VANGUARD TAX MANAGED FUND INC, 497, 1999-08-20

VANGUARD TAX MANAGED FUND INC
497, 1999-08-20

Previous: FLUSHING FINANCIAL CORP, S-8, 1999-08-20

Next: INVESCO SPECIALTY FUNDS INC, 24F-2NT, 1999-08-20

<PAGE> 1

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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. 10 [ ]
AND

REGISTRATION STATEMENT (NO. 811-07175) UNDER
THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 13 [ ]
VANGUARD TAX-MANAGED FUNDS
(EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST)

P.O. BOX 2600
VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)

REGISTRANT'S TELEPHONE NUMBER (610) 669-1000

R. GREGORY BARTON, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
on August 18, 1999 pursuant to paragraph (b) of Rule 485.
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after this Registration Statement becomes effective.

WE HAVE ELECTED TO REGISTER AN INDEFINITE NUMBER OF SHARES PURSUANT TO
REGULATION 24f-2 UNDER THE INVESTMENT COMPANY ACT OF 1940. WE FILED OUR RULE
24f-2 NOTICE FOR THE YEAR ENDED DECEMBER 31, 1998 ON FEBRUARY 25, 1999.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2

VANGUARD TAX-MANAGED FUNDS

CROSS REFERENCE SHEET

<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
- ----------- ----------------------
<S> <C> <C>
Item 1. Front and Back Cover Pages............. Front and Back Cover Pages
Item 2. Risk/Return Summary: Investments,
Risks, and Performance................. Fund Profile
Item 3. Risk/Return Summary: Fee Table......... Fee Table
Item 4. Investment Objectives, Principal
Investment Strategies, and Related
Risks.................................. A Word About Risk; An Introduction to
Tax-Efficient Investing; Primary
Investment Strategies
Item 5. Management's Discussion of Fund
Performance............................ Herein incorporated by reference to
Registrant's Annual Report to
Shareholders dated December 31, 1998
filed with the Securities & Exchange
Commission's EDGAR system on March 2,
1999.
Item 6. Management, Organization, and Capital
Structure.............................. The Funds and Vanguard; Investment
Adviser
Item 7. Shareholder Information................ Share Price; Dividends, Capital Gains,
and Taxes; Investing with Vanguard
Item 8. Distribution Arrangements.............. Inside Front Cover Page
Item 9. Financial Highlights Information....... Financial Highlights
</TABLE>

<TABLE>
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
- ----------- -------------------------
<S> <C> <C>
Item 10. Cover Pages and Table of Contents...... Cover Page; Table of Contents
Item 11. Fund History........................... Description of the Trust
Item 12. Description of the Fund and its
Investments and Risks.................. Investment Policies; Description of the
Trust; and Fundamental Investment
Limitations
Item 13. Management of the Fund................. Management of the Trust
Item 14. Control Persons and Principal Holders
of Securities.......................... Management of the Trust
Item 15. Investment Advisory and Other
Services............................... Investment Advisory Services
Item 16. Brokerage Allocation and Other
Practices.............................. Portfolio Transactions
Item 17. Capital Stock and Other Securities..... Description of the Trust
Item 18. Purchase, Redemption and Pricing of
Shares................................. Purchase of Shares; Redemption of
Shares; and Share Price
Item 19. Taxation of the Fund................... Description of the Trust
Item 20. Underwriters........................... Not Applicable
Item 21. Calculation of Performance Data........ Yield and Total Return
Item 22. Financial Statements................... Financial Statements
</TABLE>
<PAGE> 3
VANGUARD TAX-MANAGED FUNDS

Prospectus
August 18, 1999

A Group of Tax-Managed Mutual Funds

CONTENTS

1 AN INTRODUCTION TO TAX-MANAGED INVESTING

2 FUND PROFILES

2 Vanguard Tax-Managed Balanced Fund

5 Vanguard Tax-Managed Growth and
Income Fund

8 Vanguard Tax-Managed Capital
Appreciation Fund

11 Vanguard Tax-Managed Small-Cap Fund

13 Vanguard Tax-Managed International Fund

14 A WORD ABOUT RISK

15 PRIMARY INVESTMENT STRATEGIES

21 THE FUNDS AND VANGUARD

22 INVESTMENT ADVISER

22 YEAR 2000 CHALLENGE

23 DIVIDENDS, CAPITAL GAINS, AND TAXES

24 SHARE PRICE

25 FINANCIAL HIGHLIGHTS

27 INVESTING WITH VANGUARD

27 SERVICES AND ACCOUNT FEATURES

28 TYPES OF ACCOUNTS

28 BUYING SHARES

30 REDEEMING SHARES

33 TRANSFERRING REGISTRATION

34 FUND AND ACCOUNT UPDATES

GLOSSARY (inside back cover)

WHY READING THIS PROSPECTUS IS IMPORTANT

This prospectus explains the objective, risks, and strategies of each of the
Vanguard Tax-Managed Funds. To highlight terms and concepts important to mutual
fund investors, we have provided "Plain Talk" explanations along the way.
Reading the prospectus will help you to decide which Fund, if any, is the right
investment for you. We suggest that you keep it for future reference.

IMPORTANT NOTE

The Tax-Managed Growth and Income Fund, Tax-Managed Capital Appreciation Fund,
Tax-Managed Small-Cap Fund, and Tax-Managed International Fund each offer two
separate classes of shares: Investor and Institutional. The Tax-Managed Balanced
Fund offers Investor Shares only. This prospectus offers the Funds' Investor
Shares, which have an investment minimum of $10,000. The Funds' Institutional
Shares, which have an investment minimum of $10 million, are offered through a
separate prospectus. You can obtain a copy of the Institutional Shares
prospectus by calling Vanguard's Institutional Investor Services Department at
1-800-523-1036. Note that the Funds' separate share classes have different
expenses; as a result, their investment performance will vary.

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

<PAGE> 4

AN INTRODUCTION TO TAX-MANAGED INVESTING

Most mutual funds seek to maximize pretax total returns, without regard to the
personal tax consequences for investors. Yet most investors stand to lose a
significant portion of their investment returns to federal, state, and local
taxes. Fund dividends and short-term capital gains are now taxed at federal
income tax rates as high as 39.6%; and for long-term capital gains, the rates
reach up to 20%. The Vanguard Tax-Managed Funds aim to minimize the impact of
taxes on investors' total returns by operating in a tax-efficient manner. The
Funds use these tax-management techniques:

- - Low turnover. The Funds minimize turnover by employing an index-oriented
approach to stock investing. Instead of trading frequently, each Fund
simply buys and holds all -- or a representative sample -- of the stocks
comprising its target index. Frequent trading -- a hallmark of many
actively managed funds -- causes funds to realize capital gains, which must
then be distributed to shareholders, reducing their after-tax returns.

- - A disciplined sell-selection method. When selling specific securities, the
Funds will select a specific share lot -- more often than not, the
highest-cost shares -- in order to minimize realized capital gains. In
addition, each Fund may sell securities at a loss in order to offset
realized capital gains that would otherwise have to be distributed to
shareholders.

- - Bias against taxable dividend income. The Tax-Managed Balanced and
Tax-Managed Capital Appreciation Funds minimize taxable dividend income by
focusing on the lower-yielding stocks in their target index (the Russell
1000 Index). In addition, the bond portion of the Tax-Managed Balanced Fund
is comprised of municipal securities, which generate tax-exempt dividends.

- - Redemption fees. Each Fund imposes redemption fees on short-term investors,
whose in-out activity can reduce a fund's tax efficiency by causing it to
realize capital gains. The fee is 2% for shares held for less than one
year, and 1% for shares held at least one but less than five years. These
fees are paid to the Funds to help cover their transaction costs when
selling securities to meet redemptions.

<PAGE> 5

FUND PROFILE -- VANGUARD TAX-MANAGED BALANCED FUND

The following profile summarizes key features of Vanguard Tax-Managed Balanced
Fund.

INVESTMENT OBJECTIVE

The Fund is a balanced fund that seeks to provide a tax-efficient investment
return, consisting of federally tax-exempt current income, long-term capital
growth, and a modest amount of taxable current income.

INVESTMENT STRATEGIES
The Fund invests approximately 50 - 55% of its assets in municipal securities
and the balance in common stocks. The fixed-income portion of the Fund
emphasizes higher-quality municipal securities with a dollar-weighted average
maturity that will range from 7 - 12 years. The Fund's stock holdings are chosen
from the Russell 1000 Index -- an independent index of large- and
mid-capitalization U.S. companies. The Fund uses statistical methods to "sample"
the Index, aiming to closely track its investment performance while minimizing
taxable dividend distributions. For more information, see "Security Selection"
under PRIMARY INVESTMENT STRATEGIES.

PRIMARY RISKS
THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to:

- - Investment style risk, which is the chance that returns from large- or
mid-capitalization stocks will trail returns from other asset classes or
the overall stock market. Each type of stock tends to go through cycles of
doing better -- or worse -- than the stock market in general. These periods
have, in the past, lasted for as long as several years.

- - Interest rate risk, which is the chance that bond prices overall, including
the prices of bonds held by the Fund, will decline due to rising interest
rates.

- - Call risk, which is the chance that during periods of falling interest
rates, a bond issuer will "call" -- or repay -- a relatively high-yielding
bond before the bond's maturity date. The Fund would have lost the
opportunity for additional price appreciation, and would be forced to
reinvest the unanticipated proceeds at lower interest rates. As a result,
the Fund would experience a decline in income.

- - Income risk, which is the chance that falling interest rates will cause the
Fund's income to decline. Income risk is generally low for longer-term
bonds.

- - Credit risk, which is the chance that a bond issuer -- a state or local
government or regional governmental authority -- will fail to pay interest
and principal in a timely manner. Credit risk, which has the potential to
hurt the Fund's performance, should be low for the Fund.

PERFORMANCE/RISK INFORMATION

The bar chart and table on the next page provide an indication of the risk of
investing in the Fund. The bar chart shows the Fund's performance in each
calendar year since inception. The table shows how the Fund's average annual
returns for one calendar year and since inception compare with those of
broad-based securities market indexes and a composite stock/bond index weighted
to match the Fund's target allocation. Keep in mind that the Fund's past
performance does not necessarily indicate how it will perform in the future.

<PAGE> 6

- --------------------------------------------------------------------------------
ANNUAL TOTAL RETURNS
- --------------------------------------------------------------------------------

[BAR GRAPH]

1995 1996 1997 1998
----------------------------------------
24.52% 12.21% 16.55% 16.93%

During the period shown in the bar chart, the highest return for a calendar
quarter was 12.32% (quarter ended December 31, 1998) and the lowest return for a
quarter was -5.03% (quarter ended September 30, 1998).

- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
1 YEAR SINCE INCEPTION*
- --------------------------------------------------------------------------------
<S> <C> <C>
Vanguard Tax-Managed Balanced Fund 16.93% 15.71%
Russell 1000 Index 27.02 26.85
Lehman Brothers 7 Year Municipal Bond Index 6.22 6.99
Tax-Managed Balanced Composite Index** 16.98 16.82
</TABLE>
- --------------------------------------------------------------------------------
* September 6, 1994.

** Weighted 50% Russell 1000 Index and 50% Lehman Brothers 7 Year
Municipal Bond Index.
- --------------------------------------------------------------------------------

<TABLE>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees*: 2% or 1%**
</TABLE>

<TABLE>
<S> <C>
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
Management Expenses: 0.15%
12b-1 Distribution Fees: None
Other Expenses: 0.04%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.19%
</TABLE>

* Includes redemptions by exchange to another fund.

** A 2% redemption fee applies to shares held for less than one year; a 1%
redemption fee applies to shares held at least one year but less than five
years. The fees are withheld from redemption proceeds and retained by the
Fund. These fees help to cover the transaction costs borne by the Fund when
it must sell securities to meet redemptions. In addition, these fees are
intended to protect the Fund's long-term investors from short-term traders,
who erode the Fund's tax-efficiency.
<PAGE> 7

FUND PROFILE -- VANGUARD TAX-MANAGED BALANCED FUND (continued)

1 YEAR* 3 YEARS 5 YEARS** 10 YEARS
- --------------------------------------------------------------------------------
$124 $176 $107 $243

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

** Does not include a redemption fee. If you hold shares for one or more
years, but less than five years, a 1% redemption fee applies.

- --------------------------------------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- --------------------------------------------------------------------------------
$19 $61 $107 $243
- --------------------------------------------------------------------------------

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.

ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS

Dividends are paid quarterly in March, June, September, and December; capital
gains, if any, are paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
September 6, 1994

NET ASSETS AS OF DECEMBER 31, 1998
$207 million

SUITABLE FOR IRAs
No

MINIMUM INITIAL INVESTMENT
$10,000

NEWSPAPER ABBREVIATION
TxMBal

VANGUARD FUND NUMBER
103

CUSIP NUMBER
921943304

TICKER SYMBOL
VTMFX

<PAGE> 8
5

FUND PROFILE -- VANGUARD TAX-MANAGED GROWTH AND INCOME FUND

The following profile summarizes key features of Vanguard Tax-Managed Growth and
Income Fund.

INVESTMENT OBJECTIVE
The Fund is a stock fund that seeks to provide a tax-efficient investment return
consisting of a moderate level of current income and long-term capital growth.

INVESTMENT STRATEGIES
The Fund purchases stocks included in the Standard & Poor's 500 Composite Stock
Price Index -- an independent index that is dominated by dividend-paying stocks
of the largest U.S. companies. The Fund will hold substantially all of the S&P
500 stocks, in approximately the same proportions as they are represented in the
Index. For more information, see "Security Selection" under PRIMARY INVESTMENT
STRATEGIES.

PRIMARY RISKS
THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to investment style risk, which is the chance that returns
from large-capitalization stocks will trail returns from other asset classes or
the overall stock market. Large-capitalization stocks tend to go through cycles
of doing better -- or worse -- than the stock market in general. These periods
have, in the past, lasted for as long as several years.

PERFORMANCE/RISK INFORMATION
The bar chart and table below provide an indication of the risk of investing in
the Fund. The bar chart shows the Fund's performance in each calendar year since
inception. The table shows how the Fund's average annual returns for one
calendar year and since inception compare with those of a broad-based securities
market index. Keep in mind that the Fund's past performance does not necessarily
indicate how it will perform in the future.

- --------------------------------------------------------------------------------
ANNUAL TOTAL RETURNS
- --------------------------------------------------------------------------------
[BAR GRAPH]

1995 1996 1997 1998
- --------------------------------------------------------------------------------
37.53% 23.03% 33.31% 28.67%
- --------------------------------------------------------------------------------

During the period shown in the bar chart, the highest return for a calendar
quarter was 21.36% (quarter ended December 31, 1998) and the lowest return for a
quarter was -9.95% (quarter ended September 30, 1998).

- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1 YEAR SINCE INCEPTION*
- --------------------------------------------------------------------------------
<S> <C> <C>
Vanguard Tax-Managed Growth and Income Fund 28.67% 27.48%
S&P 500 Index 28.58 27.45
</TABLE>
- --------------------------------------------------------------------------------
* September 6, 1994.
- --------------------------------------------------------------------------------
<PAGE> 9

FUND PROFILE -- VANGUARD TAX-MANAGED GROWTH AND INCOME FUND (continued)

FEES AND EXPENSES

The following table describes the fees and expenses you would pay if you buy and
hold shares of the Fund. The expenses shown under Annual Fund Operating Expenses
are based upon those incurred in the fiscal year ended December 31, 1998.

<TABLE>
<CAPTION>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees*: 2% or 1%**
</TABLE>

<TABLE>
<CAPTION>
<S> <C>
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
Management Expenses: 0.15%
12b-1 Distribution Fees: None
Other Expenses: 0.04%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.19%
</TABLE>

* Includes redemptions by exchange to another fund.

** A 2% redemption fee applies to shares held for less than one year; a
1% redemption fee applies to shares held at least one year but less
than five years. The fees are withheld from redemption proceeds and
retained by the Fund. These fees help to cover the transaction costs
borne by the Fund when it must sell securities to meet redemptions. In
addition, these fees are intended to protect the Fund's long-term
investors from short-term traders, who erode the Fund's
tax-efficiency.

The following example is intended to help you compare the cost of investing
in the Fund with the cost of investing in other mutual funds. It illustrates the
hypothetical expenses that you would incur over various periods if you invest
$10,000 in the Fund's Investor Shares. This example assumes that the Fund
provides a return of 5% a year, that operating expenses remain the same, and
that you redeem all of your shares at the end of the given period. Although your
actual costs might be higher or lower, based on these assumptions your costs
would be:
- --------------------------------------------------------------------------------
1 YEAR* 3 YEARS 5 YEARS** 10 YEARS
- --------------------------------------------------------------------------------
$124 $176 $107 $243
- --------------------------------------------------------------------------------

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

** Does not include a redemption fee. If you hold shares for one or more
years, but less than five years, a 1% redemption fee applies.

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.

<PAGE> 10
7

ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS
Dividends are paid quarterly in March, June, September, and December; capital
gains, if any, are paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
September 6, 1994

NET ASSETS AS OF DECEMBER 31, 1998
$1.35 billion

SUITABLE FOR IRAs
No

MINIMUM INITIAL INVESTMENT
$10,000

NEWSPAPER ABBREVIATION
TxMGI

VANGUARD FUND NUMBER
101

CUSIP NUMBER
921943106

TICKER SYMBOL
VTGIX
<PAGE> 11

FUND PROFILE -- VANGUARD TAX-MANAGED CAPITAL APPRECIATION FUND

The following profile summarizes key features of Vanguard Tax-Managed Capital
Appreciation Fund.

INVESTMENT OBJECTIVE
The Fund is a stock fund that seeks to provide a tax-efficient investment return
consisting of long-term capital growth. The Fund may produce a small amount of
taxable current income, though not as part of its objective.

INVESTMENT STRATEGIES
The Fund purchases stocks included in the Russell 1000 Index -- an independent
index of the stocks of large- and mid-capitalization U.S. companies. The Fund
uses statistical methods to "sample" the Index, aiming to closely track its
investment performance while minimizing taxable dividend distributions. For more
information, see "Security Selection" under PRIMARY INVESTMENT STRATEGIES.

PRIMARY RISKS
THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to investment style risk, which is the chance that returns
from large- or mid-capitalization stocks will trail returns from other asset
classes or the overall stock market. Each type of stock tends to go through
cycles of doing better -- or worse -- than the stock market in general. These
periods have, in the past, lasted for as long as several years.

- --------------------------------------------------------------------------------
ANNUAL TOTAL RETURNS
- --------------------------------------------------------------------------------

[BAR GRAPH]

1995 1996 1997 1998
- --------------------------------------------------------------------------------
34.38% 20.92% 27.29% 27.95%

- --------------------------------------------------------------------------------

During the period shown in the bar chart, the highest return for a calendar
quarter was 25.47% (quarter ended December 31, 1998) and the lowest return for a
quarter was -13.09% (quarter ended September 30, 1998).

- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1 YEAR SINCE INCEPTION*
<S> <C> <C>
Vanguard Tax-Managed Capital Appreciation Fund 27.95% 25.14%
Russell 1000 Index 27.02 26.85
</TABLE>
- --------------------------------------------------------------------------------
* September 6, 1994.
- --------------------------------------------------------------------------------

<PAGE> 12

FEES AND EXPENSES

THE FOLLOWING TABLE DESCRIBES THE FEES AND EXPENSES YOU WOULD PAY IF YOU BUY AND
HOLD SHARES OF THE FUND. THE EXPENSES SHOWN UNDER ANNUAL FUND OPERATING EXPENSES
ARE BASED UPON THOSE INCURRED IN THE FISCAL YEAR ENDED DECEMBER 31, 1998.
<TABLE>
<CAPTION>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees*: 2% or 1%**
</TABLE>

<TABLE>
<CAPTION>
<S> <C>
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
Management Expenses: 0.16%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.19%
</TABLE>

* Includes redemptions by exchange to another fund.

** A 2% redemption fee applies to shares held for less than one year; a
1% redemption fee applies to shares held at least one year but less
than five years. The fees are withheld from redemption proceeds and
retained by the Fund. These fees help to cover the transaction costs
borne by the Fund when it must sell securities to meet redemptions. In
addition, these fees are intended to protect the Fund's long-term
investors from short-term traders, who erode the Fund's
tax-efficiency.

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

** Does not include a redemption fee. If you hold shares for one or more
years, but less than five years, a 1% redemption fee applies.

You would pay the following expenses if you did not redeem your shares (the
difference being that the Fund's 1% redemption fee would not apply to the one-
and three-year periods below, as it would to those shown above):
- --------------------------------------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- --------------------------------------------------------------------------------
$19 $61 $107 $243
- --------------------------------------------------------------------------------

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.
<PAGE> 13
10

FUND PROFILE -- VANGUARD TAX-MANAGED CAPITAL APPRECIATION FUND (continued)

ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS
Paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
September 6, 1994

NET ASSETS AS OF DECEMBER 31, 1998
$1.48 billion

SUITABLE FOR IRAs
No

MINIMUM INITIAL INVESTMENT
$10,000

NEWSPAPER ABBREVIATION
TxMCap

VANGUARD FUND NUMBER
102

CUSIP NUMBER
921943205

TICKER SYMBOL
VMCAX

<PAGE> 14
11

FUND PROFILE -- VANGUARD TAX-MANAGED SMALL-CAP FUND

The following profile summarizes key features of Vanguard Tax-Managed Small-Cap
Fund.

INVESTMENT STRATEGIES
The Fund purchases stocks included in the Standard & Poor's SmallCap 600 Index
- -- an independent index that is made up of stocks of smaller U.S. companies. The
Fund will hold substantially all of the S&P SmallCap 600 stocks, in
approximately the same proportions as they are represented in the Index. For
more information, see "Security Selection" under PRIMARY INVESTMENT STRATEGIES.

PRIMARY RISKS
THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to investment style risk, which is the chance that returns
from small-capitalization stocks will trail returns from other asset classes or
the overall stock market. Small-capitalization stocks tend to go through cycles
of doing better -- or worse -- than the stock market in general. These periods
have, in the past, lasted for as long as several years. Many
small-capitalization companies are new, so their stocks lack a performance
record.

PERFORMANCE/RISK INFORMATION
The Fund began operations on February 22, 1999, so performance information
(including annual total returns and average annual total returns) for a full
calendar year is not yet available.

FEES AND EXPENSES
The following table describes the fees and expenses you would pay if you buy and
hold shares of the Fund. The expenses shown under Annual Fund Operating Expenses
are based on estimated amounts for the current fiscal year. The Fund has no
operating history; actual operating expenses could be different.
<TABLE>
<CAPTION>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Transaction Fee on Purchases: 1%*
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees**: 2% or 1%***
</TABLE>

<TABLE>
<CAPTION>
<S> <C>
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
Management Expenses: 0.17%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.20%
</TABLE>

* The 1% purchase fee is deducted from all purchases (including exchanges
from other Vanguard funds), but not from reinvested dividends and capital
gains.

** Includes redemptions by exchange to another fund.

*** A 2% redemption fee applies to shares held for less than one year; a 1%
redemption fee applies to shares held at least one year but less than five
years. The fees are withheld from redemption proceeds and retained by the
Fund. These fees help to cover the transaction costs borne by the Fund when
it must sell securities to meet redemptions. In addition, these fees are
intended to protect the Fund's long-term investors from short-term traders,
who erode the Fund's tax-efficiency.
<PAGE> 15

FUND PROFILE -- VANGUARD TAX-MANAGED SMALL-CAP FUND (continued)

- --------------------------------------------------------------------------------
1 YEAR* 3 YEARS 5 YEARS** 10 YEARS
- --------------------------------------------------------------------------------
$224 $278 $212 $353
- --------------------------------------------------------------------------------

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

** Does not include a redemption fee. If you hold shares for one or more
years, but less than five years, a 1% redemption fee applies.

- --------------------------------------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- --------------------------------------------------------------------------------
$120 $164 $212 $353
- --------------------------------------------------------------------------------

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR
LOWER THAN THOSE SHOWN.

ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS
Paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
February 22, 1999

SUITABLE FOR IRAs
No

MINIMUM INITIAL INVESTMENT
$10,000

NEWSPAPER ABBREVIATION
TxMSC

VANGUARD FUND NUMBER
116

CUSIP NUMBER
921943403

TICKER SYMBOL
VTMSX

<PAGE> 16
13

FUND PROFILE -- VANGUARD TAX-MANAGED INTERNATIONAL FUND

The following profile summarizes key features of Vanguard Tax-Managed
International Fund.

INVESTMENT STRATEGIES
The Fund purchases stocks included in the Morgan Stanley Capital International
EAFE Index, which is a market value-weighted index of more than 1,000 securities
listed on the stock exchanges of countries in Europe, Australia, and Asia. The
Fund uses statistical methods to "sample" the Index, aiming to closely track its
investment performance. For more information, see "Security Selection" under
PRIMARY INVESTMENT STRATEGIES.

PRIMARY RISKS
THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to:

- - Currency risk, which is the chance that returns will be hurt by a rise in the
value of the U.S. dollar versus foreign currencies.

- - Investment style risk, which is the chance that returns from foreign stocks
will trail returns from other asset classes or the overall stock market.

- - Country risk, which is the chance than a country's economy will be hurt by
political troubles, financial problems, or natural disasters.

PERFORMANCE/RISK INFORMATION
The Fund began operations on August 18, 1999, so performance information
(including annual total returns or average annual total returns) for a full
calendar year is not yet available.

<TABLE>
<CAPTION>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Transaction Fee on Purchases: .75%*
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees**: 2% or 1%***
</TABLE>

<TABLE>
<CAPTION>
<S> <C>
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets)
Management Expenses: 0.15%
12b-1 Distribution Fees: None
Other Expenses: 0.20%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.35%
</TABLE>

* The .75% purchase fee is deducted from all purchases (including exchanges
from other Vanguard funds), but not from reinvested dividends and capital
gains.

** Includes redemptions by exchange to another fund.

<PAGE> 17

FUND PROFILE -- VANGUARD TAX-MANAGED INTERNATIONAL FUND (continued)

------------------------
1 YEAR* 3 YEARS
------------------------
$214 $300
------------------------

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

You would pay the following expenses if you did not redeem your shares (the
difference being that the Fund's 1% redemption fee would not apply to the
periods below, as it would to those shown above):

------------------------
1 YEAR 3 YEARS
------------------------
$111 $187
------------------------

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR
LOWER THAN THOSE SHOWN.

ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS
Paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
August 18, 1999

SUITABLE FOR IRAs
No

MINIMUM INITIAL INVESTMENT
$10,000

NEWSPAPER ABBREVIATION
TxMIn

VANGUARD FUND NUMBER
127

CUSIP NUMBER
921943809

[GRAPHIC]

A WORD ABOUT RISK

This prospectus describes the risks you would face as an investor in the
Vanguard Tax-Managed Funds. It is important to keep in mind one of the main
axioms of investing: The higher the potential reward, the higher the risk of
losing money. The reverse, also, is generally true: The lower the potential
reward, the lower the risk. As you consider an investment in one or more of the
Funds, you should also take into account your personal tolerance for the daily
fluctuations of the stock market.

Look for this "warning flag" symbol[FLAG GRAPHIC] throughout the
prospectus. It is used to mark detailed information about each type of risk that
you would confront as a shareholder of one or more of the Funds.

[GRAPHIC]

<PAGE> 18

PRIMARY INVESTMENT STRATEGIES

Each of the Funds follows a distinct set of investment strategies. This section
explains the strategies that the investment adviser uses in pursuit of each
Fund's objective. It also explains how the adviser implements these strategies.
In addition, this section discusses important risks faced by investors in the
Funds. The Funds' Board of Trustees oversees their management and may change the
investment strategies in the interest of shareholders.

MARKET EXPOSURE
The grid below shows, at a glance, the types of investments made by each Fund as
its primary investment strategy. In addition, the grid shows the percentage of
each Fund's assets that is normally committed to each type of investment listed.
Market exposure is expected to play the most important role in achieving a
Fund's investment objective.

- --------------------------------------------------------------------------------
VANGUARD TAX-MANAGED FUND
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>

GROWTH CAPITAL
MARKET EXPOSURE BALANCED AND INCOME APPRECIATION SMALL-CAP INTERNATIONAL
- ------------------------------------------------------------------------------------------------------------------------------------

<S> <C> <C> <C> <C> <C>
Common stocks 45 - 50% 100% 100% 100% 100%
Large- and mid-cap Large-cap U.S. Large- and mid-cap Small-cap U.S. Large-cap
U.S. companies companies U.S. companies companies foreign companies
- ------------------------------------------------------------------------------------------------------------------------------------
Municipal securities 50 - 55% None None None None
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

COMMON STOCKS
Except for the Tax-Managed International Fund, which invests primarily in stocks
of companies outside the United States, each of the Funds invests primarily in
U.S. common stocks, with variations in the size of the companies on which the
Funds focus.

[FLAG GRAPHIC]

EACH FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT STOCK
PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN LONG PERIODS. STOCK MARKETS
TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF
FALLING PRICES.

To illustrate the volatility of stock prices, the table on the next page
shows the best, worst, and average total returns for the U.S. stock market over
various periods as measured by the Standard & Poor's 500 Composite Stock Price
Index, a widely used barometer of market activity. (Total returns consist of
dividend income plus change in market price.) Note that the returns shown do not
include the costs of buying and selling stocks or other expenses that a
real-world investment portfolio would incur. Note, also, that the gap between
best and worst tends to narrow over the long term. (You will find a chart
illustrating the volatility of the international stock market on page 17.)

PLAIN TALK ABOUT
BALANCED FUNDS
Balanced funds are generally "middle-of-the-road" investments that seek to
provide some combination of growth, income, and conservation of capital by
investing in a mix of stocks, bonds, and/or money market instruments. Because
the prices of stocks and bonds often move in different directions, balanced
funds are able to use rewards from one type of investment to help offset the
risks from another.

PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies -- and mutual funds that hold these stocks
- -- can be classified by the companies' market value, or capitalization.
Generally, Vanguard defines large-capitalization (large-cap) funds as those
holding stocks of companies whose outstanding shares have a market value
exceeding $10 billion. Mid-cap funds hold stocks of companies with a market
value between $1 billion and $10 billion. Small-cap funds typically hold stocks
of companies with a market value of less than $1 billion.

<PAGE> 19

<TABLE>
<CAPTION>
U.S. STOCK MARKET RETURNS (1926 - 1998)
- --------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 54.2% 24.1% 19.9% 17.7%
Worst -43.1 -12.4 -0.8 3.1
Average 13.1 10.7 11.0 11.0
- --------------------------------------------------------------------------------
</TABLE>

The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1998. You can see, for example, that while the average return on stocks
for all of the 5-year periods was 10.7%, returns for individual 5-year periods
ranged from a -12.4% average (from 1928 through 1932) to 24.1% (from 1994
through 1998). These average returns reflect past performance on common stocks;
you should not regard them as an indication of future returns from either the
stock market as a whole or these Funds in particular.
Keep in mind that the S&P 500 Index -- which is the index tracked by the
Tax-Managed Growth and Income Fund -- holds mainly large-cap stocks.
Historically, mid- and small-cap stocks have been more volatile than -- and at
times have performed quite differently from -- large-cap stocks. This is due to
several factors, including less-certain growth and dividend prospects for
smaller companies. The Tax-Managed Balanced and Tax-Managed Capital Appreciation
Funds hold mid-cap stocks in addition to large-cap stocks. The Tax-Managed
Small-Cap Fund holds just small-cap stocks. The Tax-Managed International Fund
holds large-cap stocks.

[FLAG GRAPHIC]

THE FUNDS ARE SUBJECT, IN VARYING DEGREES, TO INVESTMENT STYLE RISK, WHICH
IS THE POSSIBILITY THAT RETURNS FROM A SPECIFIC TYPE OF STOCK (FOR
INSTANCE, SMALL- OR MID-CAP STOCKS) OR FUND WILL TRAIL RETURNS FROM OTHER
ASSET CLASSES OR THE OVERALL STOCK MARKET. EACH TYPE OF STOCK OR FUND
TENDS TO GO THROUGH CYCLES OF DOING BETTER -- OR WORSE -- THAN COMMON
STOCKS IN GENERAL. THESE PERIODS HAVE, IN THE PAST, LASTED FOR AS LONG AS
SEVERAL YEARS.

FOREIGN STOCKS
The Tax-Managed International Fund seeks to provide a tax-efficient
investment return consisting of long-term capital growth by investing in a
broadly diversified group of stocks of foreign companies. Investments in foreign
stocks can be as risky, if not more risky, than U.S. stock investments. The
prices of international stocks and the prices of U.S. stocks have often moved in
opposite directions. These periods have, in the past, lasted as long as several
years.

Because it invests mainly in international stocks, the Fund is subject to:

[FLAG GRAPHIC]

CURRENCY RISK, WHICH IS THE CHANCE THAT
RETURNS WILL BE HURT BY A RISE IN THE
VALUE OF THE U.S. DOLLAR VERSUS FOREIGN
CURRENCIES.

Conversely, when the U.S. dollar falls in value versus other currencies,
returns from international stocks are enhanced because a given sum in foreign
currency translates into more U.S. dollars.

[FLAG GRAPHIC]

COUNTRY RISK, WHICH IS THE POSSIBILITY
THAT POLITICAL EVENTS (SUCH AS A WAR),
FINANCIAL PROBLEMS (SUCH AS GOVERNMENT
DEFAULT), OR NATURAL DISASTERS (SUCH AS
AN EARTHQUAKE) WILL WEAKEN A COUNTRY'S
ECONOMY AND CAUSE INVESTMENTS IN THAT
COUNTRY TO LOSE MONEY.

PLAIN TALK ABOUT
THE RISKS OF INTERNATIONAL INVESTING
Because foreign stock markets operate differently from the U.S. market,
Americans investing abroad will encounter risks not typically associated with
U.S. companies. For instance, foreign companies are not subject to the same
accounting, auditing, and financial reporting standards and practices as U.S.
companies; and their stock may not be as liquid as the stock of similar U.S.
companies. In addition, foreign stock exchanges, brokers, and companies
generally have less government supervision and regulation than their
counterparts in the United States. These factors, among others, could negatively
impact the returns Americans receive from a foreign investment.

<PAGE> 20

International investing involves other risks and considerations, including:
differences in accounting, auditing, and financial reporting standards;
generally higher costs for trading securities; foreign withholding taxes payable
on the Fund's securities, which can reduce dividend income available to
distribute to shareholders; and adverse changes in regulatory or legal climates.

Returns on international stocks can be as volatile -- or more volatile --
than returns on U.S. stocks. To illustrate the volatility of international stock
market returns for the U.S. dollar-based investor, the following table shows the
best, worst, and average total returns for international stocks over various
periods as measured by the MSCI EAFE Index, a widely used barometer of
international stock market activity. (Total returns consist of dividend income
plus change in market price.) Note that the returns shown in the table do not
include the costs of buying and selling stocks or other expenses that a
real-world investment portfolio would incur. Note, also, that the gap between
best and worst tends to narrow over the long term. Also, keep in mind that past
returns are not indicative of future returns and that volatility in the future
could be greater or less than past volatility.

- --------------------------------------------------------------------------------
INTERNATIONAL STOCK MARKET RETURNS (1969-1998)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 69.9% 36.5% 22.8% 16.3%
Worst -23.2 1.5 5.9 12.0
Average 14.7 13.6 14.9 14.7
- --------------------------------------------------------------------------------
</TABLE>

The table covers all of the 1-, 5-, 10-, and 20-year periods from 1969 to
1998. Keep in mind that this was a particularly favorable period for foreign
markets. For instance, over 10-year periods, foreign stocks provided an average
return of 14.9%, compared to 11.0% for U.S. stocks (as measured by the S&P 500
Index) during the same time frame. These average returns reflect past
performance on international stocks; you should not regard them as an indication
of future returns from either foreign markets as a whole or the Tax-Managed
International Fund in particular.

The Fund may enter into forward foreign currency contracts, which can help
protect its holdings against unfavorable short-term changes in exchange rates. A
forward foreign currency contract is an agreement to buy or sell a country's
currency at a specific price on a specific date, usually 30, 60, or 90 days in
the future. In other words, the contract guarantees an exchange rate on a given
date. Managers of international stock funds use these contracts to guard against
sudden, unfavorable changes in U.S. dollar/foreign currency exchange rates. The
Fund will use these contracts to gain currency exposure when investing in stock
index futures, and to settle trades in a foreign currency.

MUNICIPAL SECURITIES
The Tax-Managed Balanced Fund invests 50 - 55% of its assets in municipal
securities. Municipal securities are bonds, notes, and other fixed income
instruments issued by state and local governments and regional governmental
authorities. Municipal securities pay out federally tax-exempt income. The Fund
emphasizes high-quality municipal securities; at least 75% of the municipal
bonds purchased by the Fund will be rated in one of the top three credit rating
categories as determined by an independent bond rating agency. Up to 25% of the
municipal securities purchased by the Fund may be rated in the fourth highest
rating category and, within that 25%, up to 5% may be lower rated or unrated.
The dollar-weighted average maturity of the Fund's municipal securities holdings
will range from 7 - 12 years.

PLAIN TALK ABOUT
BONDS AND INTEREST RATES
As a rule, when interest rates rise, bond prices fall. The opposite is also
true: Bond prices go up when interest rates fall. Why do bond prices and
interest rates move in opposite directions? Let's assume that you hold a bond
offering a 5% yield. A year later, interest rates are on the rise and bonds of
comparable quality and maturity are offered with a 6% yield. With
higher-yielding bonds available, you would have trouble selling your 5% bond for
the price you paid -- you would have to lower your asking price. On the other
hand if interest rates were falling and 4% bonds were being offered, you should
be able to sell your 5% bond for more than you paid.
<PAGE> 21

PLAIN TALK ABOUT
MUNICIPAL BONDS
Municipal bonds are securities issued by state and local governments and
regional governmental authorities as a way of raising money for public
construction projects (for example, highways, airports, or housing); for
operating expenses; or for loans to public institutions and facilities.

[FLAG GRAPHIC]

BECAUSE OF ITS BOND INVESTMENTS, THE TAX-MANAGED BALANCED FUND IS SUBJECT
TO INTEREST RATE RISK -- WHICH IS THE POSSIBILITY THAT BOND PRICES OVERALL
WILL FALL WHEN INTEREST RATES RISE.

Although bonds are often thought to be less risky than stocks, there have
been periods when bond prices have fallen significantly due to rising interest
rates. For instance, prices of long-term bonds fell by almost 48% between
December 1976 and September 1981.

To illustrate the relationship between bond prices and interest rates, the
following table shows the impact of a 2% change (both up and down) in interest
rates on three bonds of different maturities, each with a face value of $1,000.

- --------------------------------------------------------------------------------
HOW INTEREST RATE CHANGES AFFECT BONDS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
VALUE OF A $1,000 BOND VALUE OF A $1,000 BOND
AFTER A 2% INCREASE AFTER A 2% DECREASE
TYPE OF BOND (MATURITY) IN INTEREST RATES IN INTEREST RATES
- --------------------------------------------------------------------------------
<S> <C> <C>
Short-Term (2.5 years) $ 956 $1,046
Intermediate-Term (10 years) 870 1,156
Long-Term (20 years) 816 1,251
</TABLE>
- --------------------------------------------------------------------------------
* Assuming a 7% yield
- --------------------------------------------------------------------------------

These figures are for illustrative purposes only and should not be regarded
as an indication of future returns from the bond market as a whole, or the
Tax-Managed Balanced Fund in particular.

Changes in interest rates will affect bond income as well as bond prices.

[FLAG GRAPHIC]

BECAUSE OF ITS BOND INVESTMENTS, THE TAX-MANAGED BALANCED FUND IS
SUBJECT TO INCOME RISK, WHICH IS THE POSSIBILITY THAT THE FUND'S
DIVIDENDS (INCOME) WILL DECLINE DUE TO FALLING INTEREST RATES. INCOME
RISK IS GENERALLY GREATEST FOR SHORT-TERM BONDS AND LEAST FOR
LONG-TERM BONDS.

Problems unique to a bond issuer can also cause problems for bond fund
shareholders.

PLAIN TALK ABOUT
BOND MATURITIES

A bond is issued with a specific maturity date -- the date when the bond's
issuer, or seller, must pay back the bond's initial value (known as its "face
value"). Bond maturities generally range from less than one year (short-term) to
more than 30 years (long-term). The longer a bond's maturity, the more risk you,
as a bond investor, face as interest rates rise -- but also the more interest
you could receive. Long-term bonds are more suitable for investors willing to
take greater risks in hope of higher yields; short-term bond investors should be
willing to accept lower yields in return for less fluctuation in the value of
their investment.

PLAIN TALK ABOUT
CREDIT QUALITY
A bond's credit quality depends on the issuer's ability to pay interest on the
bond and, ultimately, to repay the debt. The lower the rating by one of the
independent bond-rating agencies (for example, Moody's or Standard & Poor's),
the greater the chance (in the rating agency's opinion) that the bond issuer
will default, or fail to meet its payment obligations. All things being equal,
the lower a bond's credit rating, the higher its yield should be to compensate
investors for assuming additional risk. Bonds rated in one of the four highest
rating categories are considered "investment grade."

<PAGE> 22
19

PLAIN TALK ABOUT
INDEXING METHODS

In seeking to track a particular index, funds generally use one of two methods
to select the stocks or bonds in which they invest. Some index funds hold each
stock in their target indexes in about the same proportions as represented in
the indexes themselves. This is called a REPLICATION METHOD. For example, if 5%
of the S&P 500 Index were made up of the stock of a specific company, a fund
tracking that index (such as Tax-Managed Growth and Income Fund) would invest 5%
of its assets in that company. Other index funds may use a different security
selection process, a SAMPLING METHOD. Using a sophisticated computer program,
these funds select stocks that will mirror their target indexes in terms of
industry weightings, market capitalization, and other characteristics. For
instance, if 10% of the Russell 1000 Index were made up of financial services
stocks, Tax-Managed Capital Appreciation Fund would invest about 10% of its
assets in the financial services stocks of the index with overall similar
financial characteristics. Funds tend to use a sampling method when the target
index includes too many stocks to track cost-effectively.

[FLAG] THE TAX-MANAGED BALANCED FUND IS SUBJECT TO CREDIT RISK, WHICH IS THE
POSSIBILITY THAT A BOND ISSUER WILL FAIL TO PAY INTEREST AND PRINCIPAL
IN A TIMELY MANNER.

The credit quality of the Tax-Managed Balanced Fund is expected to be very
high, and thus credit risk should be low. The average credit quality of the
Fund's holdings, as rated by Moody's Investors Service, as of December 31, 1998,
was AA+.

Finally, because stock and bond prices often move in different directions,
the Tax-Managed Balanced Fund's bond holdings may help to dampen--but not
eliminate--some of the stock market volatility experienced by the Fund.
Likewise, changes in interest rates may not have as dramatic an effect on the
Fund as they would on a fund made up entirely of bonds.

SECURITY SELECTION

Each of the Funds employs an index-oriented approach to stock investing, and the
only stocks purchased by a Fund are those included in its target index; the
Tax-Managed Balanced Fund selects municipal securities however, based upon
traditional, active management techniques. The grid below shows, at a glance,
the stock index tracked by each Fund and the indexing method employed.

- --------------------------------------------------------------------------------
TAX-MANAGED FUND INDEX INDEXING METHOD
- --------------------------------------------------------------------------------
Balanced Russell 1000 Sampling
Growth and Income S&P 500 Replication
Capital Appreciation Russell 1000 Sampling
Small-Cap S&P SmallCap 600 Replication
International MSCI EAFE Sampling
- --------------------------------------------------------------------------------

OTHER INVESTMENT POLICIES AND RISKS

Each of the Funds may invest, to a limited extent, in futures contracts, options
(including puts and calls), warrants, convertible securities, and swap
agreements, which are all types of derivatives. Losses (or gains) involving
futures contracts can sometimes be substantial--in part because a relatively
small price movement in a futures contract may result in an immediate and
substantial loss (or gain) for a fund. Similar risks exist for warrants
(securities that permit their owners to purchase a specific number of shares of
stock at a predetermined price), convertible securities (securities that may be
exchanged for a different asset), and swap agreements (contracts between two
parties in which each agrees to make payments to the other based on the return
of a specified index or asset). For this reason, the Funds will not use futures,
options, warrants, convertible securities, or swap agreements for speculative
purposes or as leveraged investments that magnify the gains or losses of an
investment.

Each of the Funds may invest in futures contracts and options so long as the
total value of these investments does not exceed 5% of the Fund's assets.

<PAGE> 23
20

PLAIN TALK ABOUT
DERIVATIVES

A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new types of derivatives. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.

PLAIN TALK ABOUT
TURNOVER RATE

Before investing in a mutual fund, you should review its turnover rate. This
gives an indication of how transaction costs could affect the fund's future
returns. In general, the greater the volume of buying and selling by the fund,
the greater the impact that brokerage commissions and other transaction costs
will have on its return. Also, funds with high turnover rates may be more likely
to generate capital gains that must be distributed to shareholders as income
subject to taxes. The average turnover rates for all domestic and international
stock funds are approximately 85% and 80%, respectively, according to
Morningstar, Inc.

The reasons for which a Fund will invest in futures and options are:

- - To keep cash on hand to meet shareholder redemptions or other needs
while simulating full investment in its benchmark index.

- - To reduce the Fund's transaction costs or add value when these
instruments are favorably priced.

TURNOVER RATES

Although the Funds generally seek to invest for the long term, each retains the
right to sell securities regardless of how long the securities have been held.
Generally, an index-oriented fund sells securities only to respond to redemption
requests or to adjust the number of shares held to reflect a change in the
fund's target index. Because of this, and the Funds' focus on avoiding taxable
gains, the turnover rate for each Fund has been fairly low. The Funds' turnover
rate for stocks is expected to remain below 20%; Tax-Managed Balanced Fund's
turnover rate for municipal securities is expected to remain below 40%. (A
turnover rate of 100% would occur, for example, if a Fund sold and replaced
securities valued at 100% of its net assets within a one-year period.)

COSTS AND MARKET-TIMING

Some investors try to profit from market-timing--switching money into
investments when they expect prices to rise, and taking money out when they
expect prices to fall. As money is shifted in and out, a fund incurs expenses
for buying and selling securities. These costs are borne by all fund
shareholders, including the long-term investors who do not generate the costs.
Therefore, the Tax-Managed Funds have adopted the following policies, among
others, designed to discourage short-term trading:

- - The Funds reserve the right to reject any purchase request into any of
the Funds--including exchanges from other Vanguard funds--that it
regards as disruptive to the efficient management of the Funds. This
could be because of the timing of the investment or because of a
history of excessive trading by the investor.

- - There is a limit on the number of times you can exchange into and out
of a Fund (see "Redeeming Shares" in the INVESTING WITH VANGUARD
section).
PLAIN TALK ABOUT
THE COSTS OF INVESTING

Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with the fund's buying and selling of securities. These costs
can erode a substantial portion of the gross income or capital appreciation a
fund achieves. Even seemingly small differences in expenses can, over time, have
a dramatic impact on a fund's performance.

<PAGE> 24
21

PLAIN TALK ABOUT
THE FUNDS' REDEMPTION FEE

The Tax-Managed Funds charge a redemption fee on shares that are redeemed
(including redeeming by exchange to another Vanguard fund) before they have been
held for five years. The fee is 2% for shares redeemed within one year of
purchase and 1% for shares redeemed after one year but within five years of
purchase. The Funds are intended for long-term investors, and this redemption
fee ensures that the costs associated with short-term trading are borne by the
investors making the transactions--and not by those shareholders in the Funds
for the long term.

At Vanguard, all fees are paid directly to the fund itself (unlike a sales
charge or load, which--for many fund companies--ends up in the pocket of the
sponsor, adviser, or sales representative).

- - The Funds impose a 2% redemption fee on shares that are redeemed by any
method within one year of purchase. There is a 1% redemption fee on
shares that are redeemed by any method after one year but within five
years of purchase.

- - The Funds reserve the right to stop offering shares at any time.

THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST IN THESE
FUNDS IF YOU ARE A MARKET-TIMER.

THE FUNDS AND VANGUARD

Vanguard Tax-Managed Funds are members of The Vanguard Group, a family of more
than 35 investment companies with more than 100 distinct investment portfolios
and total net assets of more than $490 billion. All of the Vanguard funds share
in the expenses associated with business operations, such as personnel, office
space, equipment, and advertising.

Vanguard also provides marketing services to the Funds. Although
shareholders do not pay sales commissions or 12b-1 distribution fees, each Fund
pays its allocated share of The Vanguard Group's marketing costs.

PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE

The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most other mutual funds are operated by for-profit management companies that may
be owned by one person, by a group of individuals, or by investors who own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.

PLAIN TALK ABOUT
FUND EXPENSES

All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. The Vanguard Tax-Managed Balanced, Growth and Income, and Capital
Appreciation Funds' expense ratio for Investor Shares in fiscal year 1998 were
each 0.19%, or $1.90 per $1,000 of average net assets. The expense ratio for
Tax-Managed Small-Cap Fund, which began operations on February 22,1999, is
expected to be 0.20%, or $2.00 per $1,000 of average net assets, for fiscal year
1999. The expense ratio for the Tax-Managed International Fund, which began
operations on August 18, 1999, is expected to be 0.35%, or $3.50 per $1,000 of
average net assets, for fiscal year 1999.

<PAGE> 25
22

PLAIN TALK ABOUT
THE FUNDS' ADVISERS

The individual primarily responsible for overseeing investments for the
Tax-Managed Growth and Income Fund, the Tax-Managed Capital Appreciation Fund,
the Tax-Managed Small-Cap Fund, the Tax-Managed International Fund, and the
stock portion of the Tax-Managed Balanced Fund is:

GEORGE U. SAUTER, Managing Director of Vanguard; has worked in
investment management since 1985; with Vanguard since 1987; has managed
portfolio investments since 1987; A.B., Dartmouth College; M.B.A., University of
Chicago.

The municipal securities portion of the Tax-Managed Balanced Fund is
overseen by:

CHRISTOPHER M. RYON, Principal of Vanguard; has worked in investment
management and with Vanguard since 1985; has managed portfolio investments since
1988; B.S., Villanova University; M.B.A., Drexel University.

INVESTMENT ADVISER

Each of the Tax-Managed Funds obtains advisory services on an at-cost basis from
The Vanguard Group, Valley Forge, Pennsylvania 19482. For the fiscal year ended
December 31, 1998, Tax-Managed Balanced Fund, Tax-Managed Growth and Income
Fund, and Tax-Managed Capital Appreciation Fund paid advisory expenses of
$39,000, $29,000, and $29,000, which represented effective annual rates of
0.02%, 0.0025%, and 0.0025%, respectively. Tax-Managed Small-Cap Fund and
Tax-Managed International Fund began operations on February 22, 1999, and August
18, 1999, respectively. Advisory expenses for the first fiscal year of both of
these Funds are estimated at an effective annual rate of 0.01%.

The Funds have authorized the advisers to choose brokers or dealers to
handle the purchase and sale of securities for the Funds, and to get the best
available price and most favorable execution from these brokers with respect to
all transactions. Also, the Funds may direct the advisers to use a particular
broker for certain transactions in exchange for commission rebates or research
services provided to the Funds.

YEAR 2000 CHALLENGE

The common practice in computer programming of using just two digits to identify
a year has resulted in the Year 2000 challenge throughout the information
technology industry. If unchanged, many computer applications and systems could
misinterpret dates occurring after December 31, 1999, leading to errors or
failure. Such failure could adversely affect a fund's operations, including
pricing, securities trading, and the servicing of shareholder accounts.

The Vanguard Group is dedicated to providing uninterrupted,
high-quality performance from our computer systems before, during, and after
2000. In July 1998, we completed the renovation and initial testing of our
internal systems. Vanguard is diligently working with external partners,
suppliers, and vendors, including fund managers and other service providers, to
assure that the systems with which we interact remain operational at all times.

In addition to taking every reasonable step to secure our internal
systems and external relationships, Vanguard is further developing contingency
plans intended to assure that unexpected systems failures will not adversely
affect the Funds' operations. Vanguard intends to monitor these processes
through the rollover of 1999 into 2000 and to quickly implement alternate
solutions if necessary.

However, despite Vanguard's efforts and contingency plans, noncompliant
computer systems could have a material adverse effect on a Fund's business,
operations, or financial condition. Additionally, a Fund's performance could be
hurt if a computer-system failure at a company or governmental unit affects the
price of securities the Fund owns.

<PAGE> 26
23

DIVIDENDS, CAPITAL GAINS, AND TAXES

The Tax-Managed Funds distribute to their shareholders virtually all of their
net income (interest and dividends less expenses), as well as any capital gains
realized from the sale of their holdings. For the Tax-Managed Balanced and
Tax-Managed Growth and Income Funds, income distributions generally occur in
March, June, September, and December; the Tax-Managed Capital Appreciation,
Tax-Managed Small-Cap, and Tax-Managed International Funds pay such
distributions in December. Capital gains distributions generally occur in
December. In addition, the Funds may occasionally be required to make
supplemental dividend or capital gains distributions at some other time during
the year.

You can receive distributions of income or capital gains in cash, or
you can have them automatically invested in more shares of a Fund. In either
case, these distributions are taxable to you. It is important to note that
distributions of dividends and capital gains that are declared in December--if
paid to you by the end of January--are taxed as if they had been paid to you in
December.

Vanguard will send you a statement each year showing the tax status of
all your distributions. If you have chosen to receive dividend and/or capital
gains distributions in cash, and the postal or other delivery service is unable
to deliver checks to your address of record, we will change the distribution
option so that all dividends and other distributions are automatically invested
in additional shares. We will not pay interest on uncashed distribution checks.

- - The dividends and short-term capital gains that you receive are taxable
to you as ordinary income for federal income tax purposes.

- - Any distributions of net long-term capital gains by a Fund are taxable
to you as long-term capital gains, no matter how long you've owned
shares in the Fund.

- - Although the Funds do not seek to realize any particular amount of
capital gains during a year, such gains are realized from time to time
as by-products of their ordinary investment activities. Consequently,
distributions may vary considerably from year to year.

- - If you sell or exchange shares, any gain or loss you have is a taxable
event. This means that you may have a capital gain to report as income,
or a capital loss to report as a deduction, when you complete your
federal income tax return.

- - Distributions of dividends or capital gains, and capital gains or
losses from your sale or exchange of Fund shares, may be subject to
state and local income taxes as well.

- - Foreign governments may withhold taxes on dividends and interest paid,
while imposing taxes on other payments or gains, with respect to
foreign securities. For investors in the Tax-Managed International Fund
who meet certain holding period requirements, an offsetting tax credit
or deduction may be available. Investors in this Fund who do not meet
these requirements may still be entitled to a deduction for certain
taxes.

PLAIN TALK ABOUT
DISTRIBUTIONS

As a shareholder, you are entitled to your share of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or a capital gains distribution. Income
dividends come from both the dividends that a fund earns from any stock holdings
and the interest it receives from any money market and bond investments. Capital
gains are realized whenever the fund sells securities for higher prices than it
paid for them. The capital gains are either short-term or long-term depending on
whether the fund held the securities for less than or more than one year.

PLAIN TALK ABOUT
"BUYING A DIVIDEND"

It is not to your advantage to buy shares of a fund shortly before it makes a
distribution, because doing so can cost you money in taxes. This is known as
"buying a dividend." For example: on December 15, you invest $5,000, buying 250
shares for $20 each. If the fund pays a distribution of $1 per share on December
16, its share price would drop to $19 (not counting market change). You still
have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x $1
= $250 in distributions), but you owe tax on the $250 distribution you
received--even if you reinvest it in more shares. To avoid "buying a dividend,"
check a fund's distribution schedule before you invest.

<PAGE> 27
24

The tax information in this prospectus is provided as general
information. (Non-U.S. investors may be subject to U.S. withholding and estate
tax.) You should consult your tax adviser about the tax consequences of an
investment in one or more of the Funds.

IMPORTANT NOTE: By law, each Fund must withhold 31% of your taxable
distributions and any redemption proceeds if you do not provide your correct
taxpayer identification number, or certify that it is correct, or if the IRS
instructs the Fund to do so.

SHARE PRICE

Each Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of trading on the New York Stock Exchange (the NAV
is not calculated on holidays or other days the Exchange is closed). Net asset
value per share for the Tax-Managed Balanced Fund is computed by adding up the
total value of the Fund's investments and other assets, subtracting any of its
liabilities (debts), and then dividing by the number of Fund shares outstanding.

TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = -----------------------------------------
NUMBER OF SHARES OUTSTANDING

Net asset value per share for the Tax-Managed Growth and Income,
Tax-Managed Capital Appreciation, Tax-Managed Small-Cap, and Tax-Managed
International Funds is computed in a similar way, by dividing the net assets
attributed to each class by the number of Fund shares outstanding for that
class.

Knowing the daily net asset value is useful to you as a shareholder
because it indicates the current value of your investment. The Fund's NAV,
multiplied by the number of shares you own, gives you the dollar amount you
would have received had you sold all of your shares back to the Fund that day.

A NOTE ON PRICING: A Fund's investments will be priced at their market
value when market quotations are readily available. When these quotations are
not readily available, investments will be priced at their fair value,
calculated according to procedures adopted by the Board of Trustees.

Each Fund's share price can be found daily in the mutual fund listings
of most major newspapers under the heading "Vanguard Index Funds." Different
newspapers use different abbreviations of the Funds' names, but the most common
are TxMBal, TxMGI, TxMCap, TxMSC, and TxMIn for the Balanced, Growth and Income,
Capital Appreciation, Small-Cap, and International Funds, respectively.

<PAGE> 28
25

FINANCIAL HIGHLIGHTS

The following financial highlights tables are intended to help you understand
each Fund's financial performance since its inception (except for the
Tax-Managed Small-Cap and the Tax-Managed International Funds, which did not
start operations until February 22, 1999, and August 18, 1999, respectively),
and certain information reflects financial results for a single Fund share. The
total returns in each table represent the BEFORE-TAX rate that an investor would
have earned or lost each period on an investment in the Fund (assuming
reinvestment of all dividend and capital gains distributions, and complete
redemption at the end of the period). This information has been derived from the
financial statements audited by PricewaterhouseCoopers LLP, independent
accountants, whose report--along with each Fund's financial statements--is
included in the Funds' most recent annual report to shareholders. You may have
the annual report sent to you without charge by contacting Vanguard.

<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
VANGUARD TAX-MANAGED BALANCED FUND

YEAR ENDED DECEMBER 31, JULY 25* TO
- ------------------------------------------------------------------------------------ DEC. 31,
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING
OF PERIOD $14.67 $12.92 $11.85 $9.79 $10.00
- --------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .39 .37 .36 .31 .09
Net Realized and Unrealized
Gain (Loss) on Investments 2.07 1.75 1.07 2.07 (.21)
-----------------------------------------------------------
Total from Investment
Operations 2.46 2.12 1.43 2.38 (.12)
-----------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (.39) (.37) (.36) (.32) (.09)
Distributions from Realized
Capital Gains -- -- -- -- --
-----------------------------------------------------------
Total Distributions (.39) (.37) (.36) (.32) (.09)
- --------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $16.74 $14.67 $12.92 $11.85 $9.79
==================================================================================================

TOTAL RETURN** 16.93% 16.55% 12.21% 24.52% (1.40)%
==================================================================================================

RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $207 $120 $63 $39 $17
Ratio of Total Expenses to
Average Net Assets 0.19% 0.17% 0.20% 0.20% 0.0%
Ratio of Net Investment Income to
Average Net Assets 2.63% 2.77% 3.04% 3.06% 2.88%+
Turnover Rate 7% 7% 5% 5% 0%
==================================================================================================
</TABLE>

*Subscription period was July 25, 1994 through September 5, 1994, during
which time all assets were held in money market instruments. Performance
measurement began September 6, 1994.

**Total returns do not reflect the 2% redemption fee on shares held less than
one year or the 1% redemption fee on shares held at least one year but less
than five years.

+Annualized.

From time to time, the Vanguard funds advertise yield and total return
figures. Yield is a measure of past dividend income. Total return includes both
past dividend income (assuming that it has been reinvested) plus realized and
unrealized capital appreciation (or depreciation). Neither yield nor total
return should be used to predict the future performance of a fund.

PLAIN TALK ABOUT

HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
This explanation uses the Tax-Managed Balanced Fund as an example. The Fund
began fiscal 1998 with a net asset value (price) of $14.67 per share. During
the year, the Fund earned $.39 per share from investment income (interest and
dividends) and $2.07 per share from investments that had appreciated in value
or that were sold for higher prices than the Fund paid for them.

Shareholders received $.39 per share in the form of dividend and capital
gains distributions. A portion of each year's distributions may come from the
prior year's income or capital gains.

The earnings ($2.46 per share) minus the distributions ($.39 per share)
resulted in a share price of $16.74 at the end of the year. This was an
increase of $2.07 per share (from $14.67 at the beginning of the year to $16.74
at the end of the year). For a shareholder who reinvested the distributions in
the purchase of more shares, the total return from the Fund was 16.93% for the
year.

As of December 31, 1998, the Fund had $207 million in net assets. For the
year, its expense ratio was 0.19% ($1.90 per $1,000 of net assets); and its net
investment income amounted to 2.63% of its average net assets. It sold and
replaced securities valued at 7% of its net assets.
<PAGE> 29
26

<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
VANGUARD TAX-MANAGED GROWTH AND INCOME FUND

YEAR ENDED DECEMBER 31, JULY 25* TO
- --------------------------------------------------------------------------------------------- DEC. 31,
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $20.88 $15.89 $13.16 $9.77 $10.00
- ------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .29 .29 .27 .25 .09
Net Realized and Unrealized Gain (Loss) on Investments 5.67 4.98 2.74 3.39 (.23)
--------------------------------------------------
Total from Investment Operations 5.96 5.27 3.01 3.64 (.14)
--------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.29) (.28) (.28) (.25) (.09)
Distributions from Realized Capital Gains -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------
Total Distributions (.29) (.28) (.28) (.25) (.09)
- ------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $26.55 $20.88 $15.89 $13.16 $9.77
============================================================================================================

TOTAL RETURN** 28.67% 33.31% 23.03% 37.53% (1.70)%
============================================================================================================

RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $1,352 $579 $235 $98 $31
Ratio of Total Expenses to Average Net Assets 0.19% 0.17% 0.20% 0.20% 0.20%+
Ratio of Net Investment Income to Average Net Assets 1.32% 1.62% 2.04% 2.37% 2.82%+
Turnover Rate 4% 2% 7% 6% 0%
============================================================================================================
</TABLE>

*Subscription period was July 25, 1994 through September 5, 1994, during which
time all assets were held in money market instruments. Performance measurement
began September 6, 1994.

**Total returns do not reflect the 2% redemption fee on shares held less than
one year or the 1% redemption fee on shares held at least one year but less
than five years.

+Annualized.

<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
VANGUARD TAX-MANAGED CAPITAL APPRECIATION FUND

Year Ended December 31, July 25* to
- ------------------------------------------------------------------------------------------------------ Dec. 31,
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $20.18 $15.95 $13.28 $9.95 $10.00
- ------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .13 .11 .12 .08 .04
Net Realized and Unrealized Gain (Loss) on Investments 5.51 4.24 2.66 3.34 (.05)
-----------------------------------------------------
Total from Investment Operations 5.64 4.35 2.78 3.42 (.01)
-----------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.13) (.12) (.11) (.09) (.04)
Distributions from Realized Capital Gains -- -- -- -- --
-----------------------------------------------------
Total Distributions (.13) (.12) (.11) (.09) (.04)
- ------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $25.69 $20.18 $15.95 $13.28 $9.95
==================================================================================================================

TOTAL RETURN** 27.95% 27.29% 20.92% 34.38% (0.50)%
==================================================================================================================

RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $1,479 $893 $517 $254 $70
Ratio of Total Expenses to Average Net Assets 0.19% 0.17% 0.20% 0.20% 0.20%+
Ratio of Net Investment Income to Average Net Assets 0.62% 0.70% 0.91% 0.97% 1.26%+
Turnover Rate 5% 4% 12% 7% 1%
==================================================================================================================
</TABLE>

*Subscription period was July 25, 1994 through September 5, 1994, during which
time all assets were held in money market instruments. Performance measurement
began September 6, 1994.

**Total returns do not reflect the 2% redemption fee on shares held less than
one year or the 1% redemption fee on shares held at least one year but less
than five years.

+Annualized.

"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," "500,"
and "Standard & Poor's SmallCap 600" are trademarks of The McGraw-Hill
Companies, Inc. Frank Russell Company is the owner of the trademarks and
copyrights relating to the Russell Indexes.

<PAGE> 30
27

INVESTING WITH VANGUARD

Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information? Establish an account for a
minor child or for your retirement savings?

Vanguard can help. Our goal is to make it easy and pleasant for you to
do business with us.

The following sections of the prospectus briefly explain the many
services we offer. Booklets providing detailed information are available on the
services marked with a [BOOK]. Please call us to request copies.

SERVICES AND ACCOUNT FEATURES

Vanguard offers many services that make it convenient to buy, sell, or exchange
shares, or to obtain fund or account information.

- --------------------------------------------------------------------------------
TELEPHONE REDEMPTIONS (SALES AND EXCHANGES)
Automatically set up for these Funds unless you notify us otherwise.

- --------------------------------------------------------------------------------
VANGUARD DIRECT DEPOSIT SERVICE(TM)[BOOK]
Automatic method for depositing your paycheck or U.S. government payment
(including Social Security and government pension checks) into your account.

- --------------------------------------------------------------------------------
VANGUARD AUTOMATIC EXCHANGE SERVICE(TM)[BOOK]
Automatic method for moving a fixed amount of money from one Vanguard fund
account to another.

- --------------------------------------------------------------------------------
VANGUARD FUND EXPRESS(R)[BOOK]
Electronic method for buying or selling shares. You can transfer money between
your Vanguard fund account and an account at your bank, savings and loan, or
credit union on a systematic schedule or whenever you wish.

- --------------------------------------------------------------------------------
VANGUARD DIVIDEND EXPRESS(TM)[BOOK]
Electronic method for transferring dividend and/or capital gains distributions
directly from your Vanguard fund account to your bank, savings and loan, or
credit union account.

- --------------------------------------------------------------------------------
VANGUARD TELE-ACCOUNT(R) 1-800-662-6273 (ON-BOARD) [BOOK]
Toll-free 24-hour access to Vanguard fund and account information--as well as
some transactions--by using any touch-tone phone. Tele-Account provides total
return, share price, price change, and yield quotations for all Vanguard funds;
gives your account balances and history (e.g., last transaction, latest dividend
distribution); and allows you to sell or exchange fund shares.

- --------------------------------------------------------------------------------
ACCESS VANGUARD(TM) WWW.VANGUARD.COM [COMPUTER]
You can use your personal computer to perform certain transactions for most
Vanguard funds by accessing our website. To establish this service, you must
register through the website. We will then send to you, by mail, an account
access password that allows you to process the following financial and
administrative transactions online:

- - Open a new account.*
- - Buy, sell, or exchange shares of most funds.
- - Change your name/address.
- - Add/change fund options (including dividend options, Vanguard Fund Express,
bank instructions, checkwriting, and Vanguard Automatic Exchange Service).

*Only current Vanguard shareholders can open a new account online, by exchanging
shares from other existing Vanguard accounts.

- --------------------------------------------------------------------------------
INVESTOR INFORMATION DEPARTMENT: 1-800-662-7447 (SHIP) TEXT TELEPHONE:
1-800-952-3335 Call Vanguard for information on our funds, fund services, and
retirement accounts, and to request literature.
- --------------------------------------------------------------------------------
CLIENT SERVICES DEPARTMENT: 1-800-662-2739 (CREW) TEXT TELEPHONE: 1-800-662-2738
Call Vanguard for information on your account, account transactions, and account
statements.
- --------------------------------------------------------------------------------
SERVICES FOR CLIENTS OF VANGUARD'S INSTITUTIONAL DIVISION: 1-888-809-8102
Vanguard's Institutional Division offers a variety of specialized services for
large institutional investors, including the ability to effect account
transactions through private electronic networks and third-party recordkeepers.
- --------------------------------------------------------------------------------

<PAGE> 31
28

TYPES OF ACCOUNTS

Individuals and institutions can establish a variety of accounts with Vanguard.
- --------------------------------------------------------------------------------

FOR ONE OR MORE PEOPLE
Open an account in the name of one (individual) or more (joint tenants) people.
- --------------------------------------------------------------------------------

FOR HOLDING PERSONAL TRUST ASSETS [BOOK]
Invest assets held in an existing personal trust.
- --------------------------------------------------------------------------------

FOR AN ORGANIZATION [BOOK]
Open an account as a corporation, partnership, endowment, foundation, or other
entity.
- --------------------------------------------------------------------------------

- --------------------------------------------------------------------------------
A NOTE ON INVESTING WITH VANGUARD THROUGH OTHER FIRMS

You may purchase or sell Fund shares through a financial intermediary such as a
bank, broker, or investment adviser. If you invest with Vanguard through an
intermediary, please read that firm's program materials carefully to learn of
any special rules that may apply. For example, special terms may apply to
additional service features, fees, or other policies. Consult your intermediary
to determine when your order will be priced.
- --------------------------------------------------------------------------------

BUYING SHARES

You buy your shares at a Fund's next-determined net asset value after Vanguard
receives your request. As long as your request is received before the close of
trading on the New York Stock Exchange, generally 4 p.m. Eastern time, you will
buy your shares at that day's net asset value.

- --------------------------------------------------------------------------------
MINIMUM INVESTMENT TO . . .
open a new account
$10,000

add to an existing account
$100 by mail or exchange; $1,000 by wire.
- --------------------------------------------------------------------------------

A NOTE ON LOW BALANCES
Each Fund reserves the right to close any account whose balance falls below the
minimum initial investment. The Fund will deduct a $10 annual fee in June if
your account balance falls below $10,000. The fee is waived if your total
Vanguard account assets are $50,000 or more.
- --------------------------------------------------------------------------------

A NOTE ON PURCHASE FEES
The Tax-Managed Small-Cap and Tax-Managed International Funds deduct a 1% fee
and 0.75% fee, respectively, from all purchases (including exchanges from other
Vanguard funds), but not from reinvested dividends or capital gains.

- --------------------------------------------------------------------------------
BY MAIL TO . . .[ENVELOPE]
open a new account
Complete and sign the application form and enclose your check.

add to an existing account
Mail your check with an Invest-By-Mail form detached from your confirmation
statement to the address listed on the form.

Make your check payable to:
The Vanguard Group (insert appropriate Fund number; see below)
Vanguard Tax-Managed Balanced Fund-103
Vanguard Tax-Managed Growth and Income Fund-101
Vanguard Tax-Managed Capital Appreciation Fund-102
Vanguard Tax-Managed Small-Cap Fund-116
Vanguard Tax-Managed International Fund-127
All purchases must be made in U.S. dollars, and checks must be drawn on U.S.
banks.
<PAGE> 32
29

First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2600 455 Devon Park Drive
Valley Forge, PA 19482-2600 Wayne, PA 19087-1815

For clients of Vanguard's Institutional Division . . .

First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815

- --------------------------------------------------------------------------------
IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.

- --------------------------------------------------------------------------------

BY TELEPHONE TO . . . [TELEPHONE]

open a new account

add to an existing account

Call Vanguard Tele-Account* 24 hours a day--or Client Services during business
hours--to exchange from another Vanguard fund account with the same registration
(name, address, taxpayer identification number, and account type). Use Vanguard
Fund Express (see "Services and Account Features") to transfer assets from your
bank account. Call Client Services before your first use to verify that this
option is in place.

Vanguard Tele-Account Client Services
1-800-662-6273 1-800-662-2739

*You must obtain a Personal Identification Number through Tele-Account at least
seven days before you request your first exchange.

- --------------------------------------------------------------------------------
IMPORTANT NOTE: Once you've requested a telephone transaction and a confirmation
number has been assigned, the transaction cannot be revoked. We reserve the
right to refuse any purchase request.
- --------------------------------------------------------------------------------

BY WIRE TO OPEN A NEW ACCOUNT OR ADD TO AN EXISTING ACCOUNT [WIRE]
Call Client Services to arrange your wire transaction.

Wire to:
FRB ABA 021001088
HSBC Bank USA

For credit to:
Account: 000112046
Vanguard Incoming Wire Account

In favor of:
The Vanguard Group (insert appropriate Fund number; see below)
Vanguard Tax-Managed Balanced Fund-103
Vanguard Tax-Managed Growth and Income Fund-101
Vanguard Tax-Managed Capital Appreciation Fund-102
Vanguard Tax-Managed Small-Cap Fund-116
Vanguard Tax-Managed International Fund-127
[Account number, or temporary number for a new account]
[Registered account owner/s]
[Registered address]
- --------------------------------------------------------------------------------
<PAGE> 33
30
BUYING SHARES (continued)

You can redeem (that is, sell or exchange) shares purchased by check or
Vanguard Fund Express at any time. However, while your redemption request will
be processed at the next-determined net asset value after it is received, your
redemption proceeds will not be available until payment for your purchase is
collected, which may take up to ten calendar days.

- --------------------------------------------------------------------------------
A NOTE ON LARGE PURCHASES
It is important that you call Vanguard before you invest a large dollar amount.
We must consider the interests of all Fund shareholders and so reserve the right
to refuse any purchase that will disrupt a Fund's operation or performance.
- --------------------------------------------------------------------------------

REDEEMING SHARES

This section describes how you can redeem--that is, sell or exchange--a Fund's
shares.

When Selling Shares:

- - Vanguard sends the redemption proceeds to you or a designated third
party.*

- - You can sell all or part of your Fund shares at any time.

*Proceeds made payable to third parties or sent to a different address require a
signature guarantee; see footnote on page 32.

When Exchanging Shares:

- - The redemption proceeds are used to purchase shares of a different
Vanguard fund.

- - You must meet the receiving fund's minimum investment requirements.

- - Vanguard reserves the right to revise or terminate the exchange
privilege, limit the amount of an exchange, or reject an exchange at
any time, without notice.

In both cases, your transaction will be based on the Fund's next-determined
share price, subject to any special rules discussed in this prospectus. For
exchanges, the purchase side of the transaction will be based on the receiving
fund's next-determined share price, again subject to any special rules discussed
in this prospectus.

- --------------------------------------------------------------------------------
A NOTE ON REDEMPTION FEES
Each Fund imposes a 2% redemption fee on shares that are redeemed by any method
within 1 year of purchase. Each Fund imposes a 1% redemption fee on shares that
are redeemed by any method after 1 year but within 5 years of purchase.
Currently, redemption fees do not apply to Fund shares held through Vanguard's
separate recordkeeping system for employee benefit plan accounts, due to certain
economies associated with these accounts. However, the Funds reserve the right
to impose redemption fees on their shares at any time if warranted by the Funds'
future costs of processing redemptions from these accounts.

- --------------------------------------------------------------------------------
NOTE: Once a redemption is requested and a confirmation number given, the
transaction CANNOT be canceled.
- --------------------------------------------------------------------------------

HOW TO REQUEST A REDEMPTION
You can request a redemption in any one of three ways: online, by telephone, or
by mail.

- --------------------------------------------------------------------------------
ONLINE REQUESTS [COMPUTER]

ACCESS VANGUARD at www.vanguard.com

You can use your personal computer to sell or exchange shares of most Vanguard
funds by accessing our website. To establish this service, you must register
through the website. We will then send you, by mail, an account access password
that will enable you to sell or exchange shares online (as well as perform other
transactions).

NOTE: The Vanguard funds whose shares you cannot exchange online or by
telephone are VANGUARD U.S. STOCK INDEX FUNDS, VANGUARD BALANCED INDEX FUND,
VANGUARD INTERNATIONAL STOCK INDEX FUNDS, VANGUARD REIT INDEX FUND, VANGUARD
TOTAL INTERNATIONAL STOCK INDEX FUND, and VANGUARD GROWTH AND INCOME FUND. If
you sell shares of these funds online, you will receive a redemption check at
your address of record.
- --------------------------------------------------------------------------------
<PAGE> 34
31

- --------------------------------------------------------------------------------
TELEPHONE REQUESTS [TELEPHONE]

Call Vanguard Tele-Account 24 hours a day--or Client Services during business
hours--to sell or exchange shares. You can exchange shares from a Fund to open
an account in another Vanguard fund or to add to an existing Vanguard fund
account with an identical registration.
- --------------------------------------------------------------------------------
SPECIAL INFORMATION: We will automatically establish the telephone redemption
option for your account, unless your instruct us otherwise in writing. While
telephone redemption is easy and convenient, this account feature involves a
risk of loss from unauthorized or fraudulent transactions. Vanguard will take
reasonable precautions to protect your account from fraud. You should do the
same by keeping your account information private and immediately reviewing any
account statements that we send to you. Make sure to contact Vanguard
immediately about any transaction you believe to be unauthorized.
- --------------------------------------------------------------------------------
We reserve the right to refuse a telephone redemption if the caller is
unable to provide:

[CHECKMARK] The ten-digit account number.

[CHECKMARK] The name and address exactly as registered on the account.

[CHECKMARK] The primary Social Security or employer identification number as
registered on the account.

[CHECKMARK] The Personal Identification Number, if applicable.

Please note that Vanguard will not be responsible for any account
losses due to telephone fraud, so long as we have taken reasonable steps to
verify the caller's identity. If you wish to remove the telephone redemption
feature from your account, please notify us in writing.

- --------------------------------------------------------------------------------
A NOTE ON UNUSUAL CIRCUMSTANCES
Vanguard reserves the right to revise or terminate the telephone redemption
privilege at any time, without notice. In addition, Vanguard can stop selling
shares or postpone payment at times when the New York Stock Exchange is closed
or under any emergency circumstances as determined by the U.S. Securities and
Exchange Commission. If you experience difficulty making a telephone redemption
during periods of drastic economic or market change, you can send us your
request by regular or express mail. Follow the instructions on selling or
exchanging shares by mail in this section.
- --------------------------------------------------------------------------------

MAIL REQUESTS [ENVELOPE]
Send a letter of instruction signed by all registered account holders. Include
the fund name and account number and (if you are selling) a dollar amount or
number of shares OR (if you are exchanging) the name of the fund you want to
exchange into and a dollar amount or number of shares. To exchange into an
account with a different registration (including a different name, address,
taxpayer identification number, or account type), you must provide Vanguard with
written instructions that include the guaranteed signatures of all current
owners of the fund from which you wish to redeem.

Depending on your account registration type, additional documentation may be
required.

First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 1120 455 Devon Park Drive
Valley Forge, PA 19482-1120 Wayne, PA 19087-1815

For clients of Vanguard's Institutional Division ...

First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
- --------------------------------------------------------------------------------

<PAGE> 35
32

REDEEMING SHARES (continued)

- --------------------------------------------------------------------------------
A NOTE ON LARGE REDEMPTIONS
It is important that you call Vanguard before you redeem a large dollar amount.
We must consider the interests of all fund shareholders and so reserve the right
to delay delivery of your redemption proceeds--up to seven days--if the amount
will disrupt the Fund's operation or performance.

If you redeem more than $250,000 worth of Fund shares within any 90-day
period, the Fund reserves the right to pay part or all of the redemption
proceeds above $250,000 in kind, i.e., in securities, rather than in cash. If
payment is made in kind, you may incur brokerage commissions if you elect to
sell the securities for cash.
- --------------------------------------------------------------------------------

OPTIONS FOR REDEMPTION PROCEEDS
You may receive your redemption proceeds in one of two ways: check, or exchange
to another Vanguard fund.
- --------------------------------------------------------------------------------

CHECK REDEMPTIONS
Normally, Vanguard will mail your check within two business days of a
redemption.
- --------------------------------------------------------------------------------

EXCHANGE REDEMPTIONS
As described above, an exchange involves using the proceeds of your redemption
to purchase shares of another Vanguard fund.
- --------------------------------------------------------------------------------

FOR OUR MUTUAL PROTECTION
For your best interests and ours, Vanguard applies these additional requirements
to redemptions:

REQUEST IN "GOOD ORDER"
All redemption requests must be received by Vanguard in "good order." This means
that your request must include:

[CHECKMARK] The Fund name and account number.

[CHECKMARK] The amount of the transaction (in dollars or shares).

[CHECKMARK] Signatures of all owners exactly as registered on the account (for
mail requests).

[CHECKMARK] Signature guarantees (if required).*

[CHECKMARK] Any supporting legal documentation that may be required.

[CHECKMARK] Any outstanding certificates representing shares to be redeemed.

*For instance, a signature guarantee must be provided by all registered account
shareholders when redemption proceeds are to be sent to a different person or
address. A signature guarantee can be obtained from most banks, credit unions,
and licensed brokers.

TRANSACTIONS ARE PROCESSED AT THE NEXT-DETERMINED SHARE PRICE AFTER VANGUARD HAS
RECEIVED ALL REQUIRED INFORMATION.
- --------------------------------------------------------------------------------

LIMITS ON ACCOUNT ACTIVITY
Because excessive account transactions can disrupt management of a Fund and
increase a Fund's costs for all shareholders, Vanguard limits account activity
as follows:

- - You may make no more than TWO SUBSTANTIVE "ROUND TRIPS" THROUGH A FUND
during any 12-month period.

- - Your round trips through a Fund must be at least 30 days apart.

- - A Fund may refuse a share purchase at any time, for any reason.

- - Vanguard may revoke an investor's telephone exchange privilege at any
time, for any reason.

A "round trip" is a redemption from a Fund followed by a purchase back into the
same Fund. Also, "round trip" covers transactions accomplished by any
combination of methods, including transactions conducted by check, wire, or
exchange to/from another Vanguard fund. "Substantive" means a dollar amount that
Vanguard determines, in its sole discretion, could adversely affect the
management of a Fund.
- --------------------------------------------------------------------------------

<PAGE> 36
33

- --------------------------------------------------------------------------------
RETURN YOUR SHARE CERTIFICATES
Any portion of your account represented by share certificates cannot be redeemed
until you return the certificates to Vanguard. Certificates must be returned
(unsigned), along with a letter requesting the sale or exchange you wish to
process, via certified mail to:

The Vanguard Group
455 Devon Park Drive
Wayne, PA 19087-1815
- --------------------------------------------------------------------------------

ALL TRADES FINAL
Vanguard will not cancel any transaction request (including any purchase or
redemption) that we believe to be authentic once the request has been received
and a confirmation number assigned.
- --------------------------------------------------------------------------------

TRANSFERRING REGISTRATION

You can transfer the registration of your Fund shares to another owner by
completing a transfer form and sending it to Vanguard.

First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 1110 455 Devon Park Drive
Valley Forge, PA 19482-1110 Wayne, PA 19087-1815

For clients of Vanguard's Institutional Division . . .

<PAGE> 37
34

FUND AND ACCOUNT UPDATES

STATEMENTS AND REPORTS
We will send you account and tax statements to help you keep track of your Fund
account throughout the year as well as when you are preparing your income tax
returns.

In addition, you will receive financial reports about the Fund twice a
year. These comprehensive reports include an assessment of the Fund's
performance (and a comparison to its industry benchmark), an overview of the
markets, a report from the advisers, and the Fund's financial statements which
include a listing of the Fund's holdings.

To keep each Fund's costs as low as possible (so that you and other
shareholders can keep more of the Fund's investment earnings), Vanguard attempts
to eliminate duplicate mailings to the same address. When we find that two or
more Fund shareholders have the same last name and address, we send just one
Fund report to that address--instead of mailing separate reports to each
shareholder. If you want us to send separate reports, however, you may notify
our Client Services Department at 1-800-662-2739.

- --------------------------------------------------------------------------------
CONFIRMATION STATEMENT
Sent each time you buy, sell, or exchange shares; confirms the trade date and
the amount of your transaction.

- --------------------------------------------------------------------------------
PORTFOLIO SUMMARY [BOOK]
Mailed quarterly for most accounts; shows the market value of your account at
the close of the statement period, as well as distributions, purchases, sales,
and exchanges for the current calendar year.

- --------------------------------------------------------------------------------

FUND FINANCIAL REPORTS
Mailed in February and August for these Funds.
- --------------------------------------------------------------------------------

TAX STATEMENTS
Generally mailed in January; report previous year's taxable dividend and capital
gains distributions, and proceeds from the sale of shares.
- --------------------------------------------------------------------------------

AVERAGE COST REVIEW STATEMENT [BOOK]
Issued quarterly for most taxable accounts (accompanies your Portfolio Summary);
shows the average cost of shares that you redeemed during the calendar year,
using the average cost single category method.
- --------------------------------------------------------------------------------
<PAGE> 38

(THIS PAGE INTENTIONALLY LEFT BLANK.)

<PAGE> 39

(THIS PAGE INTENTIONALLY LEFT BLANK.)

<PAGE> 40
GLOSSARY OF INVESTMENT TERMS

ACTIVE MANAGEMENT

An investment approach that seeks to exceed the average returns of the financial
markets. Active managers rely on research, market forecasts, and their own
judgment and experience in selecting securities to buy and sell.

BALANCED FUND

A mutual fund that seeks to provide some combination of income, capital growth,
and conservation of capital by investing in stocks, bonds, and/or money market
instruments.

BOND

A debt security (IOU) issued by a corporation, government, or government agency
in exchange for the money you lend it. In most instances, the issuer agrees to
pay back the loan by a specific date and make regular interest payments until
that date.

CAPITAL GAINS DISTRIBUTION

Payment to mutual fund shareholders of gains realized on securities that the
fund has sold at a profit, minus any realized losses.

CASH RESERVES

Cash deposits, short-term bank deposits and money market instruments which
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's acceptances.

COMMON STOCK

A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.

DIVIDEND INCOME

Payment to shareholders of income from interest or dividends generated by a
fund's investments.

DOLLAR-COST AVERAGING

Investing equal amounts of money at regular intervals on an ongoing basis. This
technique ensures that an investor buys fewer shares when prices are high and
more shares when prices are low.

EXPENSE RATIO

The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
distribution fees.

FUND DIVERSIFICATION

Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.

INVESTMENT ADVISER

An organization that makes the day-to-day decisions regarding a fund's
investments.

MUTUAL FUND

An investment company that pools the money of many people and invests it in a
variety of securities in an effort to achieve a specific objective over time.

NET ASSET VALUE (NAV)

The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.

PASSIVE MANAGEMENT

A low-cost investment strategy in which a mutual fund attempts to match --
rather than outperform -- a particular stock or bond market index. Also known as
indexing.

PRICE/EARNINGS (P/E) RATIO

The current share price of a stock, divided by its per-share earnings (profits)
from the past year. A stock selling for $20, with earnings of $2 per share, has
a price/earnings ratio of 10.

PRINCIPAL

The amount of your own money you put into an investment.

TOTAL RETURN

A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.

VOLATILITY

The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.

YIELD

Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.

<PAGE> 41
[SHIP GRAPHIC]
[VANGUARD GROUP GRAPHIC]
Post Office Box 2600
Valley Forge, PA 19482-2600

FOR MORE INFORMATION

If you'd like more information about Vanguard Tax-Managed Funds, the following
documents are available free upon request:

ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS

Additional information about the Funds' investments is available in the Funds'
annual and semiannual reports to shareholders. In these reports, you will find a
discussion of the market conditions and investment strategies that significantly
affected the Funds' performance during the most recent fiscal year.

STATEMENT OF ADDITIONAL INFORMATION (SAI)

The SAI provides more detailed information about the Funds.

The current annual and semiannual reports and the SAI are incorporated by
reference into (and are thus legally a part of) this prospectus.

To receive a free copy of the latest annual or semiannual report or the SAI, or
to request additional information about the Funds or other Vanguard funds,
please contact us as follows:

THE VANGUARD GROUP
INVESTOR INFORMATION DEPARTMENT
P.O. BOX 2600
VALLEY FORGE, PA 19482-2600

TELEPHONE:
1-800-662-7447 (SHIP)

TEXT TELEPHONE:
1-800-952-3335

WORLD WIDE WEB:
www.vanguard.com

If you are a current Fund shareholder and would like information about your
account, account transactions, and/or account statements, please call:

CLIENT SERVICES DEPARTMENT
TELEPHONE:
1-800-662-2739 (CREW)

TEXT TELEPHONE:
1-800-749-7273

INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC)

You can review and copy information about the Fund (including the SAI) at the
SEC's Public Reference Room in Washington, D.C. To find out more about this
public service, call the SEC at 1-800-SEC-0330. Reports and other information
about the Funds are also available on the SEC's website (www.sec.gov), or you
can receive copies of this information, for a fee, by writing the Public
Reference Section, Securities and Exchange Commission, Washington, DC
20549-6009.

Funds' Investment Company Act file number: 811-07175

P087N-08/18/1999
<PAGE> 42
VANGUARD TAX-MANAGED FUNDS INSTITUTIONAL SHARES
Prospectus
August 18, 1999
A Group of Tax-Managed Mutual Funds

CONTENTS

<TABLE>
<S> <C>
1 AN INTRODUCTION TO TAX-MANAGED INVESTING

2 FUND PROFILES

2 Vanguard Tax-Managed Growth and Income Fund Institutional Shares

5 Vanguard Tax-Managed Capital Appreciation Fund Institutional Shares

8 Vanguard Tax-Managed Small-Cap Fund Institutional Shares

10 Vanguard Tax-Managed International Fund Institutional Shares

11 A WORD ABOUT RISK

12 PRIMARY INVESTMENT STRATEGIES

16 THE FUNDS AND VANGUARD

17 INVESTMENT ADVISER

17 YEAR 2000 CHALLENGE

18 DIVIDENDS, CAPITAL GAINS, AND TAXES

19 SHARE PRICE

20 FINANCIAL HIGHLIGHTS

22 INVESTING WITH VANGUARD

22 SERVICES AND ACCOUNT FEATURES

22 TYPES OF ACCOUNTS

23 BUYING SHARES

24 REDEEMING SHARES

27 TRANSFERRING REGISTRATION

27 FUND AND ACCOUNT UPDATES

28 MANDATORY CONVERSION TO INVESTOR SHARES
</TABLE>

GLOSSARY (inside back cover)

- --------------------------------------------------------------------------------
WHY READING THIS PROSPECTUS IS IMPORTANT

This prospectus explains the objective, risks, and strategies of each of the
Vanguard Tax-Managed Funds Institutional Shares. To highlight terms and concepts
important to mutual fund investors, we have provided "Plain Talk" explanations
along the way. Reading the prospectus will help you to decide which Fund, if
any, is the right investment for you. We suggest that you keep it for future
reference.
- --------------------------------------------------------------------------------

- --------------------------------------------------------------------------------
IMPORTANT NOTE

Each of the Vanguard Tax-Managed Funds offers two separate classes of shares:
Investor and Institutional (except for Vanguard Tax-Managed Balanced Fund, which
offers Investor Shares only). This prospectus offers the Funds' Institutional
Shares, which have an investment minimum of $10 million. The Funds' Investor
Shares, which have an investment minimum of $10,000, are offered through a
separate prospectus. You can obtain a copy of the Investor Shares prospectus by
calling Vanguard. Note that the Funds' separate share classes have different
expenses; as a result, their investment performance will vary.
- --------------------------------------------------------------------------------

AN INTRODUCTION TO TAX-MANAGED INVESTING

- - Low turnover. The Funds minimize turnover by employing an index-oriented
approach to stock investing. Instead of trading frequently, each Fund simply
buys and holds all -- or a representative sample -- of the stocks comprising
its target index. Frequent trading -- a hallmark of many actively managed
funds -- causes funds to realize capital gains, which must then be
distributed to shareholders, reducing their after-tax returns.

- - A disciplined sell-selection method. When selling specific securities, the
Funds will select a specific share lot -- more often than not, the
highest-cost shares -- in order to minimize realized capital gains. In
addition, each Fund may sell securities at a loss in order to offset realized
capital gains that would otherwise have to be distributed to shareholders.

- - Bias against taxable dividend income. The Tax-Managed Capital Appreciation
Fund minimizes taxable dividend income by focusing on the lower-yielding
stocks in its target index (the Russell 1000 Index).

- - Redemption fees. Each Fund imposes redemption fees on short-term investors,
whose in-out activity can reduce a fund's tax efficiency by causing it to
realize capital gains. The fee is 2% for shares held for less than one year,
and 1% for shares held at least one but less than five years. These fees are
paid to the Funds to help cover their transaction costs when selling
securities to meet redemptions.

<PAGE> 44
2

FUND PROFILE--VANGUARD TAX-MANAGED GROWTH AND INCOME FUND INSTITUTIONAL SHARES

The following profile summarizes key features of Vanguard Tax-Managed Growth and
Income Fund Institutional Shares.

INVESTMENT OBJECTIVE

The Fund is a stock fund that seeks to provide a tax-efficient investment return
consisting of a moderate level of current income and long-term capital growth.

INVESTMENT STRATEGIES

The Fund purchases stocks included in the Standard & Poor's 500 Composite Stock
Price Index--an independent index that is dominated by dividend-paying stocks of
the largest U.S. companies. The Fund will hold substantially all of the S&P 500
stocks, in approximately the same proportions as they are represented in the
Index. For more information, see "Security Selection" under PRIMARY INVESTMENT
STRATEGIES.

PRIMARY RISKS

THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to investment style risk, which is the chance that returns
from large-capitalization stocks will trail returns from other asset classes or
the overall stock market. Large-capitalization stocks tend to go through cycles
of doing better--or worse--than the stock market in general. These periods have,
in the past, lasted for as long as several years.

PERFORMANCE/RISK INFORMATION

The bar chart and table below provide an indication of the risk of investing in
the Fund. The bar chart shows the performance of the Investor Shares of the Fund
in each calendar year since inception. The table shows how the average annual
returns of the Fund's Investor Shares for one calendar year and since inception
compare with those of a broad-based securities market index. Keep in mind that
the Fund's past performance does not necessarily indicate how it will perform in
the future.

Note: This prospectus offers the Fund's Institutional Shares, not the
Investor Shares. Performance for the Investor Shares is shown here because the
Fund's Institutional Shares are new and don't have a full calendar year of
performance. However, the two share classes are invested in the same portfolio
of securities and will have the same returns except to the extent that their
operating expenses differ.

- -------------------------------------------------------------------------------
ANNUAL TOTAL RETURNS FOR INVESTOR SHARES
- -------------------------------------------------------------------------------
[BAR GRAPH]

1995 1996 1997 1998

37.53% 23.03% 33.31% 28.67%

- -------------------------------------------------------------------------------

<PAGE> 45
3

<TABLE>
<CAPTION>
----------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
----------------------------------------------------------------------------
1 YEAR SINCE INCEPTION*
----------------------------------------------------------------------------
<S> <C> <C>
Vanguard Tax-Managed Growth and Income Fund
Investor Shares 28.67% 27.48%
S&P 500 Index 28.58 27.45
----------------------------------------------------------------------------
*September 6, 1994.
----------------------------------------------------------------------------
</TABLE>

FEES AND EXPENSES

The following table describes the fees and expenses you would pay if you buy and
hold Institutional Shares of the Fund. Since the Fund did not begin offering
Institutional Shares until February 22, 1999, the expenses shown under Annual
Fund Operating Expenses are based upon estimated amounts for the current fiscal
year.

ANNUAL FUND OPERATING EXPENSES (expenses deducted from
the Fund's assets)
Management Expenses: 0.07%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.10%
</TABLE>

* Includes redemptions by exchange to another fund.

** A 2% redemption fee applies to shares held for less than one year; a 1%
redemption fee applies to shares held at least one year but less than
five years. The fees are withheld from redemption proceeds and retained
by the Fund. These fees help to cover the transaction costs borne by
the Fund when it must sell securities to meet redemptions. In addition,
these fees are intended to protect the Fund's long-term investors from
short-term traders, who erode the Fund's tax-efficiency.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------
1 YEAR* 3 YEARS 5 YEARS** 10 YEARS
-----------------------------------------------------------------------
<S> <C> <C> <C>
$115 $148 $56 $128
</TABLE>

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

** Does not include a redemption fee. If you hold shares for one or more
years, but less than five years, a 1% redemption fee applies.

<PAGE> 46
4

FUND PROFILE -- VANGUARD TAX-MANAGED CAPITAL APPRECIATION FUND INSTITUTIONAL
SHARES (CONTINUED)

<TABLE>
<CAPTION>
-----------------------------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
-----------------------------------------------------------------------
<S> <C> <C> <C>
$10 $32 $56 $128
</TABLE>

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.

- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS
Dividends are paid quarterly in March, June, September, and December; capital
gains, if any, are paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
February 22, 1999

SUITABLE FOR IRAS
No

MINIMUM INITIAL INVESTMENT
$10 million

NEWSPAPER ABBREVIATION
TxMGIIst

VANGUARD FUND NUMBER
136

CUSIP NUMBER
921943700

TICKER SYMBOL
VTMIX

- --------------------------------------------------------------------------------
<PAGE> 47
5

FUND PROFILE -- VANGUARD TAX-MANAGED CAPITAL APPRECIATION FUND INSTITUTIONAL
SHARES

The following profile summarizes key features of Vanguard Tax-Managed Capital
Appreciation Fund Institutional Shares.

INVESTMENT OBJECTIVE

The Fund is a stock fund that seeks to provide a tax-efficient investment return
consisting of long-term capital growth. The Fund may produce a small amount of
taxable current income, though not as part of its objective.

INVESTMENT STRATEGIES

The Fund purchases stocks included in the Russell 1000 Index -- an independent
index of the stocks of large- and mid-capitalization U.S. companies. The Fund
uses statistical methods to "sample" the Index, aiming to closely track its
investment performance while minimizing taxable dividend distributions. For more
information, see "Security Selection" under PRIMARY INVESTMENT STRATEGIES.

PRIMARY RISKS

THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to investment style risk, which is the chance that returns
from large- or mid-capitalization stocks will trail returns from other asset
classes or the overall stock market. Each type of stock tends to go through
cycles of doing better -- or worse -- than the stock market in general. These
periods have, in the past, lasted for as long as several years.

PERFORMANCE/RISK INFORMATION

1995 1996 1997 1998

34.38% 20.92% 27.29% 27.95%

- -------------------------------------------------------------------------------

FUND PROFILE -- VANGUARD TAX-MANAGED GROWTH AND INCOME FUND INSTITUTIONAL SHARES
(CONTINUED)

<TABLE>
<CAPTION>
----------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 1998
----------------------------------------------------------------------------
1 YEAR SINCE INCEPTION*
----------------------------------------------------------------------------
<S> <C> <C>
Vanguard Tax-Managed Capital Appreciation Fund
Investor Shares 27.95% 25.14%
Russell 1000 Index 27.02 26.85
----------------------------------------------------------------------------
*September 6, 1994.
----------------------------------------------------------------------------
</TABLE>

FEES AND EXPENSES

ANNUAL FUND OPERATING EXPENSES (expenses deducted from the
Fund's assets)
Management Expenses: 0.07%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.10%
</TABLE>

* Includes redemptions by exchange to another fund.

** A 2% redemption fee applies to shares held for less than one year; a
1% redemption fee applies to shares held at least one year but less
than five years. The fees are withheld from redemption proceeds and
retained by the Fund. These fees help to cover the transaction costs
borne by the Fund when it must sell securities to meet redemptions.
In addition, these fees are intended to protect the Fund's long-term
investors from short-term traders, who erode the Fund's
tax-efficiency.

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

** Does not include a redemption fee. If you hold shares for one or
more years, but less than five years, a 1% redemption fee applies.

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.
<PAGE> 49
7

- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS
Paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
February 22, 1999

SUITABLE FOR IRAS
No

MINIMUM INITIAL INVESTMENT
$10 million

NEWSPAPER ABBREVIATION
TxMCaIst

VANGUARD FUND NUMBER
135

CUSIP NUMBER
921943601

TICKER SYMBOL
VTCIX

- --------------------------------------------------------------------------------
<PAGE> 50
8

FUND PROFILE -- VANGUARD TAX-MANAGED SMALL-CAP FUND INSTITUTIONAL SHARES

The following profile summarizes key features of Vanguard Tax-Managed Small-Cap
Fund Institutional Shares.

INVESTMENT OBJECTIVE

INVESTMENT STRATEGIES

The Fund purchases stocks included in the Standard & Poor's SmallCap 600 Index
- -- an independent index that is made up of stocks of smaller U.S. companies. The
Fund will hold substantially all of the S&P SmallCap 600 stocks, in
approximately the same proportions as they are represented in the Index. For
more information, see "Security Selection" under PRIMARY INVESTMENT STRATEGIES.

PRIMARY RISKS

THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to investment style risk, which is the chance that returns
from small-capitalization stocks will trail returns from other asset classes or
the overall stock market. Small-capitalization stocks tend to go through cycles
of doing better -- or worse -- than the stock market in general. These periods
have, in the past, lasted for as long as several years. Many
small-capitalization companies are new, so their stocks lack a performance
record.

PERFORMANCE/RISK INFORMATION

The Fund began operations on February 22, 1999, so performance information
(including annual total returns and average annual total returns) for a full
calendar year is not yet available.

FEES AND EXPENSES

The following table describes the fees and expenses you would pay if you buy and
hold Institutional Shares of the Fund. The expenses shown under Annual Fund
Operating Expenses are based on estimated amounts for the current fiscal year.
The Fund has no operating history; actual operating expenses could be different.

<TABLE>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Transaction Fee on Purchases: 1%*
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees**: 2% or 1%***

ANNUAL FUND OPERATING EXPENSES (expenses deducted from the
Fund's assets)
Management Expenses: 0.07%
12b-1 Distribution Fees: None
Other Expenses: 0.03%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.10%
</TABLE>

* The 1% purchase fee is deducted from all purchases (including
exchanges from other Vanguard funds), but not from reinvested
dividends and capital gains.

** Includes redemptions by exchange to another fund.

*** A 2% redemption fee applies to shares held for less than one year;
a 1% redemption fee applies to shares held at least one year but
less than five years. The fees are withheld from redemption proceeds
and retained by the Fund. These fees help to cover the transaction
costs borne by the Fund when it must sell securities to meet
redemptions. In addition, these fees are intended to protect the
Fund's long-term investors from short-term traders, who erode the
Fund's tax-efficiency.
<PAGE> 51
9

* Includes a 1% redemption fee. If you hold shares for less than one
year, a 2% redemption fee applies.

** Does not include a redemption fee. If you hold shares for one or more
years, but less than five years, a 1% redemption fee applies.

THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR
LOWER THAN THOSE SHOWN.

- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
Dividends and Capital Gains

Paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
February 22, 1999

SUITABLE FOR IRAS
No

MINIMUM INITIAL INVESTMENT
$10 million

NEWSPAPER ABBREVIATION
TxMSCIst

VANGUARD FUND NUMBER
118

CUSIP NUMBER
921943502
<PAGE> 52
10

FUND PROFILE -- VANGUARD TAX-MANAGED INTERNATIONAL FUND INSTITUTIONAL SHARES

The following profile summarizes key features of Vanguard Tax-Managed
International Fund Institutional Shares.

INVESTMENT OBJECTIVE

INVESTMENT STRATEGIES

The Fund purchases stocks included in the Morgan Stanley Capital International
EAFE Index, which is a market value-weighted index of more than 1,000 securities
listed on the stock exchanges of countries in Europe, Australia, and Asia. The
Fund uses statistical methods to "sample" the Index, aiming to closely track its
investment performance. For more information, see "Security Selection" under

PRIMARY INVESTMENT STRATEGIES.

PRIMARY RISKS

THE FUND'S TOTAL RETURN, LIKE STOCK PRICES GENERALLY, WILL FLUCTUATE WITHIN A
WIDE RANGE, SO AN INVESTOR COULD LOSE MONEY OVER SHORT OR EVEN LONG PERIODS. The
Fund is also subject to:

- - Currency risk, which is the chance that returns will be hurt by a rise in the
value of the U.S. dollar versus foreign currencies.

- - Investment style risk, which is the chance that returns from foreign stocks
will trail returns from other asset classes or the overall stock market.

- - Country risk, which is the chance that a country's economy will be hurt by
political troubles, financial problems, or natural disasters.

PERFORMANCE/RISK INFORMATION

The Fund began operations on August 18, 1999, so performance information
(including annual total returns or average annual total returns) for a full
calendar year is not yet available.

FEES AND EXPENSES

<TABLE>
<S> <C>
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Transaction Fee on Purchases: .75%*
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fees**: 2% or 1%***

ANNUAL FUND OPERATING EXPENSES (expenses deducted from
the Fund's assets)
Management Expenses: 0.15%
12b-1 Distribution Fees: None
Other Expenses: 0.10%
TOTAL ANNUAL FUND OPERATING EXPENSES: 0.25%
</TABLE>

* The .75% purchase fee is deducted from all purchases (including
exchanges from other Vanguard funds), but not from reinvested
dividends and capital gains.

** Includes redemptions by exchange to another fund.

*** A 2% redemption fee applies to shares held for less than one year;
a 1% redemption fee applies to shares held at least one year but
less than five years. The fees are withheld from redemption proceeds
and retained by the Fund. These fees help to cover the transaction
costs borne by the Fund when it must sell securities to meet
redemptions. In addition, these fees are intended to protect the
Fund's long-term investors from short-term traders, who erode the
Fund's tax-efficiency.
<PAGE> 53
11

<TABLE>
<CAPTION>
--------------------------
1 YEAR* 3 YEARS
--------------------------
<S> <C>
$204 $269
--------------------------
</TABLE>

* Includes a 1% redemption fee. If you hold shares for less then one
year, a 2% redemption fee applies.

You would pay the following expenses if you did not redeem your shares (the
difference being that the Fund's 1% redemption fee would not apply to the
periods below, as it would to those shown above):

<TABLE>
<CAPTION>
--------------------------
1 YEAR 3 YEARS
--------------------------
<S> <C>
$100 $155
--------------------------
</TABLE>

THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR
LOWER THAN THOSE SHOWN.

- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION

DIVIDENDS AND CAPITAL GAINS
Paid annually in December

INVESTMENT ADVISER
The Vanguard Group, Valley Forge, Pa., since inception

INCEPTION DATE
August 18, 1999

MINIMUM INITIAL INVESTMENT
$10 million

NEWSPAPER ABBREVIATION
TxMInIst

VANGUARD FUND NUMBER
137

CUSIP NUMBER
921943882
- --------------------------------------------------------------------------------

================================================================================
A WORD ABOUT RISK

Look for this "warning flag" symbol [FLAG] throughout the prospectus. It is
used to mark detailed information about each type of risk that you would
confront as a shareholder of one or more of the Funds.
================================================================================
<PAGE> 54
12

PRIMARY INVESTMENT STRATEGIES

MARKET EXPOSURE

U.S. STOCKS

Except for the Tax-Managed International Fund, which invests primarily in stocks
of companies outside the United States, each of the Funds invests primarily in
U.S. common stocks, with variations in the size of the companies on which the
Funds focus. The grid below shows, at a glance, the percentage of each Fund's
assets that is normally committed to each type of investment listed. Market
exposure is expected to play the most important role in achieving a Fund's
investment objective.

<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
VANGUARD TAX-MANAGED FUND
-------------------------------------------------------------------------------
GROWTH CAPITAL
MARKET EXPOSURE AND INCOME APPRECIATION SMALL-CAP INTERNATIONAL
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common stocks 100% 100% 100% 100%
Large-cap U.S. Large-and mid-cap Small-cap U.S. Large-cap
companies U.S. companies companies foreign companies
- --------------------------------------------------------------------------------------------------------
</TABLE>

[FLAG] EACH FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT
STOCK PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN LONG PERIODS.
STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND
PERIODS OF FALLING PRICES.

To illustrate the volatility of stock prices, the table below shows the best,
worst, and average total returns for the U.S. stock market over various periods
as measured by the Standard & Poor's 500 Composite Stock Price Index, a widely
used barometer of market activity. (Total returns consist of dividend income
plus change in market price.) Note that the returns shown do not include the
costs of buying and selling stocks or other expenses that a real-world
investment portfolio would incur. Note, also, that the gap between best and
worst tends to narrow over the long term. (You will find a chart illustrating
the volatility of the international stock market on page 14.)

<TABLE>
<CAPTION>
---------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926 - 1998)
---------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 54.2% 24.1% 19.9% 17.7%
Worst -43.1 -12.4 -0.8 3.1
Average 13.1 10.7 11.0 11.0
---------------------------------------------------------------
</TABLE>

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT

LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS

Stocks of publicly traded companies -- and mutual funds that hold these stocks
- -- can be classified by the companies' market value, or capitalization.
Generally, Vanguard defines large-capitalization (large-cap) funds as those
holding stocks of companies whose outstanding shares have a market value
exceeding $10 billion. Mid-cap funds hold stocks of companies with a market
value between $1 billion and $10 billion. Small-cap funds typically hold stocks
of companies with a market value of less than $1 billion.
- --------------------------------------------------------------------------------
<PAGE> 55
13

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
INDEXING METHODS

reflect past performance on common stocks; you should not regard them as an
indication of future returns from either the stock market as a whole or these
Funds in particular.

Keep in mind that the S&P 500 Index -- which is the index tracked by the
Tax-Managed Growth and Income Fund -- holds mainly large-cap stocks.
Historically, mid- and small-cap stocks have been more volatile than -- and at
times have performed quite differently from -- large-cap stocks. This is due to
several factors, including less-certain growth and dividend prospects for
smaller companies. The Tax-Managed Capital Appreciation Fund holds mid-cap
stocks in addition to large-cap stocks. The Tax-Managed Small-Cap Fund holds
just small-cap stocks. The Tax-Managed International Fund holds large-cap
stocks.

[FLAG] THE FUNDS ARE SUBJECT, IN VARYING DEGREES, TO INVESTMENT STYLE RISK,
WHICH IS THE POSSIBILITY THAT RETURNS FROM A SPECIFIC TYPE OF STOCK
(FOR INSTANCE, SMALL- OR MID-CAP STOCKS) OR FUND WILL TRAIL RETURNS
FROM OTHER ASSET CLASSES OR THE OVERALL STOCK MARKET. EACH TYPE OF
STOCK OR FUND TENDS TO GO THROUGH CYCLES OF DOING BETTER -- OR WORSE
--THAN COMMON STOCKS IN GENERAL. THESE PERIODS HAVE, IN THE PAST,
LASTED FOR AS LONG AS SEVERAL YEARS.

FOREIGN STOCKS

The Tax-Managed International Fund seeks to provide a tax-efficient investment
return consisting of long-term capital growth by investing in a broadly
diversified group of stocks of foreign companies. Investments in foreign stocks
can be as risky, if not more risky, than U.S. stock investments. The prices of
international stocks and the prices of U.S. stocks have often moved in opposite
directions. These periods have, in the past, lasted as long as several years.

Because it invests mainly in international stocks, the Fund is subject to:

[FLAG] CURRENCY RISK, WHICH IS THE CHANCE THAT RETURNS WILL BE HURT BY A RISE
IN THE VALUE OF THE U.S. DOLLAR VERSUS FOREIGN CURRENCIES.

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
THE RISKS OF INTERNATIONAL INVESTING

Because foreign stock markets operate differently from the U.S. market,
Americans investing abroad will encounter risks not typically associated with
U.S. companies. For instance, foreign companies are not subject to the same
accounting, auditing, and financial reporting standards and practices as U.S.
companies; and their stock may not be as liquid as the stock of similar U.S.
companies. In addition, foreign stock exchanges, brokers, and companies
generally have less government supervision and regulation than their
counterparts in the United States. These factors, among others, could negatively
impact the returns Americans receive from a foreign investment.
- --------------------------------------------------------------------------------
<PAGE> 56
14

Conversely, when the U.S. dollar falls in value versus other currencies,
returns from international stocks are enhanced because a given sum in foreign
currency translates into more U.S. dollars.

[FLAG] COUNTRY RISK, WHICH IS THE POSSIBILITY THAT POLITICAL EVENTS (SUCH AS A
WAR), FINANCIAL PROBLEMS (SUCH AS GOVERNMENT DEFAULT), OR NATURAL
DISASTERS (SUCH AS AN EARTHQUAKE) WILL WEAKEN A COUNTRY'S ECONOMY AND
CAUSE INVESTMENTS IN THAT COUNTRY TO LOSE MONEY.

International investing involves other risks and considerations, including:
differences in accounting, auditing, and financial reporting standards;
generally higher costs of trading securities; foreign withholding taxes payable
on the Fund's securities, which can reduce dividend income available to
distribute to shareholders; and adverse changes in regulatory or legal climates.

<TABLE>
<CAPTION>
---------------------------------------------------------------
INTERNATIONAL STOCK MARKET RETURNS (1969-1998)
---------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 69.9% 36.5% 22.8% 16.3%
Worst -23.2 1.5 5.9 12.0
Average 14.7 13.6 14.9 14.7
---------------------------------------------------------------
</TABLE>

The table covers all of the 1-, 5-, 10-, and 20-year periods from 1969
through 1998. Keep in mind that this was a particularly favorable period for
foreign markets. For instance, over 10-year periods, foreign stocks provided an
average return of 14.9%, compared to 11.0% for U.S. stocks (as measured by the
S&P 500 Index) during the same time frame. These average returns reflect past
performance on international stocks; you should not regard them as an indication
of future returns from either foreign markets as a whole or the Tax-Managed
International Fund in particular.

SECURITY SELECTION

Each of the Funds employs an index-oriented approach to stock investing, and the
only stocks purchased by a Fund are those included in its target index. The grid
below shows, at a glance, the index tracked by each Fund and the indexing method
employed.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------
TAX-MANAGED FUND INDEX INDEXING METHOD
-----------------------------------------------------------------------------
<S> <C> <C>
Growth and Income S&P 500 Replication
Capital Appreciation Russell 1000 Sampling
Small-Cap S&P SmallCap 600 Replication
International MSCI EAFE Sampling
-----------------------------------------------------------------------------
</TABLE>
<PAGE> 57
15

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
DERIVATIVES

OTHER INVESTMENT POLICIES AND RISKS

Each of the Funds may invest, to a limited extent, in futures contracts, options
(including puts and calls), warrants, convertible securities, and swap
agreements, which are all types of derivatives. Losses (or gains) involving
futures contracts can sometimes be substantial -- in part because a relatively
small price movement in a futures contract may result in an immediate and
substantial loss (or gain) for a fund. Similar risks exist for warrants
(securities that permit their owners to purchase a specific number of shares of
stock at a predetermined price), convertible securities (securities that may be
exchanged for a different asset), and swap agreements (contracts between two
parties in which each agrees to make payments to the other based on the return
of a specified index or asset). For this reason, the Funds will not use futures,
options, warrants, convertible securities, or swap agreements for speculative
purposes or as leveraged investments that magnify the gains or losses of an
investment.

Each of the Funds may invest in futures contracts and options so long as the
total value of these investments does not exceed 5% of the Fund's assets.

The reasons for which a Fund will invest in futures and options are:

- - To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in its benchmark index.

- - To reduce the Fund's transaction costs or add value when these instruments
are favorably priced.

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
TURNOVER RATE

TURNOVER RATES

Although the Funds generally seek to invest for the long term, each retains the
right to sell securities regardless of how long the securities have been held.
Generally, an index-oriented fund sells securities only to respond to redemption
requests or to adjust the number of shares held to reflect a change in the
fund's target index. Because of this, and the Funds' focus on avoiding taxable
gains, the turnover rate for each Fund has been fairly low. The Funds' turnover
rate is expected to remain below 20%. (A turnover rate of 100% would occur, for
example, if a Fund sold and replaced securities valued at 100% of its net assets
within a one-year period.)

COSTS AND MARKET-TIMING

Some investors try to profit from market-timing -- switching money into
investments when they expect prices to rise, and taking money out when they
expect prices to fall. As money is shifted in and out, a fund incurs expenses
for buying and selling securities. These costs are borne by all fund
shareholders, including the long-term investors who do not generate the costs.
Therefore, the Tax-Managed Funds have adopted the following policies, among
others, designed to discourage short-term trading:

- - The Funds reserve the right to reject any purchase request into any of the
Funds --including exchanges from other Vanguard funds -- that it
<PAGE> 58
16

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
THE COSTS OF INVESTING

regards as disruptive to the efficient management of the Funds. This could be
because of the timing of the investment or because of a history of excessive
trading by the investor.

- - There is a limit on the number of times you can exchange into and out of a
Fund (see "Redeeming Shares" in the INVESTING WITH VANGUARD section).

- - The Funds impose a 2% redemption fee on shares that are redeemed by any
method within one year of purchase. There is a 1% redemption fee on shares
that are redeemed by any method after one year but within five years of
purchase.

- - The Funds reserve the right to stop offering shares at any time.

THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST IN THESE FUNDS
IF YOU ARE A MARKET-TIMER.

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
THE FUNDS'
REDEMPTION FEE

The Tax-Managed Funds charge a redemption fee on shares that are redeemed
(including redeeming by exchange to another Vanguard fund) before they have been
held for five years. The fee is 2% for shares redeemed within one year of
purchase and 1% for shares redeemed after one year but within five years of
purchase. The Funds are intended for long-term investors, and this redemption
fee ensures that the costs associated with short-term trading are borne by the
investors making the transactions -- and not by those shareholders in the Funds
for the long term.

At Vanguard, all fees are paid directly to the fund itself (unlike a sales
charge or load, which -- for many fund companies -- ends up in the pocket of the
sponsor, adviser, or sales representative).
- --------------------------------------------------------------------------------

THE FUNDS AND VANGUARD

Vanguard also provides marketing services to the Funds. Although shareholders
do not pay sales commissions or 12b-1 distribution fees, each Fund pays its
allocated share of The Vanguard Group's marketing costs.

- --------------------------------------------------------------------------------
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE

<PAGE> 59
17
PLAIN TALK ABOUT
FUND EXPENSES

All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. The expense ratio for the Institutional Shares of Tax-Managed Growth
and Income, Capital Appreciation, and Small-Cap Funds, which began operations on
February 22, 1999, are expected to be 0.10%, or $1.00 per $1,000 of average net
assets, for fiscal year 1999. The expense ratio for the Tax-Managed
International Fund, which began operations on August 18,1999, is expected to be
0.25%, or $2.50 per $1,000 of average net assets, for fiscal year 1999.

- --------------------------------------------------------------------------------

INVESTMENT ADVISER

Each of the Tax-Managed Funds obtains advisory services on an at-cost basis
from The Vanguard Group, Valley Forge, Pennsylvania 19482. For the fiscal year
ended December 31, 1998, Tax-Managed Growth and Income Fund and Tax-Managed
Capital Appreciation Fund paid advisory expenses of $29,000 each, which
represented an effective annual rate of .0025% for each Fund. Tax-Managed
Small-Cap Fund and Tax-Managed International Fund began operations on February
22, 1999, and August 18, 1999, respectively. Advisory expenses for the first
fiscal year of both of these Funds are estimated at an effective annual rate of
0.01%.

The Funds have authorized the adviser to choose brokers or dealers to handle
the purchase and sale of securities for the Funds, and to get the best available
price and most favorable execution from these brokers with respect to all
transactions. Also, the Funds may direct the adviser to use a particular broker
for certain transactions in exchange for commission rebates or research services
provided to the Funds.

- --------------------------------------------------------------------------------

PLAIN TALK ABOUT
THE FUNDS' ADVISER

GEORGE U. SAUTER, Managing Director of Vanguard; has worked in investment
management since 1985; with Vanguard since 1987; has managed portfolio
investments since 1987; A.B., Dartmouth College; M.B.A., University of
Chicago.

- --------------------------------------------------------------------------------

YEAR 2000 CHALLENGE

The Vanguard Group is dedicated to providing uninterrupted, high-quality
performance from our computer systems before, during, and after 2000. In July
1998, we completed the renovation and initial testing of our internal systems.
Vanguard is diligently working with external partners, suppliers, and vendors,
including fund managers and other service providers, to assure that the systems
with which we interact remain operational at all times.

In addition to taking every reasonable step to secure our internal systems
and external relationships, Vanguard is further developing contingency plans
intended to assure that unexpected systems failures will not adversely affect
the Funds' operations. Vanguard intends to monitor these processes through the
rollover of 1999 into 2000 and to quickly implement alternate solutions if
necessary.

PLAIN TALK ABOUT
DISTRIBUTIONS

As a shareholder, you are entitled to your share of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or a capital gains distribution. Income
dividends come from both the dividends that the fund earns from its holdings and
the interest it receives from its money market and bond investments. Capital
gains are realized whenever the fund sells securities for higher prices than it
paid for them. The capital gains are either short-term or long-term depending on
whether the fund held the securities for less than or more than one year.

PLAIN TALK ABOUT
"BUYING A DIVIDEND"

It is not to your advantage to buy shares of a fund shortly before it makes a
distribution, because doing so can cost you money in taxes. This is known as
"buying a dividend." For example: on December 15, you invest $5,000, buying 250
shares for $20 each. If the fund pays a distribution of $1 per share on December
16, its share price would drop to $19 (not counting market change). You still
have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x $1
= $250 in distributions), but you owe tax on the $250 distribution you received
- -- even if you reinvest it in more shares. To avoid "buying a dividend," check a
fund's distribution schedule before you invest.

- --------------------------------------------------------------------------------

DIVIDENDS, CAPITAL GAINS, AND TAXES

The Tax-Managed Funds distribute to their shareholders virtually all of their
net income (interest and dividends less expenses), as well as any capital gains
realized from the sale of their holdings. For the Tax-Managed Growth and Income
Fund, income distributions generally occur in March, June, September, and
December; the Tax-Managed Capital Appreciation, Tax-Managed Small-Cap, and
Tax-Managed International Funds pay such distributions in December. Capital
gains distributions generally occur in December. In addition, the Funds may
occasionally be required to make supplemental dividend or capital gains
distributions at some other time during the year.

You can receive distributions of income or capital gains in cash, or you can
have them automatically invested in more shares of a Fund. In either case, these
distributions are taxable to you. It is important to note that distributions of
dividends and capital gains that are declared in December -- if paid to you by
the end of January -- are taxed as if they had been paid to you in December.

Vanguard will send you a statement each year showing the tax status of all
your distributions. If you have chosen to receive dividend and/or capital gains
distributions in cash, and the postal or other delivery service is unable to
deliver checks to your address of record, we will change the distribution option
so that all dividends and other distributions are automatically invested in
additional shares. We will not pay interest on uncashed distribution checks.

- - The dividends and short-term capital gains that you receive are taxable to
you as ordinary income for federal income tax purposes.

- - Any distributions of net long-term capital gains by a Fund are taxable to you
as long-term capital gains, no matter how long you've owned shares in the
Fund.

- - Although the Funds do not seek to realize any particular amount of capital
gains during a year, such gains are realized from time to time as by-products
of their ordinary investment activities. Consequently, distributions may vary
considerably from year to year.

- - If you sell or exchange shares, any gain or loss you have is a taxable event.
This means that you may have a capital gain to report as income, or a capital
loss to report as a deduction, when you complete your federal income tax
return.

- - Distributions of dividends or capital gains, and capital gains or losses from
your sale or exchange of Fund shares, may be subject to state and local
income taxes as well.

- - Foreign governments may withhold taxes on dividends and interest paid, while
imposing taxes on other payments or gains, with respect to foreign
securities. For investors in the Tax-Managed International Fund who meet
certain holding period requirements, an offsetting tax credit or deduction
may be available. Investors in this Fund who do not meet these requirements
may still be entitled to a deduction for certain taxes.

<PAGE> 61
19

The tax information in this prospectus is provided as general information.
(Non-U.S. investors may be subject to U.S. withholding and estate tax.) You
should consult your tax adviser about the tax consequences of an investment in
one or more of the Funds.

SHARE PRICE

Each Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of trading on the New York Stock Exchange (the NAV
is not calculated on holidays or other days the Exchange is closed). Net asset
value per share is computed by dividing the net assets attributed to the
Institutional class by the number of shares outstanding for that class.

Knowing the daily net asset value is useful to you as a shareholder because
it indicates the current value of your investment. The Fund's NAV, multiplied by
the number of shares you own, gives you the dollar amount you would have
received had you sold all of your shares back to the Fund that day.

A NOTE ON PRICING: A Fund's investments will be priced at their market value
when market quotations are readily available. When these quotations are not
readily available, investments will be priced at their fair value, calculated
according to procedures adopted by the Board of Trustees.

Each Fund's share price can be found daily in the mutual fund listings of
most major newspapers under the heading "Vanguard Index Funds." Different
newspapers use different abbreviations of the Funds' names, but the most common
are TxMGIIst, TxMCaIst, TxMSCIst, and TxMInIst for the Growth and Income,
Capital Appreciation, Small-Cap, and International Funds Institutional Shares,
respectively.
<PAGE> 62
20

FINANCIAL HIGHLIGHTS

The following financial highlights tables are intended to help you understand
each Fund's financial performance since its inception (except for the
Tax-Managed Small-Cap and the Tax-Managed International Funds, which did not
start operations until February 22, 1999, and August 18, 1999, respectively),
and certain information reflects financial results for a single Fund share. The
total returns in each table represent the BEFORE-TAX rate that an investor would
have earned or lost each period on an investment in the Fund (assuming
reinvestment of all dividend and capital gains distributions, and complete
redemption at the end of the period). This information has been derived from the
financial statements audited by PricewaterhouseCoopers LLP, independent
accountants, whose report -- along with each Fund's financial statements -- is
included in the Funds' most recent annual report to shareholders. You may have
the annual report sent to you without charge by contacting Vanguard.

NOTE: This prospectus offers the Funds' Institutional Shares not the
Investor Shares. Information for the Investor Shares is shown here because each
of the Fund's Institutional Shares are new. However, the two share classes are
invested in the same portfolio of securities and will have the same financial
performance except to the extent that their operating expenses differ.

- --------------------------------------------------------------------------------

PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE

This explanation uses the Tax-Managed Capital Appreciation Fund Investor Shares
as an example. The Fund began fiscal 1998 with a net asset value (price) of
$20.18 per share. During the year, the Fund earned $.13 per share from
investment income (interest and dividends) and $5.51 per share from investments
that had appreciated in value or that were sold for higher prices than the Fund
paid for them.

Shareholders received $.13 per share in the form of dividend and capital
gains distributions. A portion of each year's distributions may come from the
prior year's income or capital gains.

The earnings ($5.64 per share) minus the distributions ($.13 per share)
resulted in a share price of $25.69 at the end of the year. This was an increase
of $5.51 per share (from $20.18 at the beginning of the year to $25.69 at the
end of the year). For a shareholder who reinvested the distributions in the
purchase of more shares, the total return from the Fund was 27.95% for the year.

As of December 31, 1998, the Fund had $1.48 billion in net assets. For the
year, its expense ratio was 0.19% ($1.90 per $1,000 of net assets); and its net
investment income amounted to 0.62% of its average net assets. It sold and
replaced securities valued at 5% of its net assets.

- -------------------------------------------------------------------------------
VANGUARD TAX-MANAGED CAPITAL APPRECIATION FUND
INVESTOR SHARES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, JULY 25* TO
---------------------------------------------------------- DEC. 31,
1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 20.18 $ 15.95 $ 13.28 $ 9.95 $ 10.00
INVESTMENT OPERATIONS
Net Investment Income .13 .11 .12 .08 .04
Net Realized and Unrealized Gain
(Loss) on Investments 5.51 4.24 2.66 3.34 (.05)
---------------------------------------------------------------------------------
Total from Investment Operations 5.64 4.35 2.78 3.42 (.01)
---------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (.13) (.12) (.11) (.09) (.04)
Distributions from Realized
Capital Gains -- -- -- -- --
---------------------------------------------------------------------------------
Total Distributions (.13) (.12) (.11) (.09) (.04)
- ----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 25.69 $ 20.18 $ 15.95 $ 13.2 $ 9.95
==================================================================================================================================

TOTAL RETURN** 27.95% 27.29% 20.92% 34.38% (0.50)%
==================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 1,479 $ 893 $ 517 $ 254 $ 70
Ratio of Total Expenses to Average
Net Assets 0.19% 0.17% 0.20% 0.20% 0.20%+
Ratio of Net Investment Income to
Average Net Assets 0.62% 0.70% 0.91% 0.97% 1.26%+
Turnover Rate 5% 4% 12% 7% 1%
==================================================================================================================================
</TABLE>

* Subscription period was July 25, 1994 through September 5, 1994, during which
time all assets were held in money market instruments. Performance
measurement began September 6, 1994.

** Total returns do not reflect the 2% redemption fee on shares held less than
one year or the 1% redemption fee on shares held at least one year but less
than five years.

+ Annualized.
<PAGE> 63
21

- --------------------------------------------------------------------------------
VANGUARD TAX-MANAGED GROWTH AND INCOME FUND INVESTOR SHARES

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, JULY 25* TO
----------------------------------------------------------------- DEC. 31,
1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 20.88 $ 15.89 $ 13.16 $ 9.77 $ 10.00
- -----------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .29 .29 .27 .25 .09
Net Realized and Unrealized Gain (Loss)
on Investments 5.67 4.98 2.74 3.39 (.23)
-------------------------------------------------------------------------------
Total from Investment Operations 5.96 5.27 3.01 3.64 (.14)
-------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.29) (.28) (.28) (.25) (.09)
Distributions from Realized Capital Gains -- -- -- -- --
-------------------------------------------------------------------------------
Total Distributions (.29) (.28) (.28) (.25) (.09)
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 26.55 $ 20.88 $ 15.89 $ 13.16 $ 9.77
===================================================================================================================================

TOTAL RETURN** 28.67% 33.31% 23.03% 37.53% (1.70)%
===================================================================================================================================

RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 1,352 $ 579 $ 235 $ 98 $ 31
Ratio of Total Expenses to Average Net A 0.19% 0.17% 0.20% 0.20% 0.20%+
Ratio of Net Investment Income to Average
Net Assets 1.32% 1.62% 2.04% 2.37% 2.82%+
Turnover Rate 4% 2% 7% 6% 0%
===================================================================================================================================
</TABLE>

* Subscription period was July 25, 1994 through September 5, 1994, during which
time all assets were held in money market instruments. Performance
measurement began September 6, 1994.

** Total returns do not reflect the 2% redemption fee on shares held less than
one year or the 1% redemption fee on shares held at least one year but less
than five years.

+ Annualized.

INVESTING WITH VANGUARD

Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information?

Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.

The following sections of the prospectus briefly explain the many services we
offer. Booklets providing detailed information are available on the services
marked with a [GRAPHIC OF BOOKLET]. Please call us to request copies.

SERVICES AND ACCOUNT FEATURES

Vanguard offers many services that make it convenient to buy, sell, or exchange
shares, or to obtain fund or account information.

- --------------------------------------------------------------------------------

TELEPHONE REDEMPTIONS (SALES AND EXCHANGES)
Automatically set up for these Funds unless you notify us otherwise.

- --------------------------------------------------------------------------------

VANGUARD AUTOMATIC EXCHANGE SERVICE(TM) [GRAPHIC OF BOOKLET]
Automatic method for moving a fixed amount of money from one Vanguard fund
account to another.

- --------------------------------------------------------------------------------

VANGUARD TELE-ACCOUNT(R) 1-800-662-6273 (ON-BOARD) [GRAPHIC OF BOOKLET]
Toll-free 24-hour access to Vanguard fund and account information -- as well as
some transactions -- by using any touch-tone phone. Tele-Account provides total
return, share price, price change, and yield quotations for all Vanguard funds;
gives your account balances and history (e.g., last transaction, latest dividend
distribution); and allows you to sell or exchange fund shares.

- --------------------------------------------------------------------------------

ACCESS VANGUARD(TM) www.vanguard.com [GRAPHIC OF COMPUTER MONITOR]
You can use your personal computer to perform certain transactions for most
Vanguard funds by accessing our website. To establish this service, you must
register through the website. We will then send to you, by mail, an account
access password that allows you to process the following financial and
administrative transactions online:

- - Open a new account.*

- - Buy, sell, or exchange shares of most funds.

- - Change your name/address.

- - Add/change fund options (including dividend options, bank instructions,
checkwriting, and Vanguard Automatic Exchange Service).

* Only current Vanguard shareholders can open a new account online, by
exchanging shares from other existing Vanguard accounts.

- --------------------------------------------------------------------------------

SERVICES FOR CLIENTS OF VANGUARD'S INSTITUTIONAL DIVISION: 1-888-809-8102
Vanguard's Institutional Division offers a variety of specialized services for
large institutional investors, including the ability to effect account
transactions through private electronic networks.

- --------------------------------------------------------------------------------

TYPES OF ACCOUNTS

Individuals and institutions can establish a variety of accounts with Vanguard.

- --------------------------------------------------------------------------------

FOR ONE OR MORE PEOPLE
Open an account in the name of one (individual) or more (joint tenants) people.

- --------------------------------------------------------------------------------

FOR HOLDING PERSONAL TRUST ASSETS [GRAPHIC OF BOOKLET]
Invest assets held in an existing personal
trust.

- --------------------------------------------------------------------------------

FOR AN ORGANIZATION [GRAPHIC OF BOOKLET]
Open an account as a corporation, partnership, endowment, foundation, or other
entity.

- --------------------------------------------------------------------------------
<PAGE> 65
23

A NOTE ON INVESTING WITH VANGUARD THROUGH OTHER FIRMS
You may purchase or sell Fund shares through a financial intermediary such as a
bank, broker, or investment adviser. If you invest with Vanguard through an
intermediary, please read that firm's program materials carefully to learn of
any special rules that may apply. For example, special terms may apply to
additional service features, fees, or other policies. Consult your intermediary
to determine when your order will be priced.

- --------------------------------------------------------------------------------

BUYING SHARES
You buy your shares at a Fund's next-determined net asset value after Vanguard
receives your request. As long as your request is received before the close of
trading on the New York Stock Exchange, generally 4 p.m. Eastern time, you will
buy your shares at that day's net asset value. You may convert Investor Shares
of a Fund into Institutional Shares provided that you meet the minimum initial
investment requirements for Institutional Shares.

- --------------------------------------------------------------------------------

MINIMUM INVESTMENT TO . . .
open a new account
$10 million

add to an existing account
$100 by mail or exchange; $1,000 by wire.

- --------------------------------------------------------------------------------

A NOTE ON PURCHASE FEES
The Tax-Managed Small-Cap and Tax-Managed International Funds deduct a 1% fee
and a 0.75% fee, respectively, from all purchases (including exchanges from
other Vanguard funds), but not from reinvested dividends or capital gains.

- --------------------------------------------------------------------------------

BY WIRE TO OPEN A NEW ACCOUNT OR ADD TO AN EXISTING ACCOUNT
Call your assigned Service Associate to arrange your wire transaction.

Wire to:
FRB ABA 021001088
HSBC Bank USA

For credit to:
Account: 000112046
Vanguard Incoming Wire Account

In favor of:
Vanguard Tax-Managed Growth and Income Fund Institutional Shares - 136

Vanguard Tax-Managed Capital Appreciation Fund Institutional Shares - 135

Vanguard Tax-Managed Small-Cap Fund Institutional Shares - 118

Vanguard Tax-Managed International Fund Institutional Shares - 137

[Account number, or temporary number for a new account]

[Registered account owner/s]

[Registered address]

- --------------------------------------------------------------------------------

BY MAIL TO . . . [GRAPHIC OF ENVELOPE]
open a new account
Complete and sign the application form and enclose your check.

add to an existing account
Mail your check with an Invest-By-Mail form detached from your confirmation
statement to the address listed on the form.
<PAGE> 66
24

BUYING SHARES (continued)

Make your check payable to: The Vanguard Group (insert appropriate Fund number;
see below):

Vanguard Tax-Managed Growth and Income Fund Institutional Shares - 136

Vanguard Tax-Managed Capital Appreciation Fund Institutional Shares - 135

Vanguard Tax-Managed Small-Cap Fund Institutional Shares - 118

Vanguard Tax-Managed International Fund Institutional Shares - 137

All purchases must be made in U.S. dollars, and checks must be drawn on U.S.
banks.

<TABLE>
<CAPTION>
<S> <C>
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 100 Vanguard Boulevard
Valley Forge, PA 19482-2900 Malvern, PA 19355
</TABLE>

- --------------------------------------------------------------------------------

IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.

- --------------------------------------------------------------------------------

By Telephone to . . . [GRAPHIC OF TELEPHONE RECEIVER]
open a new account
Call Vanguard Tele-Account* 24 hours a day -- or your assigned Vanguard
Associate during business hours -- to exchange from another Vanguard fund
account with the same registration (name, address, taxpayer identification
number, and account type).

add to an existing account
Call Vanguard Tele-Account* 24 hours a day -- or your assigned Vanguard
Associate during business hours -- to exchange from another Vanguard fund
account with the same registration (name, address, taxpayer identification
number, and account type).

Vanguard Tele-Account
1-800-662-6273
* You must obtain a Personal Identification Number through Tele-Account at
least seven days before you request your first exchange.

- --------------------------------------------------------------------------------

IMPORTANT NOTE: Once you've requested a telephone transaction and a confirmation
number has been assigned, the transaction cannot be revoked. We reserve the
right to refuse any purchase request.

- --------------------------------------------------------------------------------

You can redeem (that is, sell or exchange) shares purchased by check at any
time. However, while your redemption request will be processed at the
next-determined net asset value after it is received, your redemption proceeds
will not be available until payment for your purchase is collected, which may
take up to ten calendar days.

- --------------------------------------------------------------------------------

A NOTE ON LARGE PURCHASES
It is important that you call Vanguard before you invest a large dollar amount.
We must consider the interests of all Fund shareholders and so reserve the right
to refuse any purchase that will disrupt a Fund's operation or performance.

- --------------------------------------------------------------------------------

REDEEMING SHARES
This section describes how you can redeem -- that is, sell or exchange -- a
Fund's shares.

When Selling Shares:

- - Vanguard sends the redemption proceeds to you or a designated third party.*

- - You can sell all or part of your Fund shares at any time.

* Proceeds made payable to third parties or sent to a different address require
a signature guarantee; see footnote on page 26.

When Exchanging Shares:

- - The redemption proceeds are used to purchase shares of a different Vanguard
fund.

- - You must meet the receiving fund's minimum investment requirements.

- - Vanguard reserves the right to revise or terminate the exchange privilege,
limit the amount of an exchange, or reject an exchange at any time, without
notice.
<PAGE> 67
25

- --------------------------------------------------------------------------------

A NOTE ON REDEMPTION FEES

Each Fund imposes a 2% redemption fee on shares that are redeemed by any method
within one year of purchase. Each Fund imposes a 1% redemption fee on shares
that are redeemed by any method after one year but within five years of
purchase. Currently, redemption fees do not apply to Fund shares held through
Vanguard's separate recordkeeping system for employee benefit plan accounts, due
to certain economies associated with these accounts. However, the Funds reserve
the right to impose redemption fees on their shares at any time if warranted by
the Funds' future costs of processing redemptions from these accounts.

- --------------------------------------------------------------------------------

NOTE: Once a redemption is requested and a confirmation number given, the
transaction CANNOT be canceled.

- --------------------------------------------------------------------------------

HOW TO REQUEST A REDEMPTION

You can request a redemption from your Fund account in any one of three ways:
online, by telephone, or by mail.

- --------------------------------------------------------------------------------

ONLINE REQUESTS [COMPUTER MONITOR GRAPHIC]

Access Vanguard at www.vanguard.com
You can use your personal computer to sell or exchange shares of most Vanguard
funds by accessing our website. To establish this service, you must register
through the website. We will then send you, by mail, an account access password
that will enable you to sell or exchange shares online (as well as perform other
transactions).

- --------------------------------------------------------------------------------

TELEPHONE REQUESTS [TELEPHONE RECEIVER GRAPHIC]

Call Vanguard Tele-Account 24 hours a day -- or your assigned Vanguard Associate
during business hours -- to sell or exchange shares. You can exchange shares
from this Fund to open an account in another Vanguard fund or to add to an
existing Vanguard fund account with an identical registration.

- --------------------------------------------------------------------------------
SPECIAL INFORMATION: We will automatically establish the telephone redemption
option for your account, unless you instruct us otherwise in writing. While
telephone redemption is easy and convenient, this account feature involves a
risk of loss from unauthorized or fraudulent transactions. Vanguard will take
reasonable precautions to protect your account from fraud. You should do the
same by keeping your account information private and immediately reviewing any
account statements that we send to you. Make sure to contact Vanguard
immediately about any transaction you believe to be unauthorized.

- --------------------------------------------------------------------------------

We reserve the right to refuse a telephone redemption if the caller is unable to
provide:

[GRAPHIC OF CHECK MARK] The ten-digit account number.

[GRAPHIC OF CHECK MARK] The name and address exactly as registered on the
account.

[GRAPHIC OF CHECK MARK] The primary Social Security or employer
identification number as registered on the account.

[GRAPHIC OF CHECK MARK] The Personal Identification Number, if applicable.

Please note that Vanguard will not be responsible for any account losses due
to telephone fraud, so long as we have taken reasonable steps to verify the
caller's identity. If you wish to remove the telephone redemption feature from
your account, please notify us in writing.

- --------------------------------------------------------------------------------
<PAGE> 68
26

REDEEMING SHARES (continued)

- --------------------------------------------------------------------------------

A NOTE ON UNUSUAL CIRCUMSTANCES

Vanguard reserves the right to revise or terminate the telephone redemption
privilege at any time, without notice. In addition, Vanguard can stop selling
shares or postpone payment at times when the New York Stock Exchange is closed
or under any emergency circumstances as determined by the U.S. Securities and
Exchange Commission. If you experience difficulty making a telephone redemption
during periods of drastic economic or market change, you can send us your
request by regular or express mail. Follow the instructions on selling or
exchanging shares by mail in this section.

- --------------------------------------------------------------------------------

MAIL REQUESTS [GRAPHIC OF ENVELOPE]

Send a letter of instruction signed by all registered account holders. Include
the fund name and account number and (if you are selling) a dollar amount or
number of shares OR (if you are exchanging) the name of the fund you want to
exchange into and a dollar amount or number of shares. To exchange into an
account with a different registration (including a different name, address,
taxpayer identification number, or account type), you must provide Vanguard with
written instructions that include the guaranteed signatures of all current
owners of the fund from which you wish to redeem.

- --------------------------------------------------------------------------------

A NOTE ON LARGE REDEMPTIONS

It is important that you call Vanguard before you redeem a large dollar amount.
We must consider the interests of all fund shareholders and so reserve the right
to delay delivery of your redemption proceeds -- up to seven days -- if the
amount will disrupt the Fund's operation or performance.

- --------------------------------------------------------------------------------

OPTIONS FOR REDEMPTION PROCEEDS

You may receive your redemption proceeds in one of two ways: check, or exchange
to another Vanguard fund.

- --------------------------------------------------------------------------------

CHECK REDEMPTIONS

Normally, Vanguard will mail your check within two business days of a
redemption.

- --------------------------------------------------------------------------------

EXCHANGE REDEMPTIONS

As described above, an exchange involves using the proceeds of your redemption
to purchase shares of another Vanguard fund.

- --------------------------------------------------------------------------------

FOR OUR MUTUAL PROTECTION

For your best interests and ours, Vanguard applies these additional requirements
to redemptions.

REQUEST IN "GOOD ORDER"

All redemption requests must be received by Vanguard in "good order." This means
that your request must include:

[GRAPHIC OF CHECK MARK] The Fund name and account number.

[GRAPHIC OF CHECK MARK] The amount of the transaction (in dollars or shares).

[GRAPHIC OF CHECK MARK] Signatures of all owners exactly as registered on the
account (for mail requests).

[GRAPHIC OF CHECK MARK] Signature guarantees (if required).*

[GRAPHIC OF CHECK MARK] Any supporting legal documentation that may be
required.

[GRAPHIC OF CHECK MARK] Any outstanding certificates representing shares to
be redeemed.

* For instance, a signature guarantee must be provided by all registered
account shareholders when redemption proceeds are to be sent to a different
person or address. A signature guarantee can be obtained from most banks,
credit unions, and licensed brokers.

TRANSACTIONS ARE PROCESSED AT THE NEXT-DETERMINED SHARE PRICE AFTER VANGUARD HAS
RECEIVED ALL REQUIRED INFORMATION.

- --------------------------------------------------------------------------------
<PAGE> 69
27

- --------------------------------------------------------------------------------

LIMITS ON ACCOUNT ACTIVITY

Because excessive account transactions can disrupt management of a Fund and
increase a Fund's costs for all shareholders, Vanguard limits account activity
as follows:

- - You may make no more than TWO SUBSTANTIVE "ROUND TRIPS" THROUGH A FUND during
any 12-month period.

- - Your round trips through a Fund must be at least 30 days apart.

- - A Fund may refuse a share purchase at any time, for any reason.

- - Vanguard may revoke an investor's telephone exchange privilege at any time,
for any reason.

A "round trip" is a redemption from a Fund followed by a purchase back into a
Fund. Also, "round trip" covers transactions accomplished by any combination of
methods, including transactions conducted by check, wire, or exchange to/from
another Vanguard fund. "Substantive" means a dollar amount that Vanguard
determines, in its sole discretion, could adversely affect the management of a
Fund.

- --------------------------------------------------------------------------------

ALL TRADES FINAL

Vanguard will not cancel any transaction request (including any purchase or
redemption) that we believe to be authentic once the request has been received
and a confirmation number assigned.

- --------------------------------------------------------------------------------

TRANSFERRING REGISTRATION

You can transfer the registration of your Fund shares to another owner by
completing a transfer form and sending it to Vanguard.

<TABLE>
<CAPTION>
<S> <C>
First-class mail to: Express or Registered mail to:
The Vanguard Group The Vanguard Group
P.O. Box 2900 455 Devon Park Drive
Valley Forge, PA 19482-2900 Wayne, PA 19087-1815
</TABLE>

- --------------------------------------------------------------------------------

FUND AND ACCOUNT UPDATES

STATEMENTS AND REPORTS

We will send you account and tax statements to help you keep track of your Fund
account throughout the year as well as when you are preparing your income tax
returns.

In addition, you will receive financial reports about the Fund twice a year.
These comprehensive reports include an assessment of the Fund's performance (and
a comparison to its industry benchmark), an overview of the markets, a report
from the advisers, and the Fund's financial statements which include a listing
of the Fund's holdings.

To keep the Fund's costs as low as possible (so that you and other
shareholders can keep more of the Fund's investment earnings), Vanguard attempts
to eliminate duplicate mailings to the same address. When we find that two or
more Fund shareholders have the same last name and address, we send just one
Fund report to that address -- instead of mailing separate reports to each
shareholder. If you want us to send separate reports, however, you may notify
our Institutional Division at 1-888-809-8102.

- --------------------------------------------------------------------------------

CONFIRMATION STATEMENT

Sent each time you buy, sell, or exchange shares; confirms the trade date and
the amount of your transaction.

- --------------------------------------------------------------------------------

PORTFOLIO SUMMARY [GRAPIC OF BOOKLET]

Mailed quarterly for most accounts; shows the market value of your account at
the close of the statement period, as well as distributions, purchases, sales,
and exchanges for the current calendar year.

- --------------------------------------------------------------------------------
<PAGE> 70
28

Fund And Account Updates (continues)

- --------------------------------------------------------------------------------

FUND FINANCIAL REPORTS

Mailed in February and August for these Funds.

- --------------------------------------------------------------------------------

TAX STATEMENTS

Generally mailed in January; report previous year's taxable dividend and capital
gains distributions, and proceeds from the sale of shares.

- --------------------------------------------------------------------------------

AVERAGE COST REVIEW STATEMENT [GRAPHIC OF BOOKLET]

Issued quarterly for most taxable accounts (accompanies your Portfolio Summary);
shows the average cost of shares that you redeemed during the calendar year,
using the average cost single category method.

- --------------------------------------------------------------------------------

MANDATORY CONVERSION TO INVESTOR SHARES

The Funds reserve the right to convert an investor's Institutional Shares into
Investor Shares of a Fund if the investor's account balance falls below $10
million. Any such conversion will be preceded by written notice to the
investor.

<PAGE> 71
GLOSSARY OF INVESTMENT TERMS

ACTIVE MANAGEMENT

CAPITAL GAINS DISTRIBUTION

Payment to mutual fund shareholders of gains realized on securities that the
fund has sold at a profit, minus any realized losses.

CASH RESERVES

Cash deposits, short-term bank deposits, and money market instruments which
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's acceptances.

COMMON STOCK

A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.

DIVIDEND INCOME

Payment to shareholders of income from interest or dividends generated by a
fund's investments.

DOLLAR-COST AVERAGING

Investing equal amounts of money at regular intervals on an ongoing basis. This
technique ensures that an investor buys fewer shares when prices are high and
more shares when prices are low.

EXPENSE RATIO

The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
distribution fees.

FUND DIVERSIFICATION

Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.

INVESTMENT ADVISER

An organization that makes the day-to-day decisions regarding a fund's
investments.

MUTUAL FUND

An investment company that pools the money of many people and invests it in a
variety of securities in an effort to achieve a specific objective over time.

NET ASSET VALUE (NAV)

The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.

PASSIVE MANAGEMENT

A low-cost investment strategy in which a mutual fund attempts to match --
rather than outperform -- a particular stock or bond market index. Also known as
indexing.

PRICE/EARNINGS (P/E) RATIO

The current share price of a stock, divided by its per-share earnings (profits)
from the past year. A stock selling for $20, with earnings of $2 per share, has
a price/earnings ratio of 10.

PRINCIPAL

The amount of your own money you put into an investment.

TOTAL RETURN

VOLATILITY

The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.

YIELD

Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE> 72
[THE VANGUARD GROUP LOGO]
Institutional Division
Post Office Box 2900
Valley Forge, PA 19482-2900

FOR MORE INFORMATION

If you'd like more information about Vanguard Tax-Managed Funds, the following
documents are available free upon request:

ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS

STATEMENT OF ADDITIONAL INFORMATION (SAI)

The SAI provides more information about the Funds.

The current annual and semiannual reports and the SAI are incorporated by
reference into (and are thus legally a part of) this prospectus.

To receive a free copy of the latest annual or semiannual report or the SAI, or
to request additional information about the Funds or other Vanguard funds,
please contact us as follows:

If you are an Individual Investor:

THE VANGUARD GROUP
INVESTOR INFORMATION DEPARTMENT
P.O. BOX 2900
VALLEY FORGE, PA 19482-2900

TELEPHONE:
1-800-662-7447 (SHIP)

TEXT TELEPHONE:
1-800-952-3335

If you are a client of Vanguard's Institutional Division:

THE VANGUARD GROUP
INSTITUTIONAL INVESTOR INFORMATION
P.O. BOX 2900
VALLEY FORGE, PA 19482-2900

TELEPHONE:
1-888-809-8102

WORLD WIDE WEB:
WWW.VANGUARD.COM

If you are a current Fund shareholder and would like information about your
account, account transactions, and/or account statements, please call:

CLIENT SERVICES DEPARTMENT TELEPHONE:
1-800-662-2739 (CREW)

TEXT TELEPHONE:
1-800-749-7273

INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC)

You can review and copy information about the Funds (including the SAI) at the
SEC's Public Reference Room in Washington, D.C. To find out more about this
public service, call the SEC at 1-800-SEC-0330. Reports and other information
about the Funds are also available on the SEC's website (www.sec.gov), or you
can receive copies of this information, for a fee, by writing the Public
Reference Section, Securities and Exchange Commission, Washington, DC
20549-6009.

Funds' Investment Company Act file number: 811-07175

I087N - 08/18/1999

<PAGE> 73

PART B

VANGUARD TAX-MANAGED FUNDS
(THE "TRUST")

STATEMENT OF ADDITIONAL INFORMATION

AUGUST 18, 1999

This Statement is not a prospectus but should be read in conjunction with
the Trust's current Prospectuses (dated August 18, 1999). To obtain the
Prospectuses or an additional Annual Report to Shareholders, which contains the
Funds' Financial Statements as hereby incorporated by reference, please call the
Investor Information Department:

1-800-662-7447 (SHIP)

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Description of the Trust.................................... B-1
Investment Policies......................................... B-3
Purchase of Shares.......................................... B-8
Redemption of Shares........................................ B-8
Share Price................................................. B-10
Fundamental Investment Limitations.......................... B-10
Management of the Trust..................................... B-12
Portfolio Transactions...................................... B-16
Performance Measures........................................ B-16
Yield and Total Return...................................... B-19
Financial Statements........................................ B-20
Appendix A -- Description of Municipal Bonds and their
Ratings................................................... B-21
</TABLE>

DESCRIPTION OF THE TRUST

ORGANIZATION

The Trust was organized as a Maryland corporation in 1994, and was
reorganized as a Delaware business trust in June, 1998. Prior to its
reorganization as a Delaware business trust, the Trust was known as Vanguard
Tax-Managed Fund, Inc. The Trust is registered with the United States Securities
and Exchange Commission under the Investment Company Act of 1940 (the "1940
Act") as an open-end diversified management investment company. It currently
offers the following funds:

Vanguard Tax-Managed Balanced Fund
Vanguard Tax-Managed Growth and Income Fund
Vanguard Tax-Managed Capital Appreciation Fund
Vanguard Tax-Managed Small-Cap Fund
Vanguard Tax-Managed International Fund
(individually, the "Fund"; collectively, the "Funds")

Each of the funds offers two classes of shares, Investor Shares and
Institutional Shares, with the exception of Vanguard Tax-Managed Balanced Fund
which offers only Investor Shares.

The Trust has the ability to offer additional funds or classes of shares. There
is no limit on the number of full and fractional shares that the Trust may issue
for a single fund or class of shares.

B-1
<PAGE> 74

SERVICE PROVIDERS

CUSTODIAN. The Chase Manhattan Bank, N.A., 4 Chase MetroTech Center,
Brooklyn, New York 11245 and Brown Brothers Harriman & Co., 40 Water Street,
Boston, Massachusetts 02109, serve as the Trust's custodians. The custodians are
responsible for maintaining the Trust's assets and keeping all necessary
accounts and records.

INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, 30 South 17th Street,
Philadelphia, Pennsylvania 19103, serves as the Trust's independent accountants.
The accountants audit the Trust's financial statements and provide other related
services.

TRANSFER AND DIVIDEND-PAYING AGENT. The Funds' transfer agent and
dividend-paying agent is The Vanguard Group, Inc., 100 Vanguard Boulevard,
Malvern, Pennsylvania 19355.

CHARACTERISTICS OF THE TRUST'S SHARES

RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions
on the right of shareholders to retain or dispose of the Trust's shares, other
than the possible future termination of the Trust or any of its funds. The Trust
or any of its funds may be terminated by reorganization into another mutual fund
or by liquidation and distribution of the assets of the affected fund. Unless
terminated by reorganization or liquidation, the Trust and its funds will
continue indefinitely.

SHAREHOLDER LIABILITY. The Trust is organized under Delaware law, which
provides that shareholders of a business trust are entitled to the same
limitations of personal liability as shareholders of a corporation organized
under Delaware law. Effectively, this means that a shareholder of the Trust will
not be personally liable for payment of the Trust's debts except by reason of
his or her own conduct or acts. In addition, a shareholder could incur a
financial loss on account of a Trust obligation only if the Trust itself had no
remaining assets with which to meet such obligation. We believe that the
possibility of such a situation arising is extremely remote.

DIVIDEND RIGHTS. The shareholders of a fund are entitled to receive any
dividends or other distributions declared for such fund. No shares have priority
or preference over any other shares of the same fund with respect to
distributions. Distributions will be made from the assets of a fund, and will be
paid ratably to all shareholders of the fund (or class) according to the number
of shares of such fund (or class) held by shareholders on the record date. The
amount of income dividends per share may vary between separate share classes of
the same fund based upon differences in the way that expenses are allocated
between share classes pursuant to a multiple class plan.

VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (i) a
shareholder vote is required under the 1940 Act; (ii) the matter concerns an
amendment to the Declaration of Trust that would adversely affect to a material
degree the rights and preferences of the shares of any class or fund; or (iii)
the Trustees determine that it is necessary or desirable to obtain a shareholder
vote. The 1940 Act requires a shareholder vote under various circumstances,
including to elect or remove Trustees upon the written request of shareholders
representing 10% or more of the Trust's net assets, and to change any
fundamental policy of the Trust. Shareholders of the Trust receive one vote for
each dollar of net asset value owned on the record date, and a fractional vote
for each fractional dollar of net asset value owned on the record date. However,
only the shares of the fund affected by a particular matter are entitled to vote
on that matter. Voting rights are non-cumulative and cannot be modified without
a majority vote.

LIQUIDATION RIGHTS. In the event of liquidation, shareholders will be
entitled to receive a pro rata share of the net assets of applicable funds of
the Trust.

PREEMPTIVE RIGHTS. There are no preemptive rights associated with shares
of the Trust.

CONVERSION RIGHTS. Shareholders of the Trust may convert their shares into
another class of shares of the same fund upon the satisfaction of any then
applicable eligibility requirements.

B-2
<PAGE> 75

REDEMPTION PROVISIONS. The Trust's redemption provisions are described in
its current prospectus and elsewhere in this Statement of Additional
Information.

SINKING FUND PROVISIONS. The Trust has no sinking fund provisions.

CALLS OR ASSESSMENT. The Trust's shares, when issued, are fully paid and
non-assessable.

TAX STATUS OF THE TRUST

Each Fund of the Trust intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code. This special tax
status means that a fund will not be liable for federal tax on income and
capital gains distributed to shareholders. In order to preserve its tax status,
each Fund of the Trust must comply with certain requirements. If a fund fails to
meet these requirements in any taxable year, it will be subject to tax on its
taxable income at corporate rates, and all distributions from earnings and
profits, including any distributions of net tax-exempt income and net long-term
capital gains, will be taxable to shareholders as ordinary income. In addition,
the fund could be required to recognize unrealized gains, pay substantial taxes
and interest, and make substantial distributions before regaining its tax status
as a regulated investment company.

INVESTMENT POLICIES

The following policies supplement the investment policies set forth in the
Trust's Prospectus:

REPURCHASE AGREEMENTS

Each Fund of the Trust may invest in repurchase agreements with commercial
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 a Fund acquires a fixed-income security (generally a
security issued by the U.S. Government or an agency thereof, a banker's
acceptance or a certificate of deposit) from a 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 Fund and is
unrelated to the interest rate on the underlying instrument. In these
transactions, the securities acquired by the Fund (including 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
Trust's Board of Trustees will monitor each Fund's repurchase agreement
transactions generally and will establish guidelines and standards for review by
the investment adviser of the creditworthiness of any bank, broker or dealer
party to a repurchase agreement with the Fund.

The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Fund may incur a loss upon disposition of the security. If the other party to
the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Fund not within its control
and therefore the realization by the Fund on such collateral may be
automatically stayed. Finally, it is possible that the Fund may not be able to
substantiate its interest in the underlying security and may be deemed an
unsecured creditor of the other party to the agreement. While each Fund's
management acknowledges these risks, it is expected that they can be controlled
through careful monitoring procedures.

LENDING OF SECURITIES

Each Fund of the Trust may lend its investment securities to qualified
institutional investors (typically brokers, dealers, banks or other financial
institutions) who need to borrow securities in order to complete certain
transactions, such as covering short sales, avoiding failures to deliver
securities or
B-3
<PAGE> 76

completing arbitrage operations. By lending its investment securities, a Fund
attempts to increase its net investment income through the receipt of interest
on the loan. Any gain or loss in the market price of the securities loaned that
might occur during the term of the loan would be for the account of the Fund.
The terms and the structure and the aggregate amount of such loans must be
consistent with the Investment Company Act of 1940, and the Rules and
Regulations or interpretations of the Securities and Exchange Commission (the
"Commission") thereunder. These provisions limit the amount of securities a fund
may lend to 33 1/3% of the fund's total assets, and require that (a) the
borrower pledge and maintain with the Fund collateral consisting of cash, an
irrevocable letter of credit or securities issued or guaranteed by the United
States Government having at all times not less than 100% of the value of the
securities loaned, (b) the borrower add to such collateral whenever the price of
the securities loaned rises (i.e., the borrower "marks to the market" on a daily
basis), (c) the loan be made subject to termination by the Fund at any time, and
(d) the Fund receive reasonable interest on the loan (which may include the
Fund's investing any cash collateral in interest bearing short-term
investments), any distribution on the loaned securities and any increase in
their market value. Loan arrangements made by each Fund will comply with all
other applicable regulatory requirements, including the rules of the New York
Stock Exchange, which presently require the borrower, after notice, to redeliver
the securities within the normal settlement time of three business days. All
relevant facts and circumstances, including the creditworthiness of the broker,
dealer or institution, will be considered in making decisions with respect to
the lending of securities, subject to review by the Trust's Board of Trustees.

At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's Trustees. In addition, voting rights pass
with the loaned securities, but if a material event will occur affecting an
investment on loan, the loan must be called and the securities voted.

VANGUARD INTERFUND LENDING PROGRAM

The SEC has issued an exemptive order permitting the Funds to participate
in Vanguard's interfund lending program. This program allows the Vanguard funds
to borrow money from and loan money to each other for temporary or emergency
purposes. The program is subject to a number of conditions, including the
requirement that no fund may borrow or lend money through the program unless it
receives a more favorable interest rate than is available from a typical bank
for a comparable transaction. In addition, a fund may participate in the program
only if and to the extent that such participation is consistent with the fund's
investment objective and other investment policies. The Boards of Trustees of
the Vanguard funds are responsible for ensuring that the interfund lending
program operates in compliance with all conditions of the SEC's exemptive order.

ILLIQUID SECURITIES

Each Fund may invest up to 15% of its net assets in illiquid securities.
Illiquid securities are securities that may not be sold or disposed of in the
ordinary course of business within seven business days at approximately the
value at which they are being carried on the Fund's books.

Each Fund may invest in restricted, privately placed securities that, under
SEC rules, may be sold only to qualified institutional buyers. Because these
securities can be resold only to qualified institutional buyers, they may be
considered illiquid securities -- meaning that they could be difficult for the
Fund to convert to cash if needed.

If a substantial market develops for a restricted security held by the
Fund, it will be treated as a liquid security, in accordance with procedures and
guidelines approved by the Trust's Board of Trustees. While the Fund's
investment adviser determines the liquidity of restricted securities on a daily
basis, the Board oversees and retains ultimate responsibility for the adviser's
decisions. Several factors the Board considers in monitoring these decisions
include the valuation of a security, the availability of qualified institutional
buyers, and the availability of information about the security's issuer.

B-4
<PAGE> 77

FUTURES CONTRACTS, OPTIONS ON FUTURES CONTRACTS, WARRANTS, CONVERTIBLE
SECURITIES AND SWAP AGREEMENTS

Each 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 management 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 maturity date and
underlying financial instrument are traded on national futures exchanges.
Futures exchanges and trading are regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission ("CFTC"), a U.S. Government agency.
Assets committed to futures contracts will be segregated to the extent required
by law.

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
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums.

After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Funds
expect to earn interest income on their initial margin deposits.

Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the prices of underlying securities. The Funds intend to use futures contracts
for bona fide hedging purposes only.

Although techniques other than the sale and purchase of futures contracts
could be used to control a Fund's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure.

RESTRICTIONS ON THE USE OF FUTURES CONTRACTS

A Fund will not enter into futures contract transactions to the extent
that, immediately thereafter, the sum of its initial margin deposits on open
contracts exceeds 3% of the market value of the Fund's total assets. In
addition, a Fund will not enter into futures contracts to the extent that its
outstanding obligations to purchase securities under these contracts would
exceed 5% 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 assurance
that a liquid secondary market will exist for any particular futures contract at
any specific time. Thus, it may not be possible to close a futures position. In
the event of adverse price movements, a Fund would continue to be required to
make daily
B-5
<PAGE> 78

cash payments to maintain its required margin. In such situations, if the Fund
has insufficient cash, it may have to sell portfolio securities to meet daily
margin requirements at a time when it may be disadvantageous to do so. In
addition, a Fund may be required to make delivery of the instruments underlying
futures contracts it holds. The inability to close options and futures positions
also could have an adverse impact on the ability to effectively hedge.

A Fund will minimize the risk that it will be unable to close out a futures
contract by only entering into futures which are traded on national futures
exchanges and for which there appears to be a liquid secondary market.

The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of a Fund are engaged in only for hedging purposes, the Adviser does
not believe that the Funds are subject to the risks of loss frequently
associated with futures transactions. A Fund would presumably have sustained
comparable losses if, instead of the futures contract, it had invested in the
underlying financial instrument and sold it after the decline.

Utilization of futures transactions by a Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that a Fund could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by each Fund of margin deposits in the event of bankruptcy of a
broker with whom a Fund has an open position in a futures contract or related
option.

Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of future positions and subjecting some futures
traders to substantial losses.

OTHER TYPES OF DERIVATIVES

In addition to futures and options, a Fund 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 separately 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 position 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
anticipated changes in interest rates. Derivatives may be structured with no or
a high degree of leverage. When derivatives are used as hedges, the risk
incurred 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
B-6
<PAGE> 79

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 Funds will only utilize derivatives for
hedging or arbitrage purposes, and not for speculative purposes.
Over-the-counter derivatives 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 Fund has identified as hedging transactions, a
Fund is required for Federal income tax purposes to recognize as income for each
taxable year its net unrealized gains and losses on certain futures contracts as
of 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 a Fund may affect the holding period of such
securities and, consequently, the nature of the gain or loss on such securities
upon disposition. A Fund may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Fund.

In order for a Fund to continue to qualify for Federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income; i.e., dividends, interest,
income derived from loans of securities, gains from the sale of securities or of
foreign currencies or other income derived with respect to the Fund's business
of investing in securities. It is anticipated that any net gain realized from
the closing out of futures contracts will be considered qualifying income for
purposes of the 90% requirement.

A Fund will distribute to shareholders annually any net capital gains which
have been recognized for Federal income tax purposes including unrealized gains
at the end of the Fund's fiscal year on futures transactions. Such distributions
will be combined with distributions of capital gains realized on the Fund's
other investments and shareholders will be advised on the nature of the
transactions.

FOREIGN INVESTMENTS

Vanguard Tax-Managed International Fund, which shall invest no less than
65% of its assets in foreign securities, invests in stocks included in the
Morgan Stanley Capital International EAFE Index, which is comprised of over
1,000 securities listed on the stock exchanges of countries in Europe,
Australia, Asia, and the Far East.

CURRENCY RISK

Since the stocks of foreign companies are frequently denominated in foreign
currencies, and since the Fund may temporarily hold uninvested reserves in bank
deposits in foreign currencies, the Fund will be affected favorably or
unfavorably by changes in currency rates and in exchange control regulations,
and may incur costs in connection with conversions between various currencies.
The Fund is authorized to enter into forward foreign currency exchange
contracts. Such contracts involve an obligation to purchase or sell a specific
currency at a future date at a price set at the time of the contract. The Fund
intends to enter into such contracts primarily to gain currency exposure when
investing in stock index futures, and to settle trades in a foreign currency,
and generally will not do so to avoid changes in the portfolio's value caused by
changes in currency exchange rates.

FEDERAL TAX TREATMENT OF NON-U.S. TRANSACTIONS

Special rules govern the Federal income tax treatment of certain
transactions denominated in terms of a currency other than the U.S. dollar or
determined by reference to the value of one or more currencies other than the
U.S. dollar. The types of transactions covered by the special rules include the
following: (i) the acquisition of, or becoming the obligor under, a bond or
other debt instrument (including, to the

B-7
<PAGE> 80

extent provided in Treasury regulations, preferred stock); (ii) the accruing of
certain trade receivables and payables; and (iii) the entering into or
acquisition of any forward contract, futures contract, option and similar
financial instrument if such instrument is not marked to market. The disposition
of a currency other than the U.S. dollar by a U.S. taxpayer is also treated as a
transaction subject to the special currency rules. However, foreign
currency-related regulated futures contracts and nonequity options are generally
not subject to the special currency rules if they are or would be treated as
sold for their fair market value at year-end under the marking-to-market rules
applicable to other futures contracts unless an election is made to have such
currency rules apply. With respect to transactions covered by the special rules,
foreign currency gain or loss is calculated separately from any gain or loss on
the underlying transaction and is normally taxable as ordinary gain or loss. A
taxpayer may elect to treat as capital gain or loss foreign currency gain or
loss arising from certain identified forward contracts, futures contracts and
options that are capital assets in the hands of the taxpayer and which are not
part of a straddle. The Treasury Department issued regulations under which
certain transactions subject to the special currency rules that are part of a
"section 988 hedging transaction" (as defined in the Internal Revenue Code of
1986, as amended, and the Treasury regulations) will be integrated and treated
as a single transaction or otherwise treated consistently for purposes of the
Code. Any gain or loss attributable to the foreign currency component of a
transaction engaged in by a Fund which is not subject to the special currency
rules (such as foreign equity investments other than certain preferred stocks)
will be treated as capital gain or loss and will not be segregated from the gain
or loss on the underlying transaction. It is anticipated that some of the
non-U.S. dollar-denominated investments and foreign currency contracts Vanguard
Tax-Managed International Fund may make or enter into will be subject to the
special currency rules described above.

FOREIGN TAX CREDIT

Foreign governments may withhold taxes on dividends and interest paid with
respect to foreign securities. Foreign governments may also impose taxes on
other payments or gains with respect to foreign securities. If, at the close of
its fiscal year, more than 50% of a Fund's total assets are invested in
securities of foreign issuers, the Fund may elect to pass through foreign taxes
paid, and thereby allow shareholders to take a tax credit or deduction on their
tax returns. If shareholders meet certain holding period requirements with
respect to Fund shares, an offsetting tax credit may be available. If
shareholders do not meet the holding period requirements, they may still be
entitled to a deduction for certain foreign taxes. In either case, a
shareholder's tax statement will show more taxable income or capital gains than
were actually distributed by the Fund, but will also show the amount of the
available offsetting credit or deduction.

A shareholder that is a nonresident alien for U.S. tax purposes may be
subject to adverse U.S. tax consequences. For example, dividends and short-term
capital gains paid by the Fund will generally be subject to U.S. federal
withholding tax at a rate of 30% (or lower treaty rate if applicable). Foreign
investors are urged to consult their tax advisers regarding the U.S. tax
treatment of ownership of shares in the Fund.

COUNTRY RISK

As foreign companies are not generally subject to uniform accounting,
auditing and financial reporting standards and practices comparable to those
applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more volatile
than securities of comparable domestic companies. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
companies than in the U.S. In addition, with respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
U.S. investments in those countries.

Although the Fund will endeavor to achieve most favorable execution costs
in its portfolio transactions, fixed commissions on many foreign stock exchanges
are generally higher than negotiated commis-
B-8
<PAGE> 81

sions on U.S. exchanges. In addition, it is expected that the expenses for
custodian arrangements of the Fund's foreign securities will be somewhat greater
than the expenses for the custodian arrangements for handling U.S. securities of
equal value.

Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income received from foreign companies held by the Fund. However, these
foreign withholding taxes are not expected to have a significant impact on the
Fund, since the Fund seeks long-term capital appreciation and any income should
be considered incidental.

NON-INVESTMENT GRADE PURCHASES

The Balanced Fund will invest 50-55% of its assets in municipal securities
which provide interest exempt from Federal income taxes.

The Fund may invest in municipal securities that are subject to the
Alternative Minimum Tax (AMT). Certain tax-exempt bonds whose proceeds 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 deductions may have to pay
Alternative Minimum Tax on the income from bonds considered "tax-preference
items."

At least 75% of the municipal securities purchased by the Tax-Managed
Balanced Fund must be rated in one of the top three ratings categories (Aaa, Aa,
and A for Moody's, or AAA, AA, and A for Standard & Poor's). No more than 25% of
the municipal securities purchased by the Fund will be rated Baa (by Moody's) or
BBB (by Standard & Poor's.) Of that 25%, 5% may be lower-rated or unrated. Bonds
rated below Baa (by Moody's) or BBB (by Standard & Poor's) may include bonds
rated as low as C (by Moody's) or D (by Standard & Poor's.)

In the event that a particular municipal security held by the Fund is
downgraded below the minimum investment level permitted by the Fund's investment
policies, the Trustees and Officers of the Trust will carefully assess the
creditworthiness of the obligation to determine whether it continues to meet the
policies and objectives of the Fund.

MUNICIPAL LEASE OBLIGATIONS

Each Fund of the Trust 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
Trust's Board of Trustees, the Fixed Income Group may determine to treat certain
municipal lease obligations as liquid, and therefore not subject to the Trust'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 general creditworthiness
of the issuer, the importance to the issuer of the property covered by the lease
and the likelihood that the marketability of the securities will be maintained
throughout the time the security is held by the Fund.

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
analysis of factors similar to those considered by nationally recognized
statistical rating organizations. In addition, the Fixed Income Group's
liquidity determinations will incorporate those factors mentioned above.

B-9
<PAGE> 82

PURCHASE OF SHARES

The Trust 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 Trust, and (iii) to
reduce or waive the minimum investment for or any other restriction on initial
and subsequent investments for certain fiduciary accounts or under circumstances
where certain economies can be achieved in sales of the Trust's shares.

REDEMPTION OF SHARES

Each Fund of the Trust may suspend redemption privileges or postpone the
date of payment: (i) during any period that the New York Stock Exchange is
closed, or trading on the Exchange is restricted as determined by the Securities
and Exchange Commission (the "Commission"), (ii) during any period when an
emergency exists as defined by the rules of the Commission as a result of which
it is not reasonably practicable for a Fund to dispose of securities owned by
it, or fairly to determine the value of its assets, and (iii) for such other
periods as the Commission may permit.

A redemption fee of 2% of the value of a Fund'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 a Fund. 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 certificate must
be provided.

SHARE PRICE

Vanguard Tax-Managed Balanced Fund's share price or "net asset value" per
share is calculated by dividing the total assets of the Fund, less all
liabilities, by the total number of shares outstanding. The share price or "net
asset value" per share for Vanguard Tax-Managed Growth and Income Fund, Vanguard
Tax-Managed Capital Appreciation Fund, Vanguard Tax-Managed Small-Cap Fund, and
Vanguard Tax-Managed International Fund is calculated by dividing the net assets
attributed to each share class by the total number of shares outstanding for
each share class. The net asset value is determined as of the close of the New
York Stock Exchange (generally 4:00 p.m. Eastern time) on each day that the
Exchange is open for trading.

Portfolio securities for which market quotations are readily available
(which include those securities listed on national securities exchanges, as well
as those quoted on the NASDAQ Stock Market) will be valued at the last quoted
sales price on the day the valuation is made. Such securities which are not
traded on the valuation date are valued at the mean of the bid and ask prices.
Price information on exchange-listed securities is taken from the exchange where
the security is primarily traded. Securities may be valued on the basis of
prices provided by a pricing service when such prices are believed to reflect
the fair market value of such securities.

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 available or which
are restricted as to sale (or resale) are valued by such methods as the Board of
Trustees deems in good faith to reflect fair value.

B-10
<PAGE> 83

The share price for each Fund can be found daily in the mutual fund
listings of most major newspapers under the heading "Vanguard Funds."

FUNDAMENTAL INVESTMENT LIMITATIONS

The Funds are subject to the following fundamental investment limitations,
which cannot be changed in any material way without the approval of the holders
of a majority of the affected Fund's shares. For these purposes, a "majority" of
a Fund's shares means shares representing the lesser of: (i) 67% or more of the
votes cast to approve a change, so long as shares representing more than 50% of
the Fund's net asset value are present or represented by proxy; or (ii) more
than 50% of a Fund's net asset value.

BORROWING. Each Fund may not borrow money, except for temporary or
emergency purposes in an amount not exceeding 15% of the Fund's net assets. Each
Fund may borrow money through banks, reverse repurchase agreements, or
Vanguard's interfund lending program only, and must comply with all applicable
regulatory conditions. Each Fund may not make any additional investments
whenever its outstanding borrowings exceed 5% of net assets.

COMMODITIES. Each Fund may not invest in commodities or commodity
contracts, except that it may invest in stock and bond futures contracts,
options, and options on futures contracts. No more than 3% of a Fund's total
assets may be used as initial margin deposit for futures contracts, and no more
than 5% of a Fund's total assets may be invested in futures contracts at any
time.

DIVERSIFICATION. With respect to 75% of its total assets, each Fund may
not; (i) purchase more than 10% of the outstanding voting securities of any one
issuer; or (ii) purchase securities of any issuer if, as a result, more than 5%
of the Fund's total assets would be invested in that issuer's securities. This
limitation does not apply to obligations of the United States Government, its
agencies, or instrumentalities.

ILLIQUID SECURITIES. Each Fund may not acquire any security if, as a
result, more than 15% of its net assets would be invested in securities that are
illiquid.

INDUSTRY CONCENTRATION. Each Fund may not invest more than 25% of its
total assets in any one industry.

INVESTING FOR CONTROL. Each Fund may not invest in a company for purposes
of controlling its management.

INVESTMENT COMPANIES. Each Fund may not invest in any other investment
company, except through a merger, consolidation or acquisition of assets
approved by the Fund's shareholders, or to the extent permitted by Section 12 of
the 1940 Act. Investment companies whose shares a Fund acquires pursuant to
Section 12 must have investment objectives and investment policies consistent
with those of the Fund.

LOANS. Each Fund may not lend money to any person except by purchasing
fixed income securities that are publicly distributed or customarily purchased
by institutional investors, by entering into repurchase agreements, by lending
its portfolio securities, or through Vanguard's interfund lending program.

MARGIN. Each Fund may not purchase securities on margin or sell securities
short, except as permitted by the Funds' investment policies relating to
commodities.

PLEDGING ASSETS. Each Fund may not pledge, mortgage or hypothecate more
than 15% of its net assets.

REAL ESTATE. Each Fund may not invest directly in real estate, although it
may invest in securities of companies that deal in real estate and, in the case
of Tax-Managed Balanced Fund, bonds secured by real estate.

B-11
<PAGE> 84

SENIOR SECURITIES. Each Fund may not issue senior securities, except in
compliance with the 1940 Act.

UNDERWRITING. Each Fund may not engage in the business of underwriting
securities issued by other persons. Each Fund will not be considered an
underwriter when disposing of its investment securities.

The investment limitations set forth above are considered at the time
investment securities are purchased. If a percentage restriction is adhered to
at the time the investment is made, a later increase in percentage resulting
from a change in the market value of assets will not constitute a violation of
such restriction.

None of these limitations prevents the Fund from participating in The
Vanguard Group, Inc. ("Vanguard"). As a member of The Vanguard Group of
Investment Companies, the Trust may own securities issued by Vanguard, make
loans to Vanguard, and contribute to Vanguard's costs or other financial
requirements. See "Management of the Trust" for more information.

MANAGEMENT OF THE TRUST
OFFICERS AND TRUSTEES

The Officers of the Trust manage its day-to-day operations and are
responsible to the Trust's Board of Trustees. The Trustees set broad policies
for the Trust and choose its Officers. The following is a list of the Trustees
and Officers of the Trust and a statement of their present positions and
principal occupations during the past five years. As a group, the Trust's
Trustees and Officers own less than 1% of the outstanding shares of each Fund of
the Trust. Each Trustee also serves as a Director of the Vanguard Group, Inc.,
and as a Trustee of each of the 36 investment companies administered by Vanguard
(35 in the case of Mr. Malkiel and 28 in the case of Mr. MacLaury). The mailing
address of the Trustees and Officers of the Trust is Post Office Box 876, Valley
Forge, PA 19482.

JOHN C. BOGLE, (DOB: 5/8/1929) Senior Chairman and Trustee*
Senior Chairman and Director of The Vanguard Group, Inc. and Trustee of each of
the investment companies in The Vanguard Group; Director of The Mead Corp.
(Paper Products), General Accident Insurance, and Chris-Craft Industries, Inc.
(Broadcasting & Plastics Manufacturer).

JOHN J. BRENNAN, (DOB: 7/29/1954) Chairman, Chief Executive Officer & Trustee*
Chairman, Chief Executive Officer and Director of The Vanguard Group, Inc., and
Trustee of each of the investment companies in The Vanguard Group.

JOANN HEFFERNAN HEISEN, (DOB: 1/25/1950) Trustee
Vice President, Chief Information Officer, and member of the Executive Committee
of Johnson and Johnson (Pharmaceuticals/Consumer Products), Director of Johnson
& Johnson*MERCK Consumer Pharmaceuticals Co., Women First HealthCare, Inc.
(Research and Education Institution), Recording for the Blind and Dyslexic, The
Medical Center at Princeton, and Women's Research and Education Institute.

BRUCE K. MACLAURY, (DOB: 5/7/1931) Trustee
President Emeritus of The Brookings Institution (Independent Non-Partisan
Research Organization); Director of American Express Bank, Ltd., The St. Paul
Companies, Inc. (Insurance and Financial Services), and National Steel Corp.

BURTON G. MALKIEL, (DOB: 8/28/1932) Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress &
Co. (Investment Management), The Jeffrey Co. (Holding Company), and Southern New
England Telecommunications Co.

B-12
<PAGE> 85

ALFRED M. RANKIN, JR., (DOB: 10/8/1941) Trustee
Chairman, President, Chief Executive Officer, and Director of NACCO Industries
(Machinery/Coal/ Appliances); Director of The BFGoodrich Co. (Aircraft
Systems/Manufacturing/Chemicals), and The Standard Products Co. (Rubber Products
Company).

JOHN C. SAWHILL, (DOB: 6/12/1936) Trustee
President and Chief Executive Officer of The Nature Conservancy (Non-Profit
Conservation Group); Director of Pacific Gas and Electric Co., Procter & Gamble
Co., NACCO Industries (Machinery/Coal/ Appliances), and Newfield Exploration Co.
(Energy); formerly, Director and Senior Partner of McKinsey & Co., and President
of New York University.

JAMES O. WELCH, JR., (DOB: 5/13/1931) Trustee
Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman
and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO
Energy, Inc. and Kmart Corp.

J. LAWRENCE WILSON, (DOB 3/2/1936) Trustee
Chairman and Chief Executive Officer of Rohm & Haas Co. (Chemicals); Director of
Cummins Engine Co. (Diesel Engine Company), and The Mead Corp. (Paper Products);
and Trustee of Vanderbilt University.

RAYMOND J. KLAPINSKY, (DOB: 12/7/1938) Secretary*
Managing Director of The Vanguard Group, Inc., Secretary of The Vanguard Group,
Inc. and of each of the investment companies in The Vanguard Group.

THOMAS J. HIGGINS, (DOB: 5/21/1957) Treasurer*
Principal of The Vanguard Group, Inc.; Treasurer of each of the investment
companies in The Vanguard Group.

ROBERT D. SNOWDEN, (DOB: 9/4/1961) Controller*
Principal of The Vanguard Group, Inc., Controller of each of the investment
companies in The Vanguard Group.
- --------------------------------------------------------------------------------

*Officers of the Trust are "interested persons" as defined in the Investment
Company Act of 1940.

THE VANGUARD GROUP

The Trust is a member of The Vanguard Group of Investment Companies which
consists of more than 35 investment companies (the "Trusts"). Through their
jointly-owned subsidiary, The Vanguard Group, Inc. ("Vanguard"), the Trust and
the other Trusts in The Vanguard Group obtain at cost virtually all of their
corporate management, administrative and distribution services. Vanguard also
provides investment advisory services on an at-cost basis to several of the
Vanguard Trusts including Vanguard Tax-Managed Funds.

Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Trusts and also
furnishes the Trusts with necessary office space, furnishings and equipment.
Each Trust pays its share of Vanguard's total expenses which are allocated among
the Trusts under methods approved by the Trustees of each Trust. In addition,
each Trust bears its own direct expenses, such as legal, auditing and custodian
fees.

Vanguard adheres to a Code of Ethics established pursuant to Rule 17j-1
under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
Officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines similar to, and in many
cases more restrictive than, those recommended by a blue ribbon panel of mutual
fund industry executives.

B-13
<PAGE> 86

Vanguard was established and operates under an Amended and Restated Funds'
Service Agreement which was approved by the shareholders of each of the Trusts.
The amounts which each of the Trusts has invested are adjusted from time to time
in order to maintain the proportionate relationship between each Trust's
relative net assets and its contribution to Vanguard's capital. The Amended and
Restated Funds' Service Agreement provides for the following arrangement: (1)
each Vanguard Trust may be called upon to invest a maximum of 0.40% of its
assets in Vanguard and (2) there is no restriction on the maximum cash
investment that the Vanguard Trusts may make in Vanguard. At December 31, 1998,
the Trust had contributed capital of $490,000 to Vanguard, representing 0.02% of
the Trust's net assets and 0.70% of Vanguard's capitalization.

MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Trusts by third parties. During the
last three fiscal years, the Funds' allocated share of Vanguard's actual net
costs of operation relating to management and administrative services (including
transfer agency) were:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31,
----------------------------------
FUND 1996 1997 1998
- ---- -------- -------- ----------
<S> <C> <C> <C>
Tax-Managed Balanced Fund...................... $ 21,000 $101,000 $ 205,000
Tax-Managed Growth and Income Fund............. 220,000 501,000 1,425,000
Tax-Managed Capital Appreciation Fund.......... 581,000 962,000 1,804,000
Tax-Managed Small-Cap Fund..................... N/A N/A N/A
Tax-Managed International Fund................. N/A N/A N/A
</TABLE>

DISTRIBUTION. Vanguard Marketing Corporation, a wholly-owned Subsidiary of
The Vanguard Group, Inc., provides all distribution and marketing activities for
the Trusts in the Group. The principal distribution expenses are for
advertising, promotional materials and marketing personnel. Distribution
services may also include organizing and offering to the public, from time to
time, one or more new investment companies which will become members of The
Vanguard Group. The Trustees and Officers of Vanguard determine the amount to be
spent annually on distribution activities, the manner and amount to be spent on
each Trust, and whether to organize new investment companies.

One half of the distribution expenses of a marketing and promotional nature
is allocated among the Trusts based upon their relative net assets. The
remaining one half of these expenses is allocated among the Trusts based upon
each Trust's sales for the preceding 24 months relative to the total sales of
the Trusts as a Group, provided, however, that no Trust's aggregate quarterly
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of the average distribution expense rate for The
Vanguard Group, and that no Trust shall incur annual distribution expenses in
excess of 20/100 of 1% of its average month-end net assets. During the last
three fiscal years, the Funds' incurred the following approximate amounts of The
Vanguard Group's distribution and marketing expenses:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31,
-------------------------------
FUND 1996 1997 1998
- ---- ------- -------- --------
<S> <C> <C> <C>
Tax-Managed Balanced Fund......................... $13,000 $ 23,000 $ 37,000
Tax-Managed Growth and Income Fund................ 39,000 87,000 199,000
Tax-Managed Capital Appreciation Fund............. 99,000 164,000 240,000
Tax-Managed Small-Cap Fund........................ N/A N/A N/A
Tax-Managed International Fund.................... N/A N/A N/A
</TABLE>

INVESTMENT ADVISORY SERVICES. Vanguard's Core Management Group provides
investment advisory services to the Trust. 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

B-14
<PAGE> 87

paid by the funds and trusts utilizing these services. During the last three
fiscal years, the Funds paid approximately the following amounts for investment
advisory services:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31,
-----------------------------
FUND 1996 1997 1998
- ---- ------- ------- -------
<S> <C> <C> <C>
Tax-Managed Balanced Fund........................... $24,000 $19,000 $39,000
Tax-Managed Growth and Income Fund.................. 12,000 12,000 29,000
Tax-Managed Capital Appreciation Fund............... 21,000 12,000 29,000
Tax-Managed Small-Cap Fund.......................... N/A N/A N/A
Tax-Managed International Fund...................... N/A N/A N/A
</TABLE>

TRUSTEE COMPENSATION

The individuals in the following table serve as Trustees of all Vanguard
Trusts, and each Trust pays a proportionate share of the Trustees' compensation.
The Trusts employ their Officers on a shared basis, as well. However, Officers
are compensated by The Vanguard Group, Inc., not the Trusts.

INDEPENDENT TRUSTEES. The Trusts compensate their independent
Trustees -- that is, the ones who are not also Officers of the Trust -- in three
ways:

- The independent Trustees receive an annual fee for their service to the
Trusts, which is subject to reduction based on absences from scheduled
Board meetings.

- The independent Trustees are reimbursed for the travel and other expenses
that they incur in attending Board meetings.

- Upon retirement, the independent Trustees receive an aggregate annual fee
of $1,000 for each year served on the Board, up to fifteen years of
service. This annual fee is paid for ten years following retirement, or
until each Trustee's death.

"INTERESTED" TRUSTEES. The Trust's interested Trustees -- Messrs. Bogle
and Brennan -- receive no compensation for their service in that capacity.
However, they are paid in their role as Officers of The Vanguard Group, Inc.

COMPENSATION TABLE. The following table provides compensation details for
each of the Trustees. For the Trust, we list the amounts paid as compensation
and accrued as retirement benefits by the Trust for each Trustee. In addition,
the table shows the total amount of benefits that we expect each Trustee to
\receive from all Vanguard Trusts upon retirement, and the total amount of
compensation paid to each Trustee by all Vanguard Trusts. All information shown
is for the fiscal year ended December 31, 1998.

B-15
<PAGE> 88

VANGUARD TAX-MANAGED FUNDS
COMPENSATION TABLE

<TABLE>
<CAPTION>
AGGREGATE PENSION OR RETIREMENT ESTIMATED TOTAL COMPENSATION
COMPENSATION BENEFITS ACCRUED AS ANNUAL BENEFITS FROM ALL VANGUARD TRUSTS
NAME OF TRUSTEES FROM TRUST PART OF TRUST EXPENSES UPON RETIREMENT PAID TO TRUSTEES(1)
---------------- ------------ ---------------------- --------------- ------------------------
<S> <C> <C> <C> <C>
John C. Bogle.................. None None None None
John J. Brennan................ None None None None
Barbara Barnes
Hauptfuhrer(2)............... $397 $54 $15,000 $75,000
JoAnn Heffernan Heisen......... $199 $23 $15,000 $37,500
Robert E. Cawthorn(2).......... $166 $36 $ 6,000 $31,250
Bruce K. MacLaury.............. $418 $40 $12,000 $70,000
Burton G. Malkiel.............. $400 $39 $15,000 $75,000
Alfred M. Rankin, Jr........... $397 $28 $15,000 $75,000
John C. Sawhill................ $397 $36 $15,000 $75,000
James O. Welch, Jr............. $397 $41 $15,000 $75,000
J. Lawrence Wilson............. $397 $30 $15,000 $75,000
</TABLE>

(1) The amounts reported in this column reflect the total compensation paid to
each Trustee for his or her service as Trustee of 36 Vanguard Trusts (35 in
the case of Mr. Malkiel; 28 in the case of Mr. MacLaury).

(2) Mr. Cawthorn and Mrs. Hauptfuhrer have retired from the Trust's Board,
effective May 31, 1998 and December 31, 1998, respectively.

PORTFOLIO TRANSACTIONS

In placing portfolio transactions, Vanguard uses its best judgment to
choose the broker most capable of providing the brokerage services necessary to
obtain best available price and most favorable execution. The full range and
quality of brokerage services available are considered in making these
determinations. In those instances where it is reasonably determined that more
than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration will be given to
those brokers which supply statistical information and provide other services in
addition to execution services to the Funds.

During the fiscal years ended December 31, 1996, 1997, and 1998, the Funds
paid the following amounts as brokerage commissions:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31,
--------------------------------
FUND 1996 1997 1998
---- -------- -------- --------
<S> <C> <C> <C>
Tax-Managed Balanced Fund........................ $ 5,597 $ 5,702 $ 13,946
Tax-Managed Growth and Income Fund............... 46,021 59,026 126,509
Tax-Managed Capital Appreciation Fund............ 157,661 104,994 203,201
Tax-Managed Small-Cap Fund....................... N/A N/A N/A
Tax-Managed International Fund................... N/A N/A N/A
</TABLE>

PERFORMANCE MEASURES

Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member trusts of The Vanguard Group of Investment Companies. Each of
the investment company members, including each Fund of Vanguard Tax-Managed
Funds, may, from time to time, use one or more of the following unmanaged
indices for comparative performance purposes.

STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX -- includes stocks
selected by Standard & Poor's Index Committee to include leading companies in
leading industries and to reflect the U.S. stock market.

STANDARD & POOR'S 500/BARRA VALUE INDEX -- consists of the stocks in the
S&P 500 Index with the lowest price-to-book ratios, comprising 50% of the market
capitalization of the S&P 500.

B-16
<PAGE> 89

STANDARD & POOR'S MIDCAP 400 INDEX -- is composed of 400 medium sized
domestic stocks.

STANDARD & POOR'S SMALLCAP 600 INDEX -- is composed of 600 small sized
domestic stocks.

STANDARD & POOR'S SMALLCAP 600/BARRA VALUE INDEX -- contains stocks of the
S&P SmallCap 600 Index which have a lower than average price-to-book ratio.

STANDARD & POOR'S SMALLCAP 600/BARRA GROWTH INDEX -- contains stocks of the
S&P SmallCap 600 Index which have a higher than average price-to-book ratio.

RUSSELL 1000 VALUE INDEX -- consists of the stocks in the Russell 1000
Index (comprising the 1,000 largest U.S.-based companies measured by total
market capitalization) with the lowest price-to-book ratios, comprising 50% of
the market capitalization of the Russell 1000.

WILSHIRE 5000 EQUITY INDEX -- consists of 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 1,000 securities listed on the
stock exchanges of countries in Europe, Australia, Asia and the Far East.

GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX -- currently includes 71 bonds and
29 preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.

SALOMON BROTHERS GNMA INDEX -- includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government National
Mortgage Association.

SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX -- consists of
publicly-issued, non-convertible corporate bonds rated Aa or Aaa. It is a
value-weighted, total return index, including approximately 800 issues with
maturities of 12 years or greater.

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.

B-17
<PAGE> 90

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 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.

B-18
<PAGE> 91

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 FUNDS 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.

YIELD AND TOTAL RETURN

SEC YIELD

Yield is the net annualized yield based on a specified 30-day (or one
month) period assuming semiannual compounding of income. Yield is calculated by
dividing the net investment income per share earned during the period by the
maximum offering price per share on the last day of the period, according to the
following formula:

YIELD = 2[((a-b)/cd+1)(6)-1]

Where:

<TABLE>
<S> <C> <C>
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends
d = the maximum offering price per share on the last day of the
period
</TABLE>

The yield* of each Fund's Investor Shares (except Tax-Managed Small-Cap
Fund and Tax-Managed International Fund) for the 30-day period ended December
31, 1998 was as follows:

<TABLE>
<S> <C>
Tax-Managed Balanced Fund................................... 2.20%
Tax-Managed Growth and Income Fund.......................... 1.16%
Tax-Managed Capital Appreciation Fund....................... 0.48%
</TABLE>

*Yield is calculated daily.

AVERAGE ANNUAL TOTAL RETURN

Average annual total return is the average annual compounded rate of return
for the periods of one year, five years, ten years or the life of the fund, all
ended on the last day of a recent month. Average annual total return quotations
will reflect changes in the price of the fund's shares and assume that all
dividends and capital gains distributions during the respective periods were
reinvested in fund shares. Average annual total return is calculated by finding
the average annual compounded rates of return of a

B-19
<PAGE> 92

hypothetical investment over such periods according to the following formula
(average annual total return is then expressed as a percentage):

T = (ERV/P)(1/n)-1

Where:

<TABLE>
<S> <C> <C>
T = average annual total return
P = a hypothetical initial investment of $1,000
n = number of years
ERV = ending redeemable value: ERV is the value, at the end of the
applicable period, of a hypothetical $1,000 investment made
at the beginning of the applicable period
</TABLE>

AVERAGE ANNUAL AFTER-TAX TOTAL RETURN QUOTATION

Calculate the Fund's average annual after-tax total return by finding the
average annual compounded rates of return over the 1-, 5-, and 10-year periods
(or for periods of the Fund's operations) that would equate the initial amount
invested to the after-tax value, according to the following formulas.

After-tax return (pre-liquidation):

P (1 + T)(n) = ATV(pre)

Where:

<TABLE>
<S> <C> <C>
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ATV(pre) = after-tax value of a hypothetical $1,000 payment made at the
beginning of the 1-, 5-, or 10-year periods at the end of
the 1-, 5-, or 10-year periods, assuming no liquidation of
the investment at the end of the measurement periods.
</TABLE>

Instructions.

1. Assume the maximum sales load (or other charges deducted from payments) is
deducted from the initial $1,000 payment.

2. Assume all distributions by the Fund are reinvested -- less the taxes due on
such dividends and distributions -- at the price stated in the prospectus
(including any sales load imposed upon reinvestment of dividends) on the
reinvestment dates during the period.

3. Calculate the taxes due on distributions by the Fund by applying the required
federal marginal tax rates to each component of the distributions on the
reinvestment date (e.g., ordinary income, short-term capital gain, long-term
capital gain, etc.). Note that the required tax rates may vary over time.
Assume no taxes are due on the portions of any distributions classified as
exempt interest or non-taxable (i.e., return of capital). Do not deduct any
amounts for state or local taxes.

4. If the fund elects to pass through any foreign taxes paid, the amount of the
foreign taxes paid should be added to the ordinary income distribution before
applying the required marginal tax rate to that portion of the distribution.
Then, the taxes due on distributions should be reduced by the amount of the
assumed foreign tax credit resulting from such distributions. If the
calculated tax due is less than zero, assume the tax due equals to zero.

5. Include all recurring fees that are charged to all shareholder accounts. For
any account fees that vary with the size of the account, assume an account
size equal to the Fund's mean (or median) account size. Assume that no
additional taxes or tax credits result from any redemption of shares required
to pay such fees.

6. State the total return quotation to the nearest hundredth of one percent.

B-20
<PAGE> 93

CUMULATIVE TOTAL RETURN

Cumulative total return is the cumulative rate of return on a hypothetical
initial investment of $1,000 for a specified period. Cumulative total return
quotations reflect changes in the price of the fund's shares and assume that all
dividends and capital gains distributions during the period were reinvested in
fund shares. Cumulative total return is calculated by finding the cumulative
rates of a return of a hypothetical investment over such periods, according to
the following formula (cumulative total return is then expressed as a
percentage):

C = (ERV/P)-1

Where:

<TABLE>
<S> <C> <C>
C = cumulative total return
P = a hypothetical initial investment of $1,000
ERV = ending redeemable value: ERV is the value, at the end of the
applicable period, of a hypothetical $1,000 investment made
at the beginning of the applicable period
</TABLE>

The average annual total return of each Fund's Investor Shares (except
Tax-Managed Small-Cap Fund, and Tax-Managed International Fund) for the one year
period ended December 31, 1998 and since its September 6, 1994 inception was as
follows:

<TABLE>
<CAPTION>
ONE YEAR ENDED SINCE INCEPTION
DECEMBER 31, 1998 SEPTEMBER 6, 1994
----------------- ------------------
<S> <C> <C>
Tax-Managed Balanced Fund...................... 16.93% 15.71%
Tax-Managed Growth and Income Fund............. 28.67% 27.48%
Tax-Managed Capital Appreciation Fund.......... 27.95% 25.14%
</TABLE>

The Trust had a subscription period for these Funds from July 25, 1994, to
September 5, 1994, during which time all assets were held in money market
instruments. Performance measurement begins September 6, 1994.

FINANCIAL STATEMENTS

The Trust's financial statements as of and for the year ended December 31,
1998, appearing in the Vanguard Tax-Managed Funds' 1998 Annual Report to
Shareholders, and the report thereon of PricewaterhouseCoopers LLP, independent
accountants, also appearing therein, are incorporated by reference in this
Statement of Additional Information. For a more complete discussion of the
Funds' performance, please see the 1998 Annual Report to Shareholders, which may
be obtained without charge.

B-21
<PAGE> 94

APPENDIX A -- DESCRIPTION OF MUNICIPAL BONDS AND THEIR RATINGS

Vanguard Tax-Managed Balanced Fund invests 50-55% of its assets in
municipal bonds and other municipal securities.

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
obligation" and "revenue" or "special tax" bonds. General obligation bonds are
secured 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 payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise or other tax, but not
from general tax revenues. The Trust 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 ability
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
obligations are secured by letters of credit or other credit support
arrangements provided by banks. The issuer of such notes normally has a
corresponding right, after a given period, to repay in its discretion the
outstanding principal 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
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. and Standard & Poor's
Corporation 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
absolute standards of quality. Consequently, Municipal Bonds with the same
maturity, 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 Fund may purchase municipal bonds subject to so-called "demand
features." In such cases the Fund may purchase a security that is nominally
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.

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

B-22
<PAGE> 95

period between commitment date and issuance 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 Trust's Trustees and Officers would
reevaluate the Fund's 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
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
Trust's Trustees and Officers would reevaluate its investment objective and
policies and consider recommending to its shareholders 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 margin
and principal is secure; Aa -- judged to be of "high quality by all standards"
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
Municipal Bonds are considered adequate, but elements may be present which
suggest 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
characteristically unreliable over any great length of time; Ba -- protection of
principal and interest payments may be very moderate; judged to have speculative
elements; their future cannot be considered as well-assured; B -- lack
characteristics 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 default 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
prospects 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 although 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
principal 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 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 obligations; BB is
being paid; D -- in default, and payment of principal and/or interest is in
arrears.
B-23
<PAGE> 96

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
issues: 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
designation 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.

B-24