Fannie Mae," and the Federal
Housing Authority (FHA). GNMA bonds are guaranteed by the full faith
and credit of the U.S. government as to the timely payment of principal
and interest; bonds issued by other government agencies are not. (Note:
The Balanced Index Fund may also invest in conventional mortgage
securities, which are packaged by private corporations and are not
guaranteed by the U.S. government.)
- - International dollar-denominated bonds are bonds denominated in U.S.
dollars issued by foreign governments and companies. Because the bond's
value is designated in dollars rather than in the currency of the
issuer's country, the investor is not exposed to currency risk; rather,
the issuer assumes the risk, usually to attract American investors
- - Asset-backed securities are bonds backed by an underlying pool of
assets such as automobile loans, credit card loans, and home equity
loans. These securities are structured with varying amounts of credit
risk, depending primarily on the quality of the underlying assets. They
are generally issued by private corporations and are not guaranteed by
the U.S. government. Asset-backed bonds are subject to prepayment risk
as discussed earlier in this prospectus.
The Fund may, from time to time, substitute one type of
investment-grade bond for another. For instance, the Fund may hold more
short-term corporate bonds (and fewer short-term U.S. Treasury bonds) than are
represented in the index so as to increase income. This corporate substitution
strategy entails the assumption of additional credit risk; however, substantial
diversification within the corporate sector should moderate issue-specific
credit risk. In addition, the Fund's
<PAGE> 39
9
current investment policy restricts corporate substitutions to issues with less
than four years remaining to maturity and in aggregate to no more than 15% of
the assets of the Fund's bond portfolio. Overall, credit risk is expected to be
very low for the Fund.
The Fund is generally managed without regard to tax ramifications.
FUND CHARACTERISTICS
STOCKS
The following table provides a snapshot of some financial characteristics of the
Fund's stock holdings as of December 31, 1998.
<TABLE>
<CAPTION>
PRICE/EARNINGS EARNINGS DIVIDEND PRICE/BOOK
RATIO GROWTH RATE YIELD RATIO
----- ----------- ----- -----
<S> <C> <C> <C>
26.1 17.6% 1.27% 4.28
</TABLE>
- - Price/earnings ratio is the current price of a stock, divided by its
per-share earnings (profits) from the past year. A stock selling for
$20, with earnings of $2 per share, has a price/earnings ratio of 10.
- - Earnings growth rate is the average annual rate, expressed as a
percentage, of growth in earnings over the past five years for the
stocks now in a fund.
- - Dividend yield is current income (interest or dividends) earned by an
investment, expressed as a percentage of the investment's price.
- - Price/book ratio is the current price of a stock, divided by its net
worth, or book value, per share. For a fund, this ratio is used to mean
the weighted average price/book ratio of the stocks held by the fund.
BONDS
The following table provides a snapshot of the financial characteristics of the
Fund's bond holdings as of December 31, 1998.
<TABLE>
<CAPTION>
NUMBER OF AVERAGE AVERAGE AVERAGE
ISSUES MATURITY QUALITY DURATION
------ -------- ------- --------
<S> <C> <C> <C>
379 8.7 years Aa1 4.4 years
</TABLE>
- - Number of issues is an indicator of diversification. The more separate
issues a fund holds, the less susceptible it is to a price decline
stemming from the problems of a particular issue.
- - 30-day yield is a snapshot of a fund's income. The yield, expressed as
a percentage of the fund's net asset value, is based on its income, net
of its operating expenses, over the past 30 days and is annualized, or
projected forward for the coming year.
- - Average maturity is the average length of time until bonds held by a
fund reach maturity (or are called) and are repaid. In general, the
longer the average maturity, the more a fund's share price will
fluctuate in response to changes in market interest rates.
- - Weighted average quality is an indicator of credit risk. This figure is
the average of the ratings assigned to a fund's securities holdings by
credit-rating agencies. The agencies make their judgment after
appraising an issuer's ability to meet its obligations. Quality is
graded on a scale, with Aaa or AAA indicating the most creditworthy
bond issuers and A-1 or MIG-1 indicating the most creditworthy issuers
of money market securities. The Fund's weighted average quality is
based on the market value of the bonds held by the Fund.
- - Average duration is an estimate of how much a bond fund's share price
will fluctuate in response to a change in interest rates. To see how
the price could shift, multiply the fund's duration by the change in
rates. If interest rates rise by one percentage point, the share price
of a fund with an average duration of five years would decline by about
5%. If rates decrease by a percentage point, the fund's share price
would rise by about 5%.
<PAGE> 40
10
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 domestic hybrid funds (a
category that includes balanced funds) is approximately 97%, according to
Morningstar, Inc.
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 22%. (A
turnover rate of 100% would occur, for example, if the Fund sold and replaced
securities valued at 100% of its total 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 U.S. common stocks and bonds, 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, to a limited extent, in stock and bond
futures and options contracts, which are traditional types of derivatives.
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 or as leveraged investments that magnify the
gains or losses of an investment. The value of all futures contracts in which
the Fund acquires an interest cannot exceed 20% of total assets.
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.
- - To reduce the Fund's transaction costs or add value when these
instruments are favorably priced.
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.
<PAGE> 41
11
PLAIN TALK ABOUT
THE FUND'S ADVISERS
Vanguard's Core Management and Fixed Income Groups provide investment advisory
services to many Vanguard funds. As of December 31, 1998, the Core Management
Group managed more than $147 billion in total stock assets, and the Fixed Income
Group managed more than $127 billion in total fixed-income assets. The
individuals responsible for overseeing the Fund's investments are:
GEORGE U. SAUTER, Managing Director of the Core Management Group; has
worked in investment management since 1985; with Vanguard since 1987; primary
responsibility for Vanguard's stock index investment policy and strategy since
1987; has served as the portfolio manager for the stock portion of the Fund
since 1992; A.B., Dartmouth College; M.B.A., University of Chicago.
IAN A. MACKINNON, Managing Director of the Fixed Income Group; has
worked in investment management since 1974; with Vanguard since 1981; primary
responsibility for Vanguard's internal fixed-income policy and strategy since
1981; has been responsible for overseeing the portfolio management of the bond
portion of the Fund since 1992; B.A., Lafayette College; M.B.A., Pennsylvania
State University.
CHRISTOPHER W. ALWINE, CFA, and (since 1998) portfolio manager of the
bond portion of the Fund; has worked in investment management since 1991; with
Vanguard since 1990; has managed portfolio investments since 1998; B.B.A.,
Temple University; M.S., Drexel University. 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 $440 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 ADVISERS
Vanguard Core Management Group and Vanguard Fixed Income Group, P.O. Box 2600,
Valley Forge, PA 19482, provide advisory services on an at-cost basis to the
Fund. For the fiscal year ended December 31, 1998, the advisory fees represented
an effective annual rate of 0.01%.
The Fund has authorized the Groups to choose brokers or dealers to
handle the purchase and sale of securities for the Fund, and to get the best
available price and most favorable execution from these brokers with respect to
all transactions.
The Fund may direct the Groups to use a particular broker for certain
transactions in exchange for commission rebates or research services provided to
the Fund.
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.
<PAGE> 42
12
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. These 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.
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 March, June,
September, and December; capital gains distributions generally occur in
December. In addition, the Fund may occasionally be required to make
supplemental income or capital gains distributions at some other time during the
year.
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 Description, or
your tax adviser about the tax consequences of an investment in the Fund and of
any plan withdrawals.
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 Index Funds." Different
newspapers use different abbreviations of the Fund's name, but the most common
is BALANCED.
<PAGE> 43
13
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 1998 with a net asset value (price) of $16.29 per share.
During the year, the Fund earned $.54 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 $.68 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 ($2.87 per share) minus the distributions ($.68 per share)
resulted in a share price of $18.48 at the end of the year. This was an increase
of $2.19 per share (from $16.29 at the beginning of the year to $18.48 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 17.85% for the year.
As of December 31, 1998, the Fund had $2 billion in net assets. For the
year, its expense ratio was 0.21% ($2.10 per $1,000 of net assets); and its net
investment income amounted to 3.29% of its average net assets. It sold and
replaced securities valued at 25% 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 BALANCED INDEX FUND
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $16.29 $13.92 $12.77 $10.34 $10.91
Investment Operations
Net Investment Income .54 .520 .50 .45 .41
Net Realized and Unrealized Gain
(Loss) on Investments 2.33 2.525 1.26 2.48 (.58)
------ ------ ------ ------ ------
Total from Investment Operations 2.87 3.045 1.76 2.93 (.17)
------ ------ ------ ------ ------
DISTRIBUTIONS
Dividends from Net Investment Income (.54) (.530) (.49) (.45) (.40)
Distributions from Realized Capital
Gains (.14) (.145) (.12) (.05) --
------ ------ ------ ------ ------
Total Distributions (.68) (.675) (.61) (.50) (.40)
- -------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $18.48 $16.29 $13.92 $12.77 $10.34
===============================================================================
TOTAL RETURN 17.85% 22.24% 13.95% 28.64% - 1.56%
===============================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $2,004 $1,260 $826 $590 $403
Ratio of Total Expenses to
Average Net Assets 0.21% 0.20% 0.20% 0.20% 0.20%
Ratio of Net Investment Income to
Average Net Assets 3.29% 3.56% 3.69% 3.85% 3.86%
Turnover Rate 25% 18% 37%* 16% 16%
===============================================================================
</TABLE>
*Turnover rate excluding in-kind redemptions was 30%.
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> 44
14
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. In all cases,
your transaction will be based on the Fund's next-determined net asset value
after Vanguard receives your request (or, in the case of new contributions, the
next-determined net asset value after Vanguard receives the order from your plan
administrator). As long as this request is received before the close of trading
on the New York Stock Exchange, generally 4 p.m. Eastern Time, you will receive
that day's net asset value.
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 participant 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> 45
(THIS PAGE INTENTIONALLY LEFT BLANK.)
<PAGE> 46
(THIS PAGE INTENTIONALLY LEFT BLANK.)
<PAGE> 47
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.
BALANCED FUND
A mutual fund that seeks to provide some combination of income, capital growth,
and conservation of capital by investing in stocks, bonds, and/or money market
instruments.
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.
CREDIT QUALITY
A measure of a bond issuer's ability to pay interest and principal in a timely
manner.
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.
FACE VALUE
The amount to be paid at maturity of a bond; also known as the par value or
principal.
FIXED-INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
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 or industry.
INVESTMENT GRADE
A bond whose credit quality is considered by independent bond-rating agencies to
be sufficient to ensure timely payment of principal and interest under current
economic circumstances.
MATURITY
The date when a bond issuer agrees to repay the bond's principal, or face value,
to the bond's buyer.
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.
PRICE/EARNINGS (P/E) RATIO
The current share price of a stock, divided by its per-share earnings (profits)
from the past year. A stock selling for $20, with earnings of $2 per share, has
a price/earnings ratio of 10.
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> 48
[VANGUARD SHIP LOGO]
THE VANGUARD GROUP(R)
Institutional Division
Post Office Box 2900
Valley Forge, PA 19482-2900
FOR MORE INFORMATION
If you'd like more information about Vanguard Balanced Index 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
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: 811-7023
(C) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
I002N - 04/30/1999
<PAGE> 49
PART B
VANGUARD BALANCED INDEX FUND
(THE TRUST)
STATEMENT OF ADDITIONAL INFORMATION
APRIL 30, 1999
This Statement is not a prospectus but should be read in conjunction with
the Trust's current Prospectus (dated April 30, 1999). To obtain the Prospectus
or an additional 1998 Annual Report to Shareholders, which contains the Fund's
financial statements as hereby incorporated by reference, please call:
VANGUARD INVESTOR INFORMATION CENTER
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Description of the Trust.................................... B-1
Investment Policies......................................... B-3
Fundamental Investment Limitations.......................... B-7
Yield and Total Return...................................... B-8
Purchase of Shares.......................................... B-9
Share Price................................................. B-9
Redemption of Shares........................................ B-10
Management of the Trust..................................... B-11
Portfolio Transactions...................................... B-14
Financial Statements........................................ B-15
Performance Measures........................................ B-15
Appendix A -- Description of Bond Ratings................... B-18
Appendix B -- Historical Performance One-Year Total
Returns................................................... B-18
</TABLE>
DESCRIPTION OF THE TRUST
ORGANIZATION
Vanguard Balanced Index Fund is a Delaware business trust. It was
originally organized as a Maryland corporation in 1992, and was reorganized as a
Delaware business trust in July 1998. More than one fund may be offered through
the Trust; currently the Trust only offers the following fund: Vanguard Balanced
Index Fund (the Fund). Throughout this Statement of Additional Information
references will be made to both the Trust and the Fund offered by the Trust.
Prior to its reorganization as a Delaware business trust, the Trust was known as
Vanguard Balanced Index Fund, Inc. The Trust is registered with the United
States Securities and Exchange Commission (the Commission) under the Investment
Company Act of 1940 (the 1940 Act) as an open-end diversified management
investment company.
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. First Union National Bank, PA4943, 530 Walnut Street,
Philadelphia, Pennsylvania 19106, 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> 50
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 Fund and provide other
related services.
TRANSFER AND DIVIDEND-PAYING AGENT. The Fund's transfer 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 Fund's shares, other
than the possible future termination of the Fund. The Fund 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 Fund 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 Fund'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 Fund obligation only if the Fund 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 Fund 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.
LIQUIDATION RIGHTS. In the event of liquidation, shareholders will be
entitled to receive a pro rata share of the net assets of applicable funds of
the Trust.
PREEMPTIVE RIGHTS. There are no preemptive rights associated with shares
of the Trust.
CONVERSION RIGHTS. There are no conversion rights associated with shares
of 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 Fund's shares, when issued, are fully paid and
non-assessable.
TAX STATUS OF THE TRUST
The Fund qualifies as a "regulated investment company" under Subchapter M
of the Internal Revenue Code. This special tax status means that the Fund will
not be liable for federal tax on income and capital gains
B-2
<PAGE> 51
distributed to shareholders. In order to preserve its tax status, the Fund must
comply with certain requirements. If the 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, the 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
REPURCHASE AGREEMENTS. The Trust may invest in repurchase agreements with
commercial banks, brokers, or dealers to generate income from its excess cash
balances. A repurchase agreement is an agreement under which the Trust acquires
a fixed-income security (generally a security issued by the U.S. Government or
an agency thereof, a banker's acceptance or a certificate of deposit) from a
Federal Reserve member bank with minimum assets of at least $2 billion or a
registered securities dealer, subject to resale to the seller at an agreed upon
price and date (normally, the next business day). A repurchase agreement may be
considered a loan collateralized by securities. The resale price reflects an
agreed upon interest rate effective for the period the instrument is held by the
Trust and is unrelated to the interest rate on the underlying instrument. In
these transactions, the securities acquired by the Trust (including accrued
interest earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by the Trust's custodian bank until
repurchased. In addition, the Trust's Board of Trustees will monitor the Trust's
repurchase agreement transactions generally and will establish guidelines and
standards for review of the creditworthiness of any bank, broker, or dealer
party to a repurchase agreement with the Trust.
The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Trust may incur a loss upon disposition of the security. If the other party to
the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Trust not within the control
of the Trust and therefore the Trust may not be able to substantiate its
interest in the underlying security and may be deemed an unsecured creditor of
the other party to the agreement. While the Trust's management acknowledges
these risks, it is expected that they can be controlled through careful
monitoring procedures.
LENDING OF SECURITIES. The Trust may lend its 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 portfolio
securities, the Trust 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 Trust. The terms, the structure, and the aggregate amount of such
loans must be consistent with the 1940 Act, and the Rules and Regulations or
interpretations of 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 Trust collateral consisting
of cash, a letter of credit issued by a domestic U.S. bank, 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 Trust at any time and (d) the Trust receive reasonable
interest on the loan (which may include the Trust'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 Trust will comply with all other applicable regulatory requirements,
including the rules of the New York Stock Exchange, which rules 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.
B-3
<PAGE> 52
VANGUARD INTERFUND LENDING PROGRAM. The Commission 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 Commission's exemptive order.
FUTURES CONTRACTS, OPTIONS ON FUTURES CONTRACTS, WARRANTS, CONVERTIBLE
SECURITIES, AND SWAP AGREEMENTS. The Fund may enter into futures contracts,
warrants, options on futures contracts, convertible securities, and swap
agreements for the purpose of simulating full investment in the underlying
Indexes and reducing transaction costs. Futures contracts provide for the future
sale by one party and purchase by another party of a specified amount of a
specific security 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 futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are 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," or "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 initial margin deposit in
cash or 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 with deposits
that may range upward from less than 5% of the value of the contract being
traded. The Fund's initial margin requirement is ordinarily in the form of U.S.
Treasury securities.
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 initial margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes 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 prices of underlying securities. The Fund intends to use futures contracts
only for bona fide 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. 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
B-4
<PAGE> 53
amounts of related securities will have been purchased or are being purchased by
the Fund upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Fund's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
the Fund will incur commission expenses in both opening and closing out futures
positions, these costs are lower than transaction costs incurred in the purchase
and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS. The Fund will not enter into
futures contract transactions to the extent that, immediately thereafter, the
sum of its initial margin deposits on open contracts exceeds 5% of the market
value of the Fund's total assets.
RISK FACTORS IN FUTURES TRANSACTIONS. Positions in futures contracts 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. In addition, the Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on the ability to effectively hedge.
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 pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as 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 stock 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.
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 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 certain futures contracts as of
B-5
<PAGE> 54
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. A 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, gains from the sale of
securities or of foreign currencies or other income derived with respect to the
Fund's business of investing in securities. 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 distributions.
ILLIQUID SECURITIES. Each 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.
Each 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 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.
FOREIGN INVESTMENTS. The Fund will invest in securities issued by foreign
governments, companies, and agencies.
The Fund is, therefore, subject to country risk, which is the possibility
that political events (such as a war), financial problems (such as government
default), or natural disasters (such as an earthquake) will weaken a country's
economy and cause securities issued by entities in that country to lose money.
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 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.
B-6
<PAGE> 55
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% or more 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 and stock futures contracts, bond and stock options and options
on bond and 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
20% of the Fund's total assets my 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.
ILLIQUID SECURITIES. The Fund may not acquire any security if, as a
result, more than 15% of its net assets would be invested in securities that are
illiquid.
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 or by entering into repurchase agreements, 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.
OIL, GAS, MINERALS. The Fund may not invest in interests in oil, gas, or
other mineral exploration or development programs.
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.
RELATED PARTY TRANSACTIONS. The Trust may not have dealings on behalf of
the Trust with officers and Trustees, except for the purchase or sale of
securities on an agency or commission basis. The Trust may not make loans to any
officers, Trustees, or employees of the Trust.
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.
B-7
<PAGE> 56
None of these limitations prevents the Fund from participating in The
Vanguard Group (Vanguard). As 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.
Compliance with the investment limitations set forth above is measured at
the time the investment is made, a later change in percentage resulting from a
change in the market value of assets will not constitute a violation of such
restriction.
YIELD AND TOTAL RETURN
Yields are calculated daily and premiums and discounts on asset-backed
securities are not amortized.
The yield of the Trust for the 30 days ended December 31, 1998 was +2.91%.
The total return of the Trust for the one and five years ended December 31, 1998
and since November 9, 1992 (Subscription period September 28, 1992 through
November 8, 1992) was +17.85%*, 15.76%*, and 15.09%*.
*Performance figures are not adjusted for the $10 annual account maintenance
fee.
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:
<TABLE>
<S> <C> <C>
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.
</TABLE>
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:
<TABLE>
<S> <C> <C>
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.
</TABLE>
B-8
<PAGE> 57
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)[to the power of 6]-1]
Where:
<TABLE>
<S> <C> <C>
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.
</TABLE>
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 as well as redemption fees for certain fiduciary
accounts or under circumstances where certain economies can be achieved in sales
of the Trust's shares.
The Fund reserves the right to deduct a transaction fee of .08% from an
investor's cumulative purchases over $100 million. The Fund may incur
substantial transaction costs in absorbing very large investments, and the
fee -- paid directly to the Fund -- is intended to protect existing shareholders
from being unfairly impacted by such costs. The Fund's adviser will consider
several factors in determining whether to apply the fee, including the
following:
- The transaction costs of buying securities, determined in part by the
availability of securities at that time.
- The offsetting effect of any Fund redemptions occurring at that time.
- The Fund's then current rate of growth.
- Whether the Fund's corporate substitution strategy provides adequate
additional returns to help offset transaction costs associated with the
large investment under then current market conditions (as discussed in
the prospectus).
SHARE PRICE
The Trust's share price, or "net asset value" per share, is calculated by
dividing the total assets of the Trust, 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 (the Exchange), generally 4:00 p.m. Eastern time
on each day that the Exchange is open for trading.
Trust 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. 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.
B-9
<PAGE> 58
Short term instruments (those 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 Trust can be found daily in the mutual fund
listings of most major newspapers under the heading of "Vanguard Index Funds".
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 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.
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.
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.
B-10
<PAGE> 59
MANAGEMENT OF THE TRUST
OFFICERS AND TRUSTEES
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 the 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, and
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.
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.
B-11
<PAGE> 60
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 1940 Act.
THE VANGUARD GROUP. The Trust is a member of the Vanguard Group of
Investment Companies which consists of more than 30 investment companies, (the
Trusts).
Through their jointly-owned subsidiary, The Vanguard Group, Inc.
(Vanguard), the Trust and the other Trusts in The Vanguard Group obtain at cost
virtually all of their corporate management, administrative, and distribution
services. Vanguard also provides investment advisory services on an at-cost
basis to certain Vanguard 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 net expenses which are allocated among
the Trusts under methods approved by the Board 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.
Vanguard adheres to a Code of Ethics established pursuant to Rule 17j-1
under the 1940 Act. 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 a Funds' Service Agreement
which was approved by the shareholders of each of the Trusts. The Amended and
Restated Funds' Service Agreement provides for the following arrangement: (1)
each Vanguard Trust may be called upon to invest a maximum of 0.40% of its
assets in Vanguard and (2) there is no restriction on the maximum cash
investment that the Vanguard Trusts may make in Vanguard. The amounts which each
of the Trusts has 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. At December 31, 1998, the Trust had
contributed capital of $336,000 to Vanguard, representing 0.02% of the Fund's
net assets and 0.5% 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
year ended December 31, 1996, 1997, and 1998, the Trust paid approximately
$812,000, $1,451,000, and $2,565,000, respectively, in management and
administration expenses.
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
B-12
<PAGE> 61
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 years ended
December 31, 1996, 1997, and 1998, the Trust incurred approximately $162,000,
$264,000, and $388,000, respectively, in distribution and marketing expenses.
INVESTMENT ADVISORY SERVICES. Vanguard provides investment advisory
services to the Trust. 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. During the fiscal years ended December 31, 1996, 1997, and 1998, the
Trust paid approximately $53,000, $80,000, and $123,000, respectively, of
Vanguard's expenses relating to investment advisory services.
TRUSTEE COMPENSATION
The same individuals serve as Trustees of all Vanguard Trusts (with two
exceptions, which are noted in the table appearing on page B-14), 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:
- 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.
- The independent Trustees are reimbursed for the travel and other expenses
that they incur in attending Board meetings.
- 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.
B-13
<PAGE> 62
COMPENSATION TABLE. The following table provides compensation details for
each of the Trustees. 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 December 31, 1998.
VANGUARD BALANCED INDEX FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE PENSION OR RETIREMENT ESTIMATED TOTAL COMPENSATION
COMPENSATION BENEFITS ACCRUED AS ANNUAL BENEFITS FROM ALL VANGUARD TRUSTS
NAMES OF TRUSTEES FROM TRUST PART OF TRUST EXPENSES UPON RETIREMENT PAID TO TRUSTEES(1)
----------------- ------------ ---------------------- --------------- ------------------------
<S> <C> <C> <C> <C>
John C. Bogle None None None None
John J. Brennan None None None None
Barbara Barnes Hauptfuhrer(2) $318 $43 $15,000 $75,000
JoAnn Heffernan Heisen $159 $19 $15,000 $37,500
Robert E. Cawthorn(2) $132 $29 $ 6,000 $31,250
Bruce K. MacLaury $332 $31 $12,000 $70,000
Burton G. Malkiel $320 $31 $15,000 $75,000
Alfred M. Rankin, Jr. $318 $23 $15,000 $75,000
John C. Sawhill $318 $29 $15,000 $75,000
James O. Welch, Jr. $318 $33 $15,000 $75,000
J. Lawrence Wilson $318 $24 $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.
PORTFOLIO TRANSACTIONS
In placing portfolio transactions, Vanguard uses 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 are 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 will be given to
those brokers which supply statistical information and provide other services in
addition to execution services to the Fund.
The Fund's bond investments are generally purchased and sold through
principal transactions, meaning that the Fund normally purchases bonds directly
from the issuer or a primary market-maker acting as principal for the bonds on a
net basis. Explicit brokerage commissions are not paid on these transactions,
although the purchase price for bonds usually includes an undisclosed
compensation. Purchases from underwriters of bonds typically include a
commission or concession paid by the issuer to the underwriter, and purchases
from dealers serving as market makers typically include a dealer's mark-up
(i.e., a spread between the bid and the asked prices).
Vanguard's Fixed Income Group chooses brokers or dealers to handle the
purchase and sale of the Fund's bonds, and is responsible for getting the best
available price and most favorable execution for all transactions. When the Fund
purchases a newly issued bond at a fixed price, the Group may designate certain
members of the underwriting syndicate to receive compensation associated with
that transaction. Certain dealers have agreed to rebate a portion of such
compensation directly to the Fund to offset its management expenses. The Group
is required to seek best execution of all transactions and is not authorized to
pay a higher brokerage commission solely on account of the receipt of research
or other services.
The Fund's adviser evaluates the reasonableness of any commissions paid by
considering: (a) historical commission rates; (b) rates which other
institutional investors are paying, based upon publicly available information;
(c) rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the
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<PAGE> 63
number of shares, dollar amount, and number of clients involved; (e) the
complexity of a particular transaction in terms of both execution and
settlement; (f) the level and type of business done with a particular firm over
a period of time; and (g) the extent to which the broker or dealer has capital
at risk in the transaction.
During the fiscal years ended December 31, 1996, 1997, and 1998, the Fund
paid approximately $80,605, $70,745, and $139,894.76, respectively, in brokerage
commissions.
FINANCIAL STATEMENTS
The Trust's financial statements as of and for the year ended December 31,
1998, appearing in the Vanguard Balanced Index Fund's 1998 Annual Report to
Shareholders, and the report thereon of PricewaterhouseCoopers LLP, independent
accountants, also appearing therein, are incorporated by reference in 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.
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 Balanced Index Fund, may from time to time, use one or more of the
following unmanaged indexes for comparative performance purposes.
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX -- includes stocks selected by
Standard & Poor's Index Committee to include leading companies in leading
industries and to reflect the U.S. stock market.
STANDARD & POOR'S MIDCAP 400 INDEX -- is composed of 400 medium sized domestic
stocks.
STANDARD & POOR'S 500/BARRA VALUE INDEX -- consists of the stocks in the
Standard & Poor's 500 Composite Stock Price Index (S&P 500) with the lowest
price-to-book ratios, comprising 50% of the market capitalization of the S&P
500.
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 more than 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.
RUSSELL 3000 STOCK INDEX -- a diversified portfolio of approximately 3,000
common stocks accounting for over 90% of the market value of publicly traded
stocks in the U.S.
RUSSELL 2000 STOCK INDEX -- a subset of approximately 2,000 of the smallest
stocks contained in the Russell 3000, a widely-used benchmark for small
capitalization common stocks.
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, Australasia, 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.
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<PAGE> 64
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 LONG-TERM TREASURY BOND INDEX -- is a market weighted index that contains
individually priced U.S. Treasury securities.
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 one year and with more than $100 million outstanding. This index
includes over 1,500 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 $100 million
principal outstanding and maturity greater than ten 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 for four high-grade, non-callable 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.
LEHMAN BROTHERS AGGREGATE BOND INDEX -- is a market-weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass-through
securities corporate rated Baa- or better. The Index has a market value of over
$5 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX -- is a
market-weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities
between one and five years. The index has a market value of over $1.6 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX -- is
a market-weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities between five and
ten years. The index has a market value of over $800 billion.
LEHMAN BROTHERS LONG (10+) GOVERNMENT/CORPORATE INDEX -- is a market-weighted
index that contains individually priced U.S. Treasury, agency, and corporate
securities rated BBB- or better with maturities greater than ten years. The
index has a market value of over $1.1 trillion.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE -- the average performance of small
company growth funds as defined by Lipper Inc. Lipper defines a small company
growth fund as a fund that by prospectus or portfolio practice, limits its
investments to companies on the basis of the size of the company. From time to
time, Vanguard may advertise using the average performance and/or the average
expense ratio of the small company growth funds. (This fund category was first
established in 1982. For years prior to 1982, the results
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<PAGE> 65
of the Lipper Small Company Growth category were estimated using the returns of
the Funds that constituted the Group at its inception.)
LIPPER BALANCED FUND AVERAGE -- an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper Inc.
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of
average non-government money market funds with similar investment objectives and
policies, as measured by Lipper Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Inc.
LIPPER GENERAL EQUITY FUND AVERAGE -- an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Inc.
LIPPER FIXED INCOME FUND AVERAGE -- an industry benchmark of average fixed
income funds with similar investment objectives and policies, as measured by
Lipper Inc.
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<PAGE> 66
APPENDIX A -- DESCRIPTION OF BOND RATINGS
Excerpts from Moody's Investors Service, Inc. description of its four
highest preferred bond ratings:
<TABLE>
<S> <C> <C>
Aaa -- Judged to be the best quality. They carry the smallest
degree of investment risk.
Aa -- Judged to be of high quality by all standards. Together with
the Aaa group they comprise what are generally known as high
grade bonds.
A -- Possess many favorable investment attributes and are to be
considered as "upper medium grade obligations".
Baa -- Considered as medium grade obligations; i.e., they are
neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the
present but certain protective elements may be lacking or
may be characteristically unreliable over any great length
of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics
as well.
</TABLE>
Moody's also supplies numerical indicators 1, 2, and 3 to rating
categories. The modifier 1 indicates that the security is in the higher end of
its rating category; the modifier 2 indicates a mid-range ranking; and 3
indicates a ranking toward the lower end of the category.
Excerpts from Standard & Poor's Corporation description of its four highest
stock ratings:
<TABLE>
<S> <C> <C>
AAA -- Highest grade obligations. Capacity to pay interest and
repay principal is extremely strong.
AA -- Also qualify as high grade obligations, a very strong
capacity to pay interest and repay principal and differs
from AAA -- issues only in small degree.
A -- Regarded as upper medium grade. They have a strong capacity
to pay interest and repay principal although they are
somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than debt in higher
rated categories.
BBB -- Regarded as having an adequate capacity to pay interest and
repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt in
this category than in higher rated categories. This group is
the lowest which qualifies for commercial bank investment.
</TABLE>
Standard & Poor's applies indicators "+", no character and "-" to its
rating categories. The indicators show relative standing within the major rating
categories.
APPENDIX B -- HISTORICAL PERFORMANCE ONE-YEAR TOTAL RETURNS*
<TABLE>
<CAPTION>
LEHMAN BROTHERS BALANCED
WILSHIRE AGGREGATE PORTFOLIO
5000 BOND INDEX (60/40)**
-------- --------------- ---------
<S> <C> <C> <C>
1988................................................. 17.94 7.89 13.87
1989................................................. 29.17 14.53 23.30
1990................................................. -6.18 8.96 -0.11
1991................................................. 34.20 16.00 26.90
1992................................................. 8.97 7.40 8.41
1993................................................. 11.28 9.75 10.72
1994................................................. -0.06 -2.92 -1.15
1995................................................. 36.45 18.47 29.03
1996................................................. 21.21 3.63 14.01
1997................................................. 31.35 9.65 22.46
Cumulative........................................... 405.20 140.58 280.48
Annualized........................................... 17.58 9.18 14.30
</TABLE>
* These total return figures are based on historical earnings and are not
intended to indicate future performance.
** A hypothetical portfolio for which 60% of its assets track the Wilshire 5000
and 40% of its assets track the Lehman Brothers Aggregate Bond Index. Assumes
monthly rebalancing to 60/40 mix.
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