<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 33-53683) UNDER THE
SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO.
POST-EFFECTIVE AMENDMENT NO. 4
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 7
VANGUARD TAX-MANAGED FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
P.O. BOX 2600,
VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
It is proposed that this filing become effective: On April 29, 1998 pursuant
to paragraph (a) of Rule 485.
Approximate Date of Proposed Public Offering: As soon as practicable after
this Registration Statement becomes effective.
We have elected to register an indefinite number of shares pursuant to
Regulation 24f-2 under the Investment Company Act of 1940. We filed our Rule
24f-2 Notice for the year ended December 31, 1997 on . .
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<PAGE>
VANGUARD TAX-MANAGED FUND, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <C> <S>
Item 1. Cover Page............................ Cover Page
Item 2. Synopsis.............................. Highlights
Item 3. Condensed Financial Information....... N/A
Item 4. General Description of Registrant..... Investment Objectives;
Investment Limitations;
Investment Policies;
General Information
Item 5. Management of the Fund................ Management of the Fund
Item 5A. Management's Discussion of Fund Herein incorporated by
Performance........................... reference to Registrant's
Annual Report to
Shareholders dated .
filed with the Securities &
Exchange Commission's EDGAR
system on .
Item 6. Capital Stock and Other Securities.... Opening an Account and
Purchasing Shares; Selling
Your Shares; The Share
Price of Each Portfolio;
Dividends, Capital Gains
and Taxes; General
Information
Item 7. Purchase of Securities Being Offered.. Cover Page; Opening an
Account and Purchasing
Shares
Item 8. Redemption or Repurchase.............. Selling Your Shares
Item 9. Pending Legal Proceedings............. Not Applicable
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
<C> <C> <S>
Item 10. Cover Page............................ Cover Page
Item 11. Table of Contents..................... Cover Page
Item 12. General Information and History....... Investment Objectives and
Policies
Item 13. Investment Objective and Policies..... Investment Objectives and
Policies; Investment
Limitations
Item 14. Management of the Registrant.......... Management of the Fund
Item 15. Control Persons and Principal Holders
of Securities......................... Management of the Fund
Item 16. Investment Advisory and Other Management of the Fund
Services..............................
Item 17. Brokerage Allocation.................. Not Applicable
Item 18. Capital Stock and Other Securities.... Financial Statements
Item 19. Purchase, Redemption and Pricing of
Securities Being Offered.............. Purchase of Shares;
Redemption of Shares
Item 20. Tax Status............................ Appendix
Item 21. Underwriters.......................... Not Applicable
Item 22. Calculations of Performance Data...... Not Applicable
Item 23. Financial Statements.................. Financial Statements
</TABLE>
<PAGE>
VANGUARD
TAX-MANAGED
FUND
P R O S P E C T U S
APRIL 29, 1998
<PAGE>
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VANGUARD
TAX-MANAGED A Member of The Vanguard Group
FUND
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PROSPECTUS--APRIL 29, 1998
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NEW ACCOUNT INFORMATION: INVESTOR INFORMATION DEPARTMENT--1-800-662-7447 (SHIP)
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SHAREHOLDER ACCOUNT SERVICES: CLIENT SERVICES DEPARTMENT--1-800-662-2739 (CREW)
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INVESTMENT Vanguard Tax-Managed Fund, Inc. (the "Fund") is an open-end
OBJECTIVE AND diversified investment company designed for long-term in-
POLICIES vestors seeking to minimize the impact of taxes on their
investment returns. The Fund uses an index-oriented ap-
proach to equity management. The Fund consists of three
Portfolios:
The GROWTH AND INCOME PORTFOLIO seeks to provide growth of
capital and moderate current income from investments in eq-
uity securities. Standard & Poor's 500 Composite Stock
Price Index (the "S&P 500 Index") is the Portfolio's bench-
mark index.
The CAPITAL APPRECIATION PORTFOLIO seeks to provide growth
of capital with nominal current income from investments in
equity securities. The Russell 1000 Index is the Portfo-
lio's benchmark index.
The BALANCED PORTFOLIO seeks to provide a balance between
capital growth and income exempt from federal income taxes.
The Portfolio invests 50-55% of its net assets in municipal
securities and 45-50% of its net assets in common stocks.
The Russell 1000 is the benchmark index for the equity por-
tion of the Portfolio.
THE FUND IS NOT A TAX-EXEMPT FUND, AND, IN FACT, MAY BE EX-
PECTED TO EARN AND DISTRIBUTE TAXABLE INCOME AND MAY ALSO
REALIZE AND DISTRIBUTE CAPITAL GAINS FROM TIME TO TIME.
There is no assurance that the Portfolios will achieve
their stated objective. Shares of the Fund are neither in-
sured nor guaranteed by any agency of the U.S. Government,
including the FDIC.
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OPENING AN Please complete and return the Account Registration Form.
ACCOUNT If you need assistance in completing this Form, please call
our Investor Information Department, Monday through Friday,
from 8:00 a.m. to 9:00 p.m. and Saturday, from 9:00 a.m. to
4:00 p.m. (Eastern time). This Fund is designed for taxable
investors and is not appropriate for Individual Retirement
Accounts (IRAs) and other tax-deferred retirement plans.
The minimum initial investment is $10,000. The Fund is of-
fered on a no-load basis (i.e., there are no sales commis-
sions or 12b-1 fees). However, the Fund incurs expenses for
investment advisory, management, administrative, and dis-
tribution services. SHAREHOLDERS WILL BE ASSESSED A 2% FEE
ON SHARES REDEEMED IF HELD FOR LESS THAN ONE YEAR AND A 1%
FEE ON SHARES REDEEMED IF HELD AT LEAST ONE YEAR BUT LESS
THAN FIVE YEARS. THE REDEMPTION FEES ARE PAYABLE TO THE
PORTFOLIOS. SEE "FUND EXPENSES."
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ABOUT THIS This Prospectus is designed to set forth concisely the in-
PROSPECTUS formation you should know about the Fund before you invest.
It should be retained for future reference. A "Statement of
Additional Information" containing additional information
about the Fund has been filed with the Securities and Ex-
change Commission. This Statement is dated April 29, 1998
and has been incorporated by reference into this Prospec-
tus. It may be obtained without charge by writing to the
Fund, calling the Investor Information Department at 1-800-
662-7447, or visiting the Securities and Exchange Commis-
sion's website (www.sec.gov).
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Highlights........................................................... 2
Introduction......................................................... 4
Fund Expenses........................................................ 5
Financial Highlights................................................. 7
Yield and Total Return............................................... 8
FUND INFORMATION
Investment Objectives................................................ 9
Investment Policies.................................................. 9
Investment Risks..................................................... 11
Who Should Invest.................................................... 12
Implementation of Policies........................................... 13
Investment Limitations............................................... 18
Management of the Fund............................................... 18
Investment Adviser................................................... 19
Dividends, Capital Gains and Taxes................................... 20
The Share Price of Each Portfolio.................................... 22
General Information.................................................. 23
SHAREHOLDER GUIDE
Opening an Account and Purchasing Shares............................. 24
When Your Account Will Be Credited................................... 28
Selling Your Shares.................................................. 28
Exchanging Your Shares............................................... 30
Important Information About Telephone Transactions................... 32
Transferring Registration............................................ 32
Other Vanguard Services.............................................. 33
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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<PAGE>
HIGHLIGHTS
OBJECTIVES AND The Fund is an open-end diversified investment company de-
POLICIES signed for long-term investors seeking to minimize the im-
pact of taxes on their investment returns. Shares of the
Fund are offered on a no-load basis, although the Fund in-
curs certain distribution expenses. The Fund consists of
three separate Portfolios, two of which invest in common
stocks and one which invests in both common stocks and mu-
nicipal bonds. The Fund uses an index-oriented approach to
equity management. PAGE 9
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THREE SEPARATE Investors may choose to invest in any of three Portfolios
PORTFOLIOS of the Fund:
GROWTH AND INCOME PORTFOLIO--seeks to provide long-term
growth of capital and moderate current income from invest-
ments in equity securities. The S&P 500 Index is the Port-
folio's benchmark index.
CAPITAL APPRECIATION PORTFOLIO--seeks to provide growth of
capital and with nominal current income from investments in
equity securities. The Russell 1000 Index is the Portfo-
lio's benchmark index.
BALANCED PORTFOLIO--seeks to provide a balance between cap-
ital growth and reasonable current income (nominal taxable
income and moderate income exempt from federal taxes). The
Portfolio invests 50-55% of its net assets in municipal se-
curities and 45-50% of its net assets in common stocks. The
Russell 1000 Index is the benchmark index for the equity
portion of the Portfolio.
There is no assurance that the Portfolios will meet their
stated objectives.
PAGE 9
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RISK As mutual funds investing in common stocks, all three Port-
CHARACTERISTICS folios are subject to market risk, which is the possibility
that common stock prices will decline, sometimes substan-
tially, over short or extended periods. In addition, in-
vestments in municipal securities expose the Balanced Port-
folio to interest rate risk and credit risk. Credit risk is
expected to be low due to the quality and diversification
of the bonds held by the Portfolio. PAGE 11
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THE VANGUARD The Fund is a member of The Vanguard Group of Investment
GROUP Companies, a group of more than 30 investment companies
with more than 95 distinct investment portfolios and total
assets in excess of $330 billion. The Vanguard Group, Inc.
("Vanguard"), a subsidiary jointly owned by the Vanguard
Funds, provides all corporate management, administrative,
distribution, and shareholder accounting services on an at-
cost basis to the Funds in the Group. PAGE 18
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INVESTMENT The Fund receives investment advisory services for its eq-
ADVISER uity investments from Vanguard's Core Management Group. The
bond portion of the Balanced Portfolio receives investment
advisory services from Vanguard's Fixed Income Group. All
investment advisory services are provided to the Fund on an
at-cost basis. As a result, the Fund receives investment
advisory services at a substantially lower cost than would
be possible if the Fund paid an investment advisory fee to
an external investment adviser. PAGE 19
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2
<PAGE>
FEES AND In order to discourage short-term trading activity, a re-
EXPENSES demption fee of 2% will be assessed on shares redeemed if
held less than one year, and a redemption fee of 1% will be
assessed on shares redeemed if held for at least one year
but less than five years. The fees help cover transaction
costs including the tax costs long-term investors may bear
when a Portfolio realizes capital gains as a result of
selling securities to meet redemptions. By being paid di-
rectly to the Portfolios, the fees tend to be more advanta-
geous to long-term investors and less advantageous to
short-term investors. PAGE 13
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DIVIDEND POLICY The Fund distributes substantially all of its net invest-
ment income in the form of dividends. The Growth and Income
and Balanced Portfolios distribute dividends quarterly,
whereas the Capital Appreciation Portfolio distributes div-
idends annually. In all three Portfolios, net capital
gains, if any, are distributed annually. PAGE 20
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TAXES A sale of shares of a Portfolio is a taxable event and may
result in a capital gain or loss. While each Portfolio
seeks to minimize taxable distributions, such distributions
will nevertheless occur. Dividend distributions, capital
gains distributions, and capital gains or losses from re-
demptions and exchanges may be subject to federal, state,
and local taxes. PAGE 20
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PURCHASING You may purchase shares by mail, wire, or exchange from an-
SHARES other Vanguard Fund. The minimum initial investment is
$10,000; the minimum for subsequent investments is $100.
There are no sales commissions or 12b-1 fees.
PAGE 24
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SELLING SHARES You may redeem shares of each Portfolio in writing or by
telephone. The share price of each Portfolio is expected to
fluctuate, and may at redemption be more or less than at
the time of initial purchase, resulting in a gain or loss.
PAGE 28
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OTHER VANGUARD The Fund offers two special services: Fund Express, for
SERVICES electronic transfers between the Fund and your bank ac-
count; and Tele-Account, for round-the-clock telephone ac-
cess to your Fund account balance and certain
transactions. PAGE 33
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SPECIAL (1) Each Portfolio may invest a portion of its assets in
CONSIDERATIONS futures contracts, options, convertible securities and swap
agreements. PAGE 16
(2) Each Portfolio may invest in short-term fixed income
securities. PAGE 15
(3) Each Portfolio may lend its securities. PAGE 17
(4) Each Portfolio may borrow money. PAGE 18
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3
<PAGE>
Vanguard Tax-Managed Fund consists of three Portfolios each
AN INTRODUCTION of which seeks to achieve a stated investment objective
TO VANGUARD TAX- while minimizing the impact of taxes on shareholders' re-
MANAGED FUND turns. Today, dividends and short-term capital gains dis-
tributed by mutual funds are taxed at federal income tax
rates as high as 39.6%. Mutual fund distributions of long-
term capital gains are taxed at federal tax rates of up to
28%. State taxes on mutual fund distributions also reduce
after-tax returns.
THE FUND IS Yet, most stock and balanced mutual funds are managed to
DESIGNED FOR maximize PRE-TAX total return, without regard to the tax
LONG-TERM consequences of portfolio activity that may result in tax-
INVESTORS able distributions. Vanguard Tax-Managed Fund has been de-
SEEKING TO signed for investors who seek to participate in broadly di-
MINIMIZE THE versified funds for the long-term (five years or longer)
IMPACT OF TAXES and to minimize the impact of taxes on their return. The
ON THEIR RETURN Fund offers three Portfolios: two equity Portfolios--the
Growth and Income Portfolio and the Capital Appreciation
Portfolio--and a Portfolio combining stocks and municipal
bonds, the Balanced Portfolio.
The Fund employs various techniques to minimize the impact
of taxes:
. First, each Portfolio employs an index-oriented approach
to equity management designed to provide low portfolio
turnover. By seeking to reduce turnover, the Portfolio
endeavors to defer the realization and minimize the dis-
tributions of capital gains.
. Second, each Portfolio is designed ONLY for long-term in-
vestors who expect to own the Portfolio for five years or
longer. A redemption fee of 2% will be assessed on shares
redeemed if held for less than one year, and a redemption
fee of 1% will be assessed on shares redeemed if held for
at least one year but less than five years. The fees will
help to cover transaction costs incurred by the Portfo-
lios when purchasing and selling securities and will in-
directly help to offset tax costs long-term investors
bear when a Portfolio is forced to realize capital gains
as a result of short-term investor activity. By being
paid directly to the Portfolios, the fees tend to be ad-
vantageous to long-term investors and disadvantageous to
short-term investors.
. Third, each Portfolio, when making sales of specific se-
curities, will select the shares on which it has the
highest cost basis in order to minimize capital gains
distributions. Additionally, each Portfolio may, when
prudent, sell securities in order to realize capital
losses. Realized capital losses can be used to offset re-
alized capital gains thus reducing capital gains distri-
butions.
. Finally, the Capital Appreciation and the Balanced Port-
folios seek to minimize taxable dividend income by empha-
sizing stocks with low dividend yields. The Balanced
Portfolio also invests at least 50% of its assets in tax-
exempt municipal bonds to provide tax-free income.
While each Portfolio seeks to minimize the realization of
capital gains, the Portfolios may nevertheless realize tax-
able gains from time to time. Additionally, while the Capi-
tal Appreciation and Balanced Portfolios seek to minimize
taxable dividend distributions, the two Portfolios will
distribute some taxable income. Of course, shareholders may
also be required to pay taxes on capital gains realized, if
any, upon redemption of shares of the Fund.
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4
<PAGE>
FUND EXPENSES The following table illustrates ALL expenses and fees you
would incur as a shareholder of the Growth and Income, Cap-
ital Appreciation, and Balanced Portfolios. The annual
Portfolio operating expenses set forth below are for the
1997 fiscal year.
<TABLE>
<CAPTION>
GROWTH AND CAPITAL
INCOME APPRECIATION BALANCED
SHAREHOLDER TRANSACTION EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO
--------------------------------------------------------------
<S> <C> <C> <C>
Sales Load Imposed on Purchases. None None None
Sales Load Imposed on Reinvested
Dividends...................... None None None
Redemption Fees*:
shares held less than 1 year... 2% 2% 2%
shares held at least 1 but less
than 5 years.................. 1% 1% 1%
shares held 5 years or more.... None None None
Exchange Fees**................. None None None
</TABLE>
*The fees withheld from redemption proceeds are paid to the
Portfolios.
**Exchanges will be treated as redemptions for purposes of
imposing the redemption fees.
<TABLE>
<CAPTION>
GROWTH AND CAPITAL
ANNUAL PORTFOLIO INCOME APPRECIATION BALANCED
OPERATING EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO
-------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Management &
Administrative
Expenses......... . % . % . %
Investment
Advisory Fees.... . . .
12b-1 Fees........ None None None
Other Expenses
Distribution
Costs........... . % . % . %
Miscellaneous
Expenses........ . . .
---- ----- ----
Total Other
Expenses......... . . .
----- ------ -----
TOTAL OPERATING
EXPENSES....... . % . % . %
===== ====== =====
</TABLE>
The purpose of this table is to assist you in understanding
the various costs and expenses that you would bear directly
or indirectly as an investor in the Growth and Income, Cap-
ital Appreciation, and Balanced Portfolios.
------------------------------------------------------------
Each Portfolio of the Vanguard Tax-Managed Fund is intended
REDEMPTION FEE for long-term investors who expect to own shares for at
least five years. A 2% fee will be assessed on shares re-
deemed if held less than one year and a fee of 1% will be
assessed on shares redeemed if held at least one but less
than five years. The fees help to cover transaction costs
including the tax costs long-term investors may bear when a
Portfolio realizes capital gains as a result of selling se-
curities to meet redemptions. By being paid directly to the
Portfolios, the fees tend to be advantageous to long-term
investors and disadvantageous to short-term investors.
Only the "first-in, first-out" (FIFO) method will be used
for the purpose of calculating the holding period of
shares. Under this method, the date of a
5
<PAGE>
redemption or exchange will be compared to the earliest
purchase date of shares in the account. If this holding pe-
riod is less than one year, a 2% fee will be assessed. If
this holding period is at least one year but less than five
years, a 1% fee will be assessed. The fee will be prorated
if the shares redeemed or exchanged have been held for time
periods subject to differing fees. The fee will not apply
to shares purchased through reinvestment of dividends or
capital gains.
ILLUSTRATION OF The following example illustrates the expenses that you
EXPENSES would incur on a $1,000 investment over various periods,
assuming (1) a 5% annual rate of return and (2) redemption
at the end of each period.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C>
$ . $ . $ . $ .
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR PERFORMANCE. ACTUAL EXPENSES MAY
BE HIGHER OR LOWER THAN THOSE SHOWN.
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6
<PAGE>
FINANCIAL The following financial highlights for a share outstanding
HIGHLIGHTS throughout each period, insofar as they relate to the pe-
riod ended December 31, 1997, have been derived from finan-
cial statements which were audited by Price Waterhouse LLP,
independent accountants, whose report thereon was unquali-
fied. This information should be read in conjunction with
the Fund's financial statements and notes thereto, which,
together with the remaining portions of the Fund's 1997 An-
nual Report to Shareholders, are incorporated by reference
in the Statement of Additional Information and in this Pro-
spectus, and which appear, along with the report of Price
Waterhouse LLP, in the Fund's 1997 Annual Report to Share-
holders. For a more complete discussion of the Fund's per-
formance, please see the Fund's 1997 Annual Report to
Shareholders which may be obtained without charge by writ-
ing to the Fund or by calling our Investor Information De-
partment at 1-800-662-7447.
<TABLE>
<CAPTION>
--------------------------------------------------------------------------
GROWTH AND CAPITAL
INCOME APPRECIATION
PORTFOLIO PORTFOLIO
------------------------------------ ------------------------------------
JULY 25+, JULY 25+,
TO TO
YEAR ENDED DECEMBER 31, DEC. 31, YEAR ENDED DECEMBER 31, DEC. 31,
1997 1996 1995 1994 1997 1996 1995 1994
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<S> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING
OF PERIOD................ . $ 13.16 $ 9.77 $10.00 . $ 13.28 $ 9.95 $10.00
----- -------- -------- ------ ----- -------- -------- ------
INVESTMENT OPERATIONS
Net Investment Income.... . .27 .25 .09 . .12 .08 .04
Net Realized and
Unrealized Gain (Loss)
on Investments ......... . 2.74 3.39 (.23) . 2.66 3.34 (.05)
----- -------- -------- ------ ----- -------- -------- ------
TOTAL FROM INVESTMENT
OPERATIONS............. . 3.01 3.64 (.14) . 2.78 3.42 (.01)
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DISTRIBUTIONS
Dividends from Net
Investment Income....... . (.28) (.25) (.09) . (.11) (.09) (.04)
Distributions from
Realized Net Gain....... -- -- -- -- -- -- -- --
----- -------- -------- ------ ----- -------- -------- ------
TOTAL DISTRIBUTIONS..... . (.28) (.25) (.09) . (.11) (.09) (.04)
- ------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................... . $ 15.89 $ 13.16 $ 9.77 . $ 15.95 $ 13.28 $ 9.95
- ------------------------------------------------------------------------------------------------------
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TOTAL RETURN**............ . 23.03% 37.53% (1.70)% . 20.92% 34.38% (0.50)%
- ------------------------------------------------------------------------------------------------------
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period
(Millions)............... . $ 235 $ 98 $ 31 . $ 517 $ 254 $ 70
Ratio of Total Expenses to
Average Net Assets....... . 0.20% 0.20% 0.20%* . 0.20% 0.20% 0.20%*
Ratio of Net Investment
Income to Average Net
Assets................... . 2.04% 2.37% 2.82%* . 0.91% .97% 1.26%*
Portfolio Turnover Rate... . 7% 6% 0% . 12% 7% 1%
Average Commission Rate
Paid .................... . $.0199 N/A N/A . $.0214 N/A N/A
</TABLE>
*Annualized.
**Total returns do not reflect the 2% redemption fee on shares held less than
one year or the 1% redemption fee on shares held more than one year but less
than five years.
+Subscription period for each Portfolio was July 25, 1994, to September 5,
1994, during which time all assets were held in money market instruments. Per-
formance measurement began September 6, 1994.
7
<PAGE>
<TABLE>
<CAPTION>
------------------------------------
BALANCED
PORTFOLIO
------------------------------------
JULY 25+
TO
YEAR ENDED DECEMBER 31, DEC. 31,
1997 1996 1995 1994
- --------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... . $ 11.85 $ 9.79 $10.00
----- -------- -------- ------
INVESTMENT OPERATIONS
Net Investment Income.. . .36 .31 .09
Net Realized and
Unrealized Gain (Loss)
on Investments ....... . 1.07 2.07 (.21)
----- -------- -------- ------
TOTAL FROM INVESTMENT
OPERATIONS........... . 1.43 2.38 (.12)
- --------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... . (.36) (.32) (.09)
Distributions from
Realized Net Gain..... -- -- -- --
----- -------- -------- ------
TOTAL DISTRIBUTIONS... . (.36) (.32) (.09)
- --------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................. . $ 12.92 $ 11.85 $ 9.79
- --------------------------------------------------------------
- --------------------------------------------------------------
TOTAL RETURN**.......... . 12.21% 24.52% (1.40)%
- --------------------------------------------------------------
- --------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions)...... . $ 63 $ 39 $ 17
Ratio of Total Expenses
to Average Net Assets.. . 0.20% 0.20% 0.0%
Ratio of Net Investment
Income to Average Net
Assets................. . 3.04% 3.06% 2.88%*
Portfolio Turnover Rate. . 5% 5% 0%
Average Commission Rate
Paid .................. . $.0216 N/A N/A
</TABLE>
*Annualized.
**Total returns do not reflect the 2% redemption fee on shares held less than
one year or the 1% redemption fee on shares held more than one year but less
than five years.
+Subscription period for each Portfolio was July 25, 1994, to September 5,
1994, during which time all assets were held in money market instruments. Per-
formance measurement began September 6, 1994.
- --------------------------------------------------------------------------------
YIELD AND From time to time a Portfolio of the Fund may advertise its
TOTAL RETURN yield and total return. Both yield and total return figures
are based on historical earnings and are not intended to
indicate future performance. The "total return" of a Port-
folio refers to the average annual compounded rates of re-
turn over one-, five- and ten-year periods or for the life
of the Portfolio (as stated in the advertisement) that
would equate an initial amount invested at the beginning of
a stated period to the ending redeemable value of the in-
vestment, assuming the reinvestment of all dividend and
capital gains distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day yield"
of a portfolio is calculated by dividing the net investment
income per share earned during a 30-day period by the net
asset value per share on the last day of the period. Net
investment income includes interest and dividend income
earned on a Portfolio's securities; it is net of all ex-
penses and all recurring and nonrecurring charges that have
been applied to all shareholder accounts. The yield calcu-
lation assumes that net investment income earned over 30
days is compounded monthly for six months and then
annualized. Methods used to calculate advertised yields are
standardized for all stock and bond mutual funds. However,
these methods differ from the accounting methods used by a
Portfolio to maintain its books and records, and so the ad-
vertised 30-day yield may not fully reflect the income paid
to an investor's account.
- --------------------------------------------------------------------------------
8
<PAGE>
INVESTMENT The Fund is an open-end diversified investment company of-
OBJECTIVES fering three Portfolios which seek to minimize the impact
of taxes on investors' returns.
. The GROWTH AND INCOME PORTFOLIO seeks to minimize capital
gains distributions while providing long-term capital
growth and a moderate level of taxable current income.
The Portfolio invests in common stocks using an index-
oriented investment approach to minimize portfolio turn-
over and the realization of capital gains within the
Portfolio. Its benchmark index is the Standard & Poor's
500 Composite Stock Price Index ("S&P 500 Index") which
emphasizes large capitalization companies. Large capital-
ization stocks, on average, have moderate dividend yields
(the dividend yield of the S&P 500 Index was 1.6% on De-
cember 31, 1997).
. The CAPITAL APPRECIATION PORTFOLIO seeks to minimize cap-
ital gains and dividend distributions while providing
long-term growth of capital. The Portfolio may be ex-
pected to provide a nominal, or relatively low level of
taxable income compared to traditionally managed or even
indexed Portfolios. Because of the Portfolio's tax-man-
aged policies the level of taxable income to be distrib-
uted is expected to be less than half of what it would
otherwise be if the Portfolio was managed as a tradi-
tional index fund. The Portfolio invests in common stocks
using an index-oriented strategy in an effort to minimize
portfolio turnover and the realization of capital gains
within the Portfolio. The Portfolio's benchmark index is
the Russell 1000 Index, an Index of large and medium cap-
italization stocks. The Portfolio emphasizes low yielding
stocks; therefore, its return will vary from the return
of the Russell 1000 Index.
. The BALANCED PORTFOLIO seeks to minimize capital gains
and taxable dividend distributions while providing a com-
bination of reasonable current income (nominal taxable
income and moderate tax-exempt income) and long-term
growth of capital. The Portfolio invests 50-55% of its
assets in intermediate-term municipal securities which
provide income that is exempt from federal income taxes.
The dollar-weighted average maturity of the municipal se-
curities is targeted to be between 7 and 12 years. The
Portfolio invests the remaining 45-50% of its assets in
common stocks using an index-oriented strategy in an ef-
fort to minimize portfolio turnover and the realization
of capital gains within the Portfolio. The benchmark in-
dex for the equity portion of the Portfolio is the Rus-
sell 1000 Index; however, the Portfolio emphasizes low
yielding stocks, therefore, the return of the equity com-
ponent will vary from the return of the Russell 1000 In-
dex.
There is no assurance that the Portfolios will achieve
their stated objectives.
These investment objectives are not fundamental and so may
be changed by the Board of Directors without shareholder
approval. However, shareholders would be notified prior to
a material change in a Portfolio's objective.
- --------------------------------------------------------------------------------
INVESTMENT The three Portfolios of the Fund are managed in order to
POLICIES minimize the impact of taxes on investors' returns. Each
Portfolio employs an index-oriented approach to equity man-
agement by attempting to approximate the performance of a
benchmark index. Indexing is appropriate for achieving each
Portfolio's
9
<PAGE>
objective for two reasons: (1) indexing is a very cost-ef-
fective method of providing broadly diversified equity re-
turns; and (2) indexing is tax efficient because it incor-
porates a buy and hold philosophy and, therefore, an in-
dexed portfolio rarely realizes capital gains, which, by
definition, is tax efficient.
The GROWTH AND INCOME PORTFOLIO invests in substantially
all 500 stocks in the S&P 500 Index, an index which empha-
sizes large capitalization companies. Management techniques
used to minimize the realization of capital gains might
from time to time cause the proportion of the Portfolio's
assets invested in each stock to differ from the proportion
found in the S&P 500 Index. As a result, the Portfolio's
return will deviate from the return of the S&P 500 Index.
The CAPITAL APPRECIATION PORTFOLIO invests in a statistical
sample of the stocks included in the Russell 1000 Index.
Stocks are selected for inclusion in the Portfolio based on
their contribution to the Portfolio's market capitaliza-
tion, industry weightings and other fundamental character-
istics such as price earnings ratios, dividend yields,
price-to-book ratios and financial leverage. To minimize
taxable dividend distributions, the Portfolio emphasizes
stocks with low dividend yields. As a result of the low
dividend emphasis and management techniques used to mini-
mize the realization of capital gains, the returns of the
Portfolio will deviate from the returns of the Russell 1000
Index.
The BALANCED PORTFOLIO invests 50-55% of its assets in in-
termediate-term municipal securities which provide interest
income exempt from federal income taxes. At least 75% of
the securities held by the Portfolio will be invested in
municipal bonds in the top three ratings categories (Aaa,
Aa, and A for Moody's Investors Service, Inc., or AAA, AA,
and A for Standard & Poor's Corporation). No more than 20%
of each Portfolio's assets may be invested in bonds rated
Baa (by Moody's) or BBB (by Standard & Poor's). The remain-
ing 5% may be invested in securities with lower ratings or
that are unrated. The securities will target a dollar-
weighted average maturity of 7-12 years.
The municipal bond portion of the Balanced Portfolio is
managed according to a traditional management style which
involves selection of securities based upon economic, fi-
nancial and market analysis and investment judgment. In
managing the municipal bond component of the Balanced Port-
folio, portfolio turnover will be kept low in order to min-
imize the realization of capital gains. The Portfolio in-
vests the remaining 45-50% of its assets in a statistical
sample of the stocks included in the Russell 1000 Index.
The equity portion of the Portfolio will follow the same
investment policies as the Capital Appreciation Portfolio
(see page 9).
Each Portfolio may, when prudent, sell securities in order
to realize capital losses. Realized capital losses can be
used to offset realized capital gains thus reducing capital
gains distributions. As a result of such techniques to min-
imize the realization of capital gains, and, in the case of
the Capital Appreciation and Balanced Portfolios, the em-
phasis on lower-yielding stocks, the Portfolios should not
be expected to track their target benchmarks with the same
precision as conventional index funds.
The Fund is responsible for voting the shares of all secu-
rities it holds.
10
<PAGE>
The investment policies of the Fund are not fundamental and
so may be changed by the Board of Directors without share-
holder approval. However, shareholders would be notified
prior to a material change.
- --------------------------------------------------------------------------------
INVESTMENT RISKS Like any investment program, the Fund entails certain
risks. Because the Growth and Income and Capital Apprecia-
EACH PORTFOLIO tion Portfolios both invest 100% of their assets in stocks
IS SUBJECT TO and the Balanced Portfolio invests 45-50% of its assets in
STOCK MARKET stocks, all three Portfolios are subject to STOCK MARKET
RISK RISK--i.e., the possibility that common stock prices will
decline over short or even extended periods. The U.S. stock
market tends to be cyclical, with periods when stock prices
generally rise and periods when stock prices generally de-
cline.
To illustrate the volatility of stock prices, the following
table sets forth the extremes for stock market returns as
well as the average return for the period from 1926 to
1997, as measured by the S&P 500 Composite Stock Price In-
dex:
U.S. STOCK MARKET RETURNS (1926-1997) OVER VARIOUS TIME
HORIZONS
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS 20 YEARS
------ ------- -------- --------
<S> <C> <C> <C> <C>
Best +53.9 +23.9 +20.1 +16.9
Worst -43.3 -12.5 - 0.9 + 3.1
Average +13.0 +10.5 +10.9 +10.9
</TABLE>
As shown, common stocks have provided annual total returns
(capital appreciation plus dividend income) averaging
+10.9% for all 10-year periods from 1926 to 1997. Average
return may not be useful for forecasting future returns in
any particular period, as stock returns are quite volatile
from year to year.
This table of U.S. stock market returns should not be
viewed as a representation of future returns from the Fund
or the U.S. stock market. The illustrated returns represent
the historical investment performance, which may be a poor
guide to future returns. Also, stock market indexes such as
the S&P 500 are based upon unmanaged portfolios of securi-
ties, before transaction costs and other expenses. Such
costs will reduce the relative investment performance of
the Fund and other "real world" portfolios.
Historically, medium capitalization stocks, such as the
smallest 50% of those found in the Russell 1000 Index on
December 31, 1997, have been more volatile in price than
the larger capitalization stocks included in the S&P 500
Index. Besides exhibiting greater price volatility, the
price of medium company stocks may, to a degree, fluctuate
independently of larger company stocks. Medium company
stocks are expected to constitute approximately 33% of the
investments of the Capital Appreciation Portfolio and the
equity portion of the Balanced Portfolio.
Additionally, the Capital Appreciation Portfolio and the
equity portion of the Balanced Portfolio emphasize low
yielding stocks which may give these Portfolios "growth"
characteristics. Stocks that emphasize particular invest-
ment characteristics, such as "growth," may fluctuate di-
vergently from the broad stock market as represented by a
given market benchmark. Further, these stocks may also dem-
onstrate greater volatility than the broad market index
over short or extended periods of time.
11
<PAGE>
THE BALANCED The Balanced Portfolio invests a larger portion of its as-
PORTFOLIO IS sets in intermediate-term municipal securities (50-55% of
SUBJECT TO assets) than in stocks. Therefore, the Balanced Portfolio
INTEREST RATE will be subject to INTEREST RATE RISK--i.e., fluctuations
RISK in the market value of bonds due to changing interest
rates. Bond prices are influenced primarily by changes in
the level of interest rates. When interest rates rise, the
prices of bonds generally fall; conversely, when interest
rates fall, bond prices generally rise. While bonds nor-
mally fluctuate less in price than stocks, there have been
extended periods of cyclical increases in interest rates
that have caused significant declines in bond prices. For
example, bond prices fell 48% from December 1976 to Septem-
ber 1981.
THE BALANCED The Balanced Portfolio is also subject to CREDIT RISK--
PORTFOLIO IS i.e., the likelihood that a bond issuer will fail to make
SUBJECT TO timely payments of interest and principal. Such credit risk
CREDIT RISK is expected to be low, however, due to the credit quality
and diversification of the Portfolio's bond investments.
From time to time, the stock and bond markets may fluctuate
independently of one another. In other words, a decline in
the stock market may in certain instances be offset by a
rise in the bond market, or vice versa. As a result, the
Balanced Portfolio, with its balance of common stock and
bond investments, is expected to entail less investment
risk (and a potentially lower return) than mutual funds in-
vesting exclusively in common stocks.
Each Portfolio may use futures contracts, options and war-
rants, convertible securities and swap agreements which may
pose certain risks as described in the section "Implementa-
tion of Policies."
- --------------------------------------------------------------------------------
WHO SHOULD The Fund is designed for long-term taxable investors who
INVEST seek to minimize receipt of taxable distributions. The Fund
is not suitable for Individual Retirement Accounts (IRAs)
LONG-TERM or other tax-deferred retirement plans such as 401(k),
TAXABLE 403(b)(7), or money purchase pension plans.
INVESTORS
SEEKING TO The three Portfolios of the Fund are designed for investors
MINIMIZE TAXABLE seeking low taxable distributions, low costs, and high pre-
DISTRIBUTIONS dictability of return relative to the underlying index
through an index-oriented management approach.
The GROWTH AND INCOME PORTFOLIO is designed for investors
seeking long-term capital growth and moderate current in-
come from a diversified portfolio of common stocks.
The CAPITAL APPRECIATION PORTFOLIO is designed for invest-
ors seeking long-term growth of capital with nominal cur-
rent income from common stocks as compared to traditionally
managed or even indexed portfolios.
The BALANCED PORTFOLIO is designed for investors seeking a
balance between long-term capital growth and moderate tax-
exempt income from municipal bonds, and nominal taxable in-
come from common stocks.
The share prices of the Growth and Income Portfolio and the
Capital Appreciation Portfolio are expected to be volatile,
and investors should be able to tolerate sudden, sometimes
substantial fluctuations in the value of their investments.
The Balanced Portfolio is expected to be less volatile than
the Growth and Income Portfolio and the Capital Apprecia-
tion Portfolio. However, invest-
12
<PAGE>
ors in the Balanced Portfolio should also be able to toler-
ate sudden fluctuations in the value of their investment.
No assurance can be given that the Portfolios will achieve
their stated objectives or that shareholders will be pro-
tected from the risks inherent in the markets in which they
invest. Investors may wish to purchase shares on a regular,
periodic basis (dollar-cost averaging) rather than invest-
ing in one lump sum in order to reduce the risk of invest-
ing at a particularly unfavorable time.
THE FUND IS DESIGNED ONLY FOR LONG-TERM INVESTORS WHO EX-
PECT TO OWN SHARES OF THE FUND FOR FIVE YEARS OR MORE. The
Fund is not intended to provide investors with a means of
speculating on short-term market movements. Investors
who engage in excessive account activity generate addi-
tional costs and may cause a Portfolio to recognize capital
gains which are borne by the Portfolio's remaining share-
holders.
In order to discourage short-term trading activity the Fund
has adopted the following policies: the Fund will charge a
2% fee on redemptions of shares held less than one year and
will charge a 1% fee on redemptions of shares held at least
one year but less than five years. The Fund reserves the
right to reject any purchase request (including exchange
purchases from other Vanguard funds) that is reasonably
deemed to be disruptive to efficient portfolio management,
either because of the timing of the investment or previous
excessive trading by the investor. Additionally, the Fund
has adopted exchange privilege limitations as described in
the section "Exchange Privilege Limitations." Finally, the
Fund reserves the right to suspend the offering of its
shares.
Investors should not consider the Fund a complete invest-
ment program, but should maintain holdings of securities
with different risk characteristics--including common
stocks, bonds and money market instruments. Investors may
also wish to complement an investment in the Fund with
other types of common stock investments.
- --------------------------------------------------------------------------------
IMPLEMENTATION The GROWTH AND INCOME PORTFOLIO holds substantially all the
OF POLICIES stocks included in the S&P 500 Index in approximately the
same proportions as they are represented in the Index.
THE GROWTH AND The S&P 500 Index is composed of 500 common stocks, which
INCOME PORTFOLIO are chosen by Standard & Poor's Corporation on a statisti-
INVESTS IN cal basis to be included in the Index. The inclusion of a
COMMON STOCK stock in the S&P 500 Index in no way implies that Standard
& Poor's Corporation believes the stock to be an attractive
investment. The 500 securities, most of which trade on the
New York Stock Exchange, represented, as of December 31,
1997, approximately 72% of the market value of all U.S.
common stocks. Each stock in the S&P 500 Index is weighted
by its market value.
Because of the market-value weighting, the 50 largest com-
panies in the S&P 500 Index currently account for approxi-
mately . % of the capitalization of the Index. Typically,
companies included in the S&P 500 Index are the largest and
most dominant firms in their respective industries. As of
December 31, 1997, the five largest companies in the Index
were: .
13
<PAGE>
The GROWTH AND INCOME PORTFOLIO is not sponsored, endorsed,
sold or promoted by Standard & Poor's Corporation ("S&P").
S&P makes no representations or warranty, implied or ex-
pressed, to the purchasers of the Portfolio or any member
of the public regarding the advisability of investing in
index funds or the ability of the S&P 500 to track general
stock market performance. S&P does not guarantee the accu-
racy and/or the completeness of the S&P 500, or any data
included herein.
S&P's only relationship to the Portfolio is the licensing
of the S&P marks, and the S&P 500 Index which is deter-
mined, composed and calculated by S&P without regard to the
Growth and Income Portfolio.
S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO
BE OBTAINED BY LICENSEE, OWNERS OF THE FUND, ANY PERSON OR
ANY ENTITY FROM THE USE OF THE S&P 500 OR ANY DATA INCLUDED
THEREIN IN CONNECTION WITH THE USE LICENSED HEREUNDER, OR
FOR ANY OTHER USE. S&P MAKES NO EXPRESS OR IMPLIED WARRAN-
TIES, AND HEREBY EXPRESSLY DISCLAIMS ALL SUCH WARRANTIES OF
MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE FOR USE
WITH RESPECT TO THE S&P 500 OR ANY DATA INCLUDED THEREIN.
THE CAPITAL The CAPITAL APPRECIATION PORTFOLIO holds a statistical sam-
APPRECIATION ple of the stocks included in the Russell 1000 Index. The
PORTFOLIO sampling technique emphasizes stocks with low dividend
EMPHASIZES yields. Because of this low dividend bias and management
COMMON STOCKS techniques used to minimize the realization of capital
WITH LOW gains, returns from the Portfolio will differ from the Rus-
DIVIDEND YIELDS sell 1000 Index.
The Russell 1000 Index is composed of stocks from the larg-
est 1000 U.S. companies. The largest company in the index
has a market value of approximately $198 billion; the
smallest company's market capitalization is approximately
$1.2 billion. The 1000 securities represented, as of Decem-
ber 31, 1997, approximately 88% of the market value of all
U.S. common stocks.
THE BALANCED The BALANCED PORTFOLIO will invest 45-50% of its assets in
PORTFOLIO a statistical sample of the 1000 stocks included in the
INVESTS 45-50% Russell 1000 Index. This equity portion of the Balanced
OF ITS ASSETS IN Portfolio will implement investment policies in the same
COMMON STOCK manner as the Capital Appreciation Portfolio (see above).
As of December 31, 1997, the five largest companies in the
index were: .
The CAPITAL APPRECIATION and the BALANCED PORTFOLIOS are
neither sponsored by nor affiliated with the Frank Russell
Company. Frank Russell's only relationship to the Portfo-
lios is the licensing of the use of the Russell 1000 Index.
Frank Russell Company is the owner of the trademarks and
copyrights relating to the Russell Indexes.
THE BALANCED The BALANCED PORTFOLIO invests the remaining 50-55% of its
PORTFOLIO assets in intermediate-term tax-exempt municipal securities
INVESTS 50-55% issued by state and local governments and regional govern-
OF ITS ASSETS IN ment authorities. Municipal securities include both munici-
MUNICIPAL BONDS pal bonds (those securities with maturities of 13 months or
more) and municipal notes (those securities with maturities
of less than 13 months).
Municipal bonds are issued for a wide variety of reasons:
to construct public facilities; to obtain funds for operat-
ing expenses; to refund outstanding municipal obligations;
and to loan funds to various public institutions and facili-
14
<PAGE>
ties. Certain industrial development bonds are also consid-
ered municipal bonds if their interest is exempt from fed-
eral income tax. Industrial development bonds are issued on
behalf of public authorities to obtain funds for various
privately-operated manufacturing facilities, housing,
sports arenas, convention centers, airports, mass transpor-
tation systems and water, gas or sewage works.
General obligation municipal bonds are secured by the is-
suer's pledge of full faith, credit and taxing power. Reve-
nue or special tax bonds are payable from the revenues de-
rived from a particular facility or, in some cases, from a
special excise or other tax, but not from general tax reve-
nue. Industrial development bonds are ordinarily dependent
on the credit quality of a private user, not the public is-
suer.
Municipal notes are issued to meet the short-term funding
requirements of local, regional and state governments. Mu-
nicipal notes include tax anticipation notes, bond antici-
pation notes, revenue anticipation notes, tax and revenue
anticipation notes, construction loan notes, short-term
discount notes, tax-exempt commercial paper, demand notes,
and similar instruments. Demand notes permit an investor
(such as the Fund) to demand from the issuer payment of
principal plus accrued interest upon a specified number of
days' notice.
Over time, the correlation between the performance of the
Growth and Income Portfolio, the Capital Appreciation Port-
folio and the equity portion of the Balanced Portfolio,
with their respective benchmarks, is expected to be at
least 0.95. A correlation of 1.00 would indicate perfect
correlation, which would be achieved when the net asset
value of a Portfolio, including the value of its dividend
and capital gains distributions, increases or decreases in
exact proportion to changes in the respective target bench-
mark.
Due to the use of the sampling technique, neither the Capi-
tal Appreciation Portfolio or the equity portion of the
Balanced Portfolio is expected to track its benchmark index
with the same degree of accuracy as evidenced by the high
degree of correlation between the Growth and Income Portfo-
lio and its benchmark. However, the principal advantage of
this technique is to provide an efficient means to invest
in the universe of stocks and to emphasize those stocks
with low dividend yields. In particular, the three Portfo-
lios are expected to provide broad diversification, and
should operate at low costs due both to their index-ori-
ented approach to portfolio management and low portfolio
turnover rate.
EACH PORTFOLIO When selling securities, each Portfolio will select the
WILL SELECT THE highest cost shares of the specific security in order to
HIGHEST COST minimize the realization of capital gains. In certain
SHARES OF A cases, the highest cost shares may produce a short-term
SECURITY BEING capital gain. Since, for tax payers in the highest tax
SOLD IN ORDER TO brackets, short-term capital gains are taxed at higher tax
MINIMIZE THE rates than long-term capital gains, the highest cost shares
REALIZATION OF with a long-term holding period may be selected if the re-
CAPITAL GAINS alization of capital gains is sufficiently small. Addition-
ally, each Portfolio may, when prudent, sell securities in
order to realize capital losses. Realized capital losses
can be used to offset realized capital gains thus reducing
capital gains distributions.
15
<PAGE>
EACH PORTFOLIO The Growth and Income and Capital Appreciation Portfolios
MAY INVEST IN attempt to remain fully invested in common stocks. The Bal-
SHORT-TERM FIXED anced Portfolio attempts to remain fully invested in common
INCOME stocks and municipal securities. The three Portfolios of
SECURITIES the Fund may invest temporarily in certain short-term fixed
income securities for defensive purposes. Such securities
may be used to invest uncommitted cash balances or to main-
tain liquidity to meet shareholder redemptions. These secu-
rities include: obligations of the United States Government
and its agencies or instrumentalities; commercial paper,
bank certificates of deposit, and bankers' acceptances; and
repurchase agreements collateralized by these securities.
DERIVATIVE Derivatives are instruments whose values are linked to or
INVESTING derived from an underlying security or index. The most com-
mon and conventional types of derivative securities are
futures and options.
EACH PORTFOLIO Each Portfolio of the Fund may utilize stock futures con-
MAY USE FUTURES tracts (bond futures contracts for the bond portion of the
CONTRACTS, Balanced Portfolio), options, including puts and calls,
OPTIONS AND warrants, convertible securities and swap agreements to a
WARRANTS, limited extent. Each Portfolio may use over-the-counter op-
CONVERTIBLE tions when exchange-traded options do not exist. Specifi-
SECURITIES AND cally, each Portfolio may enter into futures contracts and
SWAP AGREEMENTS options provided that not more than 3% of its assets are
required as a margin deposit for futures contracts or op-
tions and provided that not more than 5% of a Portfolio's
assets are invested in futures and options at any time. Ad-
ditionally, each Portfolio's investment in warrants will
not exceed more than 5% of its assets (2% with respect to
warrants not listed on the New York or American Stock Ex-
changes). Futures contracts, options, warrants, convertible
securities and swap agreements may be used for several rea-
sons: to simulate full investment in the benchmark index
while retaining a cash balance for fund management purpos-
es, to facilitate the Portfolio management process, or to
reduce transaction costs. While each of these instruments
can be used as leveraged investments, the Portfolios may
not use them to leverage their net assets. Since the Fund
seeks to minimize taxable distributions, futures contracts
will only be incorporated into the Portfolio to a very lim-
ited extent.
FUTURES The risk of loss associated with futures contracts in some
CONTRACTS, strategies can be substantial due both to the low margin
OPTIONS, deposits required and the extremely high degree of leverage
WARRANTS, involved in futures pricing. As a result, a relatively
CONVERTIBLE small price movement in a futures contract may result in an
SECURITIES AND immediate and substantial loss or gain. However, the Port-
SWAP AGREEMENTS folios will not use futures contracts, options, warrants,
POSE CERTAIN convertible securities and swap agreements for speculative
RISKS purposes or to leverage their net assets. Accordingly, the
primary risks associated with the use of futures contracts,
options, including puts and calls, warrants, convertible
securities and swap agreements by the Portfolios are: (i)
imperfect correlation between the change in market value of
the stocks held by a Portfolio and the prices of futures
contracts, options, warrants, convertible securities and
swap agreements; and (ii) possible lack of a liquid second-
ary market for a futures contract and the resulting inabil-
ity to close a futures position prior to its maturity date.
The risk of imperfect correlation will be minimized by in-
vesting only in those contracts whose behavior is expected
to resemble
16
<PAGE>
that of a Portfolio's underlying securities. The risk that
a Portfolio will be unable to close out a futures position
will be minimized by entering into such transactions on an
exchange with an active and liquid secondary market. How-
ever options, warrants, convertible securities and swap
agreements purchased or sold over-the-counter may be less
liquid than exchange-traded securities. Illiquid securi-
ties, in general, may not represent more than 15% of the
net assets of a Portfolio.
Swap agreements are contracts between parties in which one
party agrees to make payments to the other party based on
the change in market value of a specified index or asset.
In return, the other party agrees to make payments to the
first party based on the return of a different specified
index or asset. Although swap agreements entail the risk
that a party will default on its payment obligations there-
under, the Portfolios will minimize this risk by entering
into agreements that mark to market no less frequently than
quarterly. Swap agreements also bear the risk that the
Portfolios will not be able to meet their obligations to
the counterparty. This risk will be mitigated by having the
Portfolios invest in the specific asset for which they are
obligated to pay a return.
EACH PORTFOLIO Each Portfolio of the Fund may lend its investment securi-
MAY LEND ITS ties to qualified institutional investors for either short-
SECURITIES term or long-term purposes of realizing additional income.
Loans of securities by a Portfolio will be collateralized
by cash, letters of credit, or securities issued or guaran-
teed by the U.S. Government or its agencies. The collateral
will equal at least 100% of the current market value of the
loaned securities, and such loans may not exceed 33 1/3% of
the value of the Portfolio's net assets.
EACH PORTFOLIO Each Portfolio of the Fund may own restricted securities to
MAY OWN a limited extent. Restricted securities are securities
RESTRICTED which are not freely marketable or which are subject to re-
SECURITIES strictions upon sale under the Securities Act of 1933. Each
Portfolio may invest up to 15% of its net assets in illiq-
uid securities, which include certain restricted securi-
ties. The Fund's Board of Directors may from time to time
determine certain restricted securities known as Rule 144A
securities to be liquid. Such securities will not be sub-
ject to the 15% limitation described above.
PORTFOLIO Although each Portfolio generally seeks to invest for the
TURNOVER IS long term, the three Portfolios of the Fund retain the
EXPECTED TO BE right to sell securities irrespective of how long they have
LOW been held. However, because of the index-oriented invest-
ment management approach of the Fund and because of the
management techniques employed to reduce the realization of
capital gains, it is anticipated that the annual Portfolio
turnover rate for the Growth and Income and Capital Appre-
ciation Portfolios and the equity portion of the Balanced
Portfolio will not exceed 10%. The portion of the Balanced
Portfolio which is invested in municipal bonds also retains
the right to sell securities irrespective of how long they
have been held. It is anticipated that the annual portfolio
turnover rate for the bond portion of the Balanced Portfo-
lio will not exceed 40%.
- --------------------------------------------------------------------------------
17
<PAGE>
INVESTMENT The Fund has adopted limitations on some of its investment
LIMITATIONS policies. Some of these limitations are that the Portfolios
will not:
THE FUND HAS (a) with respect to 75% of its assets, purchase securities
ADOPTED CERTAIN of any issuer (except obligations of the U.S.
FUNDAMENTAL Government and its instrumentalities) if, as a result,
LIMITATIONS more than 5% of the value of the Portfolio's assets
would be invested in the securities of such issuer;
(b) with respect to 75% of its assets, purchase more than
10% of the voting securities of any issuer;
(c) invest more than 25% of its assets in any one industry;
and
(d) borrow money, except that a Portfolio may borrow from
banks (or through reverse repurchase agreements), for
temporary or emergency (not leveraging) purposes,
including the meeting of redemption requests which
might otherwise require the untimely disposition of
securities, in an amount not exceeding 15% of the value
of the Portfolio's net assets (including the amount
borrowed and the value of any outstanding reverse
repurchase agreements) at the time the borrowing is
made. Whenever borrowings exceed 5% of the value of a
Portfolio's net assets, the Portfolio will not make any
additional investments.
A complete list of the Portfolio's investment limitations
can be found in the Statement of Additional Information.
These limitations are fundamental and may be changed only
by approval of a majority of the Portfolio's shareholders.
- --------------------------------------------------------------------------------
MANAGEMENT OF The Fund is a member of The Vanguard Group of Investment
THE FUND Companies, a family of more than 30 investment companies
with more than 95 distinct portfolios and total assets in
VANGUARD excess of $330 billion. Through their jointly-owned subsid-
ADMINISTERS AND iary, The Vanguard Group, Inc. ("Vanguard"), the Fund and
DISTRIBUTES THE the other funds in the Group obtain at cost virtually all
FUND of their corporate management, administrative and distribu-
tion services. Vanguard also provides investment advisory
services on an at-cost basis to certain Vanguard funds. As
a result of Vanguard's unique corporate structure, the Van-
guard funds have costs substantially lower than those of
most competing mutual funds. In 1997, the average expense
ratio (annual costs including advisory fees divided by to-
tal net assets) for the Vanguard funds amounted to approxi-
mately . % compared to an average of . % for the mutual
fund industry (data provided by Lipper Analytical Servic-
es).
The Officers of the Fund manage its day-to-day operations
and are responsible to the Fund's Board of Directors. The
Directors set broad policies for the Fund and choose its
Officers. A list of the Directors and Officers of the Fund
and a statement of their present positions and principal
occupations during the past five years can be found in the
Statement of Additional Information.
Vanguard employs a supporting staff of management and ad-
ministrative personnel needed to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings and equipment. Each
fund pays its share of Vanguard's total expenses, which are
allocated among the funds under methods approved by the
Board of Directors of each fund. In ad-
18
<PAGE>
dition, each fund bears its own direct expenses, such as
legal, auditing and custodian fees.
Vanguard provides distribution and marketing services to
the funds. The funds are available on a no-load basis
(i.e., there are no sales commissions or 12b-1 fees). How-
ever, each fund bears its share of the Group's distribution
costs.
- --------------------------------------------------------------------------------
INVESTMENT The Growth and Income and Capital Appreciation Portfolios
ADVISER and the equity portion of the Balanced Portfolio receive
all investment advisory services on an at-cost basis from
VANGUARD MANAGES VANGUARD'S CORE MANAGEMENT GROUP. The Core Management Group
THE FUND ON AN also provides investment advisory services to several other
AT-COST BASIS Vanguard Funds, including Vanguard Index Trust, Vanguard
International Equity Index Fund, Vanguard Institutional In-
dex Fund, Vanguard Balanced Index Fund, Vanguard Variable
Insurance Fund--Equity Index Portfolio, the Total Interna-
tional Portfolio of Vanguard STAR Fund, the Aggressive
Growth Portfolio of Vanguard Horizon Fund, and a portion of
Vanguard/Windsor II and Vanguard/Morgan Growth Fund, Van-
guard Explorer Fund as well as to several indexed separate
accounts. Total assets under management by the Core Manage-
ment Group were $97 billion as of December 31, 1997. The
Core Management Group is supervised by the Officers of the
Fund.
In placing portfolio transactions, the Core Management
Group uses its best judgment to choose the broker most ca-
pable of providing the brokerage services necessary to ob-
tain the best available price and most favorable execution
at the lowest commission rate. The full range and quality
of brokerage services available are considered in making
these determinations. In those instances where it is rea-
sonably determined that more than one broker can offer the
services needed to obtain the best available price and most
favorable execution, consideration may be given to those
brokers which supply statistical information and provide
other services in addition to execution services to the
Fund.
The municipal securities portion of the Balanced Portfolio
receives all investment advisory services on an at-cost ba-
sis from VANGUARD'S FIXED INCOME GROUP. The Group also pro-
vides investment advisory services to more than 40 Vanguard
money market and bond portfolios, both taxable and tax-ex-
empt. Total assets under management by Vanguard's Fixed In-
come Group were approximately $ . billion as of December
31, 1997. The Fixed Income Group is supervised by the Offi-
cers of the Fund.
Ian A. MacKinnon, Senior Vice President of Vanguard, has
been in charge of the Group since its inception in 1981. Mr
MacKinnon is responsible for setting the broad investment
strategies employed by the Fund, and for overseeing the
portfolio manager who implements those strategies on a day-
to-day basis.
Christopher M. Ryon, Principal, serves as portfolio manager
of the municipal securities portion of the Balanced Portfo-
lio. Associated with the Fixed-Income Group since 1985, Mr.
Ryon currently manages the Long-Term and Intermediate Term
Portfolios of the Vanguard Municipal Bond Fund along with
the New York Insured Tax-Free Fund. Previously, he managed
the Short-Term and Limited-Term Portfolios of the Vanguard
Municipal Bond Fund.
19
<PAGE>
The Fixed Income Group manages the investment and reinvest-
ment of its portion of the assets of the Balanced Portfolio
and continuously reviews, supervises and administers its
investment program, subject to the maturity and quality
standards specified in this Prospectus and supplemental
guidelines approved by the Fund's Board of Directors. The
Fixed Income Group's selection of investments for the Port-
folio is based on: (a) continuing credit analysis of those
instruments held in the Portfolio and those being consid-
ered for inclusion therein; (b) possible disparities in
yield relationships between different fixed income securi-
ties; and (c) actual or anticipated movements in the gen-
eral level of interest rates.
Vanguard's Fixed Income Group places all orders for pur-
chases and sales of portfolio securities. Purchases of
portfolio securities are made either directly from the is-
suer or from municipal securities dealers. The investment
management staff may sell portfolio securities prior to
their maturity if circumstances and considerations warrant
and if it believes such dispositions advisable. The staff
seeks to obtain the best available net price and most fa-
vorable execution for the portfolio transactions. The full
range and quality of brokerage services are considered in
making these determinations.
- --------------------------------------------------------------------------------
DIVIDENDS, While the Fund seeks to minimize taxable distributions,
CAPITAL GAINS each Portfolio of the Fund may be expected to earn and dis-
AND TAXES tribute taxable income and may also be expected to realize
and distribute capital gains from time to time. The Fund
TWO PORTFOLIOS distributes substantially all of its net investment income
PAY DIVIDENDS in the form of dividends. The Growth and Income and Bal-
QUARTERLY, ONE anced Portfolios pay dividends quarterly from ordinary in-
PORTFOLIO PAYS come, while the Capital Appreciation Portfolio pays annual
DIVIDENDS dividends. For all three Portfolios, net capital gains, if
ANNUALLY any, are distributed annually.
A Portfolio's dividend and capital gains distributions may
be reinvested in additional shares or received in cash. See
"Choosing a Distribution Option" for a description of these
distribution methods.
In order to satisfy certain distribution requirements of
the Tax Reform Act of 1986, a Portfolio may declare special
year-end dividend and capital gains distributions during
December. Such distributions, if received by shareholders
by January 31, are deemed to have been paid by the Portfo-
lio and received by shareholders on December 31 of the
prior year.
Each Portfolio of the Fund intends to continue to qualify
for taxation as a "regulated investment company" under the
Internal Revenue Code so that each Portfolio will not be
subject to federal income tax to the extent its income is
distributed to shareholders. Dividends paid by the Growth
and Income Portfolio, the Capital Appreciation Portfolio,
and the equity portion of the Balanced Portfolio from net
investment income and net short-term capital gains, whether
received in cash or reinvested in additional shares, will
be taxable to shareholders as ordinary income. For corpo-
rate investors, dividends from net investment income will
generally qualify in part for the intercorporate dividends-
received deduction. However, the portion of the dividends
so qualified depends on the aggregate taxable qualifying
dividend income received by a Portfolio from domestic
(U.S.) sources.
20
<PAGE>
THE BALANCED In addition, the Balanced Portfolio intends to invest a
PORTFOLIO sufficient portion of its assets in municipal bonds and
INTENDS TO PAY notes so that it will qualify to pay "exempt-interest divi-
TAX-EXEMPT dends" to shareholders. Such exempt-interest dividends dis-
DIVIDENDS tributed to shareholders are excluded from a shareholder's
gross income for federal tax purposes. The Revenue Recon-
ciliation Act enacted during 1993 provides that market dis-
count on tax-exempt bonds, purchased after April 30, 1993
must be taxed as ordinary income. Accordingly, to the ex-
tent that the Fund purchases such discounted securities
taxable income may result. Up to 20% of the Portfolio may
be invested in securities that are subject to the Alterna-
tive Minimum Tax (AMT). Certain tax-exempt bonds whose pro-
ceeds are used to fund private, for-profit organizations
are subject to the AMT--a special tax system that ensures
that individuals pay at least some federal taxes. Although
AMT bond income is exempt from federal regular income tax,
a very limited number of taxpayers who have many tax deduc-
tions may have to pay Alternative Minimum Tax on the income
from bonds considered "tax-preference items." Taxable in-
come will also result from the Portfolio's equity invest-
ments.
In addition, any capital loss realized from municipal secu-
rities held for six months or less is disallowed to the ex-
tent of tax-exempt dividend income received. In other
words, if you held shares in a Portfolio for six months or
less, and sold those shares (or a portion of those shares)
at a loss, the capital loss you report is reduced by the
tax-exempt dividends paid by these shares.
Tax-exempt dividends from a Portfolio, capital gains dis-
tributions from a Portfolio, and any capital gains or
losses realized from the sale or exchange of shares may be
subject to state and local taxes. However, some states al-
low shareholders to exclude from state income tax that por-
tion of a Portfolio's tax-exempt income that is attribut-
able to municipal securities issued within the sharehold-
er's own state. To assist shareholders of these states, the
Fund will provide a breakdown of each Portfolio's tax-ex-
empt interest income on a state-by-state basis at year-end.
Up to 85% of an individual's Social Security benefits may
be subject to federal income tax. Along with other factors,
total tax-exempt income, including any tax-exempt dividend
income from the Balanced Portfolio, is used to calculate
the portion of Social Security benefits that is taxed.
EACH PORTFOLIO Distributions paid by a Portfolio from long-term or short-
IS MANAGED IN term capital gains, whether received in cash or reinvested
ORDER TO in additional shares, are taxable as long-term or short-
MINIMIZE THE term capital gains, regardless of the length of time you
REALIZATION OF have owned shares in the Portfolio. Long-term capital gains
CAPITAL GAINS may be taxed at different rates depending on how long the
Portfolio held the securities. Capital gains distributions
are made when a Portfolio realizes net capital gains on
sales of portfolio securities during the year. Each Portfo-
lio is managed in order to minimize the amount of capital
gains realized during a particular year. However, the real-
ization of capital gains is not entirely within the Fund's
control and is dependent on shareholder purchase and re-
demption activity. Capital gains distributions may vary
considerably from year-to-year; there will be no capital
gains distributions in years when a Portfolio realizes net
capital losses.
21
<PAGE>
Note that if you elect to receive capital gains distribu-
tions in cash, instead of reinvesting them in additional
shares, you are in effect reducing the capital at work for
you in a Portfolio. Also, keep in mind that if you purchase
shares in a Portfolio shortly before the record date for a
dividend or capital gains distribution, a portion of your
investment will be returned to you as a taxable distribu-
tion, regardless of whether you are reinvesting your dis-
tributions or receiving them in cash.
The Fund will notify you annually as to the tax status of
dividend and capital gains distributions paid by each Port-
folio.
A CAPITAL GAIN A sale of shares of a Portfolio is a taxable event, and may
OR LOSS MAY BE result in a capital gain or loss. A capital gain or loss
REALIZED UPON may be realized from an ordinary redemption of shares or an
EXCHANGE OR exchange of shares between two mutual funds (or two portfo-
REDEMPTION lios of the same fund).
Dividend distributions, capital gains distributions, and
capital gains or losses from redemptions and exchanges may
be subject to state and local taxes.
Each Portfolio of the Fund is required to withhold 31% of
taxable dividends, capital gains distributions, and redemp-
tions paid to shareholders who have not complied with IRS
taxpayer identification regulations. You may avoid this
withholding requirement by certifying on your Account Reg-
istration Form your proper Social Security or Taxpayer
Identification Number and by certifying that you are not
subject to backup withholding.
The Fund has obtained a Certificate of Authority to do
business as a foreign corporation in Pennsylvania and does
business and maintains an office in that state. In the
opinion of counsel, the shares of the Portfolios are exempt
from Pennsylvania personal property taxes.
The tax discussion set forth on pages 20, 21 and this page
is included for general information only. Prospective in-
vestors should consult their own tax advisers concerning
the tax consequences of an investment in the Fund.
- --------------------------------------------------------------------------------
THE SHARE PRICE Each Portfolio's share price, or "net asset value" per
OF EACH share, is calculated by dividing the total assets of the
PORTFOLIO Portfolio, less all liabilities, by the total number of
shares outstanding. The net asset value is determined as of
the close of the New York Stock Exchange (generally 4:00
p.m. Eastern time) on each day the exchange is open for
trading.
Portfolio securities for which market quotations are read-
ily 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 se-
curity is primarily traded. Any foreign securities are val-
ued at the latest quoted sales price available before the
time when assets are valued. Securities may be valued on
the basis of prices provided by a pricing service when such
prices are believed to reflect the fair market value of
such securities.
22
<PAGE>
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 Direc-
tors deems in good faith to reflect fair value.
The share price for each Portfolio can be found daily in
the mutual fund listings of most major newspapers under the
heading of Vanguard Funds.
- --------------------------------------------------------------------------------
GENERAL The Fund is organized as a Maryland corporation. The Arti-
INFORMATION cles of Incorporation permit the Directors to issue
750,000,000 shares of common stock with a $.001 par value.
The Board of Directors has the power to designate one or
more classes ("series") of shares of common stock and to
classify or reclassify any unissued shares with respect to
such series. Currently the Fund is offering shares of three
series.
The shares of each series are fully paid and non-assessa-
ble; have no preference as to conversion, exchange, divi-
dends, retirement or other features; and have no pre-
emptive rights. Such shares have non-cumulative voting
rights, meaning that the holders of more than 50% of the
shares voting for the election of Directors can elect 100%
of the Directors if they so choose. Annual meetings of
shareholders will not be held except as required by the In-
vestment Company Act of 1940 and other applicable law. An
annual meeting will be held to vote on the removal of a Di-
rector or Directors of the Fund if requested in writing by
the holders of not less than 10% of the outstanding shares
of the Fund.
All securities and cash are held by Chase Manhattan Bank,
New York, NY. CoreStates Bank, N.A., Philadelphia, PA,
holds daily cash balances that are used by the Fund's Port-
folios to invest in repurchase agreements or securities ac-
quired in these transactions. The Vanguard Group, Inc.,
Valley Forge, PA, serves as the Fund's Transfer and Divi-
dend Disbursing Agent. Price Waterhouse LLP, serves as in-
dependent accountants for the Fund and will audit its fi-
nancial statements annually. The Fund is not involved in
any litigation.
- --------------------------------------------------------------------------------
23
<PAGE>
SHAREHOLDER GUIDE
OPENING AN You may open an account, either by mail or wire. Simply
ACCOUNT AND complete and return an Account Registration Form and any
PURCHASING required legal documentation, indicating the amount you
SHARES wish to invest. Your purchase must be equal to or greater
than the $10,000 minimum initial investment requirement for
each Portfolio. If you need assistance with the forms or
have any questions about the Fund, please call our Investor
Information Department (1-800-662-7447). NOTE: For other
types of account registrations (e.g., corporations, associ-
ations, other organizations, trusts or powers of attorney),
please call us to determine which additional forms you may
need. The Fund is not appropriate for Individual Retirement
Accounts (IRAs) and other types of tax-deferred retirement
plans.
IMPORTANT NOTE Shares of each Portfolio are purchased at the next-deter-
ON EXPENSES mined net asset value per share after your investment has
been received. Potential investors should note that a 2%
fee is charged on redemptions and exchanges out of all
Portfolios of shares held for less than one year and a 1%
fee is charged on redemptions and exchanges of shares held
at least one but less than five years. In the event of an
early redemption due to a shareholder's death, all redemp-
tion fees will be waived. In order to substantiate the
death, a certified copy of the death certificate must be
provided. Please see "Fund Expenses" for more information.
The Fund is offered on a no-load basis (i.e., there are no
sales commissions or 12b-1 fees).
PURCHASE (1) Because of the risks associated with common stock in-
RESTRICTIONS vestments, the Fund is intended to be a long-term in-
vestment vehicle and is not designed to provide invest-
ors with a means of speculating on short-term market
movements. Consequently, each Portfolio reserves the
right to reject any specific purchase (and exchange
purchase) request. Each Portfolio also reserves the
right to suspend the offering of shares for a period of
time.
(2) Vanguard will not accept third-party checks to purchase
shares of the Fund. Please be sure your purchase check
is made payable to the Vanguard Group.
ADDITIONAL Subsequent investments to regular accounts may be made by
INVESTMENTS mail ($100 minimum), wire ($1,000 minimum), written ex-
change from another Vanguard Fund account ($100 minimum),
or Vanguard Fund Express. However, the Fund reserves the
right to reject any specific purchase request, whether it
be made by check, wire, exchange from another Vanguard Fund
account, or Vanguard Fund Express.
------------------------------------------------------------
24
<PAGE>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
PURCHASING BY Please include the Additional investments
MAIL Complete amount of your initial should include the Invest-by-Mail
and sign the investment and indi- remittance form attached to your
enclosed Account cate the Portfolio(s) Fund confirmation statements.
Registration you have selected on Please make your check payable
Form the registration form, to The Vanguard Group--(Portfolio
make your check pay- Number), see below for
able to The Vanguard the appropriate portfolio
Group--(Portfolio Num- number, write your account number
ber), see below for on your check and, using
the appropriate port- the return envelope provided,
folio number, and mail mail to the address indicated on
to: the Invest-by-Mail Form.
THE VANGUARD GROUP
CENTER P.O. BOX 2600
VALLEY FORGE, PA
19482-2600
For express or THE VANGUARD GROUP All requests should be
registered mail, CENTER 455 DEVON PARK mailed to one of the
send to: DRIVE WAYNE, PA 19087- addresses indicated
1815 for new accounts. Do
not send registered or
express mail to the
post office box address.
VANGUARD TAX-MANAGED FUND:
Growth and Income Portfolio--101
Capital Appreciation Portfolio--102
Balanced Portfolio--103
------------------------------------------------------------
PURCHASING BY WIRE CORESTATES BANK, N.A.
Money should be wired to: ABA 031000011
CORESTATES NO. 0101 9897
ATTN: VANGUARD
BEFORE WIRING VANGUARD TAX-MANAGED FUND
Please contact NAME OF PORTFOLIO
our Client ACCOUNT NUMBER
Services ACCOUNT REGISTRATION
Department (1-800-662-2739)
You should notify our Client Services Department of your
intended wire purchase, including the Federal wire number
to be used, by 12:00 noon (Eastern time). To assure proper
receipt, please be sure your bank includes the Portfolio
name, the account number Vanguard has assigned to you and
the eight-digit CoreStates number. If you are opening a new
account, please complete the Account Registration Form and
mail it to the "New Account" address after completing your
wire arrangement. NOTE: Federal Funds wire purchase orders
will be accepted only when the Fund and Custodian Banks are
open for business.
------------------------------------------------------------
25
<PAGE>
PURCHASING BY You may open a new account or purchase additional shares by
EXCHANGE (from a making an exchange from an existing Vanguard account. How-
Vanguard ever, the Fund reserves the right to refuse any exchange
account) purchase request. Call our Client Services Department (1-
800-662-2739). The new account will have the same registra-
tion as the existing account.
------------------------------------------------------------
PURCHASING BY The Fund Express Special Purchase option lets you move
FUND EXPRESS money from your bank account to your Vanguard account on an
"as needed" basis. Or if you choose the Automatic Invest-
Special Purchase ment option, money will be moved automatically from your
and Automatic bank account to your Vanguard account on the schedule
Investment (monthly, bimonthly [every other month], semiannually, or
annually) you select. To establish these Fund Express op-
tions, please provide the appropriate information on the
Account Registration Form. We will send you a confirmation
of your Fund Express enrollment; please wait two weeks be-
fore using the service.
- --------------------------------------------------------------------------------
CHOOSING A You must select one of four distribution options:
DISTRIBUTION
OPTION 1. AUTOMATIC REINVESTMENT OPTION--Both dividend and capital
gains distributions will be reinvested in additional
shares. This option will be selected for you automati-
cally unless you specify one of the other options.
2. CASH DIVIDEND OPTION--Your dividends will be paid in
cash and your capital gains will be reinvested in addi-
tional shares.
3. CASH CAPITAL GAIN OPTION--Your capital gains distribu-
tions will be paid in cash and your dividends will be re-
invested in additional shares.
4. ALL CASH OPTION--Both dividend and capital gains distri-
butions will be paid in cash.
You may change your option by calling our Client Services
Department (1-800-662-2739).
If a shareholder has chosen to receive dividend and/or cap-
ital gains distributions in cash, and the postal or other
delivery service is unable to deliver checks to the share-
holder's address of record, we will change the distribution
option so that all dividends and other distributions are
automatically reinvested in additional shares. We will not
pay interest on uncashed distribution checks.
In addition, an option to invest your cash dividend and/or
capital gains distributions in another Vanguard Fund ac-
count is available. Please call our Client Services Depart-
ment (1-800-662-2739) for information. You may also elect
Vanguard Dividend Express which allows you to transfer your
cash dividend and/or capital gains distributions automati-
cally to your bank account. Please see "Other Vanguard
Services" for more information.
- --------------------------------------------------------------------------------
26
<PAGE>
TAX CAUTION Under Federal tax laws, the Fund is required to distribute
net capital gains and dividend income to Fund shareholders.
INVESTORS SHOULD These distributions are made to all shareholders who own
ASK ABOUT THE Fund shares as of the distribution's record date, regard-
TIMING OF less of how long the shares have been owned. Purchasing
CAPITAL GAINS shares just prior to the record date could have a signifi-
AND DIVIDEND cant impact on your tax liability for the year. For exam-
DISTRIBUTIONS ple, if you purchase shares immediately prior to the record
BEFORE INVESTING date of a sizable capital gain or taxable income dividend
distribution, you will be assessed taxes on the amount of
the capital gain and/or dividend distribution later paid
even though you owned the Fund shares for just a short pe-
riod of time. (Taxes are due on the distributions even if
the dividend or capital gain is reinvested in additional
Fund shares.) While the total value of your investment will
be the same after the distribution--the amount of the dis-
tribution will offset the drop in the net asset value of
the shares--you should be aware of the tax implications the
timing of your purchase may have.
Prospective investors should, therefore, inquire about po-
tential distributions before investing. Each Portfolio's
annual capital gains are normally distributed in December.
Income dividends for the Growth and Income and Balanced
Portfolios are generally paid quarterly in March, June,
September and December, while income dividends for the Cap-
ital Appreciation Portfolio are generally paid annually in
December. In addition, the Portfolio may occasionally be
required to make supplemental dividend or capital gains
distributions at some other time during the year. For addi-
tional information on distributions and taxes, see the sec-
tion titled "Dividends, Capital Gains and Taxes."
- --------------------------------------------------------------------------------
IMPORTANT The easiest way to establish optional Vanguard services on
INFORMATION your account is to select the options you desire when you
complete your Account Registration Form.
ESTABLISHING IF YOU WISH TO ADD OPTIONS LATER, YOU MAY NEED TO PROVIDE
OPTIONAL VANGUARD WITH ADDITIONAL INFORMATION AND A SIGNATURE GUAR-
SERVICES ANTEE. PLEASE CALL OUR CLIENT SERVICES DEPARTMENT (1-800-
662-2739) FOR FURTHER ASSISTANCE.
SIGNATURE For our mutual protection, we may require a signature guar-
GUARANTEES antee on certain written transaction requests. A signature
guarantee verifies the authenticity of your signature and
may be obtained from banks, brokers and any other guarantor
that Vanguard deems acceptable. A SIGNATURE GUARANTEE CAN-
NOT BE PROVIDED BY A NOTARY PUBLIC.
CERTIFICATES Share certificates will not be available for the Fund.
BROKER/DEALER If you purchase shares in Vanguard Funds through a regis-
PURCHASES tered broker/dealer or investment adviser, the
broker/dealer or adviser may charge a service fee.
CANCELLING The Fund will not cancel any trade (e.g., purchase, ex-
TRADES change or redemption) believed to be authentic, once the
trade request has been received in writing or by telephone.
ELECTRONIC You may receive a prospectus for the Fund or any of the
PROSPECTUS Vanguard Funds in an electronic format through Vanguard's
DELIVERY website at www.vanguard.com. For additional information
please see "Other Vanguard Services--Computer Access."
- --------------------------------------------------------------------------------
27
<PAGE>
WHEN YOUR Your trade date is the date on which your account is cred-
ACCOUNT WILL BE ited. If your purchase is made by check, Federal Funds wire
CREDITED or exchange, and is received by the close of trading on the
New York Stock Exchange (generally 4:00 p.m. Eastern time),
your trade date is the day of receipt. If your purchase is
received after the close of the Exchange, your trade date
is the next business day. Shares of the Growth and Income,
Capital Appreciation, and Balanced Portfolios are purchased
at the net asset value determined on your trade date.
In order to prevent lengthy processing delays caused by the
clearing of foreign checks, Vanguard will only accept a
foreign check which has been drawn in U.S. dollars and has
been issued by a foreign bank with a U.S. correspondent
bank. The name of the U.S. correspondent bank must be
printed on the face of the foreign check.
- --------------------------------------------------------------------------------
SELLING YOUR You may withdraw any portion of the funds in your account
SHARES by redeeming shares at any time. (Please see "Important Re-
demption Information.") You generally may initiate a re-
quest by writing or by telephoning. Your redemption pro-
ceeds are normally mailed within two business days after
the receipt of the request in Good Order. No interest will
accrue on amounts represented by uncashed redemption
checks.
------------------------------------------------------------
IMPORTANT NOTE A redemption fee of 2% of the value of shares redeemed will
be deducted from the redemption proceeds if shares held for
less than one year are redeemed. A redemption fee of 1% of
the value of shares redeemed will be deducted from the re-
demption proceeds if shares held for at least one year but
less than five years are redeemed. These fees are paid di-
rectly to the Portfolio. Please see "Fund Expenses" for
more information.
------------------------------------------------------------
SELLING BY MAIL Requests should be mailed to THE VANGUARD GROUP, VANGUARD
TAX- MANAGED FUND, P.O. BOX 1120, VALLEY FORGE, PA 19482-
1120. (For express or registered mail, send your request to
The Vanguard Group, Vanguard Tax-Managed Fund, 455 Devon
Park Drive, Wayne, PA 19087-1815.)
The redemption price of shares will be the Portfolio's net
asset value next determined after Vanguard has received all
required documents in Good Order.
------------------------------------------------------------
DEFINITION OF GOOD ORDER means that the request includes the following:
GOOD ORDER
1. The account number and Portfolio name.
2. The amount of the transaction (specified in dollars or
shares).
3. Signatures of all owners EXACTLY as they are registered
on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that may be re-
quired, in the case of estates, corporations, trusts and
certain other accounts.
IF YOU HAVE QUESTIONS ABOUT THIS DEFINITION AS IT PERTAINS
TO YOUR REQUEST, PLEASE CALL OUR CLIENT SERVICES DEPARTMENT
(1-800-662-2739).
------------------------------------------------------------
SELLING BY To sell shares by telephone, you or your pre-authorized
TELEPHONE representative may call our Client Services Department at
1-800-662-2739. The proceeds will be sent to you by mail.
PLEASE NOTE: As a protection against fraud, your telephone
mail
28
<PAGE>
redemption privilege will be suspended for 15 calendar days
following any expedited address change to your account. An
expedited address change is one that is made by telephone
or in writing, without the signatures of all account own-
ers. Please see "Important Information About Telephone
Transactions."
------------------------------------------------------------
SELLING BY FUND With the Fund Express Automatic Withdrawal option, money
EXPRESS will be automatically moved from your Vanguard Fund account
to your bank account according to the schedule you have se-
Automatic lected. The Special Redemption option lets you move money
Withdrawal and from your Vanguard account to your bank account on an "as
Special needed" basis. You may elect Fund Express on the Account
Redemption Registration Form or call our Investor Information Depart-
ment (1-800-662-7447) for a Fund Express application.
------------------------------------------------------------
SELLING BY You may sell shares by making an exchange to another Van-
EXCHANGE guard Fund account. Exchanges to or from non-retirement in-
vestments in the following funds may only be made by mail:
VANGUARD INDEX TRUST, VANGUARD BALANCED INDEX FUND, VAN-
GUARD INTERNATIONAL EQUITY INDEX FUND, VANGUARD REIT INDEX
PORTFOLIO, VANGUARD TOTAL INTERNATIONAL PORTFOLIO AND VAN-
GUARD GROWTH AND INCOME PORTFOLIO. Please see "Exchanging
Your Shares" for details.
- --------------------------------------------------------------------------------
TAX CAUTION When redeeming or exchanging shares of the Fund, you may
realize taxable capital gains.
------------------------------------------------------------
IMPORTANT Shares purchased by check or Fund Express may be redeemed
REDEMPTION at any time. However, your redemption proceeds will not be
INFORMATION paid until payment for the purchase is collected, which may
take up to ten calendar days.
------------------------------------------------------------
DELIVERY OF Redemption requests received by telephone prior to the
REDEMPTION close of trading on the New York Stock Exchange (generally
PROCEEDS 4:00 p.m. Eastern time) are processed on the day of receipt
and the redemption proceeds are normally sent on the fol-
lowing business day.
Redemption requests received by telephone after the close
of the Exchange are processed on the business day following
receipt and the proceeds are normally sent on the second
business day following receipt.
Redemption proceeds must be sent to you within seven days
of receipt of your request in Good Order, except as de-
scribed above in "Important Redemption Information."
If you experience difficulty in making a telephone redemp-
tion during periods of drastic economic or market changes,
your redemption request may be made by regular or express
mail. It will be implemented at the net asset value next
determined after your request has been received by Vanguard
in Good Order. The Fund reserves the right to revise or
terminate the telephone redemption privilege at any time.
The Fund may suspend the redemption right or postpone pay-
ment at times when the New York Stock Exchange is closed or
under any emergency circumstances as determined by the
United States Securities and Exchange Commission.
29
<PAGE>
If the Board of Directors determines that it would be det-
rimental to the best interests of the Fund's remaining
shareholders to make payment in cash, the Fund may pay re-
demption proceeds in whole or in part by a distribution in
kind of readily marketable securities.
------------------------------------------------------------
VANGUARD'S If you make a redemption from a qualifying account, Van-
AVERAGE COST guard will send you an Average Cost Statement which pro-
STATEMENT vides you with the tax basis of the shares you redeemed.
Please see "Statements and Reports" for additional informa-
tion.
------------------------------------------------------------
MINIMUM ACCOUNT Due to the relatively high cost of maintaining smaller ac-
BALANCE counts, the Fund reserves the right to redeem shares in any
REQUIREMENT account that is below $10,000. It is the Fund's current
policy that, at any time your total investment in the
Growth and Income, Capital Appreciation, or Balanced Port-
folios falls below $10,000 you may be notified that the
value of your account is below the Portfolio's minimum ac-
count balance requirement. You would then be allowed 60
days to make an additional investment before the account is
liquidated. Proceeds would be promptly paid to the share-
holder.
- --------------------------------------------------------------------------------
EXCHANGING YOUR Should your investment goals change, you may exchange your
SHARES shares of Vanguard Tax-Managed Fund for those of other
available Vanguard Funds.
------------------------------------------------------------
IMPORTANT NOTE A redemption fee of 2% of the value of shares exchanged out
will be deducted from the exchange proceeds if shares held
for less than one year are exchanged. A redemption fee of
1% of the value of shares exchanged out will be deducted
from exchange proceeds if shares held at least one year but
less than five years are exchanged. These fees are paid di-
rectly to the Portfolios.
- --------------------------------------------------------------------------------
EXCHANGING BY When exchanging shares by telephone, please have ready the
TELEPHONE Portfolio name, account number, Social Security number or
employer identification number listed on the account, and
Call exact name and address in which the account is registered.
Client Services Only the registered shareholder may complete such an ex-
(1-800-662-2739) change. Requests for telephone exchanges received prior to
the close of trading on the New York Stock Exchange (gener-
ally 4:00 p.m. Eastern time) are processed at the close of
business that same day. Requests received after the close
of trading on the Exchange are processed the next day. TEL-
EPHONE EXCHANGES ARE NOT ACCEPTED INTO OR FROM NON-RETIRE-
MENT INVESTMENTS IN THE VANGUARD INDEX TRUST, VANGUARD BAL-
ANCED INDEX FUND, VANGUARD INTERNATIONAL EQUITY INDEX FUND,
VANGUARD REIT INDEX PORTFOLIO, VANGUARD TOTAL INTERNATIONAL
PORTFOLIO, AND VANGUARD GROWTH AND INCOME PORTFOLIO. If you
experience difficulty in making a telephone exchange, your
exchange request may be made by regular or express mail,
and it will be implemented at the closing net asset value
on the date received by Vanguard provided the request is
received in Good Order.
------------------------------------------------------------
EXCHANGING BY Please be sure to include on your exchange request the name
MAIL and account number of your current Portfolio, the name of
the Fund you wish to exchange into, the amount you wish to
exchange, and the signatures of all registered account
holders. Send your request to THE VANGUARD GROUP, VANGUARD
TAX-MANAGED FUND, P.O. BOX 1120, VALLEY FORGE, PA 19482-
1120. (For express
30
<PAGE>
or registered mail, send your request to The Vanguard
Group, Vanguard Tax-Managed Fund, 455 Devon Park Drive,
Wayne, PA 19087-1815.)
------------------------------------------------------------
EXCHANGING You may use your personal computer to exchange shares of
ONLINE most Vanguard funds by accessing our website
(www.vanguard.com). To establish this service for your ac-
count, you must first register through the website. We will
then send to you, by mail, an account access password that
will enable you to make online exchanges.
The Vanguard funds that you cannot purchase or sell through
online exchange are VANGUARD INDEX TRUST, VANGUARD BALANCED
INDEX FUND, VANGUARD INTERNATIONAL EQUITY INDEX FUND, VAN-
GUARD REIT INDEX PORTFOLIO, VANGUARD TOTAL INTERNATIONAL
PORTFOLIO, AND VANGUARD GROWTH AND INCOME PORTFOLIO (for-
merly known as Vanguard Quantitative Portfolios). These
funds do permit online exchanges within IRAs and other re-
tirement accounts.
------------------------------------------------------------
IMPORTANT Before you make an exchange, you should consider the fol-
EXCHANGE lowing:
INFORMATION
. Please read the Fund's prospectus before making an ex-
change. For a copy and for answers to any questions you
may have, call our Investor Information Department (1-
800-662-7447).
. An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on
the transaction.
. Exchanges by telephone are accepted only if the registra-
tions and the taxpayer identification numbers of the two
accounts are identical.
. To exchange into an account with a different registration
(including a different name, address, or taxpayer identi-
fication number), you must provide Vanguard with written
instructions that include the guaranteed signatures of
all current account owners.
. The shares to be exchanged must be on deposit and not
held in certificate form.
. New accounts are not currently accepted in the
Vanguard/Windsor Fund.
. The redemption price of shares redeemed by exchange is
the net asset value next determined after Vanguard has
received all required documentation in Good Order.
. When opening a new account by exchange, you must meet the
minimum investment requirement of the new Fund.
Every effort will be made to maintain the exchange privi-
lege. However, the Fund reserves the right to revise or
terminate its provisions, limit the amount of, or reject
any exchange, as deemed necessary, at any time.
- --------------------------------------------------------------------------------
EXCHANGE The Fund's exchange privilege is not intended to afford
PRIVILEGE shareholders a way to speculate on short-term movements in
LIMITATIONS the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive ex-
change activity.
31
<PAGE>
Exchange activity generally will not be deemed excessive if
limited to TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (AT LEAST
30 DAYS APART) from a Portfolio of the Fund during any
twelve-month period. "Substantive" means either a dollar
amount or a series of movements between Vanguard funds that
Vanguard determines, in its sole discretion, could have an
adverse impact on the management of the Fund. Notwithstand-
ing these limitations, the Fund reserves the right to re-
ject any purchase request (including exchange purchases
from other Vanguard portfolios) that is reasonably deemed
to be disruptive to efficient portfolio management.
- --------------------------------------------------------------------------------
IMPORTANT The ability to initiate redemptions (except wire or Fund
INFORMATION Express redemptions) by telephone is automatically estab-
ABOUT TELEPHONE lished on your account unless you request in writing that
TRANSACTIONS telephone transactions on your account not be permitted.
To protect your account from losses resulting from unautho-
rized or fraudulent telephone instructions, Vanguard ad-
heres to the following security procedures:
1. SECURITY CHECK. To request a transaction by telephone,
the caller must know (i) the name of the Portfolio; (ii)
the 10-digit account number; (iii) the exact name and ad-
dress used in the registration; and (iv) the Social Secu-
rity or employer identification number listed on the ac-
count.
2. PAYMENT POLICY. The proceeds of any telephone redemption
by mail will be made payable to the registered shareowner
and mailed to the address of record only.
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by tele-
phone, provided that reasonable security procedures have
been followed. Vanguard believes that the security proce-
dures described above are reasonable, and that if such pro-
cedures are followed, you will bear the risk of any losses
resulting from unauthorized or fraudulent telephone trans-
actions on your account.
- --------------------------------------------------------------------------------
TRANSFERRING You may transfer the registration of any of your Fund
REGISTRATION shares to another person by completing a transfer form and
sending it to: THE VANGUARD GROUP, ATTENTION: TRANSFER DE-
PARTMENT, P.O. BOX 1110, VALLEY FORGE, PA 19482-1110. The
request must be in Good Order. To obtain a transfer
form and full instructions, please call our Client Services
Department (1-800-662-2739).
- --------------------------------------------------------------------------------
STATEMENTS AND Vanguard will send you a confirmation statement each time
REPORTS you initiate a transaction in your account except for
checkwriting redemptions from Vanguard money market ac-
counts. You will also receive a comprehensive account
statement at the end of each calendar quarter. The fourth-
quarter statement will be a year-end statement, listing all
transaction activity for the entire calendar year.
Financial reports on the Fund will be mailed to you semi-
annually, according to the Fund's fiscal year-end.
Vanguard's Average Cost Statement provides you with the av-
erage cost of shares redeemed from your account during the
calendar year, using the average cost single category meth-
od. This service is available for most taxable accounts
opened since January 1, 1986. In general, investors who re-
deemed
32
<PAGE>
shares from a qualifying Vanguard account may expect to re-
ceive their Average Cost Statement along with their Portfo-
lio Summary Statement. Please call our Client Services De-
partment (1-800-662-2739) for information.
- --------------------------------------------------------------------------------
OTHER VANGUARD For more information about any of these services, please
SERVICES call our Investor Information Department at 1-800-662-7447.
VANGUARD DIRECT With Vanguard's Direct Deposit Service, most U.S. Govern-
DEPOSIT SERVICE ment checks (including Social Security and military pension
checks) and private payroll checks may be automatically de-
posited into your Vanguard Fund account. Separate brochures
and forms are available for direct deposit of U.S. Govern-
ment and private payroll checks.
VANGUARD Vanguard's Automatic Exchange Service allows you to move
AUTOMATIC money automatically among your Vanguard Fund accounts. For
EXCHANGE SERVICE instance, the service can be used to "dollar-cost average"
from a money market portfolio into a stock or bond fund.
Please contact our Client Services Department at 1-800-662-
2739 for additional information.
VANGUARD FUND Vanguard's Fund Express allows you to transfer money be-
EXPRESS tween your Fund account and your account at a bank, savings
and loan association, or a credit union that is a member of
the Automated Clearing House (ACH) system. You may elect
this service on the Account Registration Form or call our
Investor Information Department (1-800-662-7447) for a Fund
Express application.
Special rules govern how your Fund Express purchases or re-
demptions are credited to your account. In addition, some
services of Fund Express cannot be used with specific Van-
guard Funds. For more information, please refer to the Van-
guard Fund Express brochure.
VANGUARD Vanguard's Dividend Express allows you to transfer your
DIVIDEND EXPRESS dividend and/or capital gains distributions automatically
from your Fund account, one business day after the Fund's
payable date, to your account at a bank, savings and loan
association, or a credit union that is a member of the Au-
tomated Clearing House (ACH) system. You may elect this
service on the Account Registration Form or call the In-
vestor Information Department (1-800-662-7447) for a Van-
guard Dividend Express application.
- --------------------------------------------------------------------------------
VANGUARD Vanguard's Tele-Account is a convenient, automated service
TELE-ACCOUNT(R) that provides share price, price change and yield quota-
tions on Vanguard Funds through any TouchTone (TM) tele-
phone. This service also lets you obtain information about
your account balance, your last transaction, and your most
recent dividend or capital gains payment. In addition, you
may perform investment exchanges of Vanguard Fund shares
and redemptions by check using Tele-Account. To contact
Vanguard's Tele-Account service, dial 1-800-ON-BOARD (1-
800-662-6273). A brochure offering detailed operating in-
structions is available from our Investor Information De-
partment (1-800-662-7447).
- --------------------------------------------------------------------------------
33
<PAGE>
COMPUTER ACCESS
VANGUARD ONLINE Use your personal computer to learn more about Vanguard's
www.vanguard.com funds and services; keep in touch with your Vanguard ac-
counts; map out a long-term investment strategy; initiate
certain transactions; and ask questions, make suggestions,
and send messages to Vanguard.
Our education-oriented website provides timely news and in-
formation about Vanguard's 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.
- --------------------------------------------------------------------------------
34
<PAGE>
VANGUARD
TAX-MANAGED
FUND
- -----------------
THE VANGUARD GROUP
P.O. Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION DEPARTMENT:
1-800-662-7447 (SHIP)
CLIENT SERVICES DEPARTMENT:
1-800-662-2739 (CREW)
TELE-ACCOUNT FOR 24-HOUR ACCESS:
1-800-662-6273 (ON-BOARD)
TELECOMMUNICATION SERVICE FOR THE HEARING-IMPAIRED:
1-800-662-2738
TRANSFER AGENT:
The Vanguard Group, Inc.
P.O. Box 2600
Valley Forge, PA 19482
[LOGO OF THE VANGUARD GROUP APPEARS HERE]
P087
<PAGE>
PART B
VANGUARD TAX-MANAGED FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
APRIL 29, 1998
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated April 29, 1998). To obtain this Prospec-
tus, please call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies.......................................... B-1
Purchase of Shares......................................................... B-6
Redemption of Shares....................................................... B-6
Investment Limitations..................................................... B-7
Management of the Fund..................................................... B-9
The Vanguard Group......................................................... B-10
Portfolio Transactions..................................................... B-12
Performance Measures....................................................... B-13
Description of Shares and Voting Rights.................................... B-16
Yield and Total Return..................................................... B-16
Financial Statements....................................................... B-16
Appendix A--Description of Municipal Bonds and their Ratings............... B-17
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
The following policies supplement the investment objective and policies set
forth in the Fund's Prospectus:
REPURCHASE AGREEMENTS
Each Portfolio of the Fund may invest in repurchase agreements with commer-
cial banks, brokers or dealers either for defensive purposes due to market
conditions or to generate income from its excess cash balances. A repurchase
agreement is an agreement under which the Portfolio acquires a money market
instrument (generally a security issued by the U.S. Government or an agency
thereof, a banker's acceptance or a certificate of deposit) from a commercial
bank, broker or 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 Portfolio and is unrelated to the interest rate on the underlying in-
strument. In these transactions, the securities acquired by the Portfolio (in-
cluding accrued interest earned thereon) must have a total value in excess of
the value of the repurchase agreement and are held by a custodian bank until
repurchased. In addition, the Fund's Board of Directors will monitor a Portfo-
lio's repurchase agreement transactions generally and will establish guide-
lines and standards for review by the investment adviser of the creditworthi-
ness of any bank, broker or dealer party to a repurchase agreement with the
Portfolio. No more than an aggregate of 15% of a Portfolio's net assets, at
the time of investment, will be invested in repurchase agreements having matu-
rities longer than seven days and securities subject to legal or contractual
restrictions on resale for which there are no readily available market quota-
tions. From time to time, the Fund's Board of Directors may determine that
certain restricted securities known as Rule 144A securities are liquid and not
subject to the 15% limitation described above.
B-1
<PAGE>
The use of repurchase agreements involves certain risks. For example, if the
other party to the agreement defaults on its obligation to repurchase the un-
derlying security at a time when the value of the security has declined, the
Portfolio may incur a loss upon disposition of the security. If the other
party to the agreement becomes insolvent and subject to liquidation or reorga-
nization under the Bankruptcy Code or other laws, a court may determine that
the underlying security is collateral for a loan by the Portfolio not within
the control of the Portfolio and therefore the realization by the Portfolio on
such collateral may be automatically stayed. Finally, it is possible that the
Portfolio may not be able to substantiate its interest in the underlying secu-
rity and may be deemed an unsecured creditor of the other party to the agree-
ment. While each Portfolio's management acknowledges these risks, it is ex-
pected that they can be controlled through careful monitoring procedures.
LENDING OF SECURITIES
Each Portfolio of the Fund may lend its investment securities to qualified
brokers, dealers, banks or other financial institutions, so long as the terms
and the structure of such loans are not inconsistent with the Investment Com-
pany Act of 1940, as amended, or the Rules and Regulations or interpretations
of the Securities and Exchange Commission thereunder, which currently require
that (a) the borrower pledge and maintain with the Portfolio collateral con-
sisting of cash, an irrevocable letter of credit or securities issued or guar-
anteed by the United States Government having a value at all times not less
than 100 percent 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 Portfolio at any time and (d) the Portfolio re-
ceive reasonable interest on the loan (which may include the Portfolio's in-
vesting any cash collateral in interest bearing short-term investments), and
distributions on the loaned securities and any increase in their market value.
Each Portfolio of the Fund will not lend securities if, as a result, the ag-
gregate of such loans exceeds 33 1/3% of the value of the Portfolio's total
assets. Loan arrangements made by the Fund will comply with all other applica-
ble regulatory requirements, including the rules of the New York Stock Ex-
change, which rules presently require the borrower, after notice, to redeliver
the securities within the normal settlement time of three business days.
RESTRICTED SECURITIES
Each Portfolio of the Fund may invest in restricted securities (privately-
placed debt securities) and other securities which are not readily marketable,
but will not acquire such securities if as a result they, together with the
aggregate of other securities for which no quotations are readily available,
would comprise more than 15% of the value of the Portfolio's net assets.
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act of 1933. Where registration is required, a
Portfolio may be obligated to pay all or part of the registration expenses and
a considerable period may elapse between the time of the decision to sell and
the time the Portfolio may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions
were to develop, the Portfolio might obtain a less favorable price than pre-
vailed when it decided to sell. Restricted securities will be priced at fair
value as determined in good faith by the Board of Directors. If through the
appreciation of restricted securities or the depreciation of unrestricted se-
curities, a Portfolio should be in a position where more than 10% of the value
of its net assets are invested in illiquid assets, including restricted secu-
rities, the Portfolio will take appropriate steps to protect liquidity.
Restricted securities are securities which are not freely marketable or
which are subject to restrictions upon sale under the Securities Act of 1933.
The Portfolios may invest up to 15% of their assets in restricted securities.
(Included within this limit are restricted securities and other securities for
which price quotations are not readily available). Pursuant to Rule 144A under
the Securities Act of 1933, as
B-2
<PAGE>
amended, if a substantial market among qualified institutional buyers develops
for such securities held by any of these three Portfolios, the Fund intends to
treat such securities as liquid securities, in accordance with procedures ap-
proved by the Fund's Board of Directors.
FUTURES CONTRACTS, OPTIONS ON FUTURES CONTRACTS, WARRANTS, CONVERTIBLE
SECURITIES AND SWAP AGREEMENTS
Each Portfolio of the Fund may enter into futures contracts, options, and
options on futures contracts for several reasons: to simulate full investment
in the underlying securities while retaining a cash balance for Fund manage-
ment purposes, to facilitate trading, or to reduce 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 matu-
rity date and underlying financial instrument are traded on national futures
exchanges. Futures exchanges and trading are regulated under the Commodity Ex-
change Act by the Commodity Futures Trading Commission ("CFTC"), a U.S. Gov-
ernment Agency. Assets committed to futures contracts will be segregated at
the Fund's custodian bank to the extent required by law.
Most futures 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 margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure comple-
tion 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. Bro-
kers may establish deposit requirements which are higher than the exchange
minimums.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the con-
tract 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 deposit.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset unfavor-
able 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. Under CFTC regulations, the Portfolios may
use futures transactions for bona fide hedging purposes only, except that a
Portfolio may establish non-hedging futures positions if the aggregate initial
margin and premiums for such positions do not exceed five percent of the value
of the Portfolio's assets.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the
use of futures contracts may be a more effective means of hedging this expo-
sure.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
A Portfolio of the Fund will not enter into futures contract transactions to
the extent that, immediately thereafter, the sum of its initial margin depos-
its on open contracts exceeds 5% of the market value
B-3
<PAGE>
of the Portfolio's total assets. In addition, a Portfolio will not enter into
futures contracts to the extent that its outstanding obligations to purchase
securities under these contracts would exceed 20% of its 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 assur-
ance that a liquid secondary market will exist for any particular futures con-
tract at any specific time. Thus, it may not be possible to close a futures
position. In the event of adverse price movements, a Portfolio would continue
to be required to make daily cash payments to maintain its required margin. In
such situations, if the Portfolio 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, a Portfolio may be required to make
delivery of the instruments underlying futures contracts it holds. The inabil-
ity to close options and futures positions also could have an adverse impact
on the ability to effectively hedge.
A Portfolio 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 sub-
stantial, due both to the low margin deposits required, and the extremely high
degree of leverage involved. 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% de-
crease 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 ac-
count 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
initial margin requirement for the contract. However, because the futures
strategies of a Portfolio are engaged in only for hedging purposes and will
not be leveraged, the Adviser does not believe that the Portfolio is subject
to the risks of loss frequently associated with futures transactions. A Port-
folio 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 a Portfolio 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 a Portfolio 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 each Portfolio of margin deposits in the event of bank-
ruptcy of a broker with whom a Portfolio 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 unfa-
vorable 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.
B-4
<PAGE>
OTHER TYPES OF DERIVATIVES
In addition to futures and options, a Portfolio may invest in other types of
derivatives, including warrants, swap agreements and partnerships or grantor
trust derivative products. Derivatives are instruments whose value is linked
to or derived from an underlying security. Derivatives may be traded sepa-
rately on exchanges or in the over-the-counter market, or they may be imbedded
in securities. The most common imbedded derivative is the call option attached
to, or imbedded in, a callable bond. The owner of a traditional callable bond
holds a combination of a long position in a non-callable bond and a short po-
sition in a call option on that bond.
Derivative instruments may be used individually or in combination to hedge
against unfavorable changes in interest rates, or to take advantage of antici-
pated changes in interest rates. Derivatives may be structured with no or a
high degree of leverage. When derivatives are used as hedges, the risk in-
curred is that the derivative instrument's value may change differently than
the value of the security being hedged. This "basis risk" is generally lower
than the risk associated with an unhedged position in the security being
hedged. Some derivatives may entail liquidity risk, i.e., the risk that the
instrument cannot be sold at a reasonable price in highly volatile markets.
Leveraged derivatives used for speculation are very volatile, and therefore,
very risky. However, the Portfolios will only utilize derivatives for hedging
or arbitrage purposes, and not for speculative purposes. Over-the-counter de-
rivatives involve a counterparty risk, i.e., the risk that the individual or
institution on the other side of the agreement will not or cannot meet their
obligations under the derivative agreement.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS AND OTHER FEDERAL TAX MATTERS
Except for transactions a Portfolio has identified as hedging transactions,
the Portfolio is required for federal income tax purposes to recognize as in-
come for each taxable year its net unrealized gains and losses on certain
futures contracts as of the end of the year as well as those actually realized
during the year. In most cases, any gain or loss recognized with respect to a
futures contract is considered to be 60% long-term capital gain or loss and
40% short-term capital gain or loss, without regard to the holding period of
the contract. Furthermore, sales of futures contracts which are intended to
hedge against a change in the value of securities held by the Portfolio may
affect the holding period of such securities and, consequently, the nature of
the gain or loss on such securities upon disposition. A Portfolio may be re-
quired to defer the recognition of losses on futures contracts to the extent
of any unrecognized gains on related positions held by the Portfolio.
In order for the Portfolio 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 se-
curities or of foreign currencies or other income derived with respect to the
Portfolio's business of investing in securities. It is anticipated that any
net gain realized from the closing out of futures contracts will be considered
gain from the sale of securities and therefore be qualifying income for pur-
poses of the 90% requirement.
A Portfolio 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 Portfolio's fiscal year on futures transac-
tions. Such distributions will be combined with distributions of capital gains
realized on the portfolio's other investments and shareholders will be advised
on the nature of the transactions.
NON-INVESTMENT GRADE PURCHASES
The Balanced Portfolio will invest 50-55% of its assets in intermediate-term
municipal securities which provide interest exempt from federal income taxes.
B-5
<PAGE>
At least 95% of the municipal securities held by the Portfolio must be rated
a minimum of Baa (or BBB) by Moody's or Standard & Poor's. No more than 20% of
the Portfolio will be held in the lowest investment grade rating. Not more
than 5% of the municipal securities of each Portfolio may be lower-rated or
unrated.
In the event that a particular obligation held by a Portfolio of the Fund is
downgraded below the minimum investment level permitted by the investment pol-
icies of such Portfolio, the directors and officers of the Fund will carefully
assess the creditworthiness of the obligation to determine whether it contin-
ues to meet the policies and objectives of the Portfolio.
MUNICIPAL LEASE OBLIGATIONS
Each Portfolio of the Fund may invest in municipal lease obligations. These
securities are sometimes considered illiquid because of the inefficiency and
thinness of the market in which they are traded. Under the supervision of the
Fund's Board of Directors, the Fixed Income Group may determine to treat cer-
tain municipal lease obligations as liquid, and therefore not subject to the
Fund's 15% limit on illiquid securities. The factors that the Fixed Income
Group may consider in making these liquidity determinations include: (1) the
frequency of trades and quotations for the security; (2) the number of dealers
willing to purchase or sell the security and the number of other potential
buyers; (3) the willingness of dealers to underwrite and make a market in the
security; (4) the nature of the marketplace trades, including the time needed
to dispose of the security, the method of soliciting offers, and the mechanics
of transfer; and (5) factors unique to a particular security, including gen-
eral creditworthiness of the issuer, the importance to the issuer of the prop-
erty covered by the lease and the likelihood that the marketability of the se-
curities will be maintained throughout the time the security is held by the
Portfolio.
In the case of any unrated municipal lease obligations, a Fixed Income Group
analyst will assign a credit rating based upon criteria that include an analy-
sis of factors similar to those considered by nationally recognized statisti-
cal rating organizations. In addition, the Fixed Income Group's liquidity de-
terminations will incorporate those factors mentioned above.
PURCHASE OF SHARES
Each Portfolio reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund, and (iii) to
reduce or waive the minimum investment for or any other restriction on initial
and subsequent investments for certain accounts such as Uniform
Gifts/Transfers to Minors Act Accounts or under circumstances where certain
economies can be achieved in sales of the Portfolio's shares.
REDEMPTION OF SHARES
Each Portfolio may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange is closed, or
trading on the Exchange is restricted as determined by the Securities and Ex-
change Commission (the "Commission"), (ii) during any period when an emergency
exists as defined by the rules of the Commission as a result of which it is
not reasonably practicable for a Portfolio to dispose of securities owned by
it, or fairly to determine the value of its assets, and (iii) for such other
periods as the Commission may permit.
The Fund has made an election with the Commission to pay in cash all redemp-
tions requested by any shareholder of record limited in amount during any 90-
day period to the lesser of $250,000 or 1% of the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without
B-6
<PAGE>
the prior approval of the Commission. Redemptions in excess of the above lim-
its may be paid in whole or in part, in readily marketable investment securi-
ties or in cash, as the Directors may deem advisable; however, payment will be
made wholly in cash unless the Directors believe that economic or market con-
ditions exist which would make such a practice detrimental to the best inter-
ests of the Fund. If redemptions are paid in investment securities, such secu-
rities will be valued as set forth in the Prospectus under "The Share Price of
Each Portfolio" and a redeeming shareholder would normally incur brokerage ex-
penses if he converted these securities to cash.
A redemption fee of 2% of the value of a Portfolio's shares redeemed will be
deducted from the redemption proceeds if shares held for less than one year
are redeemed. A redemption fee of 1% of the value of shares redeemed will be
deducted from the redemption proceeds if shares held for at least one year but
less than five years are redeemed. These fees are paid directly to the Fund.
Any redemption may be more or less than the shareholder's cost depending on
the market value of the securities held by the Portfolio. In the event of an
early redemption due to a shareholder's death, all redemption fees will be
waived. In order to substantiate the death, a certified copy of the death cer-
tificate must be provided.
SIGNATURE GUARANTEES
To protect your account, the Fund and Vanguard from fraud, signature guaran-
tees are required for certain redemptions. Signature guarantees enable the
Fund to verify the identity of the person who has authorized a redemption from
your account. SIGNATURE GUARANTEES ARE REQUIRED IN CONNECTION WITH: (1) ALL
REDEMPTIONS, REGARDLESS OF THE AMOUNT INVOLVED, WHEN THE PROCEEDS ARE TO BE
PAID TO SOMEONE OTHER THAN THE REGISTERED OWNER(S), AND/OR TO AN ADDRESS OTHER
THAN THE ADDRESS OF RECORD; AND (2) SHARE TRANSFER REQUESTS.
A guarantor must be a bank, broker, or any other guarantor that Vanguard
deems acceptable. NOTARIES PUBLIC ARE NOT ACCEPTABLE GUARANTORS.
The signature guarantees must appear either: (1) on the written request for
redemption; (2) on a separate instrument for assignment ("stock power") which
should specify the total number of shares to be redeemed; or (3) on all stock
certificates tendered for redemption and, if shares held by the Fund are also
being redeemed, on the letter or stock power.
INVESTMENT LIMITATIONS
The Fund is subject to the following limitations which may not be changed
with respect to a particular Portfolio without the approval of at least a ma-
jority of the outstanding voting securities (as defined in the Investment Com-
pany Act of 1940) of that Portfolio. A Portfolio will not:
(1) Invest in commodities or commodity contracts or purchase or sell real
estate, although it may purchase and sell marketable securities of compa-
nies which deal in real estate or interests therein; except that it may in-
vest in stock and bond futures contracts, options and options on futures
contracts to the extent that not more than 3% of its assets are required as
deposit margin for futures contracts and not more than 5% of its assets are
invested in such instruments at any time;
(2) Lend money to any person except (i) by purchasing bonds, debentures
or similar obligations (including repurchase agreements) which are either
publicly distributed or customarily purchased by institutional investors,
and (ii) by lending its portfolio securities as provided under "Lending of
Securities";
(3) Purchase securities on margin or sell securities short, except as
specified above in (1);
B-7
<PAGE>
(4) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States govern-
ment and its instrumentalities) if as a result the Portfolio would hold
more than 10% of the outstanding voting securities of the issuer, or more
than 5% of the value of the Portfolio's total assets would be invested in
the securities of such issuer;
(5) Borrow money, except from banks (or through reverse repurchase agree-
ments), for temporary or emergency (not leveraging) purposes, and then in
an amount not exceeding 15% of the value of the Portfolio's net assets (in-
cluding the amount borrowed and the value of any outstanding reverse repur-
chase agreements) at the time the borrowing is made. Whenever borrowings
exceed 5% of the value of the Portfolio's net assets, the Portfolio will
not make any additional investments;
(6) Pledge, mortgage or hypothecate the Portfolio's assets to an extent
greater than 15% of the value of its total assets;
(7) Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in disposing
of Portfolio securities;
(8) Enter into repurchase agreements maturing in more than seven days,
purchase restricted securities or invest in any other illiquid securities
(including the Fund's investment in the Vanguard Group, Inc., as described
in the section entitled "Management of the Fund") if, as a result thereof,
more than 15% of the net assets of the Fund would be invested in such as-
sets.
(9) Invest for the purpose of controlling management of any company;
(10) Invest in securities of other investment companies, except as may be
acquired as a part of a merger, consolidation or acquisition of assets ap-
proved by the Fund's shareholders or otherwise to the extent permitted by
Section 12 of the Investment Company Act of 1940. The Fund will invest only
in investment companies which have investment objectives and investment
policies consistent with those of the Fund; and
(11) Concentrate its investments in a particular industry, although it
may invest up to 25% of the Portfolio's total assets (taken at value) in
the securities of issuers, all of which conduct their principal business
activities in the same industry, provided that (i) this limitation does not
apply to obligations issued or guaranteed by the U.S. Government, or its
agencies or instrumentalities, and (ii) utility companies will be divided
according to their services; for example, gas, gas transmission, electric
and gas, electric, and telephone will each be considered a separate indus-
try.
Although not fundamental policies subject to shareholder vote, as long as
the Fund's shares are registered for sale in certain states, it will not in-
vest in interests in oil, gas or other mineral exploration or development pro-
grams. The Fund does not intend to invest in securities of other investment
companies except to the extent that a closed-end investment company is in-
cluded in either index tracked by the Portfolios.
The above-referenced investment limitations are considered at the time that
portfolio securities are purchased. Notwithstanding these limitations, the
Fund may own all or any portion of the securities of, or make loans to, or
contribute to the costs or other financial requirements of any company which
will be wholly-owned by the Fund and one or more other investment companies
and is primarily engaged in the business of providing, at cost, management,
administrative or related services to the Fund and other investment companies.
See "MANAGEMENT OF THE FUND."
Each Portfolio may not purchase or retain securities of an issuer if an of-
ficer or director of such issuer is an officer or Director of the Fund or its
investment adviser and one or more of such Officers or Directors of the Fund
or its investment adviser owns beneficially more than 1/2% of the shares or
securities of such issuer and all such Directors and Officers owning more than
1/2% of such shares or securities together own more than 5% of such shares or
securities. Each Portfolio of the Fund may not invest more than 5% of its to-
tal assets in securities of companies which have (with predecessors) a record
of less than three years of continuous operation.
B-8
<PAGE>
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are responsible
to the Fund's Board of Directors. The Directors set broad policies for each Fund
and choose its Officers. The following is a list of the Directors and Officers
of the Funds and a statement of their present positions and principal
occupations during the past five years. The mailing address of the Directors and
Officers of the Fund is Post Office Box 876, Valley Forge, PA 19482.
<TABLE>
<S> <C>
JOHN C. BOGLE, (DOB: 5/8/1929) ALFRED M. RANKIN, JR., (DOB: 10/8/1941)
Senior Chairman and Director* Director
Senior Chairman and Director of The Chairman, President, Chief Exective Officer,
Vanguard Group, Inc., and each of the and Director of NACCO Industries Inc.; Director
investment companies in The Vanguard Group; of The BFGoodrich Company, and The Standard
Director of The Mead Corporation, General Products Company.
Accident Insurance, and Chris-Craft Industries,
Inc. JOHN C. SAWHILL, (DOB: 6/12/1936) Director
President and Chief Executive Officer
JOHN J. BRENNAN, (DOB: 7/29/1954) of The Nature Conservancy; formerly,
Chairman, Chief Executive Officer & Director* Director and Senior Partner of McKinsey
Chairman, Chief Executive Officer & Co., and President of New York
and Director of The Vanguard University; Director of Pacific Gas and
Group, Inc. and each of the investment Electric Company, Procter & Gamble
companies in The Vanguard Group. Company, and NACCO Industries.
ROBERT E. CAWTHORN, (DOB: 9/28/1935) JAMES O. WELCH, JR., (DOB: 5/13/1931)
Director Director
Chairman Emeritus and Director of Retired Chairman of Nabisco
Rhone-Poulenc Rorer, Inc.; Managing Brands, Inc.; retired Vice Chairman
Director of Global Health Care and Director of RJR Nabisco; Director of
Partners/DLJ Merchant Banking TECO Energy, Inc., and Kmart Corporation.
Partners; Director of Sun Company,
Inc., and Westinghouse Electric J. LAWRENCE WILSON, (DOB: 3/2/1936)
Corporation. Director
Chairman and Chief Executive Officer
BARBARA BARNES HAUPTFUHRER, (DOB: of Rohm & Haas Company; Director of
10/11/1928) Director Cummins Engine Company, and
Director of The Great Atlantic and The Mead Corporation; Trustee of
Pacific Tea Company, IKON Office Vanderbilt University.
Solutions, Inc., Raytheon Company,
Knight-Ridder, Inc., Massachusetts RAYMOND J. KLAPINSKY, (DOB: 12/7/1938)
Mutual Life Insurance Co., and Ladies Secretary*
Professional Golf Association; and Trustee Managing Director and Secretary of
Emerita of Wellesley College. The Vanguard Group, Inc.; Secretary
of each of the investment companies
BRUCE K. MACLAURY, (DOB: 5/9/1931) in The Vanguard Group.
Director
President Emeritus of The Brookings RICHARD F. HYLAND, (DOB: 3/22/1937)
Institution; Director of American Treasurer*
Express Bank, Ltd., the St. Paul Treasurer of The Vanguard Group,
Companies, Inc., and National Inc. and of each of the investment
Steel Corporation. companies in The Vanguard Group.
BURTON G. MALKIEL, (DOB: 8/28/1932) KAREN E. WEST, (DOB: 9/13/1946) Controller*
Director Principal of The Vanguard Group,
Chemical Bank Chairman's Professor Inc.; Controller of each of the
of Economics, Princeton University; Investment companies in The Vanguard Group.
Director of Prudential Insurance Co. -----------------
of America, Amdahl Corporation, * Officers of the Fund are "interested
Baker Fentress & Co., The Jeffrey Co., persons" as defined in the
and Southern New England Investment Company Act of 1940.
Telecommunications Company.
</TABLE>
B-9
<PAGE>
THE VANGUARD GROUP
Vanguard Tax-Managed Fund is a member of The Vanguard Group of Investment
Companies. Through their jointly-owned subsidiary, The Vanguard Group, Inc.
("Vanguard"), the Fund and the other Funds in the group obtain at cost virtu-
ally all of their corporate management, administrative and distribution serv-
ices. Vanguard also provides investment advisory services on an at-cost basis
to certain of the Vanguard Funds including Vanguard Tax-Managed Fund.
Vanguard employs a supporting staff of management and administrative person-
nel needed to provide the requisite services to the Funds and also furnishes
the Funds with necessary office space, furnishings and equipment. Each Fund
pays its share of Vanguard's net expenses which are allocated among the Funds
under methods approved by the Board of Directors (Trustees) of each Fund. In
addition, each Fund bears its own direct expenses, such as legal, auditing and
custodian fees.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to pre-
vent 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 per-
mitted to engage in personal securities transactions. However, such transac-
tions are subject to procedures and guidelines substantially similar to those
recommended by the mutual fund industry and approved by the U.S. Securities
and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds has invested are adjusted from time to time in
order to maintain the proportionate relationship between each Fund's relative
net assets and its contribution to Vanguard's capital. The Funds' Service
Agreement provides for the following arrangement: (1) each Vanguard Fund may
invest a maximum of 0.40% of its assets in Vanguard and (2) there is no re-
striction on the maximum cash investment that the Vanguard Funds may make in
Vanguard. At December 31, 1997, the Fund had contributed capital of $ . to
Vanguard, representing . % of Vanguard's capitalization.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During the
six months ended December 31, 1997, the Fund's allocated share of Vanguard's
actual net costs of operation relating to management and administrative
services (including transfer agency) totaled approximately $ . .
DISTRIBUTION. Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as Sales Agent for shares of the
Funds, in connection with any sales made directly to investors in the states
of Florida, Missouri, New York, Ohio, Texas and such other states as it may be
required.
The principal distribution expenses are for advertising, promotional materi-
als and marketing personnel. Distribution services may also include organizing
and offering to the public, from time to time, one or more new investment com-
panies which will become members of the Group. The Directors and Officers of
Vanguard determine the amount to be spent annually on distribution activities,
the manner and amount to be spent on each Fund, and whether to organize new
investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon their relative net assets. The remain-
ing one half of these expenses is allocated among the Funds based upon each
Fund's sales for the preceding 24 months relative to the total sales of the
Funds as a Group, provided, however, that no Fund's aggregate quarterly rate
of contribution for distribution expenses of a marketing and promotional na-
ture shall exceed 125% of the average distri-
B-10
<PAGE>
bution expense rate for the Group, and that no Fund shall incur annual distri-
bution expenses in excess of 20/100 of 1% of its average month-end net assets.
During the fiscal year ended December 31, 1997, the Fund paid approximately
$ . of the Group's distribution and marketing expenses.
INVESTMENT ADVISORY SERVICES. Vanguard's Core Management Group provides
investment advisory services to the Fund and also to the following Funds:
Vanguard Index Trust, Vanguard Balanced Index Fund, Vanguard Institutional
Index Fund, Vanguard International Equity Index Fund, the REIT Portfolio of
the Vanguard Specialized Portfolios, the Total International Portfolio of the
Vanguard STAR Fund, the Aggressive Growth Portfolio of Vanguard Horizon Fund,
a portion of the assets of Vanguard/Windsor II, the Equity Index Portfolio of
the Vanguard Variable Insurance Fund, a portion of Vanguard Morgan Growth
Fund, and Vanguard Explorer Fund, and several indexed separate accounts.
Vanguard's Fixed Income Group provides investment advisory services to the
Balanced Portfolio of the Fund and also provides investment advisory services
to the following Funds: Vanguard Municipal Bond Fund; Vanguard Money Market
Reserves; Vanguard Treasury Fund; several Portfolios of Vanguard Fixed Income
Securities Fund; Vanguard California Tax-Free Fund; Vanguard Ohio Tax-Free
Fund; Vanguard New York Tax-Free Fund; Vanguard New Jersey Tax-Free Fund; Van-
guard Pennsylvania Tax-Free Fund; Vanguard Florida Insured Tax-Free Fund; Van-
guard Balanced Index Fund; Vanguard Bond Index Fund; Vanguard Admiral Funds;
and the Money Market and High-Grade Bond Portfolios of the Vanguard Variable
Insurance Fund. These services are provided on an at-cost basis by Vanguard's
Core Management Group and Vanguard's Fixed Income Group. The compensation and
other expenses of this staff are paid by the Funds utilizing these services.
During the fiscal year ended December 31, 1997, the Fund paid approximately
$ . of Vanguard's expenses relating to investment advisory services.
REMUNERATION OF DIRECTORS AND OFFICERS. The Fund pays each Director, who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. The Fund's Officers and employees are paid by Van-
guard which, in turn, is reimbursed by the Fund, and each other Fund in the
Group, for its proportionate share of Officers' and employees' salaries and
retirement benefits. During the year ended December 31, 1997, the Fund's share
of remuneration paid to its Officers and Directors was approximately $ . .
Under its retirement plan, Vanguard contributes annually an amount equal to
10% of each Officer's annual compensation plus 5.7% of that part of the Offi-
cer's compensation during the year that exceeds the Social Security Taxable
Wage Base then in effect. Under the Thrift Plan, all Officers are permitted to
make pre-tax basic contributions in a maximum amount equal to 4% of total com-
pensation. Vanguard matches the basic contributions on a 100% basis. Directors
who are not Officers are paid an annual fee based on the number of years of
service on the Board, up to fifteen years of service, upon retirement. The fee
is equal to $1,000 for each year of service and each investment company member
of The Vanguard Group contributes a proportionate amount to this fee based on
its relative net assets. This fee is paid, subsequent to a Director's retire-
ment, for a period of ten years or until the death of a retired Director. Dur-
ing the year ended December 31, 1997, the Fund's share of retirement benefits
paid to its Officers was approximately $ . .
B-11
<PAGE>
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors for the fiscal year ended December
31, 1997.
VANGUARD TAX-MANAGED FUND COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
AGGREGATE RETIREMENT BENEFITS ESTIMATED FROM ALL
COMPENSATION ACCRUED AS PART OF ANNUAL BENEFITS VANGUARD FUNDS
NAMES OF DIRECTORS FROM FUND FUND EXPENSES UPON RETIREMENT PAID TO DIRECTORS(2)
- ------------------ ------------ ------------------- --------------- --------------------
<S> <C> <C> <C> <C>
John C. Bogle(1)........ -- -- -- --
John J. Brennan(1)...... -- -- -- --
Barbara Barnes
Hauptfuhrer............ $ . $ . $15,000 $ .
Robert E. Cawthorn...... $ . $ . $13,000 $ .
Bruce K. MacLaury....... $ . $ . $12,000 $ .
Burton G. Malkiel....... $ . $ . $15,000 $ .
Alfred M. Rankin, Jr.... $ . $ . $15,000 $ .
John C. Sawhill......... $ . $ . $15,000 $ .
James O. Welch, Jr...... $ . $ . $15,000 $ .
J. Lawrence Wilson...... $ . $ . $15,000 $ .
</TABLE>
- --------
(1) As interested Directors, Messrs. Bogle and Brennan receive no compensation
for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid to
each Director for his or her service as Director or Trustee of 35 Vanguard
Funds (34 in the case of Mr. Malkiel; 28 in the case of Mr. MacLaury).
PORTFOLIO TRANSACTIONS
In placing portfolio transactions, Vanguard uses its best judgment to choose
the broker most capable of providing the brokerage services necessary to ob-
tain best available price and most favorable execution. The full range and
quality of brokerage services available are considered in making these deter-
minations. In those instances where it is reasonably determined that more than
one broker can offer the brokerage services needed to obtain the best avail-
able price and most favorable execution, consideration will be given to those
brokers which supply statistical information and provide other services in ad-
dition to execution services to the Fund.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be made through such
firms. However, the Fund may place portfolio orders with qualified brokers or
dealers who recommend the shares of the Fund to their clients and may, when a
number of brokers and dealers can provide comparable best price and execution
on a particular transaction, consider the sale of shares by a broker or dealer
in selecting among qualified brokers or dealers.
During the period ended December 31, 1997, the Fund paid $ . in brokerage
commissions.
B-12
<PAGE>
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group, Inc.
Each of the investment company members of the Vanguard Group, including each
Portfolio of Vanguard Tax-Managed Fund, Inc., may, from time to time, use one
or more of the following unmanaged indices for comparative performance purpos-
es.
STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX--is a well diversified
list of 500 companies representing the U.S. Stock Market.
STANDARD & POOR'S/BARRA VALUE INDEX--contains common stocks of the S&P 500
Index which have lower than average price-to-book ratios.
STANDARD & POOR'S MIDCAP 400 INDEX--is composed of 400 medium sized domestic
stocks.
STANDARD & POOR'S/BARRA 600 VALUE INDEX--contains stocks of the S&P SmallCap
600 Index which have a lower than average price-to-book ratio.
STANDARD & POOR'S/BARRA 600 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 1000 INDEX--consists of approximately 1,000 large and medium
capitalization stocks.
RUSSELL 2000 INDEX--is composed of approximately 2,000 small capitalization
stocks.
RUSSELL 3000 INDEX--consists of approximately 3,000 large, medium and small
capitalization stocks.
MORGAN STANLEY CAPITAL INTERNATIONAL--SELECT EMERGING MARKETS INDEX--is an
unpublished index which includes common stocks of companies located in the
countries 12 emerging markets.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia, Asia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX--currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
SALOMON BROTHERS GNMA INDEX--includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government
National Mortgage Association.
B-13
<PAGE>
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX--consists of publicly-
issued, non-convertible corporate bonds rated Aa or Aaa. It is a value-
weighted, total return index, including approximately 800 issues with
maturities of 12 years or greater.
SALOMON BROTHERS BROAD INVESTMENT-GRADE BOND INDEX--is a market-weighted
index that contains approximately 4700 individually priced investment-grade
corporate bonds rated BBB or better, U.S. Treasury/agency issues and mortgage
passthrough securities.
LEHMAN LONG-TERM TREASURY BOND INDEX--is composed of all bonds covered by
the Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND INDEX--consists of over 4,500 U.S.
Treasury, agency and investment grade corporate bonds.
LEHMAN CORPORATE (BAA) BOND INDEX--all publicly-offered fixed-rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
LEHMAN BROTHERS LONG-TERM CORPORATE BOND INDEX--is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issued rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
BOND BUYER MUNICIPAL BOND INDEX--is a yield index on current-coupon high
grade general-obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX--is a yield index based upon the average
yield of four high grade, 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 BBB- or better. The Index has a market
value of over $4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX--is a
market-weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities
between 1 and 5 years. The Index has a market value of over $1.6 trillion.
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
B-14
<PAGE>
rated BBB- or better with maturities between 5 and 10 years. The Index has a
market value of over $700 billion.
LEHMAN BROTHERS LONG (10+) GOVERNMENT/CORPORATE INDEX--is a market-weighted
index that contains individually priced U.S. Treasury, agency, and corporate
securities rated BBB- or better with maturities greater than 10 years. The
Index has a market value of over $900 billion.
LEHMAN BROTHERS MUNICIPAL BOND INDEX--is a total return performance
benchmark for the long-term, investment-grade tax-exempt bond market.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE--the average performance of small
company growth funds as defined by Lipper Analytical Services, 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 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
Analytical Services, 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 Analytical Services, 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 Analytical Services, Inc.
LIPPER GENERAL EQUITY FUND AVERAGE--an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
LIPPER FIXED INCOME FUND AVERAGE--an industry benchmark of average fixed
income funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
MARKETING AND ADVERTISING MATERIALS FOR THE VANGUARD TAX-MANAGED FUND MAY
FROM TIME TO TIME REFERENCE DATA FROM THE FOLLOWING STUDIES.
Joel M. Dickson and John B. Shoven, "Ranking Mutual Funds on an After Tax
Basis," Center for Economic Policy Research, Publication Number 344, April
1993.
B-15
<PAGE>
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund was organized as a Maryland corporation on May 9, 1994. The Arti-
cles of Incorporation permit the Directors to issue 750,000,000 shares of Com-
mon Stock, $.001 par value from an unlimited number of separate classes
("Portfolio") of shares. Currently the Fund is offering shares of three Port-
folios. The shares of each Portfolio are fully paid and nonassessable and have
no preference as to conversion, exchange, dividends, retirement or other fea-
tures. The shares of each Portfolio have no pre-emptive rights. The shares of
each Portfolio have non-cumulative voting rights, which means that the holders
of more than 50% of the shares voting for the election of Directors can elect
100% of the Directors if they choose to do so. A shareholder is entitled to
one vote for each full share held (and a fractional vote for each fractional
share held), then standing in his name on the books of the Fund. On any matter
submitted to a vote of shareholders, all shares of the Fund then issued and
outstanding and entitled to vote, irrespective of the class, shall be voted in
the aggregate and not by class: except (i) when required by the Investment
Company Act of 1940, shares shall be voted by individual class; and (ii) when
the matter does not affect any interest of a particular class, then only
shareholders of the affected class or classes shall be entitled to vote there-
on.
YIELD AND TOTAL RETURN
The yield* of each Portfolio of the Fund for the 30-day period ended Decem-
ber 31, 1997 was as follows:
<TABLE>
<S> <C>
Growth and Income Portfolio........................................... . %
Capital Appreciation Portfolio........................................ . %
Balanced Portfolio.................................................... . %
</TABLE>
*Yield is calculated daily.
The average annual total return of each Portfolio of the Fund for the one
year period ended December 31, 1997 and since its September 6, 1994 inception
was as follows:
<TABLE>
<CAPTION>
ONE YEAR ENDED SINCE INCEPTION
DECEMBER 31, 1997 SEPTEMBER 6, 1994
----------------- -----------------
<S> <C> <C>
Growth and Income Portfolio................. + . % + . %
Capital Appreciation Portfolio.............. + . % + . %
Balanced Portfolio.......................... + . % + . %
</TABLE>
The Fund had a subscription period for each Portfolio from July 25, 1994, to
September 5, 1994, during which time all assets were held in money market in-
struments. Performance measurement begins September 6, 1994.
FINANCIAL STATEMENTS
The Fund's financial statements for the period ended December 31, 1997, in-
cluding the financial highlights for the period ended December 31, 1997, ap-
pearing in the Vanguard Tax-Managed Fund 1997 Annual Report to Shareholders,
and the report thereon of Price Waterhouse LLP, independent accountants, also
appearing therein, are incorporated by reference in this Statement of Addi-
tional Information. The Fund's Annual Report to Shareholders is enclosed with
this Statement of Additional Information.
B-16
<PAGE>
APPENDIX A--DESCRIPTION OF MUNICIPAL BONDS AND THEIR RATINGS
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
MUNICIPAL BONDS--GENERAL. Municipal Bonds generally include debt obligations
issued by states and their political subdivisions, and duly constituted
authorities and corporations, to obtain funds to construct, repair or improve
various public facilities such as airports, bridges, highways, hospitals,
housing, schools, streets and water and sewer works. Municipal Bonds may also
be issued to refinance outstanding obligations as well as to obtain funds for
general operating expenses and for loan to other public institutions and
facilities.
The two principal classifications of Municipal Bonds are "general obliga-
tion" and "revenue" or "special tax" bonds. General obligation bonds are se-
cured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are pay-
able only from the revenues derived from a particular facility or class of fa-
cilities or, in some cases, from the proceeds of a special excise or other
tax, but not from general tax revenues. The Fund may also invest in tax-exempt
industrial development bonds, short-term municipal obligations, demand notes
and tax-exempt commercial papers.
Industrial revenue bonds in most cases are revenue bonds and generally do
not have the pledge of the credit of the issuer. The payment of the principal
and interest on such industrial revenue bonds is dependent solely on the abil-
ity of the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed
as security for such payment. Short-term municipal obligations issued by
states, cities, municipalities or municipal agencies, include Tax Anticipation
Notes, Revenue Anticipation Notes, Bond Anticipation Notes, Construction Loan
Notes and Short-Term Discount Notes.
Note obligations with demand or put options may have a stated maturity in
excess of one year, but permit any holder to demand payment of principal plus
accrued interest upon a specified number of days' notice. Frequently, such ob-
ligations are secured by letters of credit or other credit support arrange-
ments provided by banks. The issuer of such notes normally has a corresponding
right, after a given period, to repay in its discretion the outstanding prin-
cipal of the note plus accrued interest upon a specific number of days' notice
to the bondholders. The interest rate on a demand note may be based upon a
known lending rate, such as a bank's prime rate, and be adjusted when such
rate changes, or the interest rate on a demand note may be a market rate that
is adjusted at specified intervals. The demand notes in which the Fund will
invest are payable on not more than 397 days' notice. Each note purchased by
the Fund will meet the quality criteria set out above for the Fund.
The yields of Municipal Bonds depend on, among other things, general money
market conditions, conditions in the Municipal Bond market, the size of a par-
ticular offering, the maturity of the obligation, and the rating of the issue.
The ratings of Moody's Investors Service, Inc. and Standard & Poor's Corpora-
tion represent their opinions of the quality of the Municipal Bonds rated by
them. It should be emphasized that such ratings are general and are not abso-
lute standards of quality. Consequently, Municipal Bonds with the same maturi-
ty, coupon and rating may have different yields, while Municipal Bonds of the
same maturity and coupon, but with different ratings may have the same yield.
It will be the responsibility of the investment management staff to appraise
independently the fundamental quality of the bonds held by the Fund.
The Portfolios may purchase municipal bonds subject to so-called "demand
features." In such cases the Portfolio may purchase a security that is nomi-
nally long-term, but has many of the features of shorter-term securities. By
virtue of this demand feature, the security will be deemed to have a maturity
date that is earlier than its stated maturity rate.
B-17
<PAGE>
Municipal Bonds are sometimes purchased on a "when issued" basis meaning the
Fund has committed to purchasing certain specified securities at an agreed
upon price when they are issued. The period between commitment date and issu-
ance date can be a month or more. It is possible that the securities will
never be issued and the commitment canceled.
From time to time proposals have been introduced before Congress to restrict
or eliminate the Federal income tax exemption for interest on Municipal Bonds.
Similar proposals may be introduced in the future. If any such proposal were
enacted, it might restrict or eliminate the ability of the Fund to achieve its
investment objective. In that event, the Fund's Directors and Officers would
reevaluate its investment objective and policies and consider recommending to
its shareholders changes in such objective and policies.
Similarly, from time to time proposals have been introduced before State and
local legislatures to restrict or eliminate the State and local income tax ex-
emption for interest on Municipal Bonds. Similar proposals may be introduced
in the future. If any such proposal were enacted, it might restrict or elimi-
nate the ability of each Portfolio to achieve its respective investment objec-
tive. In that event, the Fund's Directors and Officers would reevaluate its
investment objective and policies and consider recommending to its sharehold-
ers changes in such objectives and policies.
Excerpts from Moody's Investors Service, Inc.'s Municipal Bond ratings:
Aaa--judged to be of the "best quality" and are referred to as "gilt edge";
interest payments are protected by a large or by an exceptionally stable mar-
gin and principal is secure; Aa--judged to be of "high quality by all stan-
dards" but as to which margins of protection or other elements make long-term
risks appear somewhat larger than Aaa-rated Municipal Bonds; together with Aaa
group they comprise what are generally known as "high grade bonds"; A--possess
many favorable investment attributes and are considered "upper medium grade
obligations." Factors giving security to principal and interest of A-rated Mu-
nicipal Bonds are considered adequate, but elements may be present which sug-
gest a susceptibility to impairment sometime in the future; 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 characteris-
tically unreliable over any great length of time; Ba--protection of principal
and interest payments may be very moderate; judged to have speculative ele-
ments; their future cannot be considered as well-assured; B--lack characteris-
tics of a desirable investment; assurance of interest and principal payments
over any long period of time may be small; Caa--poor standing; may be in de-
fault or there may be present elements of danger with respect to principal and
interest; Ca--speculative in a high degree; often in default; C--lowest rated
class of bonds; issues so rated can be regarded as having extremely poor pros-
pects for ever attaining any real investment standing.
Description of Moody's ratings of state and municipal notes: Moody's ratings
for state and municipal notes and other short-term obligations are designated
Moody's Investment Grade ("MIG"). Symbols used will be as follows: MIG-1--Best
quality, enjoying strong protection from established cash flows of funds for
their servicing or from established and broad-based access to the market for
refinancing, or both: MIG-2--High quality with margins of protection ample al-
though not so large as in the preceding group.
Description of Moody's highest commercial paper rating: Prime-1 ("P-1")--
judged to be of the best quality. Their short-term debt obligations carry the
smallest degree of investment risk.
Excerpts from Standard & Poor's Corporation's Municipal Bond ratings: AAA--
has the highest rating assigned by S&P; extremely strong capacity to pay prin-
cipal and interest; AA--has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in a small degree;
A--has a strong capacity to pay principal and interest, although somewhat more
susceptible to the adverse changes in circumstances and economic conditions;
BBB--regarded as having an adequate
B-18
<PAGE>
capacity to pay principal and interest; normally exhibit adequate protection
parameters but adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest than for
bonds in A category; BB--B--CCC--CC--predominantly speculative with respect to
capacity to pay interest and repay principal in accordance with terms of obli-
gations; BB is being paid; D--in default, and payment of principal and/or in-
terest is in arrears.
The ratings from "AA" to "B" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Excerpt from Standard & Poor's Corporation's rating of municipal note is-
sues: SP-1+--very strong capacity to pay principal and interest; SP-1--strong
capacity to pay principal and interest.
Description of S&P's highest commercial papers ratings: A-1+--This designa-
tion indicates the degree of safety regarding timely payment is overwhelming.
A-1--This designation indicates the degree of safety regarding timely payments
is very strong.
In the event that a particular obligation held by the Balanced Portfolio is
downgraded below the minimum investment level permitted by the investment pol-
icies of the Portfolio, the Directors and Officers of the Fund will carefully
assess the creditworthiness of the obligation to determine whether it contin-
ues to meet the policies and objectives of the Portfolio.
B-19
<PAGE>
PART C
VANGUARD TAX-MANAGED FUND, INC.
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
(A) FINANCIAL STATEMENTS
The Registrant's audited financial statements for the year January 1, 1997
to December 31, 1997, including Price Waterhouse LLP's report thereon, are in-
corporated by reference, in the Statement of Additional Information, from the
Registrant's 1997 Annual Report and insert thereto, which has been filed with
the Commission as an Exhibit to this Registration Statement. The financial
statements included in the Annual Report and the insert thereto are:
1. Statements of Net Assets as of December 31, 1997.
2. Statements of Operations for the year ended December 31, 1997.
3. Statements of Changes in Net Assets for the two years ended December 31,
1997.
4. Financial Highlights for the two years January 1, 1996 to December 31,
1997 and the period July 25, 1994 to December 31, 1994.
5. Notes to Financial Statements.
6. Report of Independent Accountants.
(B) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<S> <C>
1.................. Articles of Incorporation*
2.................. By-Laws of Registrant*
3.................. Not Applicable
4.................. Not Applicable
5.................. Not Applicable
6.................. Not Applicable
7.................. Reference is made to the section entitled "Manage-
ment of the Fund" in the Registrant's Statement of
Additional Information
8.................. Form of Custody Agreement
9.................. Form of Vanguard Service Agreement*
10.................. Opinion of Counsel*
11.................. Consent of Independent Accountants**
12.................. Financial Statements--reference is made to (a) above
13.................. Stockholder Letter
14.................. Not Applicable
15.................. Not Applicable
16.................. Not Applicable
27.................. Financial Data Schedule**
</TABLE>
- --------
* Filed Previously.
** Filed Herewith.
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Registrant is not controlled by or under common control with any person. The
Officers of the Registrant, the investment companies in The Vanguard Group of
Investment Companies and The Vanguard Group, Inc. are identical. Reference is
made to the caption "Management of the Fund" in the Prospectus constituting
Part A and in the Statement of Additional Information constituting Part B of
this Registration Statement.
C-1
<PAGE>
ITEM 26. NUMBER OF HOLDERS OF SECURITIES
As of December 31, 1997 each Portfolio of the Fund had the following number
of shareholders:
<TABLE>
<S> <C>
Growth and Income Portfolio........................................... .
Capital Appreciation Portfolio........................................ .
Balanced Portfolio.................................................... .
</TABLE>
ITEM 27. INDEMNIFICATION
Reference is made to Article IX of Registrant's Articles of Incorporation.
Insofar as indemnification for liability arising under the Securities Act of
1933 may be permitted to Directors, Officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a Director, Officer or controlling person of the Regis-
trant in the successful defense of any action, suit or proceeding) is asserted
by such Director, Officer or controlling person in connection with the securi-
ties being registered, the Registrant will, unless in the opinion of its coun-
sel the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the fi-
nal adjudication of such issue.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Reference is made to the caption "Investment Advisers" in the prospectus
constituting Part "A" of this Registration Statement and "Investment Advisory
Services" in Part "B" of this Registration Statement.
ITEM 29. PRINCIPAL UNDERWRITERS
(a) None
(b) Not Applicable
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS
The books, accounts and other documents required by Section 31(a) under the
Investment Company Act and the rules promulgated thereunder will be maintained
in the physical possession of Registrant; Registrant's Transfer Agent, The
Vanguard Group, Inc. c/o The Vanguard Financial Center, Valley Forge, Pennsyl-
vania 19482; and the Registrant's Custodian.
ITEM 31. MANAGEMENT SERVICES
Other than the Amended and Restated Funds' Service Agreement with The Van-
guard Group, Inc. which is filed as Exhibit 9 and described in Part B hereof
under "Management of the Fund," the Registrant is not a party to any manage-
ment-related service contract.
ITEM 32. UNDERTAKINGS
Registrant hereby undertakes to provide an Annual Report to Shareholders or
prospective investors, free of charge, upon request.
C-2
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933 AND THE INVEST-
MENT COMPANY ACT OF 1940, THE REGISTRANT HAS DULY CAUSED THIS POST-EFFECTIVE
AMENDMENT TO THE REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UN-
DERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE TOWN OF VALLEY FORGE AND THE COM-
MONWEALTH OF PENNSYLVANIA, ON THE 27TH DAY OF FEBRUARY, 1998.
Vanguard Tax-Managed Fund, Inc.
By:
---------------------------------
(RAYMOND J. KLAPINSKY)
JOHN J. BRENNAN*,
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS POST-EFFEC-
TIVE AMENDMENT TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BELOW BY THE FOL-
LOWING PERSONS IN THE CAPACITIES AND ON THE DATE INDICATED:
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<S> <C> <C>
By: Senior Chairman of February 27, 1998
--------------------------------- the Board and
(RAYMOND J. KLAPINSKY) Director
JOHN C. BOGLE*
By: Chairman, Chief February 27, 1998
--------------------------------- Executive Officer
(RAYMOND J. KLAPINSKY) and Director
JOHN J. BRENNAN*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
ROBERT C. CAWTHORN*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
BARBARA B. HAUPTFUHRER*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
BURTON G. MALKIEL*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
BRUCE K. MACLAURY, JR.*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
ALFRED M. RANKIN, JR.*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
JOHN C. SAWHILL*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
JAMES O. WELCH, JR.*
By: Director February 27, 1998
---------------------------------
(RAYMOND J. KLAPINSKY)
J. LAWRENCE WILSON*
By: Treasurer and February 27, 1998
--------------------------------- Principal Financial
(RAYMOND J. KLAPINSKY) Officer and
RICHARD F. HYLAND* Accounting Officer
</TABLE>
* By Power of Attorney. See File Number 2-14336, January 23, 1990. Incorpo-
rated by Reference.
<PAGE>
VANGUARD TAX-MANAGED FUND, INC.
INDEX TO EXHIBITS
<TABLE>
<S> <C>
Schedule for Computation of Performance Quotations.................... Ex-99.B16
Financial Data Schedule............................................... Ex-27
</TABLE>
<PAGE>
EX-99.B16
SCHEDULE FOR COMPUTATION OF PERFORMANCE QUOTATIONS VANGUARD TAX-MANAGED FUND--
CAPITAL APPRECIATION PORTFOLIO
1. AVERAGE ANNUAL TOTAL RETURN (As of December 31, 1997)
P (1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
N = number of years
ERV = ending redeemable value at the end of the period
EXAMPLE:
- --------
ONE YEAR
- --------
P =
T =
N =
ERV =
FIVE YEAR
---------
P $1,000
T . %
N 1
ERV $ .
FIVE YEAR
---------
P =
T =
N =
ERV =
P $1,000
T . %
N *
ERV $ .
- --------
* Since inception on September 6, 1994.
2. YIELD (30 Days Ended December 31, 1997)
a -
b
Yield = 2[( + 1 )/6/ - 1]
----
c X d
Where: a = dividends and interest paid during the period
b = expense dollars during the period (net of reimbursements)
c = the average daily number of shares outstanding during the
period
d = the maximum offering price per share on the last day of the
period
Example a =
$ .
b =
$ .
c =
.
d =
$ .
Yield =
. %
<PAGE>
EX-99.B16
VANGUARD TAX-MANAGED FUND--BALANCED PORTFOLIO
1. AVERAGE ANNUAL TOTAL RETURN (As of December 31, 1997)
P (1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
N = number of years
ERV = ending redeemable value at the end of the period
EXAMPLE:
- --------
ONE YEAR
- --------
P =
T =
N =
ERV =
FIVE YEAR
---------
P $1,000
T . %
N 1
ERV $ .
FIVE YEAR
---------
P =
T =
N =
ERV =
P $1,000
T . %
N *
ERV $ .
- --------
* Since inception on September 6, 1994.
2. YIELD (30 Days Ended December 31, 1997)
a -
b
Yield = 2[( + 1 )/6/ - 1]
----
c X d
Where: a = dividends and interest paid during the period
b = expense dollars during the period (net of reimbursements)
c = the average daily number of shares outstanding during the
period
d = the maximum offering price per share on the last day of the
period
Example a =
$ .
b =
$ .
c =
.
d =
$ .
Yield =
. %
<PAGE>
EX-99.B16
VANGUARD TAX-MANAGED FUND--GROWTH AND INCOME PORTFOLIO
1. AVERAGE ANNUAL TOTAL RETURN (As of December 31, 1997)
P (1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
N = number of years
ERV = ending redeemable value at the end of the period
EXAMPLE:
--------
ONE YEAR
--------
P = $1,000
T = . %
N = 1
ERV = $ .
FIVE YEAR
---------
P = $1,000
T = . %
N = *
ERV = $ .
- --------
* Since inception on September 6, 1994.
2. YIELD (30 Days Ended December 31, 1997)
a -
b
Yield = 2[(+ 1 )/6/ - 1]
----
c X d
Where: a = dividends and interest paid during the period
b = expense dollars during the period (net of reimbursements)
c = the average daily number of shares outstanding during the
period
d = the maximum offering price per share on the last day of the
period
Example a =
$ .
b =
$ .
c =
.
d =
.
Yield =
. %
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