N-30D 1 vwindsorfunds.txt VANGUARD WINDSOR FUNDS VANGUARD WINDSOR(TM) FUND SEMIANNUAL REPORT * APRIL 30, 2002 STOCK [PICTURE OF A SHIP] THE VANGUARD GROUP(R) LOGO WHAT YOU CAN CONTROL As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Adviser's Report 5 Fund Profile 8 Glossary of Investment Terms 9 Performance Summary 10 Financial Statements 11 -------------------------------------------------------------------------------- SUMMARY * Vanguard Windsor Fund earned a total return of 7.6% during the first half of its 2002 fiscal year. * Value stocks performed well during the six months, though most of the strong performance was concentrated in November and December. * Your fund's return fell slightly short of the average for its peer group primarily because of the poor performance of several telephone- and cable-company stocks. LETTER FROM THE CHAIRMAN Fellow Shareholder, VANGUARD(R) WINDSOR(TM) FUND returned 7.6% during the first half of its 2002 fiscal year, largely on the strength of the solid returns registered by value stocks during the final two months of 2001. As you can see in the table below, Windsor's return during the six months ended April 30 was well above that of the Standard & Poor's 500 Index, which is dominated by large-capitalization stocks. However, the fund trailed the returns of both its average peer and the Russell 1000 Value Index, a benchmark for mid- and large-cap stocks. The table on page 4 provides details of the fund's performance, including changes in net asset value and per-share distributions for the fund's Investor Shares and Admiral(TM) Shares (a lower-cost share class for large or long-standing accounts). -------------------------------------------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED APRIL 30, 2002 -------------------------------------------------------------------------------- VANGUARD WINDSOR FUND Investor Shares 7.6% Admiral Shares* 3.7 Average Multi-Cap Value Fund** 8.9 Russell 1000 Value Index 8.9 S&P 500 Index 2.3 -------------------------------------------------------------------------------- *Since inception on November 12, 2001. **Derived from data provided by Lipper Inc. THE STOCK MARKET ROSE IN A VOLATILE PERIOD During the six months ended April 30, 2002, the U.S. stock market alternately surged and receded, but still posted a total return of 5.2%, as measured by the Wilshire 5000 Total Market Index. It was a solid gain and a welcome reversal from the declines of recent years. For those who had investments in small-capitalization stocks, the period was especially rewarding, as the small-cap Russell 2000 Index gained 20.0%. The large-cap Russell 1000 Index returned 3.4%. Across all market caps, value stocks--those with below-average prices relative to earnings, book value, and other measures--retained the lead they more or less have had over growth shares since the market's peak in March 2000. In international markets, however, the lead was reversed, with growth slightly outperforming value. U.S. and international markets did have a common denominator in the period: Their returns were hampered by slumping share prices in the troubled telecommunications industry, which was burdened by overcapacity, weak demand, and heavy debt. THE U.S. ECONOMY REBOUNDED A modest economic recovery set the stage for the turnaround in the stock market. The recession that began in March 2001 seemed to have ended even before the 1 -------------------------------------------------------------------------------- MARKET BAROMETER TOTAL RETURNS PERIODS ENDED APRIL 30, 2002 -------------------------------------- SIX ONE FIVE MONTHS YEAR YEARS* -------------------------------------------------------------------------------- STOCKS Russell 1000 Index (Large-caps) 3.4% -12.0% 7.9% Russell 2000 Index (Small-caps) 20.0 6.7 9.7 Wilshire 5000 Index (Entire market) 5.2 -9.9 7.7 MSCI EAFE Index (International) 5.5 -13.9 1.3 -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 0.0% 7.8% 7.7% (Broad taxable market) Lehman 10 Year Municipal Bond Index 1.2 7.2 6.5 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 1.0 2.9 4.8 ================================================================================ CPI Consumer Price Index 1.2% 1.6% 2.3% -------------------------------------------------------------------------------- *Annualized. year came to a close. After falling in the third quarter of 2001, the nation's real (inflation-adjusted) gross domestic product rose in the fourth quarter, then expanded at an estimated annual rate of 5.6% in the first three months of 2002. The strong growth was bolstered by heavy investment in inventories and housing, by government defense expenditures, and by consumer spending, which never really slackened despite the economic slowdown. The job market, however, still had not caught up with the improving economy. In April the unemployment rate reached 6.0%--its highest level in almost eight years, though still low compared with the jobless rates following past recessions. The economy was helped along by the Federal Reserve Board, which made 11 cuts in its target for short-term interest rates in 2001, including two during your fund's fiscal half-year. The cuts brought the federal funds rate--the interest rate that banks charge each other for overnight loans made through the Federal Reserve System--to 1.75%, the lowest level in four decades. EXCEPT FOR "JUNK," BONDS STAGNATED The Fed's rate cuts, the recovering economy, and concerns that the Fed might start raising interest rates before year-end caused yields on longer-term bonds to rise. The Lehman Brothers Aggregate Bond Index, a proxy for the taxable, investment-grade U.S. bond market, barely broke even for the six months, as falling prices completely offset interest income (bond prices move in the opposite direction from interest rates). Problems in the telecom industry made the situation worse--bonds issued by these companies fell drastically in price. The returns for high-yield ("junk") bonds were a notable exception to bonds' overall low returns: The Lehman High Yield Index gained 6.6% for the six months. The yield of the 10-year U.S. Treasury note rose 86 basis points (0.86 percentage point) during the six months to end the period at 5.09%. The yield of the 3-month Treasury bill--which follows the Fed's rate changes with a slight lag--fell 25 basis points to 1.76%. -------------------------------------------------------------------------------- The nation's real gross domestic product expanded at an estimated annual rate of 5.6% in first-quarter 2002. -------------------------------------------------------------------------------- 2 -------------------------------------------------------------------------------- Later in the period, the fund faced a market downturn and troubles for WorldCom. -------------------------------------------------------------------------------- FOR WINDSOR, A STRONG START CARRIED PERFORMANCE Vanguard Windsor Fund got off to a strong start during the half-year--returning more than 12% in the first two months of the period--but struggled later amid a general downturn in the market and a sharp drop in one of its biggest holdings. The fund lagged the Russell 1000 Value Index primarily because of poor performance among utilities holdings. A major detriment was our large stake in WorldCom, the struggling telecommunications giant, which was the fund's third-largest holding when the fiscal year began in November. WorldCom returned -82% for the six months. The company has been battered by concerns about overcapacity in the industry, price wars, tough competition, mounting debt, and a Securities and Exchange Commission review of its accounting practices. Windsor was also hurt by a slew of negative returns from cable television companies and local phone companies. Altogether, while the utilities sector was the worst-performing group in the Russell 1000 Value Index, it performed even worse for Windsor--damaging our relative return even though the fund had a smaller stake in utilities (an average of 10% of assets, versus about 15% for the index). Aside from the utilities sector, your fund booked relatively strong performance. Our commitments to the financial services and materials & processing sectors, which together accounted for more than 40% of the fund's assets during the period, contributed positively to our results. For further details on the fund's performance, see the Adviser's Report on page 5. Windsor's assets are divided between two investment advisers--Wellington Management Company, llp, and Sanford C. Bernstein & Co., LLC--each of which uses its own methods to independently pursue the objectives of long-term growth of capital and income. The table below shows the percentage of fund assets allocated to each as of April 30. We believe that our experienced investment managers are a major strength for the Windsor Fund. Our low costs also have provided us with a significant edge. The fund's annualized expense ratio (operating expenses as a percentage of average net assets) of 0.45%, or $4.50 per $1,000 invested, for the Investor Shares is just a fraction of the 1.46%, or $14.60 per $1,000 invested, charged by the average peer fund. This advantage has worked to the benefit of our shareholders year in and year out, and is especially powerful over the long run. -------------------------------------------------------------------------------- FUND ASSETS MANAGED APRIL 30, 2002 ---------------- $ MILLION PERCENTAGE -------------------------------------------------------------------------------- Wellington Management Company, llp $12,187 71% Sanford C. Bernstein & Co., LLC 4,487 26 Cash Investments* 548 3 -------------------------------------------------------------------------------- Total $17,222 100% -------------------------------------------------------------------------------- *This cash is invested by The Vanguard Group in equity index products to simulate investment in stocks. Each adviser also may maintain a modest cash position. 3 VALUE CAN PLAY AN IMPORTANT ROLE Value stocks have been in favor recently, but it wasn't long ago that growth ruled the day. That's why we advise investors to develop a portfolio diversified both across asset classes--stocks, bonds, and cash--and within asset classes. The Windsor Fund, with its low costs and experienced investment managers, provides an excellent building block for a balanced investment plan. Once you have such a plan in place, it's wise to leave your selections relatively fixed and let time and compounding pilot you toward your goals. We thank you for entrusting your hard-earned money to us. Sincerely, /S/JOHN J. BRENNAN (PHOTO OF JOHN J. BRENNAN) JOHN J. BRENNAN Chairman and Chief Executive Officer May 9, 2002 -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: OCTOBER 31, 2001-APRIL 30, 2002 DISTRIBUTIONS PER SHARE ---------------------- STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS -------------------------------------------------------------------------------- VANGUARD WINDSOR FUND Investor Shares $14.27 $14.96 $0.089 $0.312 Admiral Shares 50.00* 50.49 0.305 1.054 -------------------------------------------------------------------------------- *At inception on November 12, 2001. 4 ADVISER'S REPORT Vanguard Windsor Fund's 7.6% return during the six months ended April 30, 2002, was well ahead of the 2.3% gain of the S&P 500 Index. However, we trailed the 8.9% return recorded by both the average multi-cap value fund and the Russell 1000 Value Index. A TALE OF TWO QUARTERS The first half of our fiscal year was really a tale of two quarters. In the November- January quarter, the market was strong, rebounding from the post-September 11 sell-off. Windsor also did very well in this period, outperforming both the S&P 500 and the large-cap value indexes. In the February-April quarter, however, the market turned weak and the fund's results were not so distinguished--ahead of the S&P 500, but behind the Russell value index. The market, which priced in an economic recovery through most of last year, is getting impatient for that recovery to become more noticeable, especially in corporate profits. We are still confident that the profit trend will show clear improvement through 2002, especially given the very strong productivity improvement that we have seen in the United States over the last two quarters. As corporate profits improve, so should business sentiment and discretionary spending. These trends will join with already solid consumer spending to complete the economic recovery picture and make the market feel better about things. The other big issue in the market lately, besides corporate profits and the economy, has been the extraordinary amount of investor cynicism and mistrust spawned by the Enron collapse. Investors are questioning accountants, analysts, the credit agencies, Wall Street, and corporate America itself. Managements are trying to deliver the greatly increased and more transparent disclosure that investors are demanding. We think that all of this will run its course and that confidence will be restored, but the process will take a while. In the end, it will prove to have been a good drill, resulting in the finding that the vast preponderance of American corporations are real companies, run by basically honest folks, and with fairly stated financials. In short, Enron will turn out to have been much more exceptional than is currently feared. For our part, we never could make sense of that company, and never owned a share; we -------------------------------------------------------------------------------- INVESTMENT PHILOSOPHY The fund reflects a belief that superior long-term investment results can be achieved by emphasizing common stocks that are generally misunderstood, out of favor, or undervalued by fundamental measures such as price/earnings ratio or dividend yield. The fund may concentrate a large portion of assets in those securities or industries the advisers believe offer the best return potential. -------------------------------------------------------------------------------- 5 were never comfortable with management's assertion that Enron could make lots of money in a trading business without taking a lot of risk. After its recent sell-off, the S&P 500 Index is trading at about 21 times this year's expected earnings and about 18 times next year's. Stocks are fairly priced or slightly undervalued, in our view. As the recovery in corporate profits that we expect becomes more evident, and as investor cynicism and mistrust abate, the market should start acting better through the balance of 2002, in our opinion. THE FUND'S HALF-YEAR PERFORMANCE For our portion of the fund during the six months, the holdings in the consumer discretionary, financial services, materials & processing, health care, and energy sectors outperformed the equivalent sectors in both the S&P 500 Index and the Russell 1000 Value Index. Our holdings in industrial and information technology stocks outpaced those groups in the broad market, though not in the value index. However, our telecommunication services investments did very poorly and were a significant drag on results. In terms of individual names, the biggest positive contributors were CIGNA, TJX Companies, Staples, Toll Brothers, and Washington Mutual. The worst performers were IBM, AOL Time Warner, Adelphia Communications, Tyco International, and WorldCom. Adelphia was a plain and simple fraud, the most egregious example of management self-dealing I can recall, which has dissipated the substantial underlying asset values of the company. These asset values were the basis of our investment. WorldCom is sorely undervalued at current prices, relative to its underlying earning power in a better economy, and it has the liquidity to weather the current down cycle, in our view. We bought Tyco in early 2002 with the stock under a lot of headlines-driven pressure that we thought was way overdone. Although we are underwater to date, we think Tyco offers a quite substantial upside, to a level more in line with other well-managed, diversified industrial companies. PORTFOLIO AND INVESTMENT STRATEGY Compared with the S&P 500, we are still overweighted in cyclical stocks-- consumer cyclicals, capital goods, materials, transportation, media, and business services--though less so than we were 6 or 12 months ago; many of these stocks have given us good service, and we have reduced some positions. The 5%-plus estimated growth rate in U.S. gross domestic product for first-quarter 2002 is not sustainable, but we continue to think the economy will settle into a 31/2%-4% growth rate that can be sustained for some good period, and without touching off a significant acceleration in the current modest rate of inflation. Our view was fortified by the very impressive 5% rate of growth in U.S. productivity reported for the fourth quarter of 2001 and the first quarter of 2002. 6 If we're right in forecasting a solid economic recovery with subdued inflation, we would expect the Federal Reserve Board to reverse some of the interest rate cutting it did last year, but not all of it--maybe 150 basis points, taking the federal funds rate from its current level of 1.75% to 3.25% over the next 12-18 months. Such an increase would be less than some fear, and should allow Windsor's large concentration in financial stocks to perform well--not that there is much true interest-rate sensitivity in our holdings. We are still well underweighted in technology. The sector's valuations are still rich, even when compared with earnings expected for the recovery year of 2003. However, tech is a big sector, and there are some undervalued names that have found their way into our portfolio. Our Windsor Fund portfolio trades at about 13 times expected earnings for 2003, a price/earnings ratio roughly 30% below the overall market's P/E. Yet we foresee five-year earnings growth of about 121/2% annually for our stocks, essentially in line with the market's growth rate. Our value proposition is that the P/E discount of our holdings is unwarranted, given the parity in expected earnings growth. We think this discount will close, which would mean above-market returns for our shareholders. Charles T. Freeman, Portfolio Manager David R. Fassnacht, Assistant Portfolio Manager Wellington Management Company, llp May 17, 2002 7 FUND PROFILE AS OF APRIL 30, 2002 FOR WINDSOR FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate to both an unmanaged index that we consider a "best fit" for the fund and a broad market index. Key terms are defined on page 9. -------------------------------------------------------------------------------- PORTFOLIO CHARACTERISTICS BEST WILSHIRE FUND FIT* 5000 -------------------------------------------------------------------------------- Number of Stocks 161 690 5,915 Median Market Cap $11.9B $28.3B $29.1B Price/Earnings Ratio 24.7x 24.5x 31.5x Price/Book Ratio 2.3x 2.6x 3.1x Yield 2.1% 1.4% Investor Shares 1.2% Admiral Shares 1.2% Return on Equity 18.7% 19.6% 21.5% Earnings Growth Rate 13.6% 5.2% 10.3% Foreign Holdings 7.5% 0.0% 0.0% Turnover Rate 31%** -- -- Expense Ratio Investor Shares 0.45%** -- -- Admiral Shares 0.39%** -- -- Cash Investments 1.3% -- -- -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) Citigroup, Inc. 5.1% (banking) Alcoa Inc. 3.9 (metals & mining) Washington Mutual, Inc. 3.6 (banking) TJX Cos., Inc. 3.1 (retail) Pharmacia Corp. 2.5 (pharmaceuticals) CIGNA Corp. 2.4 (insurance) International Business Machines Corp. 2.0 (computer hardware) Eaton Corp. 2.0 (manufacturing) Petrol Brasil ADR 1.9 (energy) Engelhard Corp. 1.8 (manufacturing) -------------------------------------------------------------------------------- Top Ten 28.3% -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- VOLATILITY MEASURES BEST WILSHIRE FUND FIT* FUND 5000 -------------------------------------------------------------------------------- R-Squared 0.87 1.00 0.42 1.00 Beta 1.10 1.00 0.62 1.00 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- INVESTMENT FOCUS Market Cap Medium Style Value -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECTOR DIVERSIFICATION (% OF COMMON STOCKS) BEST WILSHIRE FUND FIT* 5000 -------------------------------------------------------------------------------- Auto & Transportation 5.4% 3.6% 2.4% Consumer Discretionary 12.3 11.3 15.4 Consumer Staples 1.5 7.1 7.4 Financial Services 28.4 32.1 21.7 Health Care 8.9 5.5 13.8 Integrated Oils 5.7 8.5 3.7 Other Energy 1.3 1.4 2.3 Materials & Processing 14.3 5.3 4.0 Producer Durables 4.2 4.1 3.9 Technology 6.5 5.4 14.0 Utilities 7.2 13.1 6.9 Other 4.3 2.6 4.5 -------------------------------------------------------------------------------- *Russell 1000 Value Index. **Annualized. (PICTURE OF COMPUTER) VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. 8 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the fund's "best fit" index benchmark and an overall market index. Each index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the index rose or fell by 10%. -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the market in general, as measured by the fund's "best fit" index benchmark and by an overall market index. If a fund's total returns were precisely synchronized with an index's returns, its R-squared would be 1.00. If the fund's returns bore no relationship to the index's returns, its R-squared would be 0. -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. -------------------------------------------------------------------------------- 9 PERFORMANCE SUMMARY AS OF APRIL 30, 2002 FOR WINDSOR FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) OCTOBER 31, 1991-APRIL 30, 2002 FUND INDEX 1992 9.3 10.7 1993 28.3 25.2 1994 6.3 0.8 1995 17.8 24.7 1996 23.2 23.7 1997 27 33.2 1998 -0.8 14.8 1999 13.7 16.5 2000 11.6 5.5 2001 -0.4 -11.9 2002** 7.6 8.9 -------------------------------------------------------------------------------- *Six months ended April 30, 2002. Note: See Financial Highlights tables on pages 17 and 18 for dividend and capital gains information. -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED MARCH 31, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE --------------------- INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL -------------------------------------------------------------------------------- Windsor Fund Investor Shares 10/23/1958 7.30% 10.40% 11.46% 2.57% 14.03% Admiral Shares 11/12/2001 9.46* -- -- -- -- -------------------------------------------------------------------------------- *Return since inception. 10 FINANCIAL STATEMENTS APRIL 30, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR FUND SHARES (000) -------------------------------------------------------------------------------- COMMON STOCKS (95.5%)(1) -------------------------------------------------------------------------------- AUTO & TRANSPORTATION (5.2%) Canadian National Railway Co. 5,692,100 $ 272,367 *(2)Continental Airlines, Inc. Class B 4,964,700 129,082 * Compagnie Generale des Etablissements Michelin Class B 3,000,586 116,261 Genuine Parts Co. 1,712,900 59,112 Norfolk Southern Corp. 2,743,600 58,795 CSX Corp. 1,619,900 58,592 Burlington Northern Santa Fe Corp. 1,949,000 53,578 Magna International, Inc. Class A 638,700 47,194 * Northwest Airlines Corp. Class A 2,129,200 39,262 Dana Corp. 1,550,200 31,407 The Goodyear Tire & Rubber Co. 1,097,000 24,408 * Lear Corp. 36,200 1,861 --------------- $ 891,919 --------------- CONSUMER DISCRETIONARY (11.7%) TJX Cos., Inc. 12,260,000 534,291 (2) Ross Stores, Inc. 6,767,000 274,808 * AOL Time Warner Inc. 14,443,400 274,713 * Staples, Inc. 11,186,500 223,394 *(2)Republic Services, Inc. Class A 8,474,800 167,801 *(2)KPMG Consulting Inc. 8,262,900 144,601 May Department Stores Co. 1,780,400 61,744 Leggett & Platt, Inc. 2,013,600 52,958 Whirlpool Corp. 629,800 47,204 Sears, Roebuck & Co. 841,800 44,405 Gannett Co., Inc. 600,000 43,980 * Federated Department Stores, Inc. 1,100,300 43,715 VF Corp. 994,300 43,521 Liz Claiborne, Inc. 1,077,000 33,699 Wendy's International, Inc. 669,600 25,043 --------------- $ 2,015,877 --------------- CONSUMER STAPLES (1.4%) Philip Morris Cos., Inc. 1,902,900 103,575 ConAgra Foods, Inc. 2,395,800 58,697 The Procter & Gamble Co. 317,000 28,612 SuperValu Inc. 942,100 28,263 Tyson Foods, Inc. 1,911,500 26,799 --------------- $ 245,946 --------------- FINANCIAL SERVICES (27.1%) BANKS--NEW YORK CITY (0.1%) J.P. Morgan Chase & Co. 415,800 14,595 BANKS--OUTSIDE NEW YORK CITY (5.9%) UnionBanCal Corp. 4,313,000 208,749 Bank of America Corp. 2,313,500 167,682 U.S. Bancorp 6,179,321 146,450 Wachovia Corp. 2,531,300 96,291 FleetBoston Financial Corp. 2,700,704 95,335 Bank One Corp. 2,220,900 90,768 National City Corp. 2,185,700 68,194 Comerica, Inc. 950,000 59,708 11 -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR FUND SHARES (000) -------------------------------------------------------------------------------- Regions Financial Corp. 1,533,450 $ 53,778 Wells Fargo & Co. 510,000 26,087 DIVERSIFIED FINANCIAL SERVICES (5.4%) Citigroup, Inc. 20,240,246 876,403 * Promise Co. Ltd. 898,900 47,395 * Takefuji Corp. 100,000 7,227 Morgan Stanley Dean Witter & Co. 76,400 3,646 FINANCIAL MISCELLANEOUS (1.9%) Fannie Mae 1,730,700 136,604 Freddie Mac 1,700,000 111,095 (2) Metris Cos., Inc. 6,461,400 84,257 INSURANCE--MULTILINE (3.8%) CIGNA Corp. 3,762,500 410,113 The Hartford Financial Services Group Inc. 2,863,400 198,434 Torchmark Corp. 1,182,800 48,365 INSURANCE--PROPERTY--CASUALTY (3.2%) Ace, Ltd. 3,092,000 134,564 RenaissanceRe Holdings Ltd. 1,080,500 126,635 (2) IPC Holdings Ltd. 2,815,200 95,998 PartnerRe Ltd. 1,622,700 87,593 The Chubb Corp. 907,500 69,605 The PMI Group Inc. 317,500 25,756 REAL ESTATE INVESTMENT TRUST (0.8%) (2) Liberty Property Trust REIT 3,924,100 125,375 Equity Office Properties Trust REIT 439,700 12,589 SAVINGS & LOAN (5.7%) Washington Mutual, Inc. 16,459,119 621,003 Golden West Financial Corp. 4,201,000 287,306 Charter One Financial, Inc. 2,065,077 73,062 * Dime Bancorp Inc. Litigation Tracking Warrants 7,771,300 1,166 SECURITIES BROKERS & SERVICES (0.3%) Lehman Brothers Holdings, Inc. 912,900 53,861 --------------- $ 4,665,689 --------------- HEALTH CARE (8.5%) Pharmacia Corp. 10,613,904 437,611 *(2)Health Net Inc. 10,398,560 308,317 * Oxford Health Plan 3,900,000 180,024 Aventis SA ADR 2,494,350 176,226 Schering-Plough Corp. 5,607,000 153,071 Merck & Co., Inc. 1,603,000 87,107 Wyeth 1,200,000 68,400 Aetna Inc. 875,400 41,669 Aventis SA Class A 99,671 7,082 * Pacificare Health Systems, Inc. 201,400 6,094 --------------- $ 1,465,601 --------------- INTEGRATED OILS (5.5%) Petrol Brasil ADR 9,722,000 239,161 ExxonMobil Corp. 4,459,008 179,118 Phillips Petroleum Co. 2,355,400 140,876 Petrol Brasil Series A ADR 3,436,300 80,409 Occidental Petroleum Corp. 2,623,200 75,417 ChevronTexaco Corp. 816,739 70,819 Petro Canada 2,004,700 53,546 Conoco Inc. 1,831,300 51,368 Amerada Hess Corp. 666,700 51,256 --------------- $ 941,970 --------------- OTHER ENERGY (1.3%) GlobalSantaFe Corp. 3,194,600 112,099 Valero Energy Corp. 951,300 41,058 EnCana Corp. 1,091,600 34,331 Devon Energy Corp. 641,826 31,648 --------------- $ 219,136 --------------- MATERIALS & PROCESSING (13.6%) Alcoa Inc. 19,667,768 669,294 (2) Engelhard Corp. 10,454,200 318,017 Air Products & Chemicals, Inc. 3,774,700 181,374 Jefferson Smurfit Group PLC ADR 6,918,641 165,563 Abitibi-Consolidated, Inc. 15,176,789 136,591 Rohm & Haas Co. 3,335,300 123,773 * Packaging Corp. of America 5,173,200 102,171 Pechiney SA ADR A 2,861,128 69,525 Praxair, Inc. 1,108,200 63,278 International Paper Co. 1,497,281 62,032 Dow Chemical Co. 1,854,900 58,986 Sonoco Products Co. 1,942,300 56,132 Monsanto Co. 1,561,100 48,082 Sherwin-Williams Co. 1,543,300 47,426 * Smurfit-Stone Container Corp. 2,487,800 40,402 MeadWestvaco Corp. 1,185,000 34,792 Eastman Chemical Co. 600,500 26,482 Ashland, Inc. 607,000 24,784 Temple-Inland Inc. 467,800 24,765 * AK Steel Corp. 1,735,452 21,277 * Owens-Illinois, Inc. 1,303,800 20,887 * Phosphate Resources Partners LP 4,018,800 17,683 Boise Cascade Corp. 473,900 16,051 * Crown Cork & Seal Co., Inc. 1,398,300 15,745 *(2)Kaiser Aluminum Corp. 6,048,434 484 --------------- $ 2,345,596 --------------- PRODUCER DURABLES (4.0%) *(2)Toll Brothers, Inc. 5,288,332 157,328 KB HOME 2,491,300 124,191 12 -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) -------------------------------------------------------------------------------- *(2)Axcelis Technologies, Inc. 6,953,089 $ 100,124 * Teradyne, Inc. 2,800,000 92,260 (2) MDC Holdings, Inc. 1,808,383 91,323 Cooper Industries, Inc. 893,100 39,118 * Varian Semiconductor Equipment Associates, Inc. 601,300 28,093 Centex Corp. 464,900 26,174 * Beazer Homes USA, Inc. 183,800 16,270 Thomas & Betts Corp. 648,600 15,242 CNH Global NV 858,500 4,936 --------------- $ 695,059 --------------- TECHNOLOGY (6.2%) International Business Machines Corp. 4,092,500 342,788 *(2)Arrow Electronics, Inc. 10,575,900 279,204 Avnet, Inc. 4,571,600 117,124 Hewlett-Packard Co. 3,961,300 67,738 * Solectron Corp. 6,650,600 48,549 * Vishay Intertechnology, Inc. 2,121,721 46,657 * Unisys Corp. 2,500,500 33,757 * Oracle Corp. 3,300,000 33,132 * Dell Computer Corp. 1,226,500 32,306 * Flextronics International Ltd. 2,000,000 27,700 * Ingram Micro, Inc. Class A 1,470,500 21,852 * Tellabs, Inc. 1,190,000 10,103 * Palm, Inc. 1,342,700 4,256 --------------- $ 1,065,166 --------------- UTILITIES (6.9%) * Comcast Corp.-Special Class A 8,541,000 228,472 * Cox Communications, Inc. Class A 5,062,200 169,027 * WorldCom Inc.- WorldCom Group 54,562,789 135,261 * Adelphia Communications Corp. Class A 15,637,000 94,135 Verizon Communications 2,195,442 88,059 SBC Communications Inc. 2,812,720 87,363 Consolidated Edison Inc. 1,376,000 59,980 American Electric Power Co., Inc. 1,213,400 55,574 Ameren Corp. 1,272,300 53,131 BellSouth Corp. 1,568,400 47,601 Cinergy Corp. 1,334,900 47,429 Qwest Communications International Inc. 7,176,350 36,097 * AT&T Wireless Services Inc. 2,806,068 25,114 * Comcast Corp. Class A 789,700 22,262 * Mediacom Communications Corp. 2,103,600 21,036 Puget Energy, Inc. 273,200 5,663 *(2)McLeodUSA, Inc. Class A 62,000,000 4,151 Worldcom, Inc.-MCI Group 1,024,773 3,844 AT&T Corp. 262,700 3,447 --------------- $ 1,187,646 --------------- OTHER (4.1%) (2) Eaton Corp. 4,026,800 340,708 Tyco International Ltd. 16,600,000 306,270 Georgia Pacific Group 1,939,371 56,203 --------------- $ 703,181 --------------- -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (COST $15,076,669) $ 16,442,786 -------------------------------------------------------------------------------- TEMPORARY INVESTMENTS (4.7%)(1) -------------------------------------------------------------------------------- Vanguard Index Participation Equity Receipts -- Total Stock Market 3,883,100 393,669 FACE AMOUNT (000) ----------- FEDERAL NATIONAL MORTGAGE ASSN. (3) 1.83%, 7/31/2002 $ 10,000 9,956 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.92%, 5/1/2002 380,057 380,057 1.92%, 5/1/2002--Note G 28,863 28,863 -------------------------------------------------------------------------------- TOTAL TEMPORARY INVESTMENTS (COST $810,577) $ 812,545 -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.2%) (COST $15,887,246) 17,255,331 -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.2%) -------------------------------------------------------------------------------- Other Assets--Note C 63,264 Liabilities--Note G (96,314) ------------- (33,050) ------------- -------------------------------------------------------------------------------- NET ASSETS (100%) $17,222,281 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. (1)The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts and exchange-traded funds. After giving effect to these investments, the fund's effective common stock and temporary cash investment positions represent 98.7% and 1.5%, respectively, of net assets. See Note F in Notes to Financial Statements. (2)Considered an affiliated company as the fund owns more than 5% of the outstanding voting securities of such company. The total market value of investments in affiliated companies was $2,621,578,000. (3)Security segregated as initial margin for open futures contracts. ADR--American Depositary Receipt. REIT--Real Estate Investment Trust. 13 -------------------------------------------------------------------------------- AMOUNT WINDSOR FUND (000) -------------------------------------------------------------------------------- AT APRIL 30, 2002, NET ASSETS CONSISTED OF: -------------------------------------------------------------------------------- Paid-in Capital $15,348,658 Undistributed Net Investment Income 47,176 Accumulated Net Realized Gains 465,642 Unrealized Appreciation (Depreciation)--Note F Investment Securities 1,368,085 Futures Contracts (7,280) -------------------------------------------------------------------------------- NET ASSETS $17,222,281 ================================================================================ Investor Shares--Net Assets Applicable to 975,501,088 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $14,592,390 -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- INVESTOR SHARES $14.96 ================================================================================ Admiral Shares--Net Assets Applicable to 52,083,896 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $2,629,891 -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $50.49 ================================================================================ 14 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. -------------------------------------------------------------------------------- WINDSOR FUND SIX MONTHS ENDED APRIL 30, 2002 (000) -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 120,444 Interest 5,464 Security Lending 577 -------------------------------------------------------------------------------- Total Income $ 126,485 -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B Basic Fee 10,996 Performance Adjustment 6,284 The Vanguard Group--Note C Management and Administrative Investor Shares 18,189 Admiral Shares 1,649 Marketing and Distribution Investor Shares 988 Admiral Shares 50 Custodian Fees 106 Auditing Fees 6 Shareholders' Reports Investor Shares 167 Admiral Shares 13 Trustees' Fees and Expenses 8 -------------------------------------------------------------------------------- Total Expenses 38,456 Expenses Paid Indirectly--Note D (2,444) -------------------------------------------------------------------------------- Net Expenses 36,012 -------------------------------------------------------------------------------- NET INVESTMENT INCOME 90,473 -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities Sold* 454,151 Futures Contracts 13,522 -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) 467,673 -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities 634,690 Futures Contracts (7,898) -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 626,792 -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $1,184,938 ================================================================================ *Dividend income and realized net gain (loss) from affiliated companies were $15,441,000 and $140,010,000, respectively. 15 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. -------------------------------------------------------------------------------- WINDSOR FUND --------------------------------- SIX MONTHS YEAR ENDED ENDED APR. 30, 2002 OCT. 31, 2001 (000) (000) -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 90,473 $ 230,086 Realized Net Gain (Loss) 467,673 389,211 Change in Unrealized Appreciation (Depreciation) 626,792 (714,033) -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations 1,184,938 (94,736) -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income Investor Shares (90,415) (255,334) Admiral Shares (8,042) -- Realized Capital Gain* Investor Shares (316,967) (1,780,680) Admiral Shares (27,793) -- -------------------------------------------------------------------------------- Total Distributions (443,217) (2,036,014) -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS--Note H Investor Shares (1,997,550) 1,957,027 Admiral Shares 2,717,048 -- -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 719,498 1,957,027 -------------------------------------------------------------------------------- Total Increase (Decrease) 1,461,219 (173,723) -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 15,761,062 15,934,785 -------------------------------------------------------------------------------- End of Period $17,222,281 $15,761,062 ================================================================================ *Includes fiscal 2002 and 2001 short-term gain distributions totaling $110,500,000 and $0, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 16 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
WINDSOR FUND INVESTOR SHARES -------------------------------------------------------------------------------- YEAR ENDED OCTOBER 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED --------------------------------------------------------- THROUGHOUT EACH PERIOD APRIL 30, 2002 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $14.27 $16.44 $16.91 $16.34 $19.55 $16.99 ------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .079 .22 .28 .27 .23 .36 Net Realized and Unrealized Gain (Loss) on Investments 1.012 (.29) 1.44 1.77 (.32) 3.94 ------------------------------------------------------------------------------------------------------------------- Total from Investment Operations 1.091 (.07) 1.72 2.04 (.09) 4.30 ------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.089) (.25) (.29) (.24) (.24) (.41) Distributions from Realized Capital Gaines (.312) (1.85) (1.90) (1.23) (2.88) (1.33) ------------------------------------------------------------------------------------------------------------------- Total Distributions (.401) (2.10) (2.19) (1.47) (3.12) (1.74) ------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $14.96 $14.27 $16.44 $16.91 $16.34 $19.55 =================================================================================================================== TOTAL RETURN 7.61% -0.37% 11.60% 13.74% -0.78% 27.04% =================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $14,592 $15,761 $15,935 $16,824 $18,355 $20,678 Ratio of Total Expenses to Average Net Assets 0.45%* 0.41% 0.31% 0.28% 0.27% 0.27% Ratio of Net Investment Income to Average Net Assets 1.05%* 1.37% 1.75% 1.56% 1.31% 1.89% Portfolio Turnover Rate 31%* 33% 41% 56% 48% 61% =================================================================================================================== *Annualized.
17 FINANCIAL HIGHLIGHTS (CONTINUED) WINDSOR FUND ADMIRAL SHARES -------------------------------------------------------------------------------- NOV. 12, 2001* TO FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD APR. 30, 2002 -------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $50.00 -------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .257 Net Realized and Unrealized Gain (Loss) on Investments 1.592 -------------------------------------------------------------------------------- Total from Investment Operations 1.849 -------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.305) Distributions from Realized Capital Gains (1.054) -------------------------------------------------------------------------------- Total Distributions (1.359) -------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $50.49 ================================================================================ TOTAL RETURN 3.67% ================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $2,630 Ratio of Total Expenses to Average Net Assets 0.39%** Ratio of Net Investment Income to Average Net Assets 1.05%** Portfolio Turnover Rate 31%** ================================================================================ *Inception. **Annualized. NOTES TO FINANCIAL STATEMENTS Vanguard Windsor Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on November 12, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments acquired over 60 days to maturity are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agree- 18 ments secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. FUTURES CONTRACTS: The fund uses S&P 500 Index and S&P MidCap 400 Index futures contracts to a limited extent, with the objective of maintaining full exposure to the stock market while maintaining liquidity. The fund may purchase or sell futures contracts to achieve a desired level of investment, whether to accommodate portfolio turnover or cash flows from capital share transactions. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the fund and the prices of futures contracts, and the possibility of an illiquid market. Futures contracts are valued at their quoted daily settlement prices. The aggregate principal amounts of the contracts are not recorded in the financial statements. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses). 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 6. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets. B. Wellington Management Company, llp, and Sanford C. Bernstein & Co., LLC, provide investment advisory services to the fund for fees calculated at an annual percentage rate of average net assets. The basic fee of Wellington Management Company, llp, is subject to quarterly adjustments based on performance for the preceding three years relative to the S&P 500 Index. The basic fee of Sanford C. Bernstein & Co., LLC, is subject to quarterly adjustments based on performance relative to the Russell 1000 Value Index. The Vanguard Group manages the cash reserves of the fund on an at-cost basis. For the six months ended April 30, 2002, the aggregate investment advisory fee represented an effective annual basic rate of 0.13% of the fund's average net assets before an increase of $6,284,000 (0.07%) based on performance. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At April 30, 2002, the fund had contributed capital of $2,735,000 to Vanguard (included in Other Assets), representing 0.02% of net assets and 2.73% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment advisers to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of 19 NOTES TO FINANCIAL STATEMENTS (CONTINUED) the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the six months ended April 30, 2002, directed brokerage and custodian fee offset arrangements reduced expenses by $2,432,000 and $12,000, respectively. The total expense reduction represented an effective annual rate of 0.03% of the fund's average net assets. E. During the six months ended April 30, 2002, the fund purchased $2,840,867,000 of investment securities and sold $2,627,277,000 of investment securities, other than temporary cash investments. F. At April 30, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $1,368,085,000, consisting of unrealized gains of $4,303,355,000 on securities that had risen in value since their purchase and $2,935,270,000 in unrealized losses on securities that had fallen in value since their purchase. At April 30, 2002, the aggregate settlement value of open futures contracts expiring in June 2002 and the related unrealized appreciation (depreciation) were: -------------------------------------------------------------------------------- (000) ----------------------- AGGREGATE UNREALIZED NUMBER OF SETTLEMENT APPRECIATION FUTURES CONTRACTS LONG CONTRACTS VALUE (DEPRECIATION) -------------------------------------------------------------------------------- S&P 500 Index 438 $117,953 $(7,954) S&P MidCap 400 Index 146 39,336 674 -------------------------------------------------------------------------------- Unrealized appreciation (depreciation) on open futures contracts is required to be treated as realized gain (loss) for tax purposes. G. The market value of securities on loan to broker/dealers at April 30, 2002, was $28,679,000, for which the fund held cash collateral of $28,863,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. H. Capital share transactions for each class of shares were: -------------------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED APR. 30, 2002 OCT. 31, 2001 ---------------------- -------------------- AMOUNT SHARES AMOUNT SHARES (000) (000) (000) (000) -------------------------------------------------------------------------------- Investor Shares Issued $ 869,749 56,307 $1,852,074 118,941 Issued in Lieu of Cash Distributions 385,916 25,507 1,910,548 133,500 Redeemed (3,253,215) (210,768) (1,805,595) (117,276) Net Increase (Decrease)-- Investor Shares (1,997,550) (128,954) 1,957,027 135,165 Admiral Shares Issued 2,766,522 53,022 -- -- Issued in Lieu of Cash Distributions 33,126 649 -- -- Redeemed (82,600) (1,587) -- -- Net Increase (Decrease)-- Admiral Shares 2,717,048 52,084 -- -- -------------------------------------------------------------------------------- 20 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. -------------------------------------------------------------------------------- TRUSTEES (YEAR ELECTED) JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and (1987) Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS The Partners of '63 (pro bono ventures in education); (2001) Senior Adviser to Greenwich Associates Successor Trustee of Yale University; Overseer of the Stern School of Business at New York (international business-strategy consulting); University; Trustee of the Whitehead Institute for Biomedical Research. RAJIV L. GUPTA Chairman and Chief Executive Officer of Rohm and Haas (2001) Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and Member (1998) of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, (1977) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co.of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. Chairman, President, Chief Executive Officer, and (1993) Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON Retired Chairman and Chief Executive Officer of Rohm (1985) and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. [PICTURE OF A SHIP] THE VANGUARD(R) LOGO POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 Vanguard, The Vanguard Group, Admiral, Windsor, and the ship logo are trademarks of The Vanguard Group, Inc. Standard & Poor's 500, S&P 500(R), and S&P MidCap 400 are trademarks of The McGraw-Hill Companies, Inc. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the fund or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C) 2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q222 062002 VANGUARD WINDSOR(TM)II FUND SEMIANNUAL REPORT * APRIL 30, 2002 STOCK [PICTURE OF A SHIP] THE VANGUARD GROUP(R) LOGO WHAT YOU CAN CONTROL As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Adviser's Report 5 Fund Profile 8 Glossary of Investment Terms 9 Performance Summary 10 Financial Statements 11 Advantages of Vanguard.com 24 -------------------------------------------------------------------------------- SUMMARY * Vanguard Windsor II Fund, benefiting from investors' preference for defensive shares, returned 7.6% during the first half of its 2002 fiscal year. * Beaten-down but still-pricey sectors such as technology continued to suffer. * In such defensively focused periods, the fund has often gained an edge from its pronounced "value" character. LETTER FROM THE CHAIRMAN Fellow Shareholder, VANGUARD(R) WINDSOR(TM) II fund returned 7.6% during the first half of its 2002 fiscal year, benefiting from the stock market's embrace of value-oriented shares. This result exceeded the returns of the broad market and the average large-capitalization value fund, but trailed the 8.9% return of the Russell 1000 Value Index, a broad benchmark of large-cap value stocks. The table below presents the total returns--capital change plus reinvested dividends--for Windsor II's Investor and Admiral(TM) Shares and for the fund's comparative standards. The components of your fund's total returns can be found on page 4. -------------------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED APRIL 30, 2002 -------------------------------------------------------- VANGUARD WINDSOR II FUND Investor Shares 7.6% Admiral Shares 7.6 Average Large-Cap Value Fund* 5.6 Russell 1000 Value Index 8.9 Wilshire 5000 Index 5.2 -------------------------------------------------------- *Derived from data provided by Lipper Inc. THE STOCK MARKET ROSE IN A VOLATILE PERIOD During the six months ended April 30, 2002, the U.S. stock market alternately surged and receded, but still produced a total return of 5.2%, as measured by the Wilshire 5000 Total Market Index. It was a solid gain and a welcome reversal from the declines of recent years. For those who had investments in small-capitalization stocks, the period was especially rewarding, as the small-cap Russell 2000 Index gained 20.0%. The large-cap Russell 1000 Index returned 3.4%. Across all market caps, value stocks--those with below-average prices relative to earnings, book value, and other measures--retained the lead they more or less have had over growth shares since the market's peak in March 2000. In international markets, however, the lead was reversed, with growth slightly outperforming value. U.S. and international markets did have a common denominator in the period: Their returns were hampered by slumping share prices in the troubled telecommunications industry, which was burdened by overcapacity, weak demand, and heavy debt. THE U.S. ECONOMY REBOUNDED A modest economic recovery set the stage for the turnaround in the stock market. The recession that began in March 2001 seemed to have ended even before the year came to a close. After falling in the third quarter of 2001, the nation's real (inflation-adjusted) gross domestic product rose in the fourth quarter, then surged 1 at an estimated annual rate of 5.6% in the first three months of 2002. The strong growth was bolstered by heavy investment in inventories and housing, by government defense expenditures, and by consumer spending, which never really slackened despite the economic slowdown. The job market, however, still had not caught up with the improving economy. In April the unemployment rate reached 6.0%--the highest level in almost eight years, though still low compared with the jobless rates following past recessions. ----------------------------------------------------------------------------- MARKET BAROMETER TOTAL RETURNS PERIODS ENDED APRIL 30, 2002 ----------------------------- SIX ONE FIVE MONTHS YEAR YEARS* ----------------------------------------------------------------------------- STOCK Russell 1000 Index (Large-caps) 3.4% -12.0% 7.9% Russell 2000 Index (Small-caps) 20.0 6.7 9.7 Wilshire 5000 Index (Entire market) 5.2 -9.9 7.7 MSCI EAFE Index (International) 5.5 -13.9 1.3 ----------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 0.0% 7.8% 7.7% (Broad taxable market) Lehman 10 Year Municipal Bond Index 1.2 7.2 6.5 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 1.0 2.9 4.8 ============================================================================= CPI Consumer Price Index 1.2% 1.6% 2.3% ----------------------------------------------------------------------------- *Annualized. The economy was helped along by the Federal Reserve Board, which made 11 cuts in its target for short-term interest rates in 2001, including two during your fund's fiscal half-year. The cuts brought the federal funds rate--the interest rate that banks charge each other for overnight loans made through the Federal Reserve System--to 1.75%, the lowest level in four decades. BONDS STAGNATED The Fed's rate cuts, the recovering economy, and concerns that the Fed may start raising interest rates before year-end caused yields on longer-term bonds to rise. The Lehman Brothers Aggregate Bond Index, a proxy for the taxable, investment-grade U.S. bond market, had a zero return for the six months, as falling prices completely offset interest income (bond prices move in the opposite direction from interest rates). As with the stock market, problems in the telecom industry made the situation worse--bonds issued by these companies fell drastically in price. The returns for high-yield ("junk") bonds were a notable exception to bonds' overall low returns: The Lehman High Yield Index gained 6.6% for the six months. The yield of the 10-year U.S. Treasury note rose 86 basis points (0.86 percentage point) during the six months to end the period at 5.09%. The yield of the 3-month Treasury bill--which follows the Fed's rate changes with a slight lag--fell 25 basis points to 1.76%. WINDSOR II'S VALUE STRATEGY FOUND FAVOR Because of its emphasis on attractively valued stocks, Vanguard Windsor II Fund benefited from holdings in some of the market's best-performing sectors during 2 the past six months. While long-suffering but still pricey sectors such as technology continued to incur the market's disfavor, your fund's financial services, consumer discretionary, and consumer staples stocks registered strong returns as investors found comfort in more defensive stocks. Together, these stocks accounted for more than half the fund's assets and helped Windsor II to outperform the broad market. -------------------------------------------------------------------------------- When value stocks come to the fore, your fund has often had an advantage over its average peer because of its consistent "value" character. Your fund also has benefited in competitive terms from its lower expenses. -------------------------------------------------------------------------------- Windsor II's result also compared favorably with that of the average large-cap value fund. In fact, your fund outperformed more than 70% of its mutual fund peers during the half-year. When value stocks come to the fore, your fund has often had an advantage over its average peer because of its consistent "value" character. Unlike Windsor II, for example, your fund's average peer held sizable positions in technology and health care stocks--two growth-oriented sectors that fared poorly during the past six months. As the table below illustrates, Windsor II's distinctive value emphasis is actually the product of decisions made by four different investment advisers, an arrangement that gives the fund flexibility in the management of its large asset base. Your fund also has benefited in competitive terms from its lower expenses. Windsor II's 0.39% expense ratio is nearly a full percentage point lower than the 1.38% average expense ratio charged by other large value funds. Low costs, of course, are a powerful advantage in any type of market. The fund lagged the unmanaged Russell 1000 Value Index--a reasonable reference point for Windsor II but one that encompasses a broader range of stocks than your fund--because some of our health care selections turned in poor performances. Your fund also paid a price for its sizable stake in Kmart, the embattled retailer, which accounted for 1.2% of fund assets at the start of the six months. The Adviser's Report on page 5 includes more information about individual stock selection. ----------------------------------------------------------------------------- FUND ASSETS MANAGED APRIL 30, 2002 -------------------------- $ MILLION PERCENTAGE ----------------------------------------------------------------------------- Barrow, Hanley, Mewhinney & Strauss, Inc. $ 15,686 61% Equinox Capital Management, LLC 3,802 15 Tukman Capital Management, Inc. 3,279 13 Vanguard Quantitative Equity Group 1,615 6 Cash Investments* 1,209 5 ----------------------------------------------------------------------------- Total $ 25,591 100% ----------------------------------------------------------------------------- * This cash is invested by The Vanguard Group in equity index products to simulate investment in stocks. Each adviser may also maintain a modest cash position. VALUE: ONE PIECE OF YOUR PLAN Value stocks have been in favor recently, but it wasn't long ago that growth ruled the day. That's why we advise investors to develop a portfolio diversified both across asset 3 classes--stocks, bonds, and cash--and within asset classes. By complementing Windsor II with a low-cost, well-managed growth fund, for example, you're better positioned for the stock market's inevitable changes in leadership. Once you have an investment plan in place, it's wise to leave your selections relatively fixed and let time and compounding lead you toward your goals. We thank you for entrusting your hard-earned money to us. Sincerely, /S/ JOHN J. BRENNAN [PHOTO OF JOHN J. BRENNAN] JOHN J. BRENNAN Chairman and Chief Executive Officer May 9, 2002 ------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: OCTOBER 31, 2001-APRIL 30, 2002 DISTRIBUTIONS PER SHARE ----------------------- STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS ------------------------------------------------------------------------------- VANGUARD WINDSOR II FUND Investor Shares $ 24.50 $ 25.92 $ 0.280 $ 0.150 Admiral Shares 43.50 46.02 0.517 0.265 ------------------------------------------------------------------------------- 4 ADVISER'S REPORT Vanguard Windsor II Fund returned 7.6% for the six-month period ended April 30, compared with an 8.9% return for the Russell 1000 Value Index. THE INVESTMENT ENVIRONMENT We have experienced quite a volatile market in the past six months. Obviously, we began the period following a sharp worldwide correction precipitated by the events of September 11. Depending on what benchmark you look at, the market is retesting the level it reached after the attacks, is up slightly, or is well above that point, but nevertheless the volatility is still there. The market has had a preference for small to midsize stocks. Even though the economy has bottomed and seems to be improving, investors no longer appear confident that increasing earnings will automatically translate into rising stock prices. Buyers of equities are becoming quite analytical about reported numbers, and the era of managed earnings and self-made revenues is over. The big credit-rating agencies are on a real rampage--a belated reaction to Enron, as the agencies fear they could be drawn into investors' legal actions as a potential source of funds. The rating agencies are now commenting on everything from off-balance-sheet financing to general business plans and accounting issues, yet they have provided no clear guidance as to what they expect from corporate borrowers. The brokerage industry is under siege by attorneys and other skeptics newly concerned about its investment-banking transactions, initial public offerings, and analyst recommendations. This atmosphere of distrust could continue for some time. The Nasdaq market surely doesn't seem a safe place to be. It is easy, on reflection, to see why investors are not very comfortable. OUR SUCCESSES Our most successful investments during the past six months included: * SEARS. The retailer has been rewarded for internal improvements, and it continues to exceed analysts' expectations, which frankly are low in our view. * ITT INDUSTRIES. This is one of the truly strong earnings stories in today's market. The company's exposure to the defense sector is a plus. * CENDANT AND BOEING. Both have rebounded nicely from the September lows created by panicked sellers. These companies will improve with the economy. -------------------------------------------------------------------------------- INVESTMENT PHILOSOPHY The fund reflects a belief that superior long-term investment results can be achieved by holding a diversified portfolio of out-of-favor stocks with below-average price/earnings ratios, above-average dividend yields, and the prospect of above-average total returns. -------------------------------------------------------------------------------- 5 * ENTERGY. The electric utility has a low price/earnings ratio, an increasing yield, relative insulation from the economy's troubles, and transparent accounting. All of these characteristics are currently valued by investors. OUR SHORTFALLS Among our missteps during the period were: * KMART. Because we are value investors, we sometimes own companies in need of improvement--i.e., turnarounds. With a significant change in leadership at Kmart, we believed there was a good chance of improvement at this admittedly mediocre retailer. However, a combination of debt, poor marketing, lower sales in the critical holiday season, and waning confidence among vendors led Kmart to seek voluntary bankruptcy protection to reorganize its business. In the process, Kmart destroyed the equity holder. * WILLIAMS COMPANIES AND MIRANT. These energy companies have been disasters not only because of the Enron fallout but because of downgrades by the rating agencies. We feel that, with normal weather, profitability will return to independent power providers. * WATSON PHARMACEUTICALS. The drugmaker surprised investors by changing its business plans and destroying its near-term profitability. * BRISTOL-MYERS SQUIBB. Like many drug companies, Bristol-Myers has seen its earnings peak, and its growth potential seems limited until new products in its pipeline make it through FDA approval. We will have to sit, wait, and add to this holding. OUR PORTFOLIO POSITIONING Amid a general flight to safety, our investment style has been favored. From time to time, there is real value in value investing. Our portfolio's price/earnings ratio is lower than those of the market and our benchmark index. We believe that the companies whose shares we own are poised for significant earnings improvements. Our high dividend yield should be a help in uncertain times. We feel that the fund is positioned to generate good relative returns. JAMES P. BARROW, Portfolio Manager BARROW, HANLEY, Mewhinney & Strauss, Inc. May 15, 2002 6 -------------------------------------------------------------------------------- PORTFOLIO CHANGES SIX MONTHS ENDED APRIL 30, 2002 ADDED COMMENTS -------------------------------------------------------------------------------- MERCK The drugmaker is a high-quality company with an attractive 2.5% dividend yield and a good long-term outlook. -------------------------------------------------------------------------------- TYCO INTERNATIONAL* This became a good value when the price dropped to 10 times earnings. Selling CIT Group this summer should solve Tyco's liquidity needs. ================================================================================ ELIMINATED AON We sold because we lost faith in management's ability to significantly improve profitability. -------------------------------------------------------------------------------- BAKER HUGHES We sold because it had generally fulfilled our expectations, even though the drilling environment is not robust. The P/E ratio was high in view of the future performance we anticipate. -------------------------------------------------------------------------------- KMART Upon detailed analysis of the retailer's assets and liabilities, we determined there would be little if any value left for the stockholder after the company is reorganized. After waiting for the extreme pressure on the stock to pass, we exited the position. -------------------------------------------------------------------------------- SCHLUMBERGER We sold this energy firm because we believe its diversification strategy has failed. -------------------------------------------------------------------------------- WATSON PHARMACEUTICALS We sold because we lost confidence in the management team and its ability to execute its strategy. We do not have faith that management can sustain the company's growth or prevent the competition from eroding its business. -------------------------------------------------------------------------------- *New holding. SEE PAGE 11 FOR A COMPLETE LISTING OF THE FUND'S HOLDINGS. 7 FUND PROFILE AS OF APRIL 30, 2002 FOR WINDSOR II FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate to both an unmanaged index that we consider a "best fit" for the fund and a broad market index. Key terms are defined on page 9. ------------------------------------------------------------------------- PORTFOLIO CHARACTERISTICS BEST WILSHIRE FUND FIT* 5000 ------------------------------------------------------------------------- Number of Stocks 353 690 5,915 Median Market Cap $23.9B $28.3B $29.1B Price/Earnings Ratio 19.9x 24.5x 31.5x Price/Book Ratio 2.4x 2.6x 3.1x Yield 2.1% 1.4% Investor Shares 1.9% Admiral Shares 2.0% Return on Equity 19.8% 19.6% 21.5% Earnings Growth Rate 6.7% 5.2% 10.3% Foreign Holdings 3.9% 0.0% 0.0% Turnover Rate 39%** -- -- Expense Ratio -- -- Investor Shares 0.39%** Admiral Shares 0.32%** Cash Investments 2.7% -- -- ------------------------------------------------------------------------- -------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) Philip Morris Cos., Inc. 3.0% (tobacco) Entergy Corp. 3.0 (electric utilities) Allstate Corp. 2.8 (insurance) Sears, Roebuck & Co. 2.6 (retail) Bank of America Corp. 2.5 (banking) Washington Mutual, Inc. 2.4 (savings & loan) Cendant Corp. 2.4 (commercial services) Citigroup, Inc. 2.4 (banking) Occidental Petroleum Corp. 2.3 (oil) American Electric Power Co., Inc. 2.2 (electric utilities) -------------------------------------------- Top Ten 25.6% -------------------------------------------- -------------------------------------------------------- VOLATILITY MEASURES BEST WILSHIRE FUND FIT* FUND 5000 -------------------------------------------------------- R-Squared 0.88 1.00 0.20 1.00 Beta 1.00 1.00 0.40 1.00 -------------------------------------------------------- ----------------------------- INVESTMENT FOCUS MARKET CAP LARGE STYLE VALUE ----------------------------- -------------------------------------------------------- SECTOR DIVERSIFICATION (% OF COMMON STOCKS) BEST WILSHIRE FUND FIT* 5000 -------------------------------------------------------- Auto & Transportation 0.9% 3.6% 2.4% Consumer Discretionary 13.7 11.3 15.4 Consumer Staples 10.4 7.1 7.4 Financial Services 28.2 32.1 21.7 Health Care 4.3 5.5 13.8 Integrated Oils 8.0 8.5 3.7 Other Energy 3.8 1.4 2.3 Materials & Processing 2.7 5.3 4.0 Producer Durables 4.3 4.1 3.9 Technology 3.3 5.4 14.0 Utilities 15.2 13.1 6.9 Other 5.2 2.6 4.5 -------------------------------------------------------- *Russell 1000 Value Index. **Annualized. [PICTURE OF A COMPUTER] VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. 8 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the fund's "best fit" index benchmark and an overall market index. Each index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the index rose or fell by 10%. -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the market in general, as measured by the fund's "best fit" index benchmark and by an overall market index. If a fund's total returns were precisely synchronized with an index's returns, its R-squared would be 1.00. If the fund's returns bore no relationship to the index's returns, its R-squared would be 0. -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. -------------------------------------------------------------------------------- 9 PERFORMANCE SUMMARY AS OF APRIL 30, 2002 FOR WINDSOR II FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) OCTOBER 31, 1991-APRIL 30, 2002 WINDSOR II FUND RUSSELL 1000 INVESTOR SHARES VALUE INDEX 1992 12.5 10.7 1993 19.5 25.2 1994 2.2 0.8 1995 23.1 24.7 1996 27.2 23.7 1997 31.3 33.2 1998 16.5 14.8 1999 4.6 16.5 2000 7.2 5.5 2001 -4.9 -11.9 2002* 7.6 8.9 -------------------------------------------------------------------------------- *Six months ended April 30, 2002. Note:See Financial Highlights tables on pages 19 and 20 for dividend and capital gains information. -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED MARCH 31, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE ---------------------------- INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL -------------------------------------------------------------------------------- Windsor II Fund Investor Shares 6/24/1985 3.30% 10.89% 11.02% 2.92% 13.94% Admiral Shares 5/14/2001 -2.92* -- -- -- -- -------------------------------------------------------------------------------- *Return since inception. 10 FINANCIAL STATEMENTS APRIL 30, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR II FUND SHARES (000) -------------------------------------------------------------------------------- COMMON STOCKS (92.5%)+ -------------------------------------------------------------------------------- AUTO & Transportation (0.8%) General Motors Corp. $ 2,479,968 $ 159,090 Union Pacific Corp. 174,900 9,934 TRW, Inc. 139,200 7,660 PACCAR, Inc. 101,200 7,233 * Lear Corp. 126,500 6,503 Ford Motor Co. 389,653 6,234 * FedEx Corp. 98,800 5,105 Norfolk Southern Corp. 206,900 4,434 Southwest Airlines Co. 159,400 2,903 Delta Air Lines, Inc. 86,300 2,391 Autoliv, Inc. 91,500 2,022 Delphi Corp. 98,200 1,527 * Northwest Airlines Corp. Class A 63,700 1,175 * Continental Airlines, Inc. Class B 26,100 679 United Parcel Service, Inc. 4,600 276 Tidewater Inc. 4,200 183 The Goodyear Tire & Rubber Co. 600 13 --------------- $ 217,362 --------------- CONSUMER DISCRETIONARY (12.7%) Sears, Roebuck & Co. 12,629,300 666,196 * Cendant Corp. 33,608,362 604,614 (1) Newell Rubbermaid, Inc. 14,448,600 453,686 Waste Management, Inc. 14,973,197 394,394 Gannett Co., Inc. 3,866,600 283,422 Wal-Mart Stores, Inc. 3,360,600 187,723 *(1)Service Corp. International 28,426,800 111,149 * Viacom Inc. Class B 2,242,391 105,617 The Walt Disney Co. 4,514,532 104,647 * Liberty Media Corp. 8,340,842 89,247 Target Corp. 1,441,500 62,921 * AOL Time Warner Inc. 2,494,000 47,436 McDonald's Corp. 307,200 8,724 Darden Restaurants Inc. 202,600 8,084 * Tricon Global Restaurants, Inc. 125,400 7,908 Mattel, Inc. 358,500 7,399 * AutoNation, Inc. 458,300 7,333 Wendy's International, Inc. 193,900 7,252 * Harrah's Entertainment, Inc. 142,300 6,995 Whirlpool Corp. 89,900 6,738 Liz Claiborne, Inc. 199,800 6,252 NIKE, Inc. Class B 106,700 5,690 * Brinker International, Inc. 162,900 5,610 * Jones Apparel Group, Inc. 127,200 4,954 * Federated Department Stores, Inc. 113,400 4,505 * Mohawk Industries, Inc. 69,900 4,497 Kimberly-Clark Corp. 58,500 3,809 VF Corp. 75,600 3,309 * AutoZone Inc. 42,500 3,230 Avon Products, Inc. 52,600 2,938 * Office Depot, Inc. 142,300 2,724 * Foot Locker, Inc. 169,100 2,663 * Outback Steakhouse 71,000 2,490 Nordstrom, Inc. 104,600 2,454 Gillette Co. 54,700 1,941 11 -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR II FUND SHARES (000) -------------------------------------------------------------------------------- * Clear Channel Communications, Inc. $ 40,300 $ 1,892 * Mandalay Resort Group 47,000 1,685 May Department Stores Co. 46,837 1,624 * Republic Services, Inc. Class A 59,100 1,170 Alberto-Culver Co. Class B 19,600 1,070 Viad Corp. 29,200 890 * USA Networks, Inc. 27,400 820 The McGraw-Hill Cos., Inc. 11,600 742 Starwood Hotels & Resorts Worldwide, Inc. 15,500 586 * Allied Waste Industries, Inc. 39,100 475 Tribune Co. 10,700 473 * Ticketmaster Class B 16,500 388 * MGM Mirage, Inc. 8,800 353 International Flavors & Fragrances, Inc. 6,000 193 * Reebok International Ltd. 1,700 47 Ross Stores, Inc. 1,100 45 --------------- $ 3,241,004 --------------- Consumer Staples (9.6%) Philip Morris Cos., Inc. 14,119,900 768,546 Imperial Tobacco Group ADR 14,840,000 422,940 ConAgra Foods, Inc. 12,948,700 317,243 Anheuser-Busch Cos., Inc. 5,537,800 293,503 The Procter & Gamble Co. 2,757,600 248,901 PepsiCo, Inc. 3,473,400 180,269 * Safeway, Inc. 2,764,700 115,979 H.J. Heinz Co. 2,046,700 85,941 The Pepsi Bottling Group, Inc. 233,000 6,673 R.J. Reynolds Tobacco Holdings, Inc. 83,600 5,785 The Clorox Co. 129,100 5,713 * Smithfield Foods, Inc. 237,000 5,001 SuperValu Inc. 129,800 3,894 Adolph Coors Co. Class B 57,200 3,824 The Coca-Cola Co. 49,800 2,764 PepsiAmericas, Inc. 53,300 813 Colgate-Palmolive Co. 11,200 594 Coca-Cola Enterprises, Inc. 16,500 324 * Constellation Brands, Inc. Class A 1,800 109 Sara Lee Corp. 500 11 --------------- $ 2,468,827 --------------- FINANCIAL SERVICES (26.1%) BANKS--NEW YORK CITY (1.9%) J.P. Morgan Chase & Co. 13,624,904 478,234 The Bank of New York Co., Inc. 79,700 2,916 BANKS--OUTSIDE NEW YORK CITY (8.5%) Bank of America Corp. 8,789,112 637,035 PNC Financial Services Group 7,853,522 433,122 Wells Fargo & Co. 7,256,100 371,150 National City Corp. 10,273,200 320,524 Wachovia Corp. 4,452,202 169,362 FleetBoston Financial Corp. 3,611,042 127,470 Bank One Corp. 486,800 19,896 U.S. Bancorp 530,822 12,580 Mellon Financial Corp. 229,100 8,651 UnionBanCal Corp. 155,774 7,539 Union Planters Corp. 147,700 7,401 Marshall & Ilsley Corp. 106,900 6,804 First Tennessee National Corp. 161,300 6,236 Hibernia Corp. Class A 312,400 6,232 Fifth Third Bancorp 88,900 6,098 AmSouth Bancorp 268,400 6,095 City National Corp. 92,200 5,094 Comerica, Inc. 68,100 4,280 First Virginia Banks, Inc. 52,200 2,987 Commerce Bancshares, Inc. 65,304 2,898 State Street Corp. 56,300 2,877 Trustmark Corp. 88,900 2,291 SunTrust Banks, Inc. 19,800 1,346 North Fork Bancorp, Inc. 34,100 1,317 KeyCorp 37,200 1,046 BB&T Corp. 20,900 796 Regions Financial Corp. 19,300 677 Wilmington Trust Corp. 1,800 114 Popular, Inc. 3,000 88 FirstMerit Corp. 100 3 DIVERSIFIED FINANCIAL SERVICES (4.8%) Citigroup, Inc. 13,908,573 602,241 John Hancock Financial Services, Inc. 8,917,300 344,208 The Goldman Sachs Group, Inc. 2,025,800 159,532 Morgan Stanley Dean Witter & Co. 2,295,800 109,556 American Express Co. 300,200 12,311 Merrill Lynch & Co., Inc. 149,700 6,278 Metropolitan Life Insurance Co. 150,100 5,124 Household International, Inc. 62,000 3,614 Marsh & McLennan Cos., Inc. 21,900 2,214 FINANCIAL--DATA PROCESSING SERVICES Deluxe Corp. 170,300 7,473 FINANCIAL--INFORMATION SERVICES * The Dunn & Bradstreet Corp. 46,500 1,791 FINANCIAL--MISCELLANEOUS (1.4%) Fannie Mae 4,161,100 328,436 Freddie Mac 137,500 8,986 MGIC Investment Corp. 88,700 6,330 Fidelity National Financial, Inc. 196,830 6,072 H & R Block, Inc. 128,900 5,171 12 -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) -------------------------------------------------------------------------------- Radian Group, Inc. $ 98,300 $ 5,102 Ambac Financial Group, Inc. 24,900 1,565 MBIA, Inc. 2,500 135 FINANCIAL--SMALL LOAN (1.6%) USA Education Inc. 4,157,600 398,506 INSURANCE--MULTILINE (5.1%) Allstate Corp. 18,301,744 727,311 American International Group, Inc. 4,172,801 288,424 The Hartford Financial Services Group Inc. 2,053,000 142,273 St. Paul Cos., Inc. 2,715,800 135,274 CIGNA Corp. 87,200 9,505 Old Republic International Corp. 193,500 6,430 Torchmark Corp. 133,000 5,438 UnumProvident Corp. 67,200 1,898 Reinsurance Group of America, Inc. 50,800 1,641 AFLAC Inc. 53,200 1,591 American Financial Group, Inc. 6,100 181 Protective Life Corp. 2,000 64 INSURANCE--PROPERTY-CASUALTY (0.1%) Progressive Corp. of Ohio 127,300 7,320 The PMI Group Inc. 72,550 5,885 HCC Insurance Holdings, Inc. 8,700 226 Erie Indemnity Co. Class A 3,100 135 REAL ESTATE INVESTMENT TRUST (0.1%) Public Storage, Inc. REIT 148,600 5,642 Mack-Cali Realty Corp. REIT 136,800 4,487 iStar Financial Inc. REIT 102,500 3,188 New Plan Excel Realty Trust REIT 101,700 1,988 Kimco Realty Corp. REIT 59,700 1,916 Simon Property Group, Inc. REIT 26,000 878 Hospitality Properties Trust REIT 8,600 292 Liberty Property Trust REIT 8,600 275 Duke Realty Corp. REIT 4,000 105 Plum Creek Timber Co. Inc. REIT 3,000 91 Arden Realty Group, Inc. REIT 900 25 RENT & Lease Services--Commercial * United Rentals, Inc. 45,000 1,147 SAVINGS & Loan (2.6%) Washington Mutual, Inc. 16,447,649 620,570 Golden West Financial Corp. 112,800 7,714 Sovereign Bancorp, Inc. 421,000 6,075 Green Point Financial Corp. 102,600 5,074 Charter One Financial, Inc. 137,000 4,847 Washington Federal Inc. 173,240 4,525 Roslyn Bancorp, Inc. 155,100 3,570 Astoria Financial Corp. 89,300 2,866 Golden State Bancorp Inc. 78,500 2,590 SECURITIES BROKERS & Services Countrywide Credit Industries, Inc. 142,609 6,661 Bear Stearns Co., Inc. 60,200 3,729 John Nuveen Co. Class A 6,800 394 --------------- $ 6,690,049 --------------- HEALTH CARE (3.9%) Merck & Co., Inc. 7,377,600 400,899 Wyeth 4,027,500 229,568 Bristol-Myers Squibb Co. 5,435,600 156,545 HCA Inc. 3,164,900 151,251 Johnson & Johnson 209,200 13,360 * Tenet Healthcare Corp. 165,000 12,106 UnitedHealth Group Inc. 90,400 7,938 AmerisourceBergen Corp. 82,500 6,394 Mylan Laboratories, Inc. 220,200 5,831 Abbott Laboratories 98,300 5,303 * DaVita, Inc. 173,600 4,500 * Medicis Pharmaceutical Corp. 74,100 3,968 Becton, Dickinson & Co. 77,700 2,888 * Universal Health Services Class B 58,100 2,705 Eli Lilly & Co. 24,600 1,625 * Boston Scientific Corp. 58,200 1,450 * HEALTHSOUTH Corp. 83,800 1,265 ICN Pharmaceuticals, Inc. 17,700 490 * Cerner Corp. 8,800 467 * Cephalon, Inc. 7,900 463 * Zimmer Holdings, Inc. 10,700 371 * Humana Inc. 15,500 253 * Sepracor Inc. 3,300 42 --------------- $ 1,009,682 --------------- INTEGRATED OILS (7.4%) (1) Occidental Petroleum Corp. 20,358,600 585,310 Phillips Petroleum Co. 8,812,000 527,046 BP PLC ADR 6,238,172 316,899 ExxonMobil Corp. 4,487,156 180,249 ChevronTexaco Corp. 1,673,543 145,113 Conoco Inc. 4,472,000 125,440 Amerada Hess Corp. 82,700 6,358 Marathon Oil Corp. 125,900 3,659 Unocal Corp. 49,900 1,856 Murphy Oil Corp. 500 47 --------------- $ 1,891,977 --------------- OTHER ENERGY (3.5%) Transocean Sedco Forex Inc. 11,478,031 407,470 Williams Cos., Inc. 18,354,400 350,569 El Paso Corp. 3,165,000 126,600 Apache Corp. 109,500 6,387 Valero Energy Corp. 142,604 6,155 13 -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR II FUND SHARES (000) -------------------------------------------------------------------------------- Sunoco, Inc. $ 79,200 $ 2,723 Burlington Resources, Inc. 23,200 1,031 Dynegy, Inc. 32,500 585 * Reliant Resources, Inc. 27,300 421 * Newfield Exploration Co. 4,900 185 * Varco International, Inc. 4,500 92 Peabody Energy Corp. 1,400 38 --------------- $ 902,256 --------------- MATERIALS & Processing (2.5%) Hanson PLC ADR 5,326,950 194,966 Dow Chemical Co. 4,623,900 147,040 (1) Millennium Chemicals, Inc. 7,368,142 100,575 (1) Crompton Corp. 6,238,569 75,175 Alcoa Inc. 1,619,900 55,125 E.I. du Pont de Nemours & Co. 342,187 15,227 International Paper Co. 255,100 10,569 Praxair, Inc. 139,800 7,983 * Pactiv Corp. 300,000 6,201 Lafarge North America Inc. 125,300 5,486 Sigma-Aldrich Corp. 103,000 4,880 * Smurfit-Stone Container Corp. 230,700 3,747 Rohm & Haas Co. 94,900 3,522 Ashland, Inc. 84,800 3,462 Temple-Inland Inc. 58,800 3,113 Engelhard Corp. 88,900 2,704 Masco Corp. 83,300 2,341 Lubrizol Corp. 54,200 1,869 Bemis Co., Inc. 20,700 1,102 MeadWestvaco Corp. 30,893 907 Cabot Corp. 26,700 796 * Sealed Air Corp. 16,800 750 Sherwin-Williams Co. 23,300 716 Weyerhaeuser Co. 4,900 292 Avery Dennison Corp. 1,800 115 Ecolab, Inc. 2,200 97 * Security Capital Group Inc. Class B 2,500 64 Boise Cascade Corp. 1,800 61 --------------- $ 648,885 --------------- PRODUCER DURABLES (4.0%) The Boeing Co. 11,665,300 520,272 Emerson Electric Co. 5,675,300 303,004 United Technologies Corp. 2,218,696 155,686 Lockheed Martin Corp. 193,700 12,184 W.W. Grainger, Inc. 92,900 5,209 Pitney Bowes, Inc. 107,600 4,530 Goodrich Corp. 80,600 2,573 Diebold, Inc. 61,500 2,326 Rockwell Collins, Inc. 94,900 2,261 Pentair, Inc. 44,400 2,156 * Tektronix, Inc. 81,600 1,795 Caterpillar, Inc. 23,900 1,305 D. R. Horton, Inc. 44,700 1,153 Lennar Corp. 13,800 766 * Polycom, Inc. 31,500 650 * Agilent Technologies, Inc. 14,300 430 HON Industries, Inc. 8,600 257 Parker Hannifin Corp. 4,200 210 * Imagistics International Inc. 3,008 52 --------------- $ 1,016,819 --------------- TECHNOLOGY (3.1%) Electronic Data Systems Corp. 3,180,800 172,590 Raytheon Co. 3,530,500 149,340 International Business Machines Corp. 1,503,700 125,950 Hewlett-Packard Co. 7,177,800 122,740 Motorola, Inc. 5,542,100 85,348 * Celestica, Inc. 2,935,400 81,311 Compaq Computer Corp. 621,300 6,306 * Micron Technology, Inc. 210,000 4,977 * Storage Technology Corp. 233,800 4,812 * National Semiconductor Corp. 149,100 4,700 Autodesk, Inc. 226,700 4,169 * Computer Sciences Corp. 78,400 3,516 * Network Associates, Inc. 176,800 3,138 * Intuit, Inc. 47,500 1,861 Harris Corp. 50,100 1,814 * UTStarcom, Inc. 72,200 1,769 * 3Com Corp. 303,500 1,751 * Unisys Corp. 113,200 1,528 * Integrated Device Technology Inc. 46,900 1,315 General Dynamics Corp. 8,600 835 * PanAmSat Corp. 30,600 719 Reynolds & Reynolds Class A 21,800 631 * Compuware Corp. 17,600 138 --------------- $ 781,258 --------------- UTILITIES (14.1%) (1) Entergy Corp. 16,297,800 756,218 American Electric Power Co., Inc. 12,402,060 568,014 (1) Public Service Enterprise Group, Inc. 11,056,700 512,478 Verizon Communications 8,660,854 347,387 Reliant Energy, Inc. 13,414,100 340,450 *(1)Mirant Corp. 22,956,600 277,316 Southern Co. 9,706,600 275,182 Duke Energy Corp. 3,850,200 147,578 AT&T Corp. 7,683,645 100,809 SBC Communications Inc. 2,952,847 91,715 Exelon Corp. 1,324,600 71,926 BellSouth Corp. 545,400 16,553 PPL Corp. 422,300 16,094 TXU Corp. 169,800 9,240 * PG&E Corp. 325,900 7,659 FirstEnergy Corp. 228,500 7,609 14 -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) -------------------------------------------------------------------------------- Pinnacle West Capital Corp. $ 128,400 $ 5,626 SCANA Corp. 173,600 5,547 Sempra Energy 198,600 5,078 Conectiv, Inc. 166,900 4,162 * Edison International 190,000 3,448 * Comcast Corp.-Special Class A 120,600 3,226 * U.S. Cellular Corp. 70,300 2,777 CMS Energy Corp. 131,600 2,548 Allete, Inc. 80,800 2,468 Alliant Energy Corp. 86,900 2,455 Sprint Corp. 153,300 2,430 Wisconsin Energy Corp. 77,300 2,010 * WorldCom Inc.-WorldCom Group 796,122 1,974 Questar Corp. 58,200 1,624 Dominion Resources, Inc. 24,300 1,614 Telephone & Data Systems, Inc. 16,500 1,419 IDACORP, Inc. 32,200 1,218 Potomac Electric Power Co. 49,600 1,134 Aquila, Inc. 60,615 972 ALLTEL Corp. 14,800 733 CenturyTel, Inc. 21,500 596 * Adelphia Communications Corp. Class A 96,100 579 Progress Energy, Inc. 8,400 436 * BroadWing Inc. 58,300 385 Constellation Energy Group, Inc. 10,500 335 KeySpan Corp. 8,200 289 Puget Energy, Inc. 8,400 174 --------------- $ 3,601,485 --------------- OTHER (4.8%) (1) ITT Industries, Inc. 7,603,400 531,174 Tyco International Ltd. 14,819,800 273,425 Honeywell International Inc. 4,981,800 182,732 General Electric Co. 4,424,400 139,590 Textron, Inc. 1,001,100 49,234 Fortune Brands, Inc. 178,700 9,339 Johnson Controls, Inc. 88,600 7,642 Illinois Tool Works, Inc. 102,200 7,369 3M Co. 56,500 7,108 * Thermo Electron Corp. 271,500 5,131 Teleflex Inc. 32,500 1,837 Georgia Pacific Group 25,400 736 Wesco Financial Corp. 470 149 --------------- $ 1,215,466 --------------- -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $19,335,555) $ 23,685,070 -------------------------------------------------------------------------------- TEMPORARY INVESTMENTS (7.4%)+ -------------------------------------------------------------------------------- Vanguard Index Participation Equity Receipts-- Total Stock Market $ 3,489,100 $ 353,725 FACE AMOUNT (000) --------------- FEDERAL HOME LOAN MORTGAGE CORP. (2) 1.79%, 8/23/2002 $ 10,000 9,944 (2) 1.83%, 7/31/2002 50,000 49,782 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.92%, 5/1/2002 1,467,791 1,467,791 1.92%, 5/1/2002--Note G 1,256 1,256 -------------------------------------------------------------------------------- TOTAL TEMPORARY INVESTMENTS (Cost $1,872,053) $ 1,882,498 -------------------------------------------------------------------------------- TOTAL INVESTMENTS (99.9%) (Cost $21,207,608) $ 25,567,568 -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (0.1%) -------------------------------------------------------------------------------- Other Assets--Note C 326,942 Liabilities--Note G (303,057) ---------------- $ 23,885 ---------------- -------------------------------------------------------------------------------- NET ASSETS (100%) $ 25,591,453 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. + The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts and exchange-traded funds. After giving effect to these investments, the fund's effective common stock and temporary cash investment positions represent 97.3% and 2.6%, respectively, of net assets. See Note F in Notes to Financial Statements. (1) Considered an affiliated company as the fund owns more than 5% of the outstanding voting securities of such company. The total market value of investments in affiliated companies was $3,403,081,000. (2) Securities with an aggregate value of $59,726,000 have been segregated as initial margin for open futures contracts. ADR--American Depositary Receipt. REIT--Real Estate Investment Trust. 15 -------------------------------------------------------------------------------- AMOUNT WINDSOR II FUND (000) -------------------------------------------------------------------------------- AT APRIL 30, 2002, NET ASSETS CONSISTED OF: -------------------------------------------------------------------------------- Paid-in Capital $ 21,284,898 Undistributed Net Investment Income 137,614 Accumulated Net Realized Losses (155,295) Unrealized Appreciation (Depreciation)--Note F Investment Securities 4,359,960 Futures Contracts (35,724) -------------------------------------------------------------------------------- NET ASSETS $ 25,591,453 ================================================================================ Investor Shares--Net Assets Applicable to 879,042,426 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $ 22,785,110 -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- INVESTOR SHARES $ 25.92 ================================================================================ Admiral Shares--Net Assets Applicable to 60,981,854 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $ 2,806,343 -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $ 46.02 ================================================================================ 16 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. -------------------------------------------------------------------------------- WINDSOR II FUND SIX MONTHS ENDED APRIL 30, 2002 (000) -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 283,857 Interest 13,906 Security Lending 38 -------------------------------------------------------------------------------- Total Income $ 297,801 -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B Basic Fee 15,543 Performance Adjustment 1,945 The Vanguard Group--Note C Management and Administrative Investor Shares 25,640 Admiral Shares 2,117 Marketing and Distribution Investor Shares 1,563 Admiral Shares 115 Custodian Fees 166 Auditing Fees 8 Shareholders' Reports Investor Shares 334 Admiral Shares 31 Trustees' Fees and Expenses 12 -------------------------------------------------------------------------------- Total Expenses 47,474 Expenses Paid Indirectly--Note D (1,788) -------------------------------------------------------------------------------- Net Expenses $ 45,686 -------------------------------------------------------------------------------- NET INVESTMENT INCOME 252,115 -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities Sold* (205,774) Futures Contracts (1,023) -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) (206,797) -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities 1,720,925 Futures Contracts 16,683 -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) $ 1,737,608 -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ 1,782,926 ================================================================================ *Dividend income and realized net gain (loss) from affiliated companies were $67,418,000 and $(555,784,000), respectively. 17 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. -------------------------------------------------------------------------------- WINDSOR II FUND --------------------------------------- SIX MONTHS YEAR ENDED ENDED APR. 30, 2002 OCT. 31, 2001 (000) (000) -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 252,115 $ 529,168 Realized Net Gain (Loss) (206,797) 172,366 Change in Unrealized Appreciation (Depreciation) 1,737,608 (1,976,080) -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations 1,782,926 (1,274,546) -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income Investor Shares (243,603) (521,004) Admiral Shares (26,230) (11,567) Realized Capital Gain Investor Shares (130,500) (1,083,480) Admiral Shares (13,444) -- -------------------------------------------------------------------------------- Total Distributions $ (413,777) $ (1,616,051) -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS--NOTE H Investor Shares 43,707 52,333 Admiral Shares 644,001 2,302,955 -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 687,708 2,355,288 -------------------------------------------------------------------------------- Total Increase (Decrease) $ 2,056,857 $ (535,309) -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 23,534,596 24,069,905 -------------------------------------------------------------------------------- End of Period $ 25,591,453 $ 23,534,596 ================================================================================ 18 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
WINDSOR II FUND INVESTOR SHARES ------------------------------------------------------------------------------------------------------------------- YEAR ENDED OCTOBER 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED --------------------------------------------------------- THROUGHOUT EACH PERIOD APRIL 30, 2002 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 24.50 $ 27.58 $ 29.03 $ 31.07 $ 29.36 $ 24.04 ------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .258 .564 .64 .64 .65 .64 Net Realized and Unrealized Gain (Loss) on Investments 1.592 (1.819) 1.08 .73 3.91 6.47 ------------------------------------------------------------------------------------------------------------------- Total from Investment Operations 1.850 (1.255) 1.72 1.37 4.56 7.11 ------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.280) (.585) (.67) (.74) (.66) (.63) Distributions from Realized Capital Gains (.150) (1.240) (2.50) (2.67) (2.19) (1.16) ------------------------------------------------------------------------------------------------------------------- Total Distributions (.430) (1.825) (3.17) (3.41) (2.85) (1.79) ------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $25.92 $24.50 $27.58 $29.03 $31.07 $29.36 =================================================================================================================== TOTAL RETURN 7.60% -4.89% 7.22% 4.57% 16.51% 31.27% =================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $22,785 $21,495 $24,070 $30,541 $29,639 $22,568 Ratio of Total Expenses to Average Net Assets 0.39%* 0.40% 0.37% 0.37% 0.41% 0.37% Ratio of Net Investment Income to Average Net Assets 2.04%* 2.10% 2.36% 2.08% 2.16% 2.49% Portfolio Turnover Rate 39%* 33% 26% 26% 31% 30% =================================================================================================================== *Annualized.
19 FINANCIAL HIGHLIGHTS (CONTINUED) WINDSOR II FUND ADMIRAL SHARES -------------------------------------------------------------------------------- SIX MONTHS MAY 14* TO ENDED OCT. 31, FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD APR. 30, 2002 2001 -------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 43.50 $ 50.00 -------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .475 .408 Net Realized and Unrealized Gain (Loss) on Investments 2.827 (6.433) -------------------------------------------------------------------------------- Total from Investment Operations 3.302 (6.025) -------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.517) (.475) Distributions from Realized Capital Gains (.265) -- -------------------------------------------------------------------------------- Total Distributions (.782) (.475) -------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $ 46.02 $ 43.50 ================================================================================ TOTAL RETURN 7.64% -12.16% ================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $2,806 $2,039 Ratio of Total Expenses to Average Net Assets 0.32%** 0.35%** Ratio of Net Investment Income to Average Net Assets 2.07%** 1.83%** Portfolio Turnover Rate 39%** 33% ================================================================================ *Inception. **Annualized. 20 NOTES TO FINANCIAL STATEMENTS Vanguard Windsor II Fund is registered under the Investment Company Act of 1940 as an open- end investment company, or mutual fund. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on May 14, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments acquired over 60 days to maturity are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. FUTURES CONTRACTS: The fund uses S&P 500 Index and S&P MidCap 400 Index futures contracts to a limited extent, with the objective of maintaining full exposure to the stock market while maintaining liquidity. The fund may purchase or sell futures contracts to achieve a desired level of investment, whether to accommodate portfolio turnover or cash flows from capital share transactions. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the fund and the prices of futures contracts, and the possibility of an illiquid market. Futures contracts are valued at their quoted daily settlement prices. The aggregate principal amounts of the contracts are not recorded in the financial statements. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses). 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 6. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution 21 NOTE TO FINANCIAL STATEMENTS (CONTINUED) expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets. B. Barrow, Hanley, Mewhinney & Strauss, Inc.; Equinox Capital Management, LLC; and Tukman Capital Management, Inc., provide investment advisory services to the fund for fees calculated at an annual percentage rate of average net assets. The basic fees thus computed for each adviser are subject to quarterly adjustments based on performance for the preceding three years relative to a designated market index: for Barrow, Hanley, Mewhinney & Strauss, Inc., the S&P 500/Barra Value Index; for Equinox Capital Management, LLC, the Russell 1000 Value Index; and for Tukman Capital Management, Inc., the S&P 500 Index. The Vanguard Group provides investment advisory services to a portion of the fund on an at-cost basis; the fund paid Vanguard advisory fees of $321,000 for the six months ended April 30, 2002. For the six months ended April 30, 2002, the aggregate investment advisory fee represented an effective annual basic rate of 0.13% of average net assets before an increase of $1,945,000 (0.02%) based on performance. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At April 30, 2002, the fund had contributed capital of $4,647,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 4.65% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment advisers to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the six months ended April 30, 2002, directed brokerage and custodian fee offset arrangements reduced expenses by $1,787,000 and $1,000, respectively. The total expense reduction represented an effective annual rate of 0.01% of the fund's average net assets. E. During the six months ended April 30, 2002, the fund purchased $4,954,754,000 of investment securities and sold $4,551,785,000 of investment securities, other than temporary cash investments. F. At April 30, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $4,359,960,000, consisting of unrealized gains of $5,854,481,000 on securities that had risen in value since their purchase and $1,494,521,000 in unrealized losses on securities that had fallen in value since their purchase. 22 At April 30, 2002, the aggregate settlement value of open futures contracts expiring in June 2002 and the related unrealized appreciation (depreciation) were: -------------------------------------------------------------------------------- (000) --------------------------------- AGGREGATE UNREALIZED NUMBER OF SETTLEMENT APPRECIATION FUTURES CONTRACTS LONG CONTRACTS VALUE (DEPRECIATION) -------------------------------------------------------------------------------- S&P 500 Index 3,004 $808,977 $(36,672) S&P MidCap 400 Index 180 48,497 948 -------------------------------------------------------------------------------- Unrealized appreciation (depreciation) on open futures contracts is required to be treated as realized gain (loss) for tax purposes. G. The market value of securities on loan to broker/dealers at April 30, 2002, was $1,072,000, for which the fund held cash collateral of $1,256,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. H. Capital share transactions for each class of shares were: SIX MONTHS ENDED YEAR ENDED APRIL 30, 2002 OCTOBER 31, 2001 ---------------------- ------------------- AMOUNT SHARES AMOUNT SHARES (000) (000) (000) (000) -------------------------------------------------------------------------------- Investor Shares Issued $ 1,649,802 $ 64,066 $ 3,899,774 $ 144,533 Issued in Lieu of Cash Distributions 359,725 14,241 1,532,452 58,813 Redeemed (1,965,820) (76,587) (5,379,893) (198,642) ------------------------------------------------ Net Increase (Decrease)-- Investor Shares 43,707 1,720 52,333 4,704 ------------------------------------------------ Admiral Shares Issued 744,643 16,317 2,342,727 47,778 Issued in Lieu of Cash Distributions 35,992 803 9,811 200 Redeemed (136,634) (3,014) (49,583) (1,102) ------------------------------------------------ Net Increase (Decrease)-- Admiral Shares $ 644,001 $ 14,106 $ 2,302,955 $ 46,876 -------------------------------------------------------------------------------- 23 [PICTURE OF A COMPUTER] ADVANTAGES OF VANGUARD.COM(TM) Why wait for the mail? You can get fund reports like this one sooner--and reduce the amount of mail you receive from us. Simply choose to view your fund reports online. Consider the benefits of using Vanguard.com. On our website, you can: * Choose to stop receiving fund reports and prospectuses via U.S. mail, and view them online instead. * Request a courtesy e-mail to notify you when a new fund report or prospectus is available. When you receive fund reports and prospectuses online, you lower Vanguard's printing and postage costs--and that helps to reduce the expense ratios of your funds. You will continue to receive confirmations of purchases, redemptions, and other account activity by mail. HOW TO NOTIFY US ABOUT YOUR MAILING PREFERENCES You can easily tell us to stop mailing your fund reports and prospectuses. Just log on to Vanguard.com (or follow the easy steps to register for secure, online access to your accounts) and update your Web Profile. Registered users can also view their account values; download records of recent transactions; research and track the performance of individual securities and funds; buy, exchange, and sell fund shares; and much more. If you invest directly with us, you can also elect to receive all of your account statements online or to have us mail out only your year-end statements, which detail every transaction you make during the year. However, if you invest with us through an employer-sponsored retirement plan or a financial intermediary, some of these options may not be available to you. All Vanguard shareholders can choose to receive our electronic newsletters: ECONOMIC WEEK IN REVIEW, a recap of each week's key economic reports and market activity; and WHAT'S NEW AT VANGUARD, an update on Vanguard investments, services, and online resources, delivered every month and whenever there's breaking news. YOUR ONLINE INFORMATION IS SECURE Vanguard.com uses some of the most secure forms of online communication available, including data encryption and Secure Sockets Layer (SSL) protocol. These technologies provide a high level of security and privacy when you access your account information, initiate online transactions, or send us messages. 24 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. -------------------------------------------------------------------------------- TRUSTEES (YEAR ELECTED) JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and (1987) Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS The Partners of '63 (pro bono ventures in education); (2001) Senior Adviser to Greenwich Associates Successor Trustee of Yale University; Overseer of the Stern School of Business at New York (international business-strategy consulting); University; Trustee of the Whitehead Institute for Biomedical Research. RAJIV L. GUPTA Chairman and Chief Executive Officer of Rohm and Haas (2001) Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and Member (1998) of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, (1977) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co.of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. Chairman, President, Chief Executive Officer, and (1993) Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON Retired Chairman and Chief Executive Officer of Rohm (1985) and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. [PICTURE OF A SHIP] THE VANGUARD(R) LOGO POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 Vanguard, The Vanguard Group, Vanguard.com, and the ship logo are trademarks of The Vanguard Group, Inc. Calvert Social Index is a trademark of Calvert Group, Ltd., and has been licensed for use by The Vanguard Group, Inc. Vanguard Calvert Social Index Fund is not sponsored, endorsed, sold, or promoted by Calvert Group, Ltd., and Calvert Group, Ltd., makes no representation regarding the advisability of investing in the fund. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the funds or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C) 2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q732 062002