485APOS 1 specialized485a.txt VANGUARD SPECIALIZED FUNDS 485A FILING ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-1A REGISTRATION STATEMENT (NO. 2-88116) UNDER THE SECURITIES ACT OF 1933 PRE-EFFECTIVE AMENDMENT NO. POST-EFFECTIVE AMENDMENT NO. 43 AND REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 AMENDMENT NO. 45 VANGUARD SPECIALIZED FUNDS (EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST) P.O. BOX 2600, VALLEY FORGE, PA 19482 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) REGISTRANT'S TELEPHONE NUMBER (610) 669-1000 R. GREGORY BARTON, ESQUIRE P.O. BOX 876 VALLEY FORGE, PA 19482 IT IS PROPOSED THAT THIS AMENDMENT BECOME EFFECTIVE ON NOVEMBER 25, 2003, PURSUANT TO PARAGRAPH (A) OF RULE 485. ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- The Vanguard Energy, Precious Metals, Health Care, and Dividend Growth Funds Prospectuses, are incorporated by reference from the prior filing of the 41st Post-Effective Amendment to the Trust's Registration Statement on Form N-1A, filed on May 20, 2003. VANGUARD(R) REIT INDEX FUND Institutional Shares . November 25, 2003 This prospectus contains financial data for the Fund through the fiscal period ended July 31, 2003. STOCK PROSPECTUS NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [THE VANGUARD GROUP LOGO] VANGUARD REIT INDEX FUND Institutional Shares Prospectus November 25, 2003 A Real Estate Stock Mutual Fund -------------------------------------------------------------------------------- CONTENTS 1 FUND PROFILE 16 INVESTING WITH VANGUARD 4 ADDITIONAL INFORMATION 16 Buying Shares 5 MORE ON THE FUND 18 Converting Shares 10 THE FUND AND VANGUARD 18 Redeeming Shares 10 INVESTMENT ADVISOR 20 Exchanging Shares 11 DIVIDENDS, CAPITAL GAINS, AND TAXES 21 Other Rules You Should Know 13 SHARE PRICE 23 Fund and Account Updates 14 FINANCIAL HIGHLIGHTS 24 Contacting Vanguard GLOSSARY (inside back cover) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- WHY READING THIS PROSPECTUS IS IMPORTANT This prospectus explains the investment objective, policies, strategies, and risks associated with the Fund. To highlight terms and concepts important to mutual fund investors, we have provided Plain Talk/(R)/ explanations along the way. Reading the prospectus will help you decide whether the Fund is the right investment for you. We suggest that you keep this prospectus for future reference. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SHARE CLASS OVERVIEW The Fund offers three separate classes of shares: Investor Shares, Admiral/TM/ Shares, and Institutional Shares. This prospectus offers the Fund's Institutional Shares, which are for investors who do not require special employee benefit plan services and who are willing to invest a minimum of $10 million. A separate prospectus offers the Fund's Investor Shares and Admiral Shares, which have investment minimums of $3,000 ($1,000 for IRAs) and $250,000, respectively. To obtain a copy of the prospectus for Investor Shares and Admiral Shares, please call Vanguard at 1-800-662-7447. The Fund's separate share classes have different expenses; as a result, their investment performances will differ. -------------------------------------------------------------------------------- 1 FUND PROFILE INVESTMENT OBJECTIVE The Fund seeks to provide a high level of income and moderate long-term capital growth by tracking the performance of a benchmark index that measures the performance of publicly traded equity REITs. PRIMARY INVESTMENT STRATEGIES The Fund normally invests at least 98% of its assets in stocks issued by real estate investment trusts (known as REITs) in an attempt to parallel the investment performance of the Morgan Stanley REIT Index. The Fund invests in the stocks that make up the Index; the remaining assets are allocated to cash investments. PRIMARY RISKS An investment in the Fund could lose money over short or even long periods. You should expect the Fund's share price and total return to fluctuate within a wide range, like the fluctuations of the overall stock market. The Fund's performance could be hurt by: o Industry concentration risk, which is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Because the Fund concentrates its assets in REIT stocks, real estate industry risk is high. o Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. o Interest rate risk, which is the chance that REIT stock prices overall will decline because of rising interest rates. Interest rate risk should be high for the Fund. o Investment style risk, which is the chance that the returns from REIT stocks--which typically are small- or mid-capitalization stocks--will trail returns from the overall stock market. Historically, these stocks have been more volatile in price than the large-cap stocks that dominate the overall stock market, and they often perform quite differently. PERFORMANCE/RISK INFORMATION The following bar chart and table are intended to help you understand the risks of investing in the Fund. Both the bar chart and the table present information for the Investor Shares only, because Institutional Shares were not available during the time periods shown. The bar chart shows how the performance of the Fund's Investor Shares (including operating expenses but excluding shareholder fees) has varied from one calendar year to another over the periods shown. The table shows how the average annual total returns of the Investor Shares (including operating and any applicable shareholder fees) compare with those of its target index and other comparative indexes. Keep in mind that the Fund's past returns (before and after taxes) do not indicate how it will perform in the future. ---------------------------------------------------- ANNUAL TOTAL RETURNS--INVESTOR SHARES [BAR CHART] 1997 18.77 1998 -16.32 1999 -4.04 2000 26.35 2001 12.35 2002 3.75 ---------------------------------------------------- The year-to-date return as of the most recent calendar quarter, which ended September 30, 2003, was 24.14%. If applicable shareholder fees were reflected, returns would be less than those shown. ---------------------------------------------------- 2 During the periods shown in the bar chart, the highest return for a calendar quarter was 12.27% (quarter ended June 30, 2003), and the lowest return for a quarter was -10.41% (quarter ended September 30, 1998). -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2002 -------------------------------------------------------------------------------- SINCE 1 YEAR 5 YEARS INCEPTION* -------------------------------------------------------------------------------- VANGUARD REIT INDEX FUND INVESTOR SHARES Return Before Taxes 3.75% 3.41% 9.52% Return After Taxes on Distributions 1.64 1.13 7.20 Return After Taxes on Distributions and Sale of Fund Shares 2.33 1.52 6.61 -------------------------------------------------------------------------------- COMPARATIVE INDEXES (reflect no deduction for fees, expenses, or taxes): WILSHIRE 5000 TOTAL MARKET INDEX -20.86% -0.87% 5.08% MORGAN STANLEY REIT INDEX 3.64 3.30 9.46 TARGET REIT COMPOSITE** 3.61 3.31 9.41 -------------------------------------------------------------------------------- *Since-inception returns are from May 13, 1996--the inception date of the Investor Shares--through December 31, 2002. **The Target REIT Composite consists of the Morgan Stanley REIT Index adjusted to include a 2% cash position (Lipper Money Market Average). -------------------------------------------------------------------------------- NOTE ON AFTER-TAX RETURNS. Actual after-tax returns depend on your tax situation and may differ from those shown in the table above. When calculating after-tax return figures for a fund, we assume the shareholder was in the highest federal marginal income tax bracket at the time of each distribution of income or capital gains, but we do not consider state or local income taxes. Please note that actual after-tax returns will vary for a fund's separate share classes and are not relevant for a shareholder who holds fund shares in a tax-deferred account, such as an individual retirement account or a 401(k) plan. Also, for any fund, figures captioned Return After Taxes on Distributions and Sale of Fund Shares will be higher than other return figures for the same period if a capital loss occurs upon redemption and results in an assumed tax deduction for the shareholder. FEES AND EXPENSES The following table describes the fees and expenses you may pay if you buy and hold Institutional Shares of the Fund. The expenses shown under Annual Fund Operating Expenses are based on estimated amounts for the current fiscal year. 3 SHAREHOLDER FEES (fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases: None Purchase Fee: None Sales Charge (Load) Imposed on Reinvested Dividends: None Redemption Fee: 1% * ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets) Management Expenses: 0.14% 12b-1 Distribution Fee: None Other Expenses: 0.01% TOTAL ANNUAL FUND OPERATING EXPENSES: 0.15% *The 1% fee applies to shares redeemed within one year of purchase by selling or by exchanging to another fund. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. The following example is intended to help you compare the cost of investing in the Fund's Institutional Shares with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. This example assumes that the Fund provides a return of 5% a year and that operating expenses match our estimates. The results apply whether or not you redeem your investment at the end of the given period. -------------------------------------------------- 1 YEAR 3 YEARS 5 YEARS 10 YEARS -------------------------------------------------- $ 15 $48 $85 $192 -------------------------------------------------- THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN. -------------------------------------------------------------------------------- PLAIN TALK ABOUT FUND EXPENSES All mutual funds have operating expenses. These expenses, which are deducted from a fund's gross income, are expressed as a percentage of the net assets of the fund. We expect Vanguard REIT Index Fund Institutional Shares' expense ratio for the current fiscal year to be 0.15%, or $1.50 per $1,000 of average net assets. The average real estate mutual fund had expenses in 2002 of 1.64%, or $16.40 per $1,000 of average net assets (derived from data provided by Lipper Inc., which reports on the mutual fund industry). Management expenses, which are one part of operating expenses, include investment advisory fees as well as other costs of managing a fund--such as account maintenance, reporting, accounting, legal, and other administrative expenses. -------------------------------------------------------------------------------- 4 -------------------------------------------------------------------------------- PLAIN TALK ABOUT COSTS OF INVESTING Costs are an important consideration in choosing a mutual fund. That's because you, as a shareholder, pay the costs of operating a fund, plus any transaction costs incurred when the fund buys or sells securities. These costs can erode a substantial portion of the gross income or capital appreciation a fund achieves. Even seemingly small differences in expenses can, over time, have a dramatic effect on a fund's performance. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- ADDITIONAL INFORMATION DIVIDENDS AND CAPITAL GAINS MINIMUM INITIAL INVESTMENT Dividends are distributed quarterly in March, $10 million June, September, and December. These distributions may include income, capital gains, NEWSPAPER ABBREVIATION and a return of capital. Additional capital gains REITInstl may be distributed annually in December. VANGUARD FUND NUMBER INVESTMENT ADVISOR 3123 The Vanguard Group, Valley Forge, Pa., since inception CUSIP NUMBER 921908869 INCEPTION DATE Investor Shares--May 13, 1996 TICKER SYMBOL Institutional Shares--November 25, 2003 VGSNX NET ASSETS (INVESTOR AND ADMIRAL SHARE CLASSES) AS OF JULY 31, 2003 $2.9 billion -------------------------------------------------------------------------------- 5 MORE ON THE FUND This prospectus describes the primary risks you would face as a Fund shareholder. It is important to keep in mind one of the main axioms of investing: The higher the risk of losing money, the higher the potential reward. The reverse, also, is generally true: The lower the risk, the lower the potential reward. As you consider an investment in any mutual fund, you should take into account your personal tolerance for daily fluctuations in the securities markets. Look for this [FLAG] symbol throughout the prospectus. It is used to mark detailed information about the more significant risks that you would confront as a Fund shareholder. The following sections explain the primary investment strategies and policies that the Fund uses in pursuit of its objective. The Fund's board of trustees, which oversees the Fund's management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. MARKET EXPOSURE The Fund normally invests at least 98% of its assets in stocks of real estate investment trusts (REITs) and holds any remaining assets in cash investments to meet shareholder redemptions.This policy may only be changed upon 60 days' notice to shareholders. -------------------------------------------------------------------------------- PLAIN TALK ABOUT REITS Rather than owning properties directly--which can be costly and difficult to convert into cash when needed--some investors buy shares in a company that owns and manages real estate. Such a company is known as a real estate investment trust, or REIT. Unlike corporations, REITs do not have to pay income taxes if they meet certain Internal Revenue Code requirements. To qualify, a REIT must distribute at least 90% of its taxable income to its shareholders and receive at least 75% of that income from rents, mortgages, and sales of property. REITs offer investors greater liquidity and diversification than direct ownership of a handful of properties, as well as greater income potential than an investment in common stocks. As with any investment in real estate, however, a REIT's performance depends on several factors, such as its ability to find tenants for its properties, to renew leases, and to finance property purchases and renovations. That said, returns from REITs may not correspond to returns from direct property ownership. -------------------------------------------------------------------------------- [FLAG]THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE CHANCE THAT RETURNS FROM REIT STOCKS--WHICH TYPICALLY ARE SMALL- OR MID-CAP STOCKS--WILL TRAIL RETURNS FROM THE OVERALL MARKET. HISTORICALLY, THESE STOCKS HAVE BEEN MORE VOLATILE IN PRICE THAN THE LARGE-CAP STOCKS THAT DOMINATE THE OVERALL STOCK MARKET, AND THEY OFTEN PERFORM QUITE DIFFERENTLY. Stocks of publicly traded companies and funds that invest in stocks are often classified according to market value, or market capitalization. These classifications typically include small-cap, mid-cap, or large-cap. It's important to understand that, for both companies and stock funds, market capitalization ranges change over time. Also, interpretations of size vary, and there are no "official" definitions of small-, mid-, and large-cap, even among Vanguard fund advisors. REIT stocks in the Morgan Stanley REIT Index tend to be small or medium-- 6 size companies. The median market capitalization of the Fund as of July 31, 2003, was $2.3 billion. Small- and mid-cap stocks tend to have greater volatility than large-cap stocks because, among other things, smaller companies often have fewer customers, financial resources, and products than larger firms. Such characteristics can make small and medium-size companies more sensitive to changing economic conditions. REIT stocks tend to have a significant amount of dividend income to soften the impact of this volatility. However, the index and, thus, the Fund are subject to additional risk because of the concentration in the real estate sector. This single-sector focus may result in more risk than would a more diversified, multi-sector portfolio. -------------------------------------------------------------------------------- PLAIN TALK ABOUT TYPES OF REITS An equity REIT owns properties directly. Equity REITs generate income (from rental and lease payments) and offer the potential for growth (from property appreciation) as well as occasional capital gains from the sale of property. A mortgage REIT makes loans to commercial real estate developers. Mortgage REITs earn interest income and are subject to credit risk (that is, the chance that a developer will fail to repay a loan). A hybrid REIT holds both properties and mortgages. The Fund invests in equity REITs only. -------------------------------------------------------------------------------- [FLAG]THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT STOCK PRICES OVERALL WILL DECLINE. STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF FALLING PRICES. To illustrate the volatility of stock prices, the following table shows the best, worst, and average total returns for the U.S. stock market over various periods as measured by the Standard & Poor's 500 Index, a widely used barometer of market activity. (Total returns consist of dividend income plus change in market price.) Note that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. ---------------------------------------------------------- U.S. STOCK MARKET RETURNS (1926-2002) ---------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS 20 YEARS ---------------------------------------------------------- Best 54.2% 28.6% 19.9% 17.8% Worst - 43.1 -12.4 -0.8 3.1 Average 12.2 10.9 11.2 11.4 ---------------------------------------------------------- The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926 through 2002. You can see, for example, that while the average return on common stocks for all of the 5-year periods was 10.9%, average returns for individual 5-year periods ranged from -12.4% (from 1928 through 1932) to 28.6% (from 1995 through 1999). These average returns reflect past performance on common stocks; you should not regard them as an indication of future returns from either the stock market as a whole or this Fund in particular. [FLAG]THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE CHANCE THAT REIT STOCK PRICES OVERALL WILL DECLINE BECAUSE OF RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE HIGH FOR THE FUND. 7 In general, during periods of high interest rates, REITs may lose some of their appeal for investors who may be able to obtain higher yields from other income-producing investments, such as long-term bonds. Higher interest rates also mean that financing for property purchases and improvements is more costly and difficult to obtain. [FLAG]THE FUND IS SUBJECT TO REAL ESTATE INDUSTRY RISK, WHICH IS THE CHANCE THAT THE STOCKS OF REITS WILL DECLINE BECAUSE OF ADVERSE DEVELOPMENTS AFFECTING THE REAL ESTATE INDUSTRY AND REAL PROPERTY VALUES. BECAUSE THE FUND CONCENTRATES ITS ASSETS IN REIT STOCKS, REAL ESTATE INDUSTRY RISK IS HIGH. Because of its emphasis on REIT stocks, the Fund's performance may at times be linked to the ups and downs of the real estate market. In general, real estate values can be affected by a variety of factors, including supply and demand for properties; the economic health of the country as well as different regions; and the strength of specific industries that rent properties. Ultimately, an individual REIT's performance depends on the types and locations of the properties it owns and on how well the REIT manages its properties. For instance, rental income could decline because of extended vacancies, increased competition from nearby properties, tenants' failure to pay rent, or incompetent management. Property values could decrease because of overbuilding in the area, environmental liabilities, uninsured damages caused by natural disasters, a general decline in the neighborhood, losses due to casualty or condemnation, increases in property taxes, or changes in zoning laws. Loss of IRS status as a qualified REIT may also affect an individual REIT's performance. The target index tracked by the Fund is broadly diversified. Similarly, the Fund is broadly diversified, holding stocks of more than 100 companies. It is possible that the Fund's target index, in the future, could become less diversified if the index's largest companies significantly increase in value relative to the index's other components. In an extreme situation, the Fund might no longer meet the legal definition of "diversified." For this reason, the Fund is classified as "nondiversified." However, the Fund, from its inception until the date of this prospectus, in actuality has been diversified, and Vanguard expects the Fund to continue to be diversified. SECURITY SELECTION The Fund employs an indexing, or passively managed, investment approach. The Fund's advisor, The Vanguard Group (Vanguard), normally invests at least 98% of the Fund's assets in REIT securities in an attempt to parallel the performance of the target benchmark, the Morgan Stanley REIT Index. The Fund holds each stock contained in the Morgan Stanley REIT Index in roughly the same proportions as in the Index itself. For example, if 5% of the Morgan Stanley REIT Index were made up of the stock of a specific REIT, the Fund would invest the same percentage of its noncash assets in that stock. The Morgan Stanley REIT Index is made up of the stocks of publicly traded equity REITs that meet certain criteria. For example, to be included initially in the Index, a REIT must have a total market capitalization of at least $100 million and have enough shares and trading volume to be considered liquid. In line with the Index, the Fund invests in equity REITs only. As of July 31, 2003, 112 equity REITs were included in the Index. The Index is rebalanced every calendar quarter, as well as each time that a REIT is removed from the Index. A REIT 8 may be removed from the Index because the REIT's market capitalization falls below $75 million; because the REIT becomes illiquid; because of other changes in the REIT's status; or because of corporate activity such as a merger, an acquisition, a leveraged buyout, bankruptcy, IRS removal of REIT status, or a fundamental change in business. Stocks in the Morgan Stanley REIT Index represent a broadly diversified range of property types. The Index's makeup, as of July 31, 2003, was as follows: --------------------------------------------- PROPERTY TYPES PERCENTAGE OF INDEX --------------------------------------------- Retail 26% Residential Apartments 19 Office 19 Industrial 13 Diversified 12 Health Care 5 Hotels 4 Cash 2 --------------------------------------------- The Fund is generally managed without regard to tax ramifications. OTHER INVESTMENT POLICIES AND RISKS Besides investing in common stocks of REITs, the Fund may make certain other kinds of investments to achieve its objective. [FLAG]THE FUND MAY INVEST, TO A LIMITED EXTENT, IN DERIVATIVES. DERIVATIVES MAY INVOLVE RISKS DIFFERENT FROM, AND POSSIBLY GREATER THAN, THOSE OF TRADITIONAL INVESTMENTS. The Fund may also invest, to a limited extent, in futures and options contracts, which are types of derivatives. The Fund will invest in futures only for purposes of matching the performance of its target index, and not for speculative purposes or as leveraged investments that magnify losses or gains. Losses (or gains) involving futures can sometimes be substantial--in part because a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for a fund. The Fund's obligation under futures contracts will not exceed 20% of its total assets. To the extent that the Fund invests in futures contracts, it will not have 98% of its assets invested in REIT stocks. The reasons for which the Fund may invest in futures include: o To keep cash on hand to meet shareholder redemptions or other needs while simulating full investment in stocks. o To reduce the Fund's transaction costs or add value when these instruments are favorably priced. 9 -------------------------------------------------------------------------------- PLAIN TALK ABOUT DERIVATIVES A derivative is a financial contract whose value is based on (or "derived" from) a traditional security (such as a stock or a bond), an asset (such as a commodity like gold), or a market index (such as the S&P 500 Index). Some forms of derivatives, such as exchange-traded futures and options on securities, commodities, or indexes, have been trading on regulated exchanges for decades. These types of derivatives are standardized contracts that can easily be bought and sold, and whose market values are determined and published daily. Nonstandardized derivatives (such as swap agreements), on the other hand, tend to be more specialized or complex, and may be harder to value. Derivatives can carry considerable risks, particularly if used for speculation or as leveraged investments. -------------------------------------------------------------------------------- REDEMPTION FEE The Fund charges a fee on shares that are redeemed before they have been held for one year. This fee applies when shares are redeemed by exchange to another Vanguard fund. Unlike a sales charge or load paid to a broker or fund management company, the redemption fee is paid directly to the Fund to offset the costs of buying and selling securities. The fee ensures that short-term investors pay their share of the Fund's transaction costs and that long-term investors do not subsidize the activities of short-term traders. COSTS AND MARKET-TIMING Some investors try to profit from a strategy called market-timing--switching money into mutual funds when they expect prices to rise and taking money out when they expect prices to fall. As money is shifted in and out, a fund incurs expenses for buying and selling securities. These costs are borne by all fund shareholders, including the long-term investors who do not generate the costs. This is why all Vanguard funds have adopted special policies to discourage short-term trading or to compensate the funds for the costs associated with it. Specifically: o Each Vanguard fund reserves the right to reject any purchase request--including exchanges from other Vanguard funds--that it regards as disruptive to efficient portfolio management. A purchase request could be rejected because of the timing of the investment or because of a history of excessive trading by the investor. o Each Vanguard fund (other than the money market funds) limits the number of times that an investor can exchange into and out of the fund. o Certain Vanguard funds charge purchase and/or redemption fees on transactions. See the INVESTING WITH VANGUARD section of this prospectus for further details on Vanguard's transaction policies. THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST WITH VANGUARD IF YOU ARE A MARKET-TIMER. TURNOVER RATE Although the Fund normally seeks to invest for the long term, it may sell securities regardless of how long they have been held. The FINANCIAL HIGHLIGHTS section of this prospectus shows historical turnover rates for the Fund. A turnover rate of 100%, for example, would mean that the Fund had sold and replaced securities valued at 100% of its net assets within a one-year period. 10 -------------------------------------------------------------------------------- PLAIN TALK ABOUT TURNOVER RATE Before investing in a mutual fund, you should review its turnover rate. This gives an indication of how transaction costs could affect the fund's future returns. In general, the greater the volume of buying and selling by the fund, the greater the impact that brokerage commissions and other transaction costs will have on its return. Also, funds with high turnover rates may be more likely to generate capital gains that must be distributed to shareholders as taxable income. As of July 31, 2003, the average turnover rate for all real estate funds was approximately 68%, according to Morningstar, Inc. -------------------------------------------------------------------------------- THE FUND AND VANGUARD The Fund is a member of The Vanguard Group, a family of 35 investment companies with more than 100 funds holding assets in excess of $640 billion. All of the funds that are members of The Vanguard Group share in the expenses associated with administrative services and business operations, such as personnel, office space, equipment, and advertising. Vanguard also provides marketing services to the funds. Although shareholders do not pay sales commissions or 12b-1 distribution fees, each fund pays its allocated share of The Vanguard Group's marketing costs. -------------------------------------------------------------------------------- PLAIN TALK ABOUT VANGUARD'S UNIQUE CORPORATE STRUCTURE The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by the funds it oversees and thus indirectly by the shareholders in those funds. Most other mutual funds are operated by for-profit management companies that may be owned by one person, by a group of individuals, or by investors who own the management company's stock. By contrast, Vanguard provides its services on an "at-cost" basis, and the funds' expense ratios reflect only these costs. -------------------------------------------------------------------------------- INVESTMENT ADVISOR The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482, which began operations in 1975, serves as advisor to the Fund through its Quantitative Equity Group. As of July 31, 2003, Vanguard served as advisor for about $450 billion in assets. Vanguard manages the Fund on an at-cost basis, subject to the supervision and oversight of the trustees and officers of the Fund. For the fiscal period ended July 31, 2003, the advisory expenses represented an effective annual rate of 0.01% of the Fund's average net assets. The advisor is authorized to choose broker-dealers to handle the purchase and sale of the Fund's securities and to seek to obtain the best available price and most favorable execution for all transactions. Also, the board of trustees may direct the advisor to use a particular broker for certain transactions in exchange for commission rebates paid to the Fund as well as for brokerage or research services provided to the advisor. 11 -------------------------------------------------------------------------------- PLAIN TALK ABOUT THE FUND'S ADVISOR The manager primarily responsible for overseeing the Fund's investments is: GEORGE U. SAUTER, Managing Director and Chief Investment Officer of Vanguard and head of Vanguard's Quantitative Equity Group. He has worked in investment management since 1985 and has had primary responsibility for Vanguard's stock indexing and active quantitative investments and strategy since joining the company in 1987. Education: A.B., Dartmouth College; M.B.A., University of Chicago. -------------------------------------------------------------------------------- DIVIDENDS, CAPITAL GAINS, AND TAXES FUND DISTRIBUTIONS Each March, June, September, and December, Vanguard REIT Index Fund pays out to shareholders virtually all of the distributions it receives from its REIT investments, less expenses. Distributions may include income, return of capital, and capital gains. The Fund may also realize capital gains on the sale of its REIT investments. Distributions of these gains, if any, are included in the December distribution. In addition, the Fund may occasionally be required to make supplemental distributions at some other time during the year. You can receive distributions of income or capital gains in cash, or you can have them automatically reinvested in more shares of the Fund. -------------------------------------------------------------------------------- PLAIN TALK ABOUT DISTRIBUTIONS As a shareholder, you are entitled to your portion of a fund's income from interest and dividends as well as gains from the sale of investments. Income consists of both the dividends that the fund earns from any stock holdings and the interest it receives from any money market and bond investments. Capital gains are realized whenever the fund sells securities for higher prices than it paid for them. These capital gains are either short-term or long-term, depending on whether the fund held the securities for one year or less or for more than one year. You receive the fund's earnings as either a dividend or capital gains distribution. -------------------------------------------------------------------------------- BASIC TAX POINTS Vanguard expects to send you a statement each FEBRUARY showing the tax status of all your distributions. (Other Vanguard funds mail their tax statements in January; the Fund mails its statements later because REITs do not provide information on the taxability of their distributions until after the calendar year-end.) In addition, taxable investors should be aware of the following basic tax points: o Distributions (other than any return of capital) are taxable to you for federal income tax purposes, whether or not you reinvest these amounts in additional Fund shares. o Distributions declared in December--if paid to you by the end of January--are taxable for federal income tax purposes as if received in December. o Any dividend and short-term capital gains distributions that you receive are taxable to you as ordinary income for federal income tax purposes. If you are an individual and meet certain holding-period requirements with respect to your Fund shares, you may be eligible for reduced federal tax rates on "qualified dividend income" distributed by the Fund. 12 o Any distributions of net long-term capital gains are taxable to you as long-term capital gains for federal income tax purposes, no matter how long you've owned shares in the Fund. o Capital gains distributions may vary considerably from year to year as a result of the Fund's normal investment activities and cash flows. o A sale or exchange of Fund shares is a taxable event. This means that you may have a capital gain to report as income, or a capital loss to report as a deduction, when you complete your federal income tax return. o Dividend and capital gains distributions that you receive, as well as your gains or losses from any sale or exchange of Fund shares, may be subject to state and local income taxes. o Dividend distributions attributable to the Fund's REIT investments are not eligible for the corporate dividends-received deduction. o Your cost basis in the Fund will be decreased by the amount of any return of capital distributions that you receive. This, in turn, will affect the amount of any capital gain or loss that you realize when selling or exchanging your Fund shares. o Return-of-capital distributions generally are not taxable to you, unless your cost basis has been reduced to zero. If your cost basis is at zero, return-of-capital distributions will be taxed to you as capital gains. o Any conversion between classes of shares of the same fund is a nontaxable event. By contrast, an exchange between classes of shares of different funds is a taxable event. -------------------------------------------------------------------------------- PLAIN TALK ABOUT RETURN OF CAPITAL The Internal Revenue Code requires a REIT to distribute at least 90% of its taxable income to investors. In many cases, however, because of "noncash" expenses such as property depreciation, an equity REIT's cash flow will exceed its taxable income. The REIT may distribute this excess cash to offer a more competitive yield (in other words, provide investors with a higher distribution). This portion of the distribution is classified as a return of capital. -------------------------------------------------------------------------------- GENERAL INFORMATION BACKUP WITHHOLDING. By law, Vanguard must withhold 28% of any taxable distributions or redemptions from your account if you do not: o Provide us with your correct taxpayer identification number; o Certify that the taxpayer identification number is correct; and o Confirm that you are not subject to backup withholding. Similarly, Vanguard must withhold taxes from your account if the IRS instructs us to do so. FOREIGN INVESTORS. Vanguard funds generally are not sold outside the United States, except to certain qualifying investors. If you reside outside the United States, please consult our website at www.vanguard.com and review "Non-U.S. Investors." Foreign investors should be aware that U.S. withholding and estate taxes may apply to any investments in Vanguard funds. INVALID ADDRESSES. If a dividend or capital gains distribution check mailed to your address of record is returned as undeliverable, Vanguard will automatically reinvest all future distributions until you provide us with a valid mailing address. 13 TAX CONSEQUENCES. This prospectus provides general tax information only. If you are investing through a tax-deferred retirement account, such as an IRA, special tax rules apply. Please consult your tax advisor for detailed information about a fund's tax consequences for you. -------------------------------------------------------------------------------- PLAIN TALK ABOUT "BUYING A DIVIDEND" Unless you are investing through a tax-deferred retirement account (such as an IRA), you should consider avoiding a purchase of fund shares shortly before the fund makes a distribution, because doing so can cost you money in taxes. This is known as "buying a dividend." For example: On December 15, you invest $5,000, buying 250 shares for $20 each. If the fund pays a distribution of $1 per share on December 16, its share price will drop to $19 (not counting market change). You still have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you owe tax on the $250 distribution you received--even if you reinvest it in more shares. To avoid "buying a dividend," check a fund's distribution schedule before you invest. -------------------------------------------------------------------------------- SHARE PRICE The Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time. NAV per share is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. On holidays or other days when the Exchange is closed, the NAV is not calculated, and the Fund does not transact purchase or redemption requests. However, on those days the value of the Fund's assets may be affected to the extent that the Fund holds foreign securities that trade on foreign markets that are open. Stocks held by a Vanguard fund are valued at their market value when reliable market quotations are readily available. Certain short-term debt instruments used to manage a fund's cash are valued on the basis of amortized cost. The values of any foreign securities held by a fund are converted into U.S. dollars using an exchange rate obtained from an independent third party. When reliable market quotations are not readily available, securities are priced at their fair value, calculated according to procedures adopted by the board of trustees. A fund also may use fair-value pricing if the value of a security it holds has been materially affected by events occurring before the fund's pricing time but after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign securities, but may occur in other cases as well. When fair-value pricing is employed, the prices of securities used by a fund to calculate its NAV may differ from quoted or published prices for the same securities. Vanguard fund share prices can be found daily in the mutual fund listings of most major newspapers under various "Vanguard" headings. 14 FINANCIAL HIGHLIGHTS The following financial highlights table is intended to help you understand the Investor Shares' financial performance for the periods shown, and certain information reflects financial results for a single Investor Share. The total returns in the table represent the rate that an investor would have earned or lost each period on an investment in the Investor Shares (assuming reinvestment of all distributions). The information for the six-month period ended July 31, 2003, has not been audited by independent accountants. The information for all other periods in the table through January 31, 2003, has been derived from the annual financial statements audited by PricewaterhouseCoopers LLP, independent accountants, whose report--along with the Fund's annual financial statements--is included in the Fund's most recent annual report to shareholders. To receive a free copy of the latest annual or semiannual report, you may access a report online at www.vanguard.com or you may contact Vanguard by telephone or by mail. NOTE: This prospectus offers the Fund's Institutional Shares, not the Investor Shares. Information for the Investor Shares is shown here because the Fund's Institutional Shares had not commenced operations. However, the two share classes invest in the same portfolio of securities and will have the same financial performance except to the extent that their operating expenses differ. -------------------------------------------------------------------------------- PLAIN TALK ABOUT HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE The Investor Shares began the fiscal period ended July 31, 2003, with a net asset value (price) of $11.52 per share. During the period, each Investor Share earned $0.34 from investment income (interest and dividends) and $2.23 from investments that had appreciated in value or that were sold for higher prices than the Fund paid for them. Shareholders received $0.29 per share in the form of dividend distributions. A portion of each year's distributions may come from the prior year's income or capital gains. The share price at the end of the period was $13.80, reflecting earnings of $2.57 per share and distributions of $0.29 per share. This was an increase of $2.28 per share (from $11.52 at the beginning of the period to $13.80 at the end of the period). For a shareholder who reinvested the distributions in the purchase of more shares, the total return was 22.59% for the period. As of July 31, 2003, the Investor Shares had approximately $2.4 billion in net assets. For the period, the annualized expense ratio was 0.27% ($2.70 per $1,000 of net assets), and the annualized net investment income amounted to 5.55% of average net assets. The Fund sold and replaced securities valued at an annualized rate of 4% of its net assets. -------------------------------------------------------------------------------- 15
REIT INDEX FUND INVESTOR SHARES ----------------------------------------------------------------------------------------------------------------------- YEAR ENDED JANUARY 31, ------------------------------------------------------------------ SIX MONTHS ENDED JULY 31, 2003* 2003 2002 2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $11.52 $12.10 $11.61 $ 9.91 $10.81 $13.98 ----------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .34 .606 .631 .642 .660 .666 Net Realized and Unrealized Gain (Loss) 2.23 (.426) .669 1.878 (.780) (3.026) on Investments** ----------------------------------------------------------------------------------------------------------------------- Total from Investment Operations 2.57 .180 1.300 2.520 (.120) (2.360) ----------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.29) (.667) (.631) (.644) (.670) (.666) Distributions from Realized Capital Gains -- -- -- -- -- -- Return of Capital -- (.093) (.179) (.176) (.110) (.144) ----------------------------------------------------------------------------------------------------------------------- Total Distributions (.29) (.760) (.810) (.820) (.780) (.810) ----------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $13.80 $11.52 $12.10 $11.61 $ 9.91 $10.81 ----------------------------------------------------------------------------------------------------------------------- TOTAL RETURN*** 22.59% 1.20% 11.59% 26.13% -1.04% -17.31% ----------------------------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $2,372 $1,734 $1,270 $1,092 $888 $904 Ratio of Total Expenses to Average Net Assets 0.27%+ 0.27% 0.28% 0.33% 0.33% 0.26% Ratio of Net Investment Income to Average Net Assets 5.55%+ 4.90% 5.35% 5.73% 5.98% 5.19% Turnover Rate 4%+ 12% 10% 21%++ 12% 29% -----------------------------------------------------------------------------------------------------------------------
* Unaudited. ** Includes increases from redemption fees of $0.00, $0.01, $0.00, $0.00, $0.01, and $0.02. *** Total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. + Annualized. ++ The turnover rate excluding in-kind redemptions was 14%. 16 -------------------------------------------------------------------------------- INVESTING WITH VANGUARD This section of the prospectus explains the basics of doing business with Vanguard. A special booklet, Investing Made Easy, provides information that will help individual investors make the most of their relationship with Vanguard. A separate booklet, The Compass, does the same for institutional investors. You can request either booklet by calling or writing Vanguard, using the Contacting Vanguard instructions at the end of this section. BUYING SHARES CONVERTING SHARES REDEEMING SHARES EXCHANGING SHARES OTHER RULES YOU SHOULD KNOW FUND AND ACCOUNT UPDATES CONTACTING VANGUARD -------------------------------------------------------------------------------- BUYING SHARES ACCOUNT MINIMUMS FOR INSTITUTIONAL SHARES TO OPEN AND MAINTAIN AN ACCOUNT: $10 million. Vanguard Institutional clients may meet the minimum investment amount by aggregating up to three separate accounts within the same fund. This exception does not apply to clients receiving special administrative services from Vanguard, nor does this exception apply to omnibus accounts maintained by financial intermediaries. TO ADD TO AN EXISTING ACCOUNT: $100 by mail, exchange, or Fund Express; $1,000 by wire. Vanguard reserves the right to increase or decrease the minimum amount required to open and maintain an account, or to add to an existing account, without prior notice. HOW TO BUY SHARES ONLINE: You can open certain types of accounts or buy shares in an existing account through our website at www.vanguard.com. BY CHECK: Mail your check and a completed account registration form to Vanguard. When adding to an existing account, send your check with an Invest-By-Mail form detached from your last account statement. Make your check payable to: The Vanguard Group--3123. For addresses, see Contacting Vanguard. BY EXCHANGE PURCHASE: You can purchase shares with the proceeds of a redemption from another Vanguard/(R)/ fund. See Exchanging Shares and Other Rules You Should Know. BY WIRE: Call Vanguard to purchase shares by wire. See Contacting Vanguard. BY FUND EXPRESS/(R)/ (AUTOMATIC OR SPECIAL PURCHASES): You can purchase shares by electronically transferring money from a previously designated bank account. To establish this 17 option, you must complete a special form or the appropriate section of your account registration. YOUR PURCHASE PRICE ONLINE, BY CHECK, BY EXCHANGE, OR BY WIRE: You buy shares at a fund's NAV determined as of your TRADE DATE. For all Vanguard funds (other than money market funds), purchases received at Vanguard before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time) receive a trade date of the same day, and purchases received after that time receive a trade date of the first business day following the date of receipt. For money market funds, the trade date depends on the method of payment for the purchase. BY FUND EXPRESS: For all Vanguard funds, Fund Express instructions received at Vanguard before the close of regular trading on the Exchange will result in a purchase that occurs on and receives a trade date of the next business day (two business days later for money market funds). PURCHASE RULES YOU SHOULD KNOW ^CHECK PURCHASES. All purchase checks must be written in U.S. dollars and drawn on a U.S. bank. Vanguard does not accept cash, traveler's checks, or money orders. In addition, to protect the funds from check fraud, Vanguard will not accept checks made payable to third parties. ^NEW ACCOUNTS. We are required by law to obtain from you certain personal information that we will use to verify your identity. If you do not provide the information, we may not be able to open your account. If we are unable to verify your identity, Vanguard reserves the right to close your account or take such other steps as we deem reasonable. ^LARGE PURCHASES. Vanguard reserves the right to reject any purchase request that may disrupt a fund's operation or performance. Please call us before attempting to invest a large dollar amount. ^NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT cancel any transaction once it has been initiated and a confirmation number has been assigned (if applicable). ^FUTURE PURCHASES. All Vanguard funds reserve the right to stop selling shares at any time, or to reject specific purchase requests, including purchases by exchange from another Vanguard fund, at any time, for any reason. CONVERTING SHARES ANY CONVERSION BETWEEN CLASSES OF SHARES OF THE SAME FUND IS A NONTAXABLE EVENT. 18 PRICING OF SHARE CLASS CONVERSIONS If you convert from one class of shares to another, the transaction will be based on the respective share prices of the separate classes on the trade date for the conversion. Consequently, a conversion may provide you with fewer shares or more shares than you originally owned, depending on that day's share prices. At the time of conversion, the total value of your "old" shares will equal the total value of your "new" shares. However, subsequent share price fluctuations may decrease or increase the total value of your "new" shares as compared with that of your "old" shares. CONVERSION FROM INVESTOR SHARES OR ADMIRAL SHARES You may convert Investor Shares or Admiral Shares into Institutional Shares of the same Fund (if available), provided that your account balance in the Fund is at least $10 million. MANDATORY CONVERSIONS INTO INVESTOR SHARES OR ADMIRAL SHARES If an investor no longer meets the requirements for Institutional Shares, the Fund may convert the investor's Institutional Shares into Investor Shares or Admiral Shares, as appropriate. A decline in the investor's account balance because of market movement may result in such a conversion. The Fund will notify the investor in writing before any mandatory conversion into Investor Shares or Admiral Shares. REDEEMING SHARES HOW TO REDEEM SHARES Be sure to check Other Rules You Should Know before initiating your request. ONLINE: Request a redemption through our website at www.vanguard.com. BY TELEPHONE: Contact Vanguard by telephone to request a redemption. For telephone numbers, see Contacting Vanguard. BY MAIL: Send your written redemption instructions to Vanguard. For addresses, see Contacting Vanguard. BY FUND EXPRESS: If you've established the Fund Express option on your account, you can redeem shares by electronically transferring your redemption proceeds to a previously designated bank account. The Fund Express option is not automatic; you must establish it by completing a special form or the appropriate section of your account registration. REDEMPTION FEES The Fund charges a 1% redemption fee on shares redeemed within one year of purchase by selling or by exchanging to another fund. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. We will always redeem your "oldest" shares first. If you transfer your shares to a different account registration (or convert them to a different share class), the shares will retain 19 their redemption fee status. If you transfer (or convert) less than 100% of your account, we will carry over the redemption fee status of your shares on a proportionate basis. From time to time, the Fund may waive or modify redemption fees for certain categories of investors. YOUR REDEMPTION PRICE You redeem shares at a fund's next-determined NAV after Vanguard receives your redemption request, including any special documentation required under the circumstances. As long as your request is received before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time), your shares are redeemed at that day's NAV. This is known as your TRADE DATE. TYPES OF REDEMPTIONS ^CHECK REDEMPTIONS. Unless instructed otherwise, Vanguard will mail you a check, normally within two business days of your trade date. ^EXCHANGE REDEMPTIONS. You may instruct Vanguard to apply the proceeds of your redemption to purchase shares of another Vanguard fund. See Exchanging Shares and Other Rules You Should Know. ^FUND EXPRESS REDEMPTIONS. Proceeds of shares redeemed by Fund Express will be credited to your bank account two business days after your trade date. ^WIRE REDEMPTIONS. When redeeming from a money market fund or a bond fund, you may instruct Vanguard to wire your redemption proceeds ($1,000 minimum) to a previously designated bank account. Wire redemptions are not available for Vanguard's balanced or stock funds. The wire redemption option is not automatic; you must establish it by completing a special form or the appropriate section of your account registration. A $5 fee applies to wire redemptions under $5,000. Money Market Funds: For telephone requests received at Vanguard by 10:45 a.m. (2 p.m. for Vanguard/(R)/ Prime Money Market Fund), Eastern time, the redemption proceeds will leave Vanguard by the close of business that same day. For other requests received before 4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close of business on the following business day. Bond Funds: For requests received at Vanguard by 4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close of business on the following business day. REDEMPTION RULES YOU SHOULD KNOW ^SPECIAL ACCOUNTS. Special documentation may be required to redeem from certain types of accounts, such as trust, corporate, nonprofit, or retirement accounts. Please call us before attempting to redeem from these types of accounts. 20 ^POTENTIALLY DISRUPTIVE REDEMPTIONS. Vanguard reserves the right to pay all or part of your redemption in kind--that is, in the form of securities--if we believe that a cash redemption would disrupt the fund's operation or performance. Under these circumstances, Vanguard also reserves the right to delay payment of your redemption proceeds for up to seven calendar days. By calling us before you attempt to redeem a large dollar amount, you are more likely to avoid in-kind or delayed payment of your redemption. ^RECENTLY PURCHASED SHARES. While you can redeem shares at any time, proceeds will not be made available to you until the Fund collects payment for your purchase. This may take up to ten calendar days for shares purchased by check or Vanguard Fund Express/(R)/. ^PAYMENT TO A DIFFERENT PERSON OR ADDRESS. We can make your redemption check payable to a different person or send it to a different address. However, this requires the written consent of all registered account owners, which must be provided under signature guarantees. You can obtain a signature guarantee from most commercial and savings banks, credit unions, trust companies, or member firms of a U.S. stock exchange. A notary public cannot provide a signature guarantee. ^NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT cancel any transaction once it has been initiated and a confirmation number has been assigned (if applicable). ^EMERGENCY CIRCUMSTANCES. Vanguard funds can postpone payment of redemption proceeds for up to seven calendar days. In addition, Vanguard funds can suspend redemptions and/or postpone payments of redemption proceeds beyond seven calendar days at times when the New York Stock Exchange is closed or during emergency circumstances, as determined by the U.S. Securities and Exchange Commission. EXCHANGING SHARES All open Vanguard funds accept exchange requests online (through your account registered with Vanguard.com), by telephone, or by mail. However, because excessive exchanges can disrupt management of a fund and increase the fund's costs for all shareholders, Vanguard places certain limits on the exchange privilege. If you are exchanging into or out of the U.S. STOCK INDEX FUNDS, INTERNATIONAL STOCK INDEX FUNDS, REIT INDEX FUND, BALANCED INDEX FUND, CALVERT SOCIAL INDEX FUND, INTERNATIONAL GROWTH FUND, INTERNATIONAL VALUE FUND, 21 INTERNATIONAL EXPLORER(TM) FUND, or GROWTH AND INCOME FUND, these limits generally are as follows: o No online or telephone exchanges between 2:30 p.m. and 4 p.m., Eastern time, on business days. Any exchange request placed during these hours will not be accepted. On days when the New York Stock Exchange is scheduled to close early, this end-of-day restriction will be adjusted to begin 11^2 hours prior to the scheduled close. (For example, if the New York Stock Exchange is scheduled to close at 1 p.m., Eastern time, the cutoff for online and telephone exchanges will be 11:30 a.m., Eastern time.) o No more than two exchanges OUT of a fund may be requested online or by telephone within any 12-month period. For ALL OTHER VANGUARD FUNDS, the following limits generally apply: o No more than two substantive "round trips" through a non-money-market fund during any 12-month period. A "round trip" is a redemption OUT of a fund (by any means) followed by a purchase back INTO the same fund (by any means). "Substantive" means a dollar amount that Vanguard determines, in its sole discretion, could adversely affect management of the fund. o Round trips must be at least 30 days apart. Please note that Vanguard reserves the right to revise or terminate the exchange privilege, limit the amount of any exchange, or reject an exchange, at any time, for any reason. Also, in the event of a conflict between the exchange- privilege limitations of two funds, the stricter policy will apply to the transaction. OTHER RULES YOU SHOULD KNOW VANGUARD.COM/(R)/ ^REGISTRATION. You can use your personal computer to review your account holdings, to sell or exchange shares of most Vanguard funds, and to perform other transactions. To establish this service, you can register online. ^SOME VANGUARD FUNDS DO NOT PERMIT ONLINE EXCHANGES BETWEEN 2:30 P.M. AND 4 P.M., EASTERN TIME. To discourage market-timing, the following Vanguard funds generally do not permit online exchanges between 2:30 p.m. and 4 p.m., Eastern time, on business days: the U.S. Stock Index Funds, International Stock Index Funds, REIT Index Fund, Balanced Index Fund, Calvert Social Index Fund, Inter national Growth Fund, International Value Fund, International Explorer Fund, and Growth and Income Fund. Funds may be 22 added to or deleted from this list at any time without prior notice to shareholders. TELEPHONE TRANSACTIONS ^AUTOMATIC. In setting up your account, we'll automatically enable you to do business with us by telephone, unless you instruct us otherwise in writing. ^TELE-ACCOUNT/(R)/. To conduct account transactions through Vanguard's automated telephone service, you must first obtain a Personal Identification Number (PIN). Call Tele-Account to obtain a PIN, and allow seven days before using this service. ^PROOF OF A CALLER'S AUTHORITY. We reserve the right to refuse a telephone request if the caller is unable to provide the following information exactly as registered on the account: o Ten-digit account number. o Complete owner name and address. o Primary Social Security or employer identification number. o Personal Identification Number (PIN), if applicable. ^SUBJECT TO REVISION. We reserve the right to revise or terminate Vanguard's telephone transaction service at any time, without notice. ^SOME VANGUARD FUNDS DO NOT PERMIT TELEPHONE EXCHANGES BETWEEN 2:30 P.M. AND 4 P.M., EASTERN TIME. To discourage market-timing, the following Vanguard funds generally do not permit telephone exchanges between 2:30 p.m. and 4 p.m., Eastern time, on business days: the U.S. Stock Index Funds, International Stock Index Funds, REIT Index Fund, Balanced Index Fund, Calvert Social Index Fund, International Growth Fund, International Value Fund, International Explorer Fund, and Growth and Income Fund. Funds may be added to or deleted from this list at any time without prior notice to shareholders. WRITTEN INSTRUCTIONS ^"GOOD ORDER" REQUIRED. We reserve the right to reject any written transaction instructions that are not in "good order." This means that your instructions must include: o The fund name and account number. o The amount of the transaction (in dollars, shares, or percent). o Authorized signatures, as registered on the account. o Signature guarantees, if required for the type of transaction.* o Any supporting legal documentation that may be required. * For instance, signature guarantees must be provided by all registered account owners when redemption proceeds are to be sent to a different person or address. Call Vanguard for specific signature-guarantee requirements. 23 ACCOUNTS WITH MORE THAN ONE OWNER In the case of an account with more than one owner, Vanguard will accept telephone instructions from any one owner or authorized person. RESPONSIBILITY FOR FRAUD Vanguard will not be responsible for any account losses due to fraud, so long as we reasonably believe that the person transacting business on an account is authorized to do so. Please take precautions to protect yourself from fraud. Keep your account information private and immediately review any account statements that we send to you. Contact Vanguard immediately about any transactions you believe to be unauthorized. UNCASHED CHECKS Please cash your distribution or redemption checks promptly. Vanguard will not pay interest on uncashed checks. UNUSUAL CIRCUMSTANCES If you experience difficulty contacting Vanguard online, by telephone, or by Tele-Account, you can send us your transaction request by regular or express mail. See Contacting Vanguard for addresses. INVESTING WITH VANGUARD THROUGH OTHER FIRMS You may purchase or sell Investor Shares of most Vanguard funds through a financial intermediary, such as a bank, broker, or investment adviser. If you invest with Vanguard through an intermediary, please read that firm's program materials carefully to learn of any rules or fees that may apply. LOW-BALANCE ACCOUNTS The Fund reserves the right to convert an investor's Institutional Shares into Investor Shares or Admiral Shares of the Fund if the investor's fund account balance falls below the minimum initial investment. Any such conversion will be preceded by written notice to the investor. No transaction fee will be imposed on share-class conversions. FUND AND ACCOUNT UPDATES CONFIRMATION STATEMENTS We will send you a statement confirming the trade date and amount of your transaction when you buy, sell, exchange, or convert shares. PORTFOLIO SUMMARIES We will send you quarterly portfolio summaries to help you keep track of your accounts throughout the year. Each summary shows the market value of your account at the close of the statement period, as well as all distributions, purchases, sales, and exchanges for the current calendar year. TAX STATEMENTS We will send you annual tax statements to assist in preparing your income tax returns. These statements, which are gener- 24 ally mailed in January, will report the previous year's dividend and capital gains distributions, proceeds from the sale of shares, and distributions from IRAs or other retirement plans. AVERAGE-COST REVIEW STATEMENTS For most taxable accounts, average-cost review statements will accompany the quarterly portfolio summaries. These statements show the average cost of shares that you redeemed during the current calendar year, using the average-cost single-category method, which is one of the methods established by the IRS. ANNUAL AND SEMIANNUAL REPORTS Financial reports about Vanguard REIT Index Fund will be mailed twice a year, in March and September. These comprehensive reports include overviews of the financial markets and specific information concerning the Fund: o Performance assessments with comparisons to industry benchmarks. o Reports from the adviser. o Financial statements with detailed listings of the Fund's holdings. To keep the Fund's costs as low as possible (so that you and other shareholders can keep more of the Fund's investment earnings), Vanguard attempts to eliminate duplicate mailings to the same address. When we find that two or more shareholders have the same last name and address, we send just one copy of the Fund report to that address, instead of mailing separate reports to each shareholder, unless you contact our Client Services Department in writing, by telephone, or by e-mail and instruct us otherwise. Vanguard can deliver your Fund reports electronically, if you prefer. If you are a registered user of Vanguard.com, you can consent to the electronic delivery of Fund reports by logging on and changing your mailing preference under "My Profile." You can revoke your electronic consent at any time, and we will send paper copies of Fund reports within 30 days of receiving your notice. CONTACTING VANGUARD ONLINE VANGUARD.COM o Your best source of Vanguard news o For fund, account, and service information o For most account transactions o For literature requests o 24 hours per day, 7 days per week 25 VANGUARD TELE-ACCOUNT/(R)/ 1-800-662-6273 (ON-BOARD) o For automated fund and account information o For redemptions by check, exchange (subject to certain limitations), or wire o Toll-free, 24 hours per day, 7 days per week INVESTOR INFORMATION 1-800-662-7447 (SHIP) (Text telephone at 1-800-952-3335) o For fund and service information o For literature requests o Business hours only CLIENT SERVICES 1-800-662-2739 (CREW) (Text telephone at 1-800-749-7273) o For account information o For most account transactions o Business hours only INSTITUTIONAL DIVISION 1-888-809-8102 o For information and services for large institutional investors o Business hours only VANGUARD ADDRESSES REGULAR MAIL (INDIVIDUALS): The Vanguard Group P.O. Box 1110 Valley Forge, PA 19482-1110 REGULAR MAIL (INSTITUTIONS): The Vanguard Group P.O. Box 2900 Valley Forge, PA 19482-2900 REGISTERED, EXPRESS, OR OVERNIGHT MAIL: The Vanguard Group 455 Devon Park Drive Wayne, PA 19087-1815 FUND NUMBERS Please use the specific fund number when contacting us about Vanguard REIT Index Fund Institutional Shares--3123. The Vanguard Group, Vanguard, Vanguard.com, Plain Talk, Admiral, Vanguard Fund Express, Fund Express, Vanguard Tele-Account, Tele-Account, Explorer, 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 exclusive property of their respective owners. (THIS PAGE INTENTIONALLY LEFT BLANK.) (THIS PAGE INTENTIONALLY LEFT BLANK.) (THIS PAGE INTENTIONALLY LEFT BLANK.) GLOSSARY OF INVESTMENT TERMS ACTIVE MANAGEMENT An investment approach that seeks to exceed the average returns of the financial markets. Active managers rely on research, market forecasts, and their own judgment and experience in selecting securities to buy and sell. CAPITAL GAINS DISTRIBUTION Payment to mutual fund shareholders of gains realized on securities that a fund has sold at a profit, minus any realized losses. CASH INVESTMENTS Cash deposits, short-term bank deposits, and money market instruments that include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase agreements, commercial paper, and banker's acceptances. COST BASIS The adjusted cost of an investment, used to determine a capital gain or loss for tax purposes. DISTRIBUTIONS Payments to shareholders of dividend income, capital gains, and return of capital generated by the fund's investment activities and distribution policies, after expenses. DIVIDEND DISTRIBUTION Payment to mutual fund shareholders of income from interest or dividends generated by a fund's investments. EXPENSE RATIO The percentage of a fund's average net assets used to pay its expenses during a fiscal year. The expense ratio includes management fees, administrative fees, and any 12b-1 distribution fees. INDEX An unmanaged group of securities whose overall performance is used as a standard to measure investment performance. INDUSTRY CONCENTRATION Focusing on the securities of a specific industry (such as energy, precious metals, health care, or real estate). INVESTMENT ADVISOR An organization that makes the day-to-day decisions regarding a fund's investments. LIQUIDITY The degree of a security's marketability (that is, how quickly the security can be sold at a fair price and converted to cash). MUTUAL FUND An investment company that pools the money of many people and invests it in a variety of securities in an effort to achieve a specific objective over time. PASSIVE MANAGEMENT A low-cost investment strategy in which a mutual fund attempts to match--rather than outperform--a particular stock or bond market index; also known as indexing. PRINCIPAL The amount of money you put into an investment. REAL ESTATE INVESTMENT TRUST (REIT) A company that owns and manages real estate. RETURN OF CAPITAL A nontaxable portion of distributions. In general, the cost basis of an investment is reduced when a return of capital is distributed, deferring taxes until the investment is sold. TOTAL RETURN A percentage change, over a specified time period, in a mutual fund's net asset value, assuming the reinvestment of all distributions of dividends and capital gains. VOLATILITY The fluctuations in value of a mutual fund or other security. The greater a fund's volatility, the wider the fluctuations in its returns. YIELD Income (interest or dividends) earned by an investment, expressed as a percentage of the investment's price. [SHIP] [THE VANGUARD GROUP LOGO] Institutional Division Post Office Box 2900 Valley Forge, PA 19482-2900 FOR MORE INFORMATION If you'd like more information about Vanguard REIT Index Fund Institutional Shares, the following documents are available free upon request: ANNUAL/SEMIANNUAL REPORTS TO SHAREHOLDERS Additional information about the Fund's investments is available in the Fund's annual and semiannual reports to shareholders. In the Fund's annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Fund's performance during its last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI provides more detailed information about the Fund. The current annual and semiannual reports and the SAI are incorporated by reference into (and are thus legally a part of) this prospectus. To receive a free copy of the latest annual or semiannual report or the SAI, or to request additional information about the Fund or other Vanguard funds, please contact us as follows: If you are an individual investor: THE VANGUARD GROUP INVESTOR INFORMATION DEPARTMENT P.O. BOX 2900 VALLEY FORGE, PA 19482-2900 TELEPHONE: 1-800-662-7447 (SHIP) TEXT TELEPHONE: 1-800-952-3335 If you are a client of Vanguard's Institutional Division: THE VANGUARD GROUP INSTITUTIONAL INVESTOR INFORMATION DEPARTMENT P.O. BOX 2900 VALLEY FORGE, PA 19482-2900 TELEPHONE: 1-888-809-8102 TEXT TELEPHONE: 1-800-952-3335 WORLD WIDE WEB: WWW.VANGUARD.COM If you are a current Fund shareholder and would like information about your account, account transactions, and/or account statements, please call: CLIENT SERVICES DEPARTMENT TELEPHONE: 1-800-662-2739 (CREW) TEXT TELEPHONE: 1-800-749-7273 INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC) You can review and copy information about the Fund (including the SAI) at the SEC's Public Reference Room in Washington, DC. To find out more about this public service, call the SEC at 1-202-942-8090. Reports and other information about the Fund are also available on the SEC's Internet site at http://www.sec.gov, or you can receive copies of this information, for a fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the Public Reference Section, Securities and Exchange Commission, Washington, DC 20549-0102. Fund's Investment Company Act file number: 811-3916 (C) 2003 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. I3123 112003 VANGUARD(R) REIT INDEX FUND Investor Shares & Admiral(TM) Shares . November 25, 2003 This prospectus contains financial data for the Fund through the fiscal period ended July 31, 2003. STOCK PROSPECTUS NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [GRAPHIC] [LOGO] THE VANGUARD GROUP(R) VANGUARD REIT INDEX FUND Investor Shares and Admiral Shares Prospectus November 25, 2003 A Real Estate Stock Mutual Fund -------------------------------------------------------------------------------- CONTENTS 1 FUND PROFILE 4 ADDITIONAL INFORMATION 5 MORE ON THE FUND 10 THE FUND AND VANGUARD 10 INVESTMENT ADVISOR 11 DIVIDENDS, CAPITAL GAINS, AND TAXES 13 SHARE PRICE 14 FINANCIAL HIGHLIGHTS 17 INVESTING WITH VANGUARD 17 Buying Shares 19 Converting Shares 20 Redeeming Shares 22 Exchanging Shares 23 Other Rules You Should Know 25 Fund and Account Updates 26 Contacting Vanguard GLOSSARY (inside back cover) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- WHY READING THIS PROSPECTUS IS IMPORTANT This prospectus explains the investment objective, policies, strategies, and risks associated with the Fund. To highlight terms and concepts important to mutual fund investors, we have provided Plain Talk/(R)/ explanations along the way. Reading the prospectus will help you decide whether the Fund is the right investment for you. We suggest that you keep this prospectus for future reference. ------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SHARE CLASS OVERVIEW The Fund offers three separate classes of shares: Investor Shares, Admiral Shares, and Institutional Shares. this prospectus offers the Fund's Investor Shares and Admiral Shares. Please note that Admiral Shares are NOT available to: - SIMPLE IRAs and 403(b)(7) custodial accounts; - Other retirement plan accounts receiving special administrative services from Vanguard; or - Accounts maintained by financial intermediaries, except in limited circumstances. A separate prospectus offers the Fund's Institutional Shares, which are for investors who do not require special employee benefit plan services and who are willing to invest a minimum of $10 million. The Fund's separate share classes have different expenses; as a result, their investment performances will differ. ------------------------------------------------------------------------------- 1 FUND PROFILE INVESTMENT OBJECTIVE The Fund seeks to provide a high level of income and moderate long-term capital growth by tracking the performance of a benchmark index that measures the performance of publicly traded equity REITs. PRIMARY INVESTMENT STRATEGIES The Fund normally invests at least 98% of its assets in stocks issued by real estate investment trusts (known as REITs) in an attempt to parallel the investment performance of the Morgan Stanley REIT Index. The Fund invests in the stocks that make up the Index; the remaining assets are allocated to cash investments. PRIMARY RISKS An investment in the Fund could lose money over short or even long periods. You should expect the Fund's share price and total return to fluctuate within a wide range, like the fluctuations of the overall stock market. The Fund's performance could be hurt by: - Industry concentration risk, which is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Because the Fund concentrates its assets in REIT stocks, real estate industry risk is high. - Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. - Interest rate risk, which is the chance that REIT stock prices overall will decline because of rising interest rates. Interest rate risk should be high for the Fund. - Investment style risk, which is the chance that the returns from REIT stocks--which typically are small- or mid-capitalization stocks--will trail returns from the overall stock market. Historically, these stocks have been more volatile in price than the large-cap stocks that dominate the overall stock market, and they often perform quite differently. PERFORMANCE/RISK INFORMATION The following bar chart and table are intended to help you understand the risks of investing in the Fund. The bar chart shows how the performance of the Fund's Investor Shares (including operating expenses but excluding shareholder fees) has varied from one calendar year to another over the periods shown. ---------------------------------------------------- ANNUAL TOTAL RETURNS--INVESTOR SHARES [BAR CHART] 1997 18.77 1998 -16.32 1999 -4.04 2000 26.35 2001 12.35 2002 3.75 ---------------------------------------------------- The year-to-date return as of the most recent calendar quarter, which ended September 30, 2003, was 24.14%. If applicable shareholder fees were reflected, returns would be less than those shown. ---------------------------------------------------- 2 During the periods shown in the bar chart, the highest return for a calendar quarter was 12.27% (quarter ended June 30, 2003), and the lowest return for a quarter was -10.41% (quarter ended September 30, 1998). The table shows how the average annual total returns of the share classes presented (including operating expenses and any applicable shareholder fees) compare with those of the Fund's target index and other comparative indexes. Keep in mind that the Fund's past returns (before and after taxes) do not indicate how it will perform in the future. -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS -------------------------------------------------------------------------------- PERIODS ENDED DECEMBER 31, 2002 SINCE 1 YEAR 5 YEARS INCEPTION* -------------------------------------------------------------------------------- VANGUARD REIT INDEX FUND INVESTOR SHARES Return Before Taxes 3.75% 3.41% 9.52% Return After Taxes on Distributions 1.64 1.13 7.20 Return After Taxes on Distributions 2.33 1.52 6.61 and Sale of Fund Shares -------------------------------------------------------------------------------- VANGUARD REIT INDEX FUND ADMIRAL SHARES** Return Before Taxes 3.73% -- -- WILSHIRE 5000 TOTAL MARKET INDEX (reflects no deduction for fees, expenses, or taxes) -20.86% -0.87% 5.08% MORGAN STANLEY REIT INDEX (reflects no deduction for fees, expenses, or taxes) 3.64 3.30 9.46 TARGET REIT COMPOSITE+ (reflects no deduction for fees, expenses, or taxes) 3.61 3.31 9.41 -------------------------------------------------------------------------------- *Since-inception returns are from May 13, 1996--the inception date of the of the Investor Shares--through December 31, 2002. **Average annual total returns from November 12, 2001--the inception date of the Admiral Shares--through December 31, 2002, were 8.77% for Vanguard REIT Index Fund Admiral Shares; -15.57 for the Wilshire 5000 Index; 8.82% for the Morgan Stalney REIT Index; and 8.68% for the Target REIT Composite. +The Target REIT Composite consists of the Morgan Stanley REIT Index adjusted to include a 2% cash position (Lipper Money Market Average). ------------------------------------------------------------------------------- NOTE ON AFTER-TAX RETURNS. Actual after-tax returns depend on your tax situation and may differ from those shown in the table above. When calculating after-tax return figures for a fund, we assume the shareholder was in the highest federal marginal income tax bracket at the time of each distribution of income or capital gains, but we do not consider state or local income taxes. Please note that actual after-tax returns will vary for a fund's separate share classes and are not relevant for a shareholder who holds fund shares in a tax-deferred account, such as an individual retirement account or a 401(k) plan. Also, for any fund, figures captioned Return After Taxes on Distributions and Sale of Fund Shares will be higher than other return figures for the same period if a capital loss occurs upon redemption and results in an assumed tax deduction for the shareholder. FEES AND EXPENSES The following table describes the fees and expenses you may pay if you buy and hold Investor Shares or Admiral Shares of the Fund. The expenses shown under Annual Fund Operating Expenses are based on estimated amounts for the current fiscal year. 3 INVESTOR ADMIRAL SHARES SHARES ------ ------ SHAREHOLDER FEES (fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases: None None Purchase Fee: None None Sales Charge (Load) Imposed on Reinvested None None Dividends: Redemption Fee: 1%* 1%* ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets) Management Expenses: 0.25% 0.20% 12b-1 Distribution Fee: None None Other Expenses: 0.02% 0.01% TOTAL ANNUAL FUND OPERATING EXPENSES: 0.27% 0.21% *The 1% fee applies to shares redeemed within one year of purchase by selling, by exchanging to another fund, or by application of the low-balance account-closure policy. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. The following examples are intended to help you compare the cost of investing in the Fund's Investor Shares or Admiral Shares with the cost of investing in other mutual funds. They illustrate the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. These examples assume that the Fund provides a return of 5% a year and that operating expenses match our estimates. The results apply whether or not you redeem your investment at the end of the given period. --------------------------------------------------------- 1 YEAR 3 YEARS 5 YEARS 10 YEARS --------------------------------------------------------- Investor Shares $28 $87 $152 $343 Admiral Shares $22 $68 $118 $268 --------------------------------------------------------- THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN. -------------------------------------------------------------------------------- PLAIN TALK ABOUT FUND EXPENSES All mutual funds have operating expenses. These expenses, which are deducted from a fund's gross income, are expressed as a percentage of the net assets of the fund. We expect Vanguard REIT Index Fund's expense ratios for the current fiscal year to be as follows: for Investor Shares, 0.27%, or $2.70 per $1,000 of average net assets; for Admiral Shares, 0.21%, or $2.10 per $1,000 of average net assets. The average real estate mutual fund had expenses in 2002 of 1.64%, or $16.40 per $1,000 of average net assets (derived from data provided by Lipper Inc., which reports on the mutual fund industry). Management expenses, which are one part of operating expenses, include investment advisory fees as well as other costs of managing a fund--such as account maintenance, reporting, accounting, legal, and other administrative expenses. -------------------------------------------------------------------------------- 4 -------------------------------------------------------------------------------- PLAIN TALK ABOUT COSTS OF INVESTING Costs are an important consideration in choosing a mutual fund. That's because you, as a shareholder, pay the costs of operating a fund, plus any transaction costs incurred when the fund buys or sells securities. These costs can erode a substantial portion of the gross income or capital appreciation a fund achieves. Even seemingly small differences in expenses can, over time, have a dramatic effect on a fund's performance. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- ADDITIONAL INFORMATION DIVIDENDS AND CAPITAL GAINS CONVERSION FEATURES Dividends are distributed Investor Shares--May be converted to quarterly in March, June, September, Admiral Shares if you meet certain and December. These distributions account balance and tenure requirements. may include income, capital gains, Admiral Shares--May be converted to and a return of capital. Investor Shares if you are no longer Additional capital gains may be eligible for Admiral Shares. distributed annually in December. NEWSPAPER ABBREVIATION INVESTMENT ADVISOR Investor Shares--REIT The Vanguard Group, Valley Forge, Admiral Shares--REITAdml Pa., since inception VANGUARD FUND NUMBER Investor Shares--123 INCEPTION DATE Admiral Shares--5123 Investor Shares--May 13, 1996 Admiral Shares--November 12, 2001 CUSIP NUMBER Investor Shares--921908703 NET ASSETS (ALL SHARE CLASSES) AS OF Admiral Shares--921908877 JULY 31, 2003 $2.9 billion TICKER SYMBOL Investor Shares--VGSIX SUITABLE FOR IRAS Admiral Shares--VGSLX Yes MINIMUM INITIAL INVESTMENT Investor Shares--$3,000; $1,000 for IRAs and most custodial accounts for minors Admiral Shares--$250,000 -------------------------------------------------------------------------------- MORE ON THE FUND This prospectus describes the primary risks you would face as a Fund shareholder. It is important to keep in mind one of the main axioms of investing: The higher the risk of losing money, the higher the potential reward. The reverse, also, is generally true: The lower the risk, the lower the potential reward. As you consider an investment in any mutual fund, you should take into account your personal tolerance for daily fluctuations in the securities markets. Look for this [FLAG] symbol throughout the prospectus. It is used to mark detailed information about the more significant risks that you would confront as a Fund shareholder. The following sections explain the primary investment strategies and policies that the Fund uses in pursuit of its objective. The Fund's board of trustees, which oversees the Fund's management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. 5 MARKET EXPOSURE The Fund normally invests at least 98% of its assets in stocks of real estate investment trusts (REITs) and holds any remaining assets in cash investments to meet shareholder redemptions. This policy may only be changed upon 60 days' notice to shareholders. -------------------------------------------------------------------------------- PLAIN TALK ABOUT REITS Rather than owning properties directly--which can be costly and difficult to convert into cash when needed--some investors buy shares in a company that owns and manages real estate. Such a company is known as a real estate investment trust, or REIT. Unlike corporations, REITs do not have to pay income taxes if they meet certain Internal Revenue Code requirements. To qualify, a REIT must distribute at least 90% of its taxable income to its shareholders and receive at least 75% of that income from rents, mortgages, and sales of property. REITs offer investors greater liquidity and diversification than direct ownership of a handful of properties, as well as greater income potential than an investment in common stocks. As with any investment in real estate, however, a REIT's performance depends on several factors, such as its ability to find tenants for its properties, to renew leases, and to finance property purchases and renovations. That said, returns from REITs may not correspond to returns from direct property ownership. -------------------------------------------------------------------------------- [FLAG] THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE CHANCE THAT RETURNS FROM REIT STOCKS--WHICH TYPICALLY ARE SMALL- OR MID-CAP STOCKS--WILL TRAIL RETURNS FROM THE OVERALL MARKET. HISTORICALLY, THESE STOCKS HAVE BEEN MORE VOLATILE IN PRICE THAN THE LARGE-CAP STOCKS THAT DOMINATE THE OVERALL STOCK MARKET, AND THEY OFTEN PERFORM QUITE DIFFERENTLY. Stocks of publicly traded companies and funds that invest in stocks are often classified according to market value, or market capitalization. These classifications typically include small-cap, mid-cap, or large-cap. It's important to understand that, for both companies and stock funds, market capitalization ranges change over time. Also, interpretations of size vary, and there are no "official" definitions of small-, mid-, and large-cap, even among Vanguard fund advisors. REIT stocks in the Morgan Stanley REIT Index tend to be small or medium-size companies. The median market capitalization of the Fund as of July 31, 2003, was $2.3 billion. Small- and mid-cap stocks tend to have greater volatility than large-cap stocks because, among other things, smaller companies often have fewer customers, financial resources, and products than larger firms. Such characteristics can make small and medium-size companies more sensitive to changing economic conditions. REIT stocks tend to have a significant amount of dividend income to soften the impact of this volatility. However, the index and, thus, the Fund, are subject to additional risk because of the concentration in the real estate sector. This single-sector focus may result in more risk than would a more diversified, multi-sector portfolio. 6 -------------------------------------------------------------------------------- PLAIN TALK ABOUT TYPES OF REITS An equity REIT owns properties directly. Equity REITs generate income (from rental and lease payments) and offer the potential for growth (from property appreciation) as well as occasional capital gains from the sale of property. A mortgage REIT makes loans to commercial real estate developers. Mortgage REITs earn interest income and are subject to credit risk (that is, the chance that a developer will fail to repay a loan). A hybrid REIT holds both properties and mortgages. The Fund invests in equity REITs only. -------------------------------------------------------------------------------- [FLAG] THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT STOCK PRICES OVERALL WILL DECLINE. STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF FALLING PRICES. To illustrate the volatility of stock prices, the following table shows the best, worst, and average total returns for the U.S. stock market over various periods as measured by the Standard & Poor's 500 Index, a widely used barometer of market activity. (Total returns consist of dividend income plus change in market price.) Note that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. ---------------------------------------------------------- U.S. STOCK MARKET RETURNS (1926-2002) ---------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS 20 YEARS ---------------------------------------------------------- Best 54.2% 28.6% 19.9% 17.8% Worst -43.1 -12.4 -0.8 3.1 Average 12.2 10.9 11.2 11.4 ---------------------------------------------------------- The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926 through 2002. You can see, for example, that while the average return on common stocks for all of the 5-year periods was 10.9%, average returns for individual 5-year periods ranged from -12.4% (from 1928 through 1932) to 28.6% (from 1995 through 1999). These average returns reflect past performance on common stocks; you should not regard them as an indication of future returns from either the stock market as a whole or this Fund in particular. [FLAG] THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE CHANCE THAT REIT STOCK PRICES OVERALL WILL DECLINE BECAUSE OF RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE HIGH FOR THE FUND. In general, during periods of high interest rates, REITs may lose some of their appeal for investors who may be able to obtain higher yields from other income-producing investments, such as long-term bonds. Higher interest rates also mean that financing for property purchases and improvements is more costly and difficult to obtain. [FLAG] THE FUND IS SUBJECT TO REAL ESTATE INDUSTRY RISK, WHICH IS THE CHANCE THAT THE STOCKS OF REITS WILL DECLINE BECAUSE OF ADVERSE DEVELOPMENTS AFFECTING THE REAL ESTATE INDUSTRY AND REAL PROPERTY VALUES. BECAUSE THE FUND CONCENTRATES ITS ASSETS IN REIT STOCKS, REAL ESTATE INDUSTRY RISK IS HIGH. 7 Because of its emphasis on REIT stocks, the Fund's performance may at times be linked to the ups and downs of the real estate market. In general, real estate values can be affected by a variety of factors, including supply and demand for properties; the economic health of the country as well as different regions; and the strength of specific industries that rent properties. Ultimately, an individual REIT's performance depends on the types and locations of the properties it owns and on how well the REIT manages its properties. For instance, rental income could decline because of extended vacancies, increased competition from nearby properties, tenants' failure to pay rent, or incompetent management. Property values could decrease because of overbuilding in the area, environmental liabilities, uninsured damages caused by natural disasters, a general decline in the neighborhood, losses due to casualty or condemnation, increases in property taxes, or changes in zoning laws. Loss of IRS status as a qualified REIT may also affect an individual REIT's performance. The target index tracked by the Fund is broadly diversified. Similarly, the Fund is broadly diversified, holding stocks of more than 100 companies. It is possible that the Fund's target index, in the future, could become less diversified if the index's largest companies significantly increase in value relative to the index's other components. In an extreme situation, the Fund might no longer meet the legal definition of "diversified." For this reason, the Fund is classified as "nondiversified." However, the Fund, from its inception until the date of this prospectus, in actuality has been diversified, and Vanguard expects the Fund to continue to be diversified. SECURITY SELECTION The Fund employs an indexing, or passively managed, investment approach. The Fund's advisor, The Vanguard Group (Vanguard), normally invests at least 98% of the Fund's assets in REIT securities in an attempt to parallel the performance of the target benchmark, the Morgan Stanley REIT Index. The Fund holds each stock contained in the Morgan Stanley REIT Index in roughly the same proportions as in the Index itself. For example, if 5% of the Morgan Stanley REIT Index were made up of the stock of a specific REIT, the Fund would invest the same percentage of its noncash assets in that stock. The Morgan Stanley REIT Index is made up of the stocks of publicly traded equity REITs that meet certain criteria. For example, to be included initially in the Index, a REIT must have a total market capitalization of at least $100 million and have enough shares and trading volume to be considered liquid. In line with the Index, the Fund invests in equity REITs only. As of July 31, 2003, 112 equity REITs were included in the Index. The Index is rebalanced every calendar quarter, as well as each time that a REIT is removed from the Index. A REIT may be removed from the Index because the REIT's market capitalization falls below $75 million; because the REIT becomes illiquid; because of other changes in the REIT's status; or because of corporate activity such as a merger, an acquisition, a leveraged buyout, bankruptcy, IRS removal of REIT status, or a fundamental change in business. 8 Stocks in the Morgan Stanley REIT Index represent a broadly diversified range of property types. The Index's makeup, as of July 31, 2003, was as follows: --------------------------------------------- PROPERTY TYPES PERCENTAGE OF INDEX --------------------------------------------- Retail 26% Residential Apartments 19 Office 19 Industrial 13 Diversified 12 Health Care 5 Hotels 4 Cash 2 --------------------------------------------- The Fund is generally managed without regard to tax ramifications. OTHER INVESTMENT POLICIES AND RISKS Besides investing in common stocks of REITs, the Fund may make certain other kinds of investments to achieve its objective. [FLAG] THE FUND MAY INVEST, TO A LIMITED EXTENT, IN DERIVATIVES. DERIVATIVES MAY INVOLVE RISKS DIFFERENT FROM, AND POSSIBLY GREATER THAN, THOSE OF TRADITIONAL INVESTMENTS. The Fund may also invest, to a limited extent, in futures and options contracts, which are types of derivatives. The Fund willl invest in futures only for purposes of matching the performance of its target index, and not for speculative purposes or as leveraged investments that magnify losses or gains. Losses (or gains) involving futures can sometimes be substantial-- in part because a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for a fund. The Fund's obligation under futures contracts will not exceed 20% of its total assets. To the extent that the Fund invests in futures contracts, it will not have 98% of its assets invested in REIT stocks. The reasons for which the Fund may invest in futures include: - To keep cash on hand to meet shareholder redemptions or other needs while simulating full investment in stocks. - To reduce the Fund's transaction costs or add value when these instruments are favorably priced. 9 -------------------------------------------------------------------------------- PLAIN TALK ABOUT DERIVATIVES A derivative is a financial contract whose value is based on (or "derived" from) a traditional security (such as a stock or a bond), an asset (such as a commodity like gold), or a market index (such as the S&P 500 Index). Some forms of derivatives, such as exchange-traded futures and options on securities, commodities, or indexes, have been trading on regulated exchanges for decades. These types of derivatives are standardized contracts that can easily be bought and sold, and whose market values are determined and published daily. Nonstandardized derivatives (such as swap agreements), on the other hand, tend to be more specialized or complex, and may be harder to value. Derivatives can carry considerable risks, particularly if used for speculation or as leveraged investments. -------------------------------------------------------------------------------- REDEMPTION FEE The Fund charges a fee on shares that are redeemed before they have been held for one year. This fee applies when shares are redeemed by exchange to another Vanguard fund or by application of the low-balance account-closure policy. Unlike a sales charge or load paid to a broker or fund management company, the redemption fee is paid directly to the Fund to offset the costs of buying and selling securities. The fee ensures that short-term investors pay their share of the Fund's transaction costs and that long-term investors do not subsidize the activities of short-term traders. COSTS AND MARKET-TIMING Some investors try to profit from a strategy called market-timing--switching money into mutual funds when they expect prices to rise and taking money out when they expect prices to fall. As money is shifted in and out, a fund incurs expenses for buying and selling securities. These costs are borne by all fund shareholders, including the long-term investors who do not generate the costs. This is why all Vanguard funds have adopted special policies to discourage short-term trading or to compensate the funds for the costs associated with it. Specifically: - Each Vanguard fund reserves the right to reject any purchase request--including exchanges from other Vanguard funds--that it regards as disruptive to efficient portfolio management. A purchase request could be rejected because of the timing of the investment or because of a history of excessive trading by the investor. - Each Vanguard fund (other than the money market funds) limits the number of times that an investor can exchange into and out of the fund. - Certain Vanguard funds charge purchase and/or redemption fees on transactions. See the INVESTING WITH VANGUARD section of this prospectus for further details on Vanguard's transaction policies. THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST WITH VANGUARD IF YOU ARE A MARKET-TIMER. TURNOVER RATE Although the Fund normally seeks to invest for the long term, it may sell securities regardless of how long they have been held. The FINANCIAL HIGHLIGHTS section of this prospectus shows historical turnover rates for the Fund. A turnover rate of 100%, for example, would mean that the Fund had sold and replaced securities valued at 100% of its net assets within a one-year period. 10 -------------------------------------------------------------------------------- PLAIN TALK ABOUT TURNOVER RATE Before investing in a mutual fund, you should review its turnover rate. This gives an indication of how transaction costs could affect the fund's future returns. In general, the greater the volume of buying and selling by the fund, the greater the impact that brokerage commissions and other transaction costs will have on its return. Also, funds with high turnover rates may be more likely to generate capital gains that must be distributed to shareholders as taxable income. As of July 31, 2003, the average turnover rate for all real estate funds was approximately 68%, according to Morningstar, Inc. -------------------------------------------------------------------------------- THE FUND AND VANGUARD The Fund is a member of The Vanguard Group, a family of 35 investment companies with more than 100 funds holding assets in excess of $640 billion. All of the funds that are members of The Vanguard Group share in the expenses associated with administrative services and business operations, such as personnel, office space, equipment, and advertising. Vanguard also provides marketing services to the funds. Although shareholders do not pay sales commissions or 12b-1 distribution fees, each fund pays its allocated share of The Vanguard Group's marketing costs. -------------------------------------------------------------------------------- PLAIN TALK ABOUT VANGUARD'S UNIQUE CORPORATE STRUCTURE The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by the funds it oversees and thus indirectly by the shareholders in those funds. Most other mutual funds are operated by for-profit management companies that may be owned by one person, by a group of individuals, or by investors who own the management company's stock. By contrast, Vanguard provides its services on an "at-cost" basis, and the funds' expense ratios reflect only these costs. -------------------------------------------------------------------------------- INVESTMENT ADVISOR The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482, which began operations in 1975, serves as advisor to the Fund through its Quantitative Equity Group. As of July 31, 2003, Vanguard served as advisor for about $450 billion in assets. Vanguard manages the Fund on an at-cost basis, subject to the supervision and oversight of the trustees and officers of the Fund. For the fiscal year ended July 31, 2003, the advisory expenses represented an effective annual rate of 0.01% of the Fund's average net assets. The advisor is authorized to choose broker-dealers to handle the purchase and sale of the Fund's securities and to seek to obtain the best available price and most favorable execution for all transactions. Also, the board of trustees may direct the advisor to use a particular broker for certain transactions in exchange for commission rebates paid to the Fund as well as for brokerage or research services provided to the advisor. 11 -------------------------------------------------------------------------------- PLAIN TALK ABOUT THE FUND'S ADVISOR The manager primarily responsible for overseeing the Fund's investments is: GEORGE U. SAUTER, Managing Director Chief Investment Officer of Vanguard and head of Vanguard's Quantitative Equity Group. He has worked in investment management since 1985 and has had primary responsibility for Vanguard's stock indexing and active quantitative investments and strategy since joining the company in 1987. Education: A.B., Dartmouth College; M.B.A., University of Chicago. -------------------------------------------------------------------------------- DIVIDENDS, CAPITAL GAINS, AND TAXES FUND DISTRIBUTIONS Each March, June, September, and December, Vanguard REIT Index Fund pays out to shareholders virtually all of the distributions it receives from its REIT investments, less expenses. Distributions may include income, return of capital, and capital gains. The Fund may also realize capital gains on the sale of its REIT investments. Distributions of these gains, if any, are included in the December distribution. In addition, the Fund may occasionally be required to make supplemental distributions at some other time during the year. You can receive distributions of income or capital gains in cash, or you can have them automatically reinvested in more shares of the Fund. -------------------------------------------------------------------------------- PLAIN TALK ABOUT DISTRIBUTIONS As a shareholder, you are entitled to your portion of a fund's income from interest and dividends as well as gains from the sale of investments. Income consists of both the dividends that the fund earns from any stock holdings and the interest it receives from any money market and bond investments. Capital gains are realized whenever the fund sells securities for higher prices than it paid for them. These capital gains are either short-term or long-term, depending on whether the fund held the securities for one year or less or for more than one year. You receive the fund's earnings as either a dividend or capital gains distribution. -------------------------------------------------------------------------------- BASIC TAX POINTS Vanguard expects to send you a statement each FEBRUARY showing the tax status of all your distributions. (Other Vanguard funds mail their tax statements in January; the Fund mails its statements later because REITs do not provide information on the taxability of their distributions until after the calendar year-end.) In addition, taxable investors should be aware of the following basic tax points: - Distributions (other than any return of capital) are taxable to you for federal income tax purposes, whether or not you reinvest these amounts in additional Fund shares. - Distributions declared in December--if paid to you by the end of January--are taxable for federal income tax purposes as if received in December. - Any dividend and short-term capital gains distributions that you receive are taxable to you as ordinary income for federal income tax purposes. If you are an individual and meet certain holding-period requirements with respect to your Fund shares, you may be eligible for reduced federal tax rates on "qualified dividend income" distributed by the Fund. 12 - Any distributions of net long-term capital gains are taxable to you as long-term capital gains for federal income tax purposes, no matter how long you've owned shares in the Fund. - Capital gains distributions may vary considerably from year to year as a result of the Fund's normal investment activities and cash flows. - A sale or exchange of Fund shares is a taxable event. This means that you may have a capital gain to report as income, or a capital loss to report as a deduction, when you complete your federal income tax return. - Dividend and capital gains distributions that you receive, as well as your gains or losses from any sale or exchange of Fund shares, may be subject to state and local income taxes. - Dividend distributions attributable to the Fund's REIT investments are not eligible for the corporate dividends-received deduction. - Your cost basis in the Fund will be decreased by the amount of any return of capital distributions that you receive. This, in turn, will affect the amount of any capital gain or loss that you realize when selling or exchanging your Fund shares. - Return-of-capital distributions generally are not taxable to you, unless your cost basis has been reduced to zero. If your cost basis is at zero, return-of-capital distributions will be taxed to you as capital gains. - Any conversion between classes of shares of the same fund is a nontaxable event. By contrast, an exchange between classes of shares of different funds is a taxable event. -------------------------------------------------------------------------------- PLAIN TALK ABOUT RETURN OF CAPITAL The Internal Revenue Code requires a REIT to distribute at least 90% of its taxable income to investors. In many cases, however, because of "noncash" expenses such as property depreciation, an equity REIT's cash flow will exceed its taxable income. The REIT may distribute this excess cash to offer a more competitive yield (in other words, provide investors with a higher distribution). This portion of the distribution is classified as a return of capital. -------------------------------------------------------------------------------- GENERAL INFORMATION BACKUP WITHHOLDING. By law, Vanguard must withhold 28% of any taxable distributions or redemptions from your account if you do not: - Provide us with your correct taxpayer identification number; - Certify that the taxpayer identification number is correct; and - Confirm that you are not subject to backup withholding. Similarly, Vanguard must withhold taxes from your account if the IRS instructs us to do so. FOREIGN INVESTORS. Vanguard funds generally are not sold outside the United States, except to certain qualifying investors. If you reside outside the United States, please consult our website at www.vanguard.com and review "Non-U.S. Investors." Foreign investors should be aware that U.S. withholding and estate taxes may apply to any investments in Vanguard funds. INVALID ADDRESSES. If a dividend or capital gains distribution check mailed to your address of record is returned as undeliverable, Vanguard will automatically reinvest all future distributions until you provide us with a valid mailing address. TAX CONSEQUENCES. This prospectus provides general tax information only. If you are investing through a tax-deferred retirement account, such as an IRA, special tax rules apply. 13 Please consult your tax advisor for detailed information about a fund's tax consequences for you. -------------------------------------------------------------------------------- PLAIN TALK ABOUT "BUYING A DIVIDEND" Unless you are investing through a tax-deferred retirement account (such as an IRA), you should consider avoiding a purchase of fund shares shortly before the fund makes a distribution, because doing so can cost you money in taxes. This is known as "buying a dividend." For example: On December 15, you invest $5,000, buying 250 shares for $20 each. If the fund pays a distribution of $1 per share on December 16, its share price will drop to $19 (not counting market change). You still have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you owe tax on the $250 distribution you received--even if you reinvest it in more shares. To avoid "buying a dividend," check a fund's distribution schedule before you invest. -------------------------------------------------------------------------------- SHARE PRICE The Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time. NAV per share is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. On holidays or other days when the Exchange is closed, the NAV is not calculated, and the Fund does not transact purchase or redemption requests. However, on those days the value of the Fund's assets may be affected to the extent that the Fund holds foreign securities that trade on foreign markets that are open. Stocks held by a Vanguard fund are valued at their market value when reliable market quotations are readily available. Certain short-term debt instruments used to manage a fund's cash are valued on the basis of amortized cost. The values of any foreign securities held by a fund are converted into U.S. dollars using an exchange rate obtained from an independent third party. When reliable market quotations are not readily available, securities are priced at their fair value, calculated according to procedures adopted by the board of trustees. A fund also may use fair-value pricing if the value of a security it holds has been materially affected by events occurring before the fund's pricing time but after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign securities, but may occur in other cases as well. When fair-value pricing is employed, the prices of securities used by a fund to calculate its NAV may differ from quoted or published prices for the same securities. Vanguard fund share prices can be found daily in the mutual fund listings of most major newspapers under various "Vanguard" headings. 14 FINANCIAL HIGHLIGHTS The following financial highlights tables are intended to help you understand the Fund's financial performance for the periods shown, and certain information reflects financial results for a single Fund share. The total returns in each table represent the rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). The information for the six-month period ended July 31, 2003, has not been audited by independent accountanct. The information for all other periods in the table through January 31, 2003, has been derived from the annual financial statements audited by PricewaterhouseCoopers LLP, independent accountants, whose report--along with the Fund's annual financial statements--is included in the Fund's most recent annual report to shareholders. To receive a free copy of the latest annual or semiannual report, you may access a report online at www.vanguard.com or you may contact Vanguard by telephone or by mail. -------------------------------------------------------------------------------- PLAIN TALK ABOUT HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE This explanation uses the Fund's Investor Shares as an example. The Investor Shares began the fiscal period ended July 31, 2003 with a net asset value (price) of $11.52 per share. During the period, each Investor Share earned $0.34 from investment income (interest and dividends) and $2.23 from investments that had appreciated in value or that were sold for higher prices than the Fund paid for them. Shareholders received $0.29 per share in the form of dividend distributions. A portion of each year's distributions may come from the prior year's income or capital gains. The share price at the end of the period was $13.80, reflecting earnings of $2.57 per share and distributions of $0.29 per share. This was an increase of $2.28 per share (from $11.52 at the beginning of the period to $13.80 at the end of the period). For a shareholder who reinvested the distributions in the purchase of more shares, the total return was 22.59% for the period. As of July 31, 2003, the Investor Shares had approximately $2.4 billion in net assets. For the period, the annualized expense ratio was 0.27% ($2.70 per $1,000 of net assets), and the annualized net investment income amounted to 5.55% of average net assets. The Fund sold and replaced securities valued at an annualized rate of 4% of its net assets. -------------------------------------------------------------------------------- 15
REIT INDEX FUND INVESTOR SHARES ----------------------------------------------------------------------------------------------------------------------- YEAR ENDED JANUARY 31, ------------------------------------------------------------------ SIX MONTHS ENDED JULY 31, 2003* 2003 2002 2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $11.52 $12.10 $11.61 $ 9.91 $10.81 $13.98 ----------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .34 .606 .631 .642 .660 .666 Net Realized and Unrealized Gain (Loss) 2.23 (.426) .669 1.878 (.780) (3.026) on Investments** ----------------------------------------------------------------------------------------------------------------------- Total from Investment Operations 2.57 .180 1.300 2.520 (.120) (2.360) ----------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.29) (.667) (.631) (.644) (.670) (.666) Distributions from Realized Capital Gains -- -- -- -- -- -- Return of Capital -- (.093) (.179) (.176) (.110) (.144) ----------------------------------------------------------------------------------------------------------------------- Total Distributions (.29) (.760) (.810) (.820) (.780) (.810) ----------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $13.80 $11.52 $12.10 $11.61 $ 9.91 $10.81 ----------------------------------------------------------------------------------------------------------------------- TOTAL RETURN*** 22.59% 1.20% 11.59% 26.13% -1.04% -17.31% ----------------------------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $2,372 $1,734 $1,270 $1,092 $888 $904 Ratio of Total Expenses to Average Net Assets 0.27%+ 0.27% 0.28% 0.33% 0.33% 0.26% Ratio of Net Investment Income to Average Net Assets 5.55%+ 4.90% 5.35% 5.73% 5.98% 5.19% Turnover Rate 4%+ 12% 10% 21%++ 12% 29% -----------------------------------------------------------------------------------------------------------------------
* Unaudited. ** Includes increases from redemption fees of $0.00, $0.01, $0.00, $0.00, $0.01, and $0.02. *** Total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. + Annualized. ++ The turnover rate excluding in-kind redemptions was 14%. 16
REIT INDEX FUND ADMIRAL SHARES ======================================================================================================== YEAR NOV. 12, ENDED 2001* TO SIX MONTH ENDED JAN. 31, JAN. 31, FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD JULY 31, 2003** 2003 2002 -------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $49.14 $51.65 $50.00 -------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income 1.474 2.619 .494 Net Realized and Unrealized Gain (Loss) on Investments*** 9.550 (1.854) 2.401 -------------------------------------------------------------------------------------------------------- Total from Investment Operations 11.024 .765 2.895 -------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (1.254) (2.878) (.970) Distributions from Realized Capital Gains -- -- -- Return of Capital -- (.397) (.275) -------------------------------------------------------------------------------------------------------- Total Distributions (1.254) (3.275) (1.245) -------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $58.91 $49.14 $51.65 -------------------------------------------------------------------------------------------------------- TOTAL RETURN+ 22.72% 1.19% 5.78% -------------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $526 $320 $166 Ratio of Total Expenses to Average Net Assets 0.21%++ 0.21% 0.23%++ Ratio of Net Investment Income to Average Net Assets 5.57%++ 4.99% 5.27%++ Portfolio Turnover Rate 4%++ 12% 10% ========================================================================================================
* Unaudited. ** Inception. *** Includes increases from redemption fees of $0.01, $0.03 and $0.01. + Total returns do not reflect the 1% fee assessed that is assessed on redemptions of shares held for less than one year. ++ Annualized. 17 -------------------------------------------------------------------------------- INVESTING WITH VANGUARD This section of the prospectus explains the basics of doing business with Vanguard. A special booklet, Investing Made Easy, provides information that will help individual investors make the most of their relationship with Vanguard. A separate booklet, The Compass, does the same for institutional investors. You can request either booklet by calling or writing Vanguard, using the Contacting Vanguard instructions at the end of this section. BUYING SHARES CONVERTING SHARES REDEEMING SHARES EXCHANGING SHARES OTHER RULES YOU SHOULD KNOW FUND AND ACCOUNT UPDATES CONTACTING VANGUARD -------------------------------------------------------------------------------- BUYING SHARES ACCOUNT MINIMUMS FOR INVESTOR SHARES TO OPEN AND MAINTAIN AN ACCOUNT: $3,000 for regular accounts; $1,000 for IRAs and most custodial accounts for minors. TO ADD TO AN EXISTING ACCOUNT: $100 by mail, exchange, or Fund Express; $1,000 by wire. Vanguard reserves the right to increase or decrease the minimum amount required to open and maintain an account, or to add to an existing account, without prior notice. ACCOUNT MINIMUMS FOR ADMIRAL SHARES TO OPEN AND MAINTAIN AN ACCOUNT: $250,000 for new investors; $150,000 or $50,000 for existing investors who are eligible to convert Investor Shares into Admiral Shares (see Converting Shares). Institutional clients should contact Vanguard for information on special rules that may apply to them. TO ADD TO AN EXISTING ACCOUNT: $100 by mail, exchange, or Fund Express; $1,000 by wire. HOW TO BUY SHARES ONLINE: You can open certain types of accounts or buy shares in an existing account through our website at www.vanguard.com. BY CHECK: Mail your check and a completed account registration form to Vanguard. When adding to an existing account, send your check with an Invest-By-Mail form detached from your last account statement. Make your check payable to: The Vanguard Group--Fund number. For a list of Fund numbers and addresses, see Contacting Vanguard. BY EXCHANGE PURCHASE: You can purchase shares with the proceeds of a redemption from another Vanguard/(R)/ fund. See Exchanging Shares and Other Rules You Should Know. 18 BY WIRE: Call Vanguard to purchase shares by wire. See Contacting Vanguard. BY FUND EXPRESS/(R)/ (AUTOMATIC OR SPECIAL PURCHASES): You can purchase shares by electronically transferring money from a previously designated bank account. To establish this option, you must complete a special form or the appropriate section of your account registration. YOUR PURCHASE PRICE ONLINE, BY CHECK, BY EXCHANGE, OR BY WIRE: You buy shares at a fund's NAV determined as of your TRADE DATE. For all Vanguard funds (other than money market funds), purchases received at Vanguard before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time) receive a trade date of the same day, and purchases received after that time receive a trade date of the first business day following the date of receipt. For money market funds, the trade date depends on the method of payment for the purchase. BY FUND EXPRESS: For all Vanguard funds, Fund Express instructions received at Vanguard before the close of regular trading on the Exchange will result in a purchase that occurs on and receives a trade date of the next business day (two business days later for money market funds). PURCHASE RULES YOU SHOULD KNOW ^ADMIRAL SHARES. Please note that Admiral Shares are NOT available to: - SIMPLE IRAs and 403(b)(7) custodial accounts; - Other retirement plan accounts receiving special administrative services from Vanguard; or - Accounts maintained by financial intermediaries, except in limited circumstances. ^CHECK PURCHASES. All purchase checks must be written in U.S. dollars and drawn on a U.S. bank. Vanguard does not accept cash, traveler's checks, or money orders. In addition, to protect the funds from check fraud, Vanguard will not accept checks made payable to third parties. ^NEW ACCOUNTS. We are required by law to obtain from you certain personal information that we will use to verify your identity. If you do not provide the information, we may not be able to open your account. If we are unable to verify your identity, Vanguard reserves the right to close your account or take such other steps as we deem reasonable. ^LARGE PURCHASES. Vanguard reserves the right to reject any purchase request that may disrupt a fund's operation or performance. Please call us before attempting to invest a large dollar amount. ^NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT cancel any transaction once it has 19 been initiated and a confirmation number has been assigned (if applicable). ^FUTURE PURCHASES. All Vanguard funds reserve the right to stop selling shares at any time, or to reject specific purchase requests, including purchases by exchange from another Vanguard fund, at any time, for any reason. CONVERTING SHARES ANY CONVERSION BETWEEN CLASSES OF SHARES OF THE SAME FUND IS A NONTAXABLE EVENT. PRICING OF SHARE CLASS CONVERSIONS If you convert from one class of shares to another, the transaction will be based on the respective share prices of the separate classes on the trade date for the conversion. Consequently, a conversion may provide you with fewer shares or more shares than you originally owned, depending on that day's share prices. At the time of conversion, the total value of your "old" shares will equal the total value of your "new" shares. However, subsequent share price fluctuations may decrease or increase the total value of your "new" shares as compared with that of your "old" shares. IMMEDIATE CONVERSIONS INTO ADMIRAL SHARES All shares purchased before the issuance of Admiral Shares are considered Investor Shares. You may convert Investor Shares into Admiral Shares at any time if your account balance in the Fund is at least $250,000. Registered users of Vanguard.com may request a conversion to Admiral Shares online. Or you may contact Vanguard by telephone or mail to request this transaction. TENURE CONVERSIONS INTO ADMIRAL SHARES THREE-YEAR PRIVILEGE. After three years in the Fund, you may convert Investor Shares into Admiral Shares if your account balance in the Fund is at least $150,000 and you are registered with Vanguard.com. TEN-YEAR PRIVILEGE. After ten years in the Fund, you may convert Investor Shares into Admiral Shares if your account balance in the Fund is at least $50,000 and you are registered with Vanguard.com. Registered users of Vanguard.com may request a tenure conversion online. Or you may contact Vanguard by telephone or mail to request this transaction. CONVERSIONS INTO INSTITUTIONAL SHARES You may convert Investor Shares or Admiral Shares into Institutional Shares of the Fund (if applicable), provided that your account balance in the Fund is at least $10 million. The Fund's Institutional Shares are offered through a separate prospectus. Please contact Vanguard's Institutional Division for more information. 20 MANDATORY CONVERSIONS INTO INVESTOR SHARES If an investor no longer meets the requirements for Admiral Shares, the Fund may convert the investor's Admiral Shares into Investor Shares. A decline in the investor's account balance because of market movement may result in such a conversion. The Fund will notify the investor in writing before any mandatory conversion into Investor Shares. REDEEMING SHARES HOW TO REDEEM SHARES Be sure to check Other Rules You Should Know before initiating your request. ONLINE: Request a redemption through our website at www.vanguard.com. BY TELEPHONE: Contact Vanguard by telephone to request a redemption. For telephone numbers, see Contacting Vanguard. BY MAIL: Send your written redemption instructions to Vanguard. For addresses, see Contacting Vanguard. BY FUND EXPRESS: If you've established the Fund Express option on your account, you can redeem shares by electronically transferring your redemption proceeds to a previously designated bank account. The Fund Express option is not automatic; you must establish it by completing a special form or the appropriate section of your account registration. REDEMPTION FEES The Fund charges a 1% redemption fee on shares redeemed within one year of purchase by selling, by exchanging to another fund, or by application of the low-balance account-closure policy. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. We will always redeem your "oldest" shares first. If you transfer your shares to a different account registration (or convert them to a different share class), the shares will retain their redemption fee status. If you transfer (or convert) less than 100% of your account, we will carry over the redemption fee status of your shares on a proportionate basis. From time to time, the Fund may waive or modify redemption fees for certain categories of investors. YOUR REDEMPTION PRICE You redeem shares at a fund's next-determined NAV after Vanguard receives your redemption request, including any special documentation required under the circumstances. As long as your request is received before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time), your shares are redeemed at that day's NAV. This is known as your TRADE DATE. TYPES OF REDEMPTIONS ^CHECK REDEMPTIONS. Unless instructed otherwise, Vanguard will mail you a check, normally within two business days of your trade date. ^EXCHANGE REDEMPTIONS. You may instruct Vanguard to apply the proceeds of your redemption to purchase shares of another Vanguard fund. See Exchanging Shares and Other Rules You Should Know. 21 ^FUND EXPRESS REDEMPTIONS. Proceeds of shares redeemed by Fund Express will be credited to your bank account two business days after your trade date. ^WIRE REDEMPTIONS. When redeeming from a money market fund or a bond fund, you may instruct Vanguard to wire your redemption proceeds ($1,000 minimum) to a previously designated bank account. Wire redemptions are not available for Vanguard's balanced or stock funds. The wire redemption option is not automatic; you must establish it by completing a special form or the appropriate section of your account registration. A $5 fee applies to wire redemptions under $5,000. Money Market Funds: For telephone requests received at Vanguard by 10:45 a.m. (2 p.m. for Vanguard/(R)/ Prime Money Market Fund), Eastern time, the redemption proceeds will leave Vanguard by the close of business that same day. For other requests received before 4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close of business on the following business day. Bond Funds: For requests received at Vanguard by 4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close of business on the following business day. REDEMPTION RULES YOU SHOULD KNOW ^SPECIAL ACCOUNTS. Special documentation may be required to redeem from certain types of accounts, such as trust, corporate, nonprofit, or retirement accounts. Please call us before attempting to redeem from these types of accounts. ^POTENTIALLY DISRUPTIVE REDEMPTIONS. Vanguard reserves the right to pay all or part of your redemption in kind--that is, in the form of securities--if we believe that a cash redemption would disrupt the fund's operation or performance. Under these circumstances, Vanguard also reserves the right to delay payment of your redemption proceeds for up to seven calendar days. By calling us before you attempt to redeem a large dollar amount, you are more likely to avoid in-kind or delayed payment of your redemption. ^RECENTLY PURCHASED SHARES. While you can redeem shares at any time, proceeds will not be made available to you until the Fund collects payment for your purchase. This may take up to ten calendar days for shares purchased by check or Vanguard Fund Express/(R)/. ^SHARE CERTIFICATES. If share certificates have been issued for your account, those shares cannot be redeemed until you return the certificates (unsigned) to Vanguard by registered mail. For the correct address, see Contacting Vanguard. ^PAYMENT TO A DIFFERENT PERSON OR ADDRESS. We can make your redemption check payable to a different person or send it to a different address. However, this requires the written consent of all registered account owners, which must be 22 provided under signature guarantees. You can obtain a signature guarantee from most commercial and savings banks, credit unions, trust companies, or member firms of a U.S. stock exchange. A notary public cannot provide a signature guarantee. ^NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT cancel any transaction once it has been initiated and a confirmation number has been assigned (if applicable). ^EMERGENCY CIRCUMSTANCES. Vanguard funds can postpone payment of redemption proceeds for up to seven calendar days. In addition, Vanguard funds can suspend redemptions and/or postpone payments of redemption proceeds beyond seven calendar days at times when the New York Stock Exchange is closed or during emergency circumstances, as determined by the U.S. Securities and Exchange Commission. EXCHANGING SHARES All open Vanguard funds accept exchange requests online (through your account registered with Vanguard.com), by telephone, or by mail. However, because excessive exchanges can disrupt management of a fund and increase the fund's costs for all shareholders, Vanguard places certain limits on the exchange privilege. If you are exchanging into or out of the U.S. STOCK INDEX FUNDS, INTERNATIONAL STOCK INDEX FUNDS, REIT INDEX FUND, BALANCED INDEX FUND, CALVERT SOCIAL INDEX FUND, INTERNATIONAL GROWTH FUND, INTERNATIONAL VALUE FUND, INTERNATIONAL EXPLORER(TM) FUND, or GROWTH AND INCOME FUND, these limits generally are as follows: - No online or telephone exchanges between 2:30 p.m. and 4 p.m., Eastern time, on business days. Any exchange request placed during these hours will not be accepted. On days when the New York Stock Exchange is scheduled to close early, this end-of-day restriction will be adjusted to begin 11^2 hours prior to the scheduled close. (For example, if the New York Stock Exchange is scheduled to close at 1 p.m., Eastern time, the cutoff for online and telephone exchanges will be 11:30 a.m., Eastern time.) - No more than two exchanges OUT of a fund may be requested online or by telephone within any 12-month period. 23 For ALL OTHER VANGUARD FUNDS, the following limits generally apply: - No more than two substantive "round trips" through a non-money-market fund during any 12-month period. A "round trip" is a redemption OUT of a fund (by any means) followed by a purchase back INTO the same fund (by any means). "Substantive" means a dollar amount that Vanguard determines, in its sole discretion, could adversely affect management of the fund. - Round trips must be at least 30 days apart. Please note that Vanguard reserves the right to revise or terminate the exchange privilege, limit the amount of any exchange, or reject an exchange, at any time, for any reason. Also, in the event of a conflict between the exchange- privilege limitations of two funds, the stricter policy will apply to the transaction. OTHER RULES YOU SHOULD KNOW VANGUARD.COM/(R)/ ^REGISTRATION. You can use your personal computer to review your account holdings, to sell or exchange shares of most Vanguard funds, and to perform other transactions. To establish this service, you can register online. ^SOME VANGUARD FUNDS DO NOT PERMIT ONLINE EXCHANGES BETWEEN 2:30 P.M. AND 4 P.M., EASTERN TIME. To discourage market-timing, the following Vanguard funds generally do not permit online exchanges between 2:30 p.m. and 4 p.m., Eastern time, on business days: the U.S. Stock Index Funds, International Stock Index Funds, REIT Index Fund, Balanced Index Fund, Calvert Social Index Fund, International Growth Fund, International Value Fund, International Explorer Fund, and Growth and Income Fund. Funds may be added to or deleted from this list at any time without prior notice to shareholders. TELEPHONE TRANSACTIONS ^AUTOMATIC. In setting up your account, we'll automatically enable you to do business with us by telephone, unless you instruct us otherwise in writing. ^TELE-ACCOUNT/(R)/. To conduct account transactions through Vanguard's automated telephone service, you must first obtain a Personal Identification Number (PIN). Call Tele-Account to obtain a PIN, and allow seven days before using this service. 24 ^PROOF OF A CALLER'S AUTHORITY. We reserve the right to refuse a telephone request if the caller is unable to provide the following information exactly as registered on the account: - Ten-digit account number. - Complete owner name and address. - Primary Social Security or employer identification number. - Personal Identification Number (PIN), if applicable. ^SUBJECT TO REVISION. We reserve the right to revise or terminate Vanguard's telephone transaction service at any time, without notice. ^SOME VANGUARD FUNDS DO NOT PERMIT TELEPHONE EXCHANGES BETWEEN 2:30 P.M. AND 4 P.M., EASTERN TIME. To discourage market-timing, the following Vanguard funds generally do not permit telephone exchanges between 2:30 p.m. and 4 p.m., Eastern time, on business days: the U.S. Stock Index Funds, International Stock Index Funds, REIT Index Fund, Balanced Index Fund, Calvert Social Index Fund, International Growth Fund, International Value Fund, International Explorer Fund, and Growth and Income Fund. Funds may be added to or deleted from this list at any time without prior notice to shareholders. WRITTEN INSTRUCTIONS ^"GOOD ORDER" REQUIRED. We reserve the right to reject any written transaction instructions that are not in "good order." This means that your instructions must include: - The fund name and account number. - The amount of the transaction (in dollars, shares, or percent). - Authorized signatures, as registered on the account. - Signature guarantees, if required for the type of transaction.* - Any supporting legal documentation that may be required. *For instance, signature guarantees must be provided by all registered account owners when redemption proceeds are to be sent to a different person or address. Call Vanguard for specific signature-guarantee requirements. ACCOUNTS WITH MORE THAN ONE OWNER In the case of an account with more than one owner, Vanguard will accept telephone instructions from any one owner or authorized person. RESPONSIBILITY FOR FRAUD Vanguard will not be responsible for any account losses due to fraud, so long as we reasonably believe that the person transacting business on an account is authorized to do so. Please take precautions to protect yourself from fraud. Keep your account information private and immediately review any account statements that we send to you. Contact 25 Vanguard immediately about any transactions you believe to be unauthorized. UNCASHED CHECKS Please cash your distribution or redemption checks promptly. Vanguard will not pay interest on uncashed checks. UNUSUAL CIRCUMSTANCES If you experience difficulty contacting Vanguard online, by telephone, or by Tele-Account, you can send us your transaction request by regular or express mail. See Contacting Vanguard for addresses. INVESTING WITH VANGUARD THROUGH OTHER FIRMS You may purchase or sell Investor Shares of most Vanguard funds through a financial intermediary, such as a bank, broker, or investment advisor. HOWEVER, ACCESS TO ADMIRAL SHARES THROUGH A FINANCIAL INTERMEDIARY IS RESTRICTED. PLEASE CONSULT YOUR FINANCIAL INTERMEDIARY TO DETERMINE WHETHER ADMIRAL SHARES ARE AVAILABLE THROUGH THAT FIRM. If you invest with Vanguard through an intermediary, please read that firm's program materials carefully to learn of any rules or fees that may apply. LOW-BALANCE ACCOUNTS All Vanguard funds reserve the right to close any investment-only retirement-plan account or any nonretirement account whose balance falls below the minimum initial investment. If a fund has a redemption fee, that fee will apply to shares redeemed upon closure of the account. Vanguard deducts a $10 fee in June from each nonretirement account whose balance at that time is below $2,500 ($500 for Vanguard/(R)/ STAR(TM) Fund). The fee can be waived if your total Vanguard account assets are $50,000 or more. FUND AND ACCOUNT UPDATES CONFIRMATION STATEMENTS We will send you a statement confirming the trade date and amount of your transaction when you buy, sell, exchange, or convert shares. PORTFOLIO SUMMARIES We will send you quarterly portfolio summaries to help you keep track of your accounts throughout the year. Each summary shows the market value of your account at the close of the statement period, as well as all distributions, purchases, sales, and exchanges for the current calendar year. TAX STATEMENTS We will send you annual tax statements to assist in preparing your income tax returns. These statements, which are generally mailed in January, will report the previous year's dividend and capital gains distributions, proceeds from the sale of shares, and distributions from IRAs or other retirement plans. 26 AVERAGE-COST REVIEW STATEMENTS For most taxable accounts, average-cost review statements will accompany the quarterly portfolio summaries. These statements show the average cost of shares that you redeemed during the current calendar year, using the average-cost single-category method, which is one of the methods established by the IRS. ANNUAL AND SEMIANNUAL REPORTS Financial reports about Vanguard REIT Index Fund will be mailed twice a year, in March and September. These comprehensive reports include overviews of the financial markets and specific information concerning the Fund: - Performance assessments with comparisons to industry benchmarks. - Reports from the advisor. - Financial statements with detailed listings of the Fund's holdings. To keep the Fund's costs as low as possible (so that you and other shareholders can keep more of the Fund's investment earnings), Vanguard attempts to eliminate duplicate mailings to the same address. When we find that two or more shareholders have the same last name and address, we send just one copy of the Fund report to that address, instead of mailing separate reports to each shareholder, unless you contact our Client Services Department in writing, by telephone, or by e-mail and instruct us otherwise. Vanguard can deliver your Fund reports electronically, if you prefer. If you are a registered user of Vanguard.com, you can consent to the electronic delivery of Fund reports by logging on and changing your mailing preference under "My Profile." You can revoke your electronic consent at any time, and we will send paper copies of Fund reports within 30 days of receiving your notice. CONTACTING VANGUARD ONLINE VANGUARD.COM - Your best source of Vanguard news n For fund, account, and service information - For most account transactions n For literature requests n 24 hours per day, 7 days per week VANGUARD TELE-ACCOUNT/(R)/ 1-800-662-6273 (ON-BOARD) - For automated fund and account information - For redemptions by check, exchange (subject to certain limitations), or wire n Toll-free, 24 hours per day, 7 days per week 27 INVESTOR INFORMATION 1-800-662-7447 (SHIP) (Text telephone at 1-800-952-3335) - For fund and service information - For literature requests - Business hours only CLIENT SERVICES 1-800-662-2739 (CREW) (Text telephone at 1-800-749-7273) - For account information - For most account transactions - Business hours only ADMIRAL SERVICE CENTER 1-888-237-9949 - For Admiral account information - For most Admiral transactions - Business hours only INSTITUTIONAL DIVISION 1-888-809-8102 - For information and services for large institutional investors - Business hours only VANGUARD ADDRESSES REGULAR MAIL (INDIVIDUALS): The Vanguard Group P.O. Box 1110 Valley Forge, PA 19482-1110 REGULAR MAIL (INSTITUTIONS): The Vanguard Group P.O. Box 2900 Valley Forge, PA 19482-2900 REGISTERED, EXPRESS, OR OVERNIGHT MAIL: The Vanguard Group 455 Devon Park Drive Wayne, PA 19087-1815 FUND NUMBERS Please use the specific fund number when contacting us about Vanguard REIT Index Fund--123 (Investor Shares) or 5123 (Admiral Shares). The Vanguard Group, Vanguard, Vanguard.com, Plain Talk, Admiral, Vanguard Fund Express, Fund Express, Vanguard Tele-Account, Tele-Account, STAR, Explorer, 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 exclusive property of their respective owners. (THIS PAGE INTENTIONALLY LEFT BLANK.) (THIS PAGE INTENTIONALLY LEFT BLANK.) GLOSSARY OF INVESTMENT TERMS ACTIVE MANAGEMENT An investment approach that seeks to exceed the average returns of the financial markets. Active managers rely on research, market forecasts, and their own judgment and experience in selecting securities to buy and sell. CAPITAL GAINS DISTRIBUTION Payment to mutual fund shareholders of gains realized on securities that a fund has sold at a profit, minus any realized losses. CASH INVESTMENTS Cash deposits, short-term bank deposits, and money market instruments that include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase agreements, commercial paper, and banker's acceptances. COST BASIS The adjusted cost of an investment, used to determine a capital gain or loss for tax purposes. DISTRIBUTIONS Payments to shareholders of dividend income, capital gains, and return of capital generated by the fund's investment activities and distribution policies, after expenses. DIVIDEND DISTRIBUTION Payment to mutual fund shareholders of income from interest or dividends generated by a fund's investments. EXPENSE RATIO The percentage of a fund's average net assets used to pay its expenses during a fiscal year. The expense ratio includes management fees, administrative fees, and any 12b-1 distribution fees. INDEX An unmanaged group of securities whose overall performance is used as a standard to measure investment performance. INDUSTRY CONCENTRATION Focusing on the securities of a specific industry (such as energy, precious metals, health care, or real estate). INVESTMENT advisor An organization that makes the day-to-day decisions regarding a fund's investments. LIQUIDITY The degree of a security's marketability (that is, how quickly the security can be sold at a fair price and converted to cash). MUTUAL FUND An investment company that pools the money of many people and invests it in a variety of securities in an effort to achieve a specific objective over time. PASSIVE MANAGEMENT A low-cost investment strategy in which a mutual fund attempts to match--rather than outperform--a particular stock or bond market index; also known as indexing. PRINCIPAL The amount of money you put into an investment. REAL ESTATE INVESTMENT TRUST (REIT) A company that owns and manages real estate. RETURN OF CAPITAL A nontaxable portion of distributions. In general, the cost basis of an investment is reduced when a return of capital is distributed, deferring taxes until the investment is sold. TOTAL RETURN A percentage change, over a specified time period, in a mutual fund's net asset value, assuming the reinvestment of all distributions of dividends and capital gains. VOLATILITY The fluctuations in value of a mutual fund or other security. The greater a fund's volatility, the wider the fluctuations in its returns. YIELD Income (interest or dividends) earned by an investment, expressed as a percentage of the investment's price. [SHIP LOGO] THE VANGUARD GROUP (R) Post Office Box 2600 Valley Forge, PA 19482-2600 FOR MORE INFORMATION If you'd like more information about Vanguard REIT Index Fund, the following documents are available free upon request: ANNUAL/SEMIANNUAL REPORTS TO SHAREHOLDERS Additional information about the Fund's investments is available in the Fund's annual and semiannual reports to shareholders. In the Fund's annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Fund's performance during its last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI provides more detailed information about the Fund. The current annual and semiannual reports and the SAI are incorporated by reference into (and are thus legally a part of) this prospectus. To receive a free copy of the latest annual or semiannual report or the SAI, or to request additional information about the Fund or other Vanguard funds, please contact us as follows: THE VANGUARD GROUP INVESTOR INFORMATION DEPARTMENT P.O. BOX 2600 VALLEY FORGE, PA 19482-2600 TELEPHONE: 1-800-662-7447 (SHIP) TEXT TELEPHONE: 1-800-952-3335 WORLD WIDE WEB: WWW.VANGUARD.COM If you are a current Fund shareholder and would like information about your account, account transactions, and/or account statements, please call: CLIENT SERVICES DEPARTMENT TELEPHONE: 1-800-662-2739 (CREW) TEXT TELEPHONE: 1-800-749-7273 INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC) You can review and copy information about the Fund (including the SAI) at the SEC's Public Reference Room in Washington, DC. To find out more about this public service, call the SEC at 1-202-942-8090. Reports and other information about the Fund are also available on the SEC's Internet site at http://www.sec.gov, or you can receive copies of this information, for a fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the Public Reference Section, Securities and Exchange Commission, Washington, DC 20549-0102. Fund's Investment Company Act file number: 811-3916 (C) 2003 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. P123 112003 VANGUARD(R) REIT INDEX FUND Investor Shares for Participants . November 25, 2003 This prospectus contains financial data for the Fund through the fiscal period ended July 31, 2003. STOCK PROSPECTUS NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [LOGO] THE VANGUARD GROUP(R) VANGUARD REIT INDEX FUND Investor Shares Participant Prospectus November 25, 2003 A Real Estate Stock Mutual Fund -------------------------------------------------------------------------------- CONTENTS 1 FUND PROFILE 3 ADDITIONAL INFORMATION 4 MORE ON THE FUND 9 THE FUND AND VANGUARD 9 INVESTMENT advisor 10 DIVIDENDS, CAPITAL GAINS, AND TAXES 11 SHARE PRICE 11 FINANCIAL HIGHLIGHTS 13 INVESTING WITH VANGUARD 14 ACCESSING FUND INFORMATION BY COMPUTER GLOSSARY (inside back cover) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- WHY READING THIS PROSPECTUS IS IMPORTANT This prospectus explains the investment objective, policies, strategies, and risks associated with the Fund. To highlight terms and concepts important to mutual fund investors, we have provided Plain Talk/(R)/ explanations along the way. Reading the prospectus will help you decide whether the Fund is the right investment for you. We suggest that you keep this prospectus for future reference. This prospectus offers the Fund's Investor Shares and is intended for participants in employer-sponsored retirement or savings plans. Another version--for investors who would like to open a personal investment account--can be obtained by calling Vanguard at 1-800-662-7447. ------------------------------------------------------------------------------- 1 FUND PROFILE INVESTMENT OBJECTIVE The Fund seeks to provide a high level of income and moderate long-term capital growth by tracking the performance of a benchmark index that measures the performance of publicly traded equity REITs. PRIMARY INVESTMENT STRATEGIES The Fund normally invests at least 98% of its assets in stocks issued by real estate investment trusts (known as REITs) in an attempt to parallel the investment performance of the Morgan Stanley REIT Index. The Fund invests in the stocks that make up the Index; the remaining assets are allocated to cash investments. PRIMARY RISKS An investment in the Fund could lose money over short or even long periods. You should expect the Fund's share price and total return to fluctuate within a wide range, like the fluctuations of the overall stock market. The Fund's performance could be hurt by: - Industry concentration risk, which is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Because the Fund concentrates its assets in REIT stocks, real estate industry risk is high. - Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. - Interest rate risk, which is the chance that REIT stock prices overall will decline because of rising interest rates. Interest rate risk should be high for the Fund. - Investment style risk, which is the chance that the returns from REIT stocks--which typically are small- or mid-capitalization stocks--will trail returns from the overall stock market. Historically, these stocks have been more volatile in price than the large-cap stocks that dominate the overall stock market, and they often perform quite differently. PERFORMANCE/RISK INFORMATION The following bar chart and table are intended to help you understand the risks of investing in the Fund. The bar chart shows how the performance of the Fund's Investor Shares (including operating expenses but excluding shareholder fees) has varied from one calendar year to another over the periods shown. The table shows how the average annual total returns (including operating expenses and any applicable shareholder fees) compare with those of the Fund's target index and other comparative indexes. Keep in mind that the Fund's past performance does not indicate how it will perform in the future. 2 ---------------------------------------------------- ANNUAL TOTAL RETURNS--INVESTOR SHARES [BAR CHART] 1997 18.77 1998 -16.32 1999 -4.04 2000 26.35 2001 12.35 2002 3.75 ---------------------------------------------------- The year-to-date return as of the most recent calendar quarter, which ended September 30, 2003, was 24.14%. If applicable shareholder fees were reflected, returns would be less than those shown. ---------------------------------------------------- During the periods shown in the bar chart, the highest return for a calendar quarter was 12.27% (quarter ended June 30, 2003), and the lowest return for a quarter was -10.41% (quarter ended September 30, 1998). -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2002 -------------------------------------------------------------------------------- SINCE 1 YEAR 5 YEARS INCEPTION* -------------------------------------------------------------------------------- Vanguard REIT Index Fund Investor Shares 3.75% 3.41% 9.52% Wilshire 5000 Target Index -20.86 -0.87 5.08 Morgan Stanley REIT Index 3.64 3.30 9.46 Target REIT Composite** 3.61 3.31 9.41 -------------------------------------------------------------------------------- *Since-inception returns are from May 13, 1996--the inception date of the Investor Shares--through December 31, 2002. **The Target REIT Composite consists of the Morgan Stanley REIT Index adjusted to include a 2% cash position (Lipper Money Market Average). ------------------------------------------------------------------------------- FEES AND EXPENSES The following table describes the fees and expenses you may pay if you buy and hold Investor Shares of the Fund. The expenses shown under Annual Fund Operating Expenses are based estimated amounts for the current fiscal year. SHAREHOLDER FEES (fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases: None Purchase Fee: None Sales Charge (Load) Imposed on Reinvested Dividends: None Redemption Fee: 1%* ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets) Management Expenses: 0.25% 12b-1 Distribution Fee: None Other Expenses: 0.02% TOTAL ANNUAL FUND OPERATING EXPENSES: 0.27% *The 1% fee applies to shares redeemed within one year of purchase by selling or by exchanging to another fund. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. The following example is intended to help you compare the cost of investing in the Fund's Investor Shares with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. This example assumes that the Fund provides a return of 5% a year and that operating expenses match our estimates. The results apply whether or not you redeem your investment at the end of the given period. -------------------------------------------------- 1 YEAR 3 YEARS 5 YEARS 10 YEARS -------------------------------------------------- $28 $87 $152 $343 -------------------------------------------------- 3 THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN. -------------------------------------------------------------------------------- PLAIN TALK ABOUT FUND EXPENSES All mutual funds have operating expenses. These expenses, which are deducted from a fund's gross income, are expressed as a percentage of the net assets of the fund. We expect Vanguard REIT Index Fund Investor Shares' expense ratio in fiscal year 2003 was 0.27%, or $2.70 per $1,000 of average net assets. The average real estate mutual fund had expenses in 2002 of 1.64%, or $16.40 per $1,000 of average net assets (derived from data provided by Lipper Inc., which reports on the mutual fund industry). Management expenses, which are one part of operating expenses, include investment advisory fees as well as other costs of managing a fund--such as account maintenance, reporting, accounting, legal, and other administrative expenses. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PLAIN TALK ABOUT COSTS OF INVESTING Costs are an important consideration in choosing a mutual fund. That's because you, as a shareholder, pay the costs of operating a fund, plus any transaction costs incurred when the fund buys or sells securities. These costs can erode a substantial portion of the gross income or capital appreciation a fund achieves. Even seemingly small differences in expenses can, over time, have a dramatic effect on a fund's performance. -------------------------------------------------------------------------------- 4 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION DIVIDENDS AND CAPITAL GAINS NEWSPAPER ABBREVIATION Dividends are distributed quarterly in March, REIT June, September, and December. These distributions may include income, capital gains, VANGUARD FUND NUMBER and a return of capital. Additional capital 123 gains may be distributed annually in December. CUSIP NUMBER INVESTMENT advisor 921908703 The Vanguard Group, Valley Forge, Pa., annually in December. TICKER SYMBOL VGSIX INCEPTION DATE Investor Shares--May 13, 1996 Admiral Shares--November 12, 2001 NET ASSETS (ALL SHARE CLASSES) AS OF JULY 31, 2003 $2.9 billion -------------------------------------------------------------------------------- MORE ON THE FUND This prospectus describes the primary risks you would face as a Fund shareholder. It is important to keep in mind one of the main axioms of investing: The higher the risk of losing money, the higher the potential reward. The reverse, also, is generally true: The lower the risk, the lower the potential reward. As you consider an investment in any mutual fund, you should take into account your personal tolerance for daily fluctuations in the securities markets. Look for this [FLAG] symbol throughout the prospectus. It is used to mark detailed information about the more significant risks that you would confront as a Fund shareholder. The following sections explain the primary investment strategies and policies that the Fund uses in pursuit of its objective. The Fund's board of trustees, which oversees the Fund's management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. MARKET EXPOSURE The Fund normally invests at least 98% of its assets in stocks of real estate investment trusts (REITs) and holds any remaining assets in cash investments to meet shareholder redemptions. This policy may only be changed upon 60 days' notice to shareholders. 5 -------------------------------------------------------------------------------- PLAIN TALK ABOUT REITS Rather than owning properties directly--which can be costly and difficult to convert into cash when needed--some investors buy shares in a company that owns and manages real estate. Such a company is known as a real estate investment trust, or REIT. Unlike corporations, REITs do not have to pay income taxes if they meet certain Internal Revenue Code requirements. To qualify, a REIT must distribute at least 90% of its taxable income to its shareholders and receive at least 75% of that income from rents, mortgages, and sales of property. REITs offer investors greater liquidity and diversification than direct ownership of a handful of properties, as well as greater income potential than an investment in common stocks. As with any investment in real estate, however, a REIT's performance depends on several factors, such as its ability to find tenants for its properties, to renew leases, and to finance property purchases and renovations. That said, returns from REITs may not correspond to returns from direct property ownership. -------------------------------------------------------------------------------- [FLAG] THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE CHANCE THAT RETURNS FROM REIT STOCKS--WHICH TYPICALLY ARE SMALL- OR MID-CAP STOCKS--WILL TRAIL RETURNS FROM THE OVERALL MARKET. HISTORICALLY, THESE STOCKS HAVE BEEN MORE VOLATILE IN PRICE THAN THE LARGE-CAP STOCKS THAT DOMINATE THE OVERALL STOCK MARKET, AND THEY OFTEN PERFORM QUITE DIFFERENTLY. Stocks of publicly traded companies and funds that invest in stocks are often classified according to market value, or market capitalization. These classifications typically include small-cap, mid-cap, or large-cap. It's important to understand that, for both companies and stock funds, market capitalization ranges change over time. Also, interpretations of size vary, and there are no "official" definitions of small-, mid-, and large-cap, even among Vanguard fund advisors. REIT stocks in the Morgan Stanley REIT Index tend to be small or medium-size companies. The median market capitalization of the Fund as of July 31, 2003, was $2.3 billion. Small- and mid-cap stocks tend to have greater volatility than large-cap stocks because, among other things, smaller companies often have fewer customers, financial resources, and products than larger firms. Such characteristics can make small and medium-size companies more sensitive to changing economic conditions. REIT stocks tend to have a significant amount of dividend income to soften the impact of this volatility. However, the index and, thus, the Fund, are subject to additional risk because of the concentration in the real estate sector. This single-sector focus may result in more risk than would a more diversified, multi-sector portfolio. -------------------------------------------------------------------------------- PLAIN TALK ABOUT TYPES OF REITS An equity REIT owns properties directly. Equity REITs generate income (from rental and lease payments) and offer the potential for growth (from property appreciation) as well as occasional capital gains from the sale of property. A mortgage REIT makes loans to commercial real estate developers. Mortgage REITs earn interest income and are subject to credit risk (that is, the chance that a developer will fail to repay a loan). A hybrid REIT holds both properties and mortgages. The Fund invests in equity REITs only. -------------------------------------------------------------------------------- [FLAG] THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT STOCK PRICES OVERALL WILL DECLINE. STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF FALLING PRICES. To illustrate the volatility of stock prices, the following table shows the best, worst, and average total returns for the U.S. stock market over various periods as measured by the Standard & Poor's 500 Index, a widely used barometer of market activity. (Total returns consist of dividend income plus change in market price.) Note that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. ---------------------------------------------------------- U.S. STOCK MARKET RETURNS (1926-2002) ---------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS 20 YEARS ---------------------------------------------------------- Best 54.2% 28.6% 19.9% 17.8% Worst -43.1 -12.4 -0.8 3.1 Average 12.2 10.9 11.2 11.4 ---------------------------------------------------------- The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926 through 2002. You can see, for example, that while the average return on common stocks for all of the 5-year periods was 10.9%, average returns for individual 5-year periods ranged from -12.4% (from 1928 through 1932) to 28.6% (from 1995 through 1999). These average returns reflect past [FLAG] THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE CHANCE THAT REIT STOCK PRICES OVERALL WILL DECLINE BECAUSE OF RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE HIGH FOR THE FUND. 6 In general, during periods of high interest rates, REITs may lose some of their appeal for investors who may be able to obtain higher yields from other income-producing investments, such as long-term bonds. Higher interest rates also mean that financing for property purchases and improvements is more costly and difficult to obtain. [FLAG] THE FUND IS SUBJECT TO REAL ESTATE INDUSTRY RISK, WHICH IS THE CHANCE THAT THE STOCKS OF REITS WILL DECLINE BECAUSE OF ADVERSE DEVELOPMENTS AFFECTING THE REAL ESTATE INDUSTRY AND REAL PROPERTY VALUES. BECAUSE THE FUND CONCENTRATES ITS ASSETS IN REIT STOCKS, REAL ESTATE INDUSTRY RISK IS HIGH. Because of its emphasis on REIT stocks, the Fund's performance may at times be linked to the ups and downs of the real estate market. In general, real estate values can be affected by a variety of factors, including supply and demand for properties; the economic health of the country as well as different regions; and the strength of specific industries that rent properties. Ultimately, an individual REIT's performance depends on the types and locations of the properties it owns and on how well the REIT manages its properties. For instance, rental income could decline because of extended vacancies, increased competition from nearby properties, tenants' failure to pay rent, or incompetent management. Property values could decrease because of overbuilding in the area, environmental liabilities, uninsured damages caused by natural disasters, a general decline in the neighborhood, losses due to casualty or condemnation, increases in property taxes, or changes in zoning laws. Loss of IRS status as a qualified REIT may also affect an individual REIT's performance. The target index tracked by the Fund is broadly diversified. Similarly, the Fund is broadly diversified, holding stocks of more than 100 companies. It is possible that the Fund's target index, in the future, could become less diversified if the index's largest companies significantly increase in value relative to the index's other components. In an extreme situation, the Fund might no longer meet the legal definition of "diversified." For this reason, the Fund is classified as "nondiversified." However, the Fund, from its inception until the date of this prospectus, in actuality has been diversified, and Vanguard expects the Fund to continue to be diversified SECURITY SELECTION The Fund employs an indexing, or passively managed, investment approach. The Fund's advisor, The Vanguard Group (Vanguard), normally invests at least 98% of the Fund's assets in REIT securities in an attempt to parallel the performance of the target benchmark, the Morgan Stanley REIT Index. The Fund holds each stock contained in the Morgan Stanley REIT Index in roughly the same proportions as in the Index itself. For example, if 5% of the Morgan Stanley REIT Index were made up of the stock of a specific REIT, the Fund would invest the same percentage of its noncash assets in that stock. The Morgan Stanley REIT Index is made up of the stocks of publicly traded equity REITs that meet certain criteria. For example, to be included initially in the Index, a REIT must have a total market capitalization of at least $100 million and have enough shares and trading volume to be considered liquid. In line with the Index, the Fund invests in equity REITs only. As of July 31, 2003, 112 equity REITs were included in the Index. The Index is rebalanced every calendar quarter, as well as each time that a REIT is removed from the Index. A REIT may be removed from the Index because the REIT's market capitalization falls below $75 million; because the REIT becomes illiquid; because of other changes in the REIT's status; or because of corporate activity such as a merger, an acquisition, a leveraged buyout, bankruptcy, IRS removal of REIT status, or a fundamental change in business. 7 Stocks in the Morgan Stanley REIT Index represent a broadly diversified range of property types. The Index's makeup, as of July 31, 2003, was as follows: --------------------------------------------- PROPERTY TYPES PERCENTAGE OF INDEX --------------------------------------------- Retail 26% Residential Apartments 19 Office 19 Industrial 13 Diversified 12 Health Care 5 Hotels 4 Cash 2 --------------------------------------------- The Fund is generally managed without regard to tax ramifications. OTHER INVESTMENT POLICIES AND RISKS Besides investing in common stocks of REITs, the Fund may make certain other kinds of investments to achieve its objective. [FLAG] THE FUND MAY INVEST, TO A LIMITED EXTENT, IN DERIVATIVES. DERIVATIVES MAY INVOLVE RISKS DIFFERENT FROM, AND POSSIBLY GREATER THAN, THOSE OF TRADITIONAL INVESTMENTS. The Fund may also invest, to a limited extent, in futures and options contracts, which are types of derivatives. The Fund will invest in futures only for purposes of matching the performance of its target index, and not for speculative purposes or as leveraged investments that magnify losses or gains. Losses (or gains) involving futures can sometimes be substantial--in part because a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for a fund. The Fund's obligation under futures contracts will not exceed 20% of its total assets. To the extent that the Fund invests in futures contracts, it will not have 98% of its assets invested in REIT stocks. The reasons for which the Fund may invest in futures include: - To keep cash on hand to meet shareholder redemptions or other needs while simulating full investment in stocks. - To reduce the Fund's transaction costs or add value when these instruments are favorably priced. -------------------------------------------------------------------------------- PLAIN TALK ABOUT DERIVATIVES A derivative is a financial contract whose value is based on (or "derived" from) a traditional security (such as a stock or a bond), an asset (such as a commodity like gold), or a market index (such as the S&P 500 Index). Some forms of derivatives, such as exchange-traded futures and options on securities, commodities, or indexes, have been trading on regulated exchanges for decades. These types of derivatives are standardized contracts that can easily be bought and sold, and whose market values are determined and published daily. Nonstandardized derivatives (such as swap agreements), on the other hand, tend to be more specialized or complex, and may be harder to value. Derivatives can carry considerable risks, particularly if used for speculation or as leveraged investments. -------------------------------------------------------------------------------- 8 REDEMPTION FEE The Fund charges a fee on shares that are redeemed before they have been held for one year. This fee also applies when shares are redeemed by exchange to another Vanguard fund. Unlike a sales charge or load paid to a broker or fund management company, the redemption fee is paid directly to the Fund to offset the costs of buying and selling securities. The fee ensures that short-term investors pay their share of the Fund's transaction costs and that long-term investors do not subsidize the activities of short-term traders. From time to time, the Fund may waive or modify redemption fees for certain categories of investors. COSTS AND MARKET-TIMING Some investors try to profit from a strategy called market-timing--switching money into mutual funds when they expect prices to rise and taking money out when they expect prices to fall. As money is shifted in and out, a fund incurs expenses for buying and selling securities. These costs are borne by all fund shareholders, including the long-term investors who do not generate the costs. This is why all Vanguard funds have adopted special policies to discourage short-term trading or to compensate the funds for the costs associated with it. Specifically: - Each Vanguard fund reserves the right to reject any purchase request--including exchanges from other Vanguard funds--that it regards as disruptive to efficient portfolio management. A purchase request could be rejected because of the timing of the investment or because of a history of excessive trading by the investor. - Each Vanguard fund (other than the money market funds) limits the number of times that an investor can exchange into and out of the fund. - Certain Vanguard funds charge purchase and/or redemption fees on transactions. See the INVESTING WITH VANGUARD section of this prospectus for further details on Vanguard's transaction policies. THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST WITH VANGUARD IF YOU ARE A MARKET-TIMER. TURNOVER RATE Although the Fund normally seeks to invest for the long term, it may sell securities regardless of how long they have been held. The FINANCIAL HIGHLIGHTS section of this prospectus shows historical turnover rates for the Fund. A turnover rate of 100%, for example, would mean that the Fund had sold and replaced securities valued at 100% of its net assets within a one-year period. -------------------------------------------------------------------------------- PLAIN TALK ABOUT TURNOVER RATE Before investing in a mutual fund, you should review its turnover rate. This gives an indication of how transaction costs could affect the fund's future returns. In general, the greater the volume of buying and selling by the fund, the greater the impact that brokerage commissions and other transaction costs will have on its return. Also, funds with high turnover rates may be more likely to generate capital gains that must be distributed to shareholders as taxable income. As of July 31, 2003, the average turnover rate for all real estate funds was approximately 68%, according to Morningstar, Inc. -------------------------------------------------------------------------------- 9 THE FUND AND VANGUARD The Fund is a member of The Vanguard Group, a family of 35 investment companies with more than 100 funds holding assets in excess of $640 billion. All of the funds that are members of The Vanguard Group share in the expenses associated with administrative services and business operations, such as personnel, office space, equipment, and advertising. Vanguard also provides marketing services to the funds. Although shareholders do not pay sales commissions or 12b-1 distribution fees, each fund pays its allocated share of The Vanguard Group's marketing costs. -------------------------------------------------------------------------------- PLAIN TALK ABOUT VANGUARD'S UNIQUE CORPORATE STRUCTURE The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by the funds it oversees and thus indirectly by the shareholders in those funds. Most other mutual funds are operated by for-profit management companies that may be owned by one person, by a group of individuals, or by investors who own the management company's stock. By contrast, Vanguard provides its services on an "at-cost" basis, and the funds' expense ratios reflect only these costs. -------------------------------------------------------------------------------- INVESTMENT ADVISOR The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482, which began operations in 1975, serves as advisor to the Fund through its Quantitative Equity Group. As of July 31, 2003, Vanguard served as advisor for about $450 billion in assets. Vanguard manages the Fund on an at-cost basis, subject to the supervision and oversight of the trustees and officers of the Fund. For the fiscal year ended July 31, 2003, the advisory expenses represented an effective annual rate of 0.01% of the Fund's average net assets. The advisor is authorized to choose broker-dealers to handle the purchase and sale of the Fund's securities and to seek to obtain the best available price and most favorable execution for all transactions. Also, the board of trustees may direct the advisor to use a particular broker for certain transactions in exchange for commission rebates paid to the Fund as well as brokerage or research services provided to the advisor. -------------------------------------------------------------------------------- PLAIN TALK ABOUT THE FUND'S ADVISOR The manager primarily responsible for overseeing the Fund's investments is: GEORGE U. SAUTER, Managing Director and chief Investment Officer of Vanguard and head of Vanguard's Quantitative Equity Group. He has worked in investment management since 1985 and has had primary responsibility for Vanguard's stock indexing and active quantitative investments and strategy since joining the company in 1987. Education: A.B., Dartmouth College; M.B.A., University of Chicago. -------------------------------------------------------------------------------- 10 DIVIDENDS, CAPITAL GAINS, AND TAXES Each March, June, September, and December, Vanguard REIT Index Fund pays out to shareholders virtually all of the distributions it receives from its REIT investments, less expenses. Distributions may include income, return of capital, and capital gains. The Fund may also realize capital gains on the sale of its REIT investments. Distributions of these gains, if any, are included in the December distribution. In addition, the Fund may occasionally be required to make supplemental distributions at some other time during the year. Your distributions will be reinvested in additional Fund shares and accumulate on a tax-deferred basis if you are investing through an employer-sponsored retirement or savings plan. You will not owe taxes on these distributions until you begin withdrawals from the plan. You should consult your plan administrator, your plan's Summary Plan Description, or your tax advisor about the tax consequences of plan withdrawals. -------------------------------------------------------------------------------- PLAIN TALK ABOUT DISTRIBUTIONS As a shareholder, you are entitled to your portion of a fund's income from interest and dividends as well as gains from the sale of investments. Income consists of both the dividends that the fund earns from any stock holdings and the interest it receives from any money market and bond investments. Capital gains are realized whenever the fund sells securities for higher prices than it paid for them. These capital gains are either short-term or long-term, depending on whether the fund held the securities for one year or less or for more than one year. You receive the fund's earnings as either a dividend or capital gains distribution. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PLAIN TALK ABOUT RETURN OF CAPITAL The Internal Revenue Code requires a REIT to distribute at least 90% of its taxable income to investors. In many cases, however, because of "noncash" expenses such as property depreciation, an equity REIT's cash flow will exceed its taxable income. The REIT may distribute this excess cash to offer a more competitive yield (in other words, provide investors with a higher distribution). This portion of the distribution is classified as a return of capital. -------------------------------------------------------------------------------- 11 SHARE PRICE The Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time. NAV per share is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. On holidays or other days when the Exchange is closed, the NAV is not calculated, and the Fund does not transact purchase or redemption requests. However, on those days the value of the Fund's assets may be affected to the extent that the Fund holds foreign securities that trade on foreign markets that are open. Stocks held by a Vanguard fund are valued at their market value when reliable market quotations are readily available. Certain short-term debt instruments used to manage a fund's cash are valued on the basis of amortized cost. The values of any foreign securities held by a fund are converted into U.S. dollars using an exchange rate obtained from an independent third party. When reliable market quotations are not readily available, securities are priced at their fair value, calculated according to procedures adopted by the board of trustees. A fund also may use fair-value pricing if the value of a security it holds has been materially affected by events occurring before the fund's pricing time but after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign securities, but may occur in other cases as well. When fair-value pricing is employed, the prices of securities used by a fund to calculate its NAV may differ from quoted or published prices for the same securities. Vanguard fund share prices can be found daily in the mutual fund listings of most major newspapers under various "Vanguard" headings. FINANCIAL HIGHLIGHTS The following financial highlights table is intended to help you understand the Investor Shares' financial performance for the periods shown, and certain information reflects financial results for a single Investor Share. The total returns in the table represent the rate that an investor would have earned or lost each period on an investment in the Investor Shares (assuming reinvestment of all distributions). The information for the six-month period ended July 31, 2003, has not been audited by independent accountants. The information for all other periods in the table through January 31, 2003, has been derived from the annual financial statements audited by PricewaterhouseCoopers LLP, independent accountants, whose report--along with the Fund's annual financial statements--is included in the Fund's most recent annual report to shareholders. To receive a free copy of the latest annual or semiannual report, you may access a report online at www.vanguard.com or you may contact Vanguard by telephone or by mail. 12 -------------------------------------------------------------------------------- PLAIN TALK ABOUT HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE The Investor Shares began the fiscal period edned July 31, 2003, with a net asset value (price) of $11.52 per share. During the period, each Investor Share earned $0.34 from investment income (interest and dividends)and 42.23 from investments that had appreciated in value or that were sold for higher prices than the Fund paid for them. Shareholders received $0.29 per share in the form of dividend distributions. A portion of each year's distributions may come from the prior year's income or capital gains. The share price at the end of the period was $13.80, reflecting earnings of $2.57 per share and distributions of $0.29 per share. This was an increase of $2.28 per share (from $11.52 at the beginning of the period to $13.80 at the end of the period). For a shareholder who reinvested the distributions in the purchase of more shares, the total return was 22.59% for the period. As of July 31, 2003, the Investor Shares had approximately $2.4 billion in net assets. For the period, the annualized expense ratio was 0.27% ($2.70 per $1,000 of net assets), and the annualized net investment income amounted to 5.55% of average net assets. The Fund sold and replaced securities valued at an annualized rate of 4% of its net assets. --------------------------------------------------------------------------------
REIT INDEX FUND INVESTOR SHARES ----------------------------------------------------------------------------------------------------------------------- YEAR ENDED JANUARY 31, ------------------------------------------------------------------ SIX MONTHS ENDED JULY 31, 2003* 2003 2002 2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $11.52 $12.10 $11.61 $ 9.91 $10.81 $13.98 ----------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .34 .606 .631 .642 .660 .666 Net Realized and Unrealized Gain (Loss) 2.23 (.426) .669 1.878 (.780) (3.026) on Investments** ----------------------------------------------------------------------------------------------------------------------- Total from Investment Operations 2.57 .180 1.300 2.520 (.120) (2.360) ----------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.29) (.667) (.631) (.644) (.670) (.666) Distributions from Realized Capital Gains -- -- -- -- -- -- Return of Capital -- (.093) (.179) (.176) (.110) (.144) ----------------------------------------------------------------------------------------------------------------------- Total Distributions (.29) (.760) (.810) (.820) (.780) (.810) ----------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $13.80 $11.52 $12.10 $11.61 $ 9.91 $10.81 ----------------------------------------------------------------------------------------------------------------------- TOTAL RETURN*** 22.59% 1.20% 11.59% 26.13% -1.04% -17.31% ----------------------------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $2,372 $1,734 $1,270 $1,092 $888 $904 Ratio of Total Expenses to Average Net Assets 0.27%+ 0.27% 0.28% 0.33% 0.33% 0.26% Ratio of Net Investment Income to Average Net Assets 5.55%+ 4.90% 5.35% 5.73% 5.98% 5.19% Turnover Rate 4%+ 12% 10% 21%++ 12% 29% -----------------------------------------------------------------------------------------------------------------------
* Unaudited. ** Includes increases from redemption fees of $0.00, $0.01, $0.00, $0.00, $0.01, and $0.02. *** Total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. + Annualized. ++ The turnover rate excluding in-kind redemptions was 14%. 13 INVESTING WITH VANGUARD The Fund is an investment option in your retirement or savings plan. Your plan administrator or your employee benefits office can provide you with detailed information on how to participate in your plan and how to elect the Fund as an investment option. - If you have any questions about the Fund or Vanguard, including those about the Fund's investment objective, strategies, or risks, contact Vanguard's Participant Access Center, toll-free, at 1-800-523-1188. - If you have questions about your account, contact your plan administrator or the organization that provides recordkeeping services for your plan. INVESTMENT OPTIONS AND ALLOCATIONS Your plan's specific provisions may allow you to change your investment selections, the amount of your contributions, or how your contributions are allocated among the investment choices available to you. Contact your plan administrator or employee benefits office for more details. TRANSACTIONS Contributions, exchanges, or redemptions of the Fund's shares are processed as soon as they have been received by Vanguard in good order. Good order means that your request includes complete information on your contribution, exchange, or redemption, and that Vanguard has received the appropriate assets. In all cases, your transaction will be based on the Fund's next-determined net asset value (NAV) after Vanguard receives your request (or, in the case of new contributions, the next-determined NAV after Vanguard receives the order from your plan administrator). As long as this request is received before the close of trading on the New York Stock Exchange, generally 4 p.m., Eastern time, you will receive that day's NAV. This is known as your TRADE DATE. EXCHANGES The exchange privilege (your ability to redeem shares from one fund to purchase shares of another fund) may be available to you through your plan. Although we make every effort to maintain the exchange privilege, Vanguard reserves the right to revise or terminate this privilege, limit the amount of an exchange, or reject any exchange, at any time, without notice. Because excessive exchanges can potentially disrupt the management of the Vanguard/(R)/ funds and increase their transaction costs, Vanguard places certain limits on the exchange privilege. If you are exchanging out of the International Growth Fund, International Value Fund, International Explorer(tm) Fund, European Stock Index Fund, Pacific Stock Index Fund, Emerging Markets Stock Index Fund, Total International Stock Index Fund, Developed Markets Index Fund, or Institutional Developed Markets Index Fund, regardless of the dollar amount, the following policies generally apply: - You must wait 90 days before exchanging back into the fund from any source. - The 90-day clock restarts after every exchange our of the fund. - Exchanges out of the fund will not prevent you from making your usual periodic contributions to the fund through your employer plan. 14 For ALL OTHER VANGUARD FUNDS, the following policies generally apply: - Participant exchange activity is limited to no more than FOUR SUBSTANTIVE "ROUND TRIPS" THROUGH NON-MONEY-MARKET FUNDS (at least 90 days apart) during any 12-month period. - A "round trip" is a redemption from a fund followed by a purchase back into the fund. - "Substantive" means a dollar amount that Vanguard determines, in its sole discretion, could adversely affect the management of a fund. Please note that Vanguard reserves the right to revise the exchange privilege, limit the amount of any exchange, or reject an exchange, at any time, for any reason. Also, in the event of a conflict between the exchange-privilege limitations of two funds, the stricter policy will apply to the transaction. Before making an exchange to or from another fund available in your plan, consider the following: - Certain investment options, particularly funds made up of company stock or investment contracts, may be subject to unique restrictions. - Be sure to read that fund's prospectus. Contact Vanguard's Participant Access Center, toll-free, at 1-800-523-1188 for a copy. - Vanguard can accept exchanges only as permitted by your plan. Contact your plan administrator for details on the exchange policies that apply to your plan. ACCESSING FUND INFORMATION BY COMPUTER VANGUARD ON THE WORLD WIDE WEB WWW.VANGUARD.COM Use your personal computer to visit Vanguard's education-oriented website, which provides timely news and information about Vanguard funds and services; the online Education Center that offers a variety of mutual fund classes; and easy-to-use, interactive tools to help you create your own investment and retirement strategies. The Vanguard Group, Vanguard, Plain Talk, Explorer, and the ship logo are trademarks of The Vanguard Group, Inc. All other marks are the exclusive property of their respective owners. (THIS PAGE INTENTIONALLY LEFT BLANK.) GLOSSARY OF INVESTMENT TERMS ACTIVE MANAGEMENT An investment approach that seeks to exceed the average returns of the financial markets. Active managers rely on research, market forecasts, and their own judgment and experience in selecting securities to buy and sell. CAPITAL GAINS DISTRIBUTION Payment to mutual fund shareholders of gains realized on securities that a fund has sold at a profit, minus any realized losses. CASH INVESTMENTS Cash deposits, short-term bank deposits, and money market instruments that include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase agreements, commercial paper, and banker's acceptances. COST BASIS The adjusted cost of an investment, used to determine a capital gain or loss for tax purposes. DISTRIBUTIONS Payments to shareholders of dividend income, capital gains, and return of capital generated by the fund's investment activities and distribution policies, after expenses. DIVIDEND DISTRIBUTION Payment to mutual fund shareholders of income from interest or dividends generated by a fund's investments. EXPENSE RATIO The percentage of a fund's average net assets used to pay its expenses during a fiscal year. The expense ratio includes management fees, administrative fees, and any 12b-1 distribution fees. INDEX An unmanaged group of securities whose overall performance is used as a standard to measure investment performance. INDUSTRY CONCENTRATION Focusing on the securities of a specific industry (such as energy, precious metals, health care, or real estate). INVESTMENT advisor An organization that makes the day-to-day decisions regarding a fund's investments. LIQUIDITY The degree of a security's marketability (that is, how quickly the security can be sold at a fair price and converted to cash). MUTUAL FUND An investment company that pools the money of many people and invests it in a variety of securities in an effort to achieve a specific objective over time. PASSIVE MANAGEMENT A low-cost investment strategy in which a mutual fund attempts to match--rather than outperform--a particular stock or bond market index; also known as indexing. PRINCIPAL The amount of money you put into an investment. REAL ESTATE INVESTMENT TRUST (REIT) A company that owns and manages real estate. RETURN OF CAPITAL A nontaxable portion of distributions. In general, the cost basis of an investment is reduced when a return of capital is distributed, deferring taxes until the investment is sold. TOTAL RETURN A percentage change, over a specified time period, in a mutual fund's net asset value, assuming the reinvestment of all distributions of dividends and capital gains. VOLATILITY The fluctuations in value of a mutual fund or other security. The greater a fund's volatility, the wider the fluctuations in its returns. YIELD Income (interest or dividends) earned by an investment, expressed as a percentage of the investment's price. [SHIP LOGO] THE VANGUARD GROUP(R) Institutional Division Post Office Box 2900 Valley Forge, PA 19482-2900 FOR MORE INFORMATION If you'd like more information about Vanguard REIT Index Fund, the following documents are available free upon request: ANNUAL/SEMIANNUAL REPORTS TO SHAREHOLDERS Additional information about the Fund's investments is available in the Fund's annual and semiannual reports to shareholders. In the Fund's annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Fund's performance during its last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI provides more detailed information about the Fund. The current annual and semiannual reports and the SAI are incorporated by reference into (and are thus legally a part of) this prospectus. To receive a free copy of the latest annual or semiannual report or the SAI, or to request additional information about the Fund or other Vanguard funds, please contact us as follows: THE VANGUARD GROUP PARTICIPANT ACCESS CENTER P.O. BOX 2900 VALLEY FORGE, PA 19482-2900 TELEPHONE: 1-800-523-1188 TEXT TELEPHONE: 1-800-523-8004 WORLD WIDE WEB: WWW.VANGUARD.COM INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC) You can review and copy information about the Fund (including the SAI) at the SEC's Public Reference Room in Washington, DC. To find out more about this public service, call the SEC at 1-202-942-8090. Reports and other information about the Fund are also available on the SEC's Internet site at http://www.sec.gov, or you can receive copies of this information, for a fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the Public Reference Section, Securities and Exchange Commission, Washington, DC 20549-0102. Fund's Investment Company Act file number: 811-3916 (C) 2003 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. I123 112003 VANGUARD(R) REIT INDEX FUND Admiral(TM) Shares for Participants .November 25, 2003 This prospectus contains financial data for the Fund through the fiscal period ended November 25, 2003. STOCK PROSPECTUS NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [LOGO] THE VANGUARD GROUP(R) VANGUARD REIT INDEX FUND Admiral Shares Participant Prospectus November 25, 2003 A Real Estate Stock Mutual Fund -------------------------------------------------------------------------------- CONTENTS 1 FUND PROFILE 3 ADDITIONAL INFORMATION 4 MORE ON THE FUND 9 THE FUND AND VANGUARD 9 INVESTMENT advisor 10 DIVIDENDS, CAPITAL GAINS, AND TAXES 11 SHARE PRICE 11 FINANCIAL HIGHLIGHTS 13 INVESTING WITH VANGUARD 14 ACCESSING FUND INFORMATION BY COMPUTER GLOSSARY (inside back cover) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- WHY READING THIS PROSPECTUS IS IMPORTANT This prospectus explains the investment objective, policies, strategies, and risks associated with the Fund. To highlight terms and concepts important to mutual fund investors, we have provided Plain Talk/(R)/ explanations along the way. Reading the prospectus will help you decide whether the Fund is the right investment for you. We suggest that you keep this prospectus for future reference. This prospectus offers the Fund's Admiral Shares and is intended for participants in employer-sponsored retirement or savings plans. Another version--for investors who would like to open a personal investment account--can be obtained by calling Vanguard at 1-800-662-7447. ------------------------------------------------------------------------------- 1 FUND PROFILE INVESTMENT OBJECTIVE The Fund seeks to provide a high level of income and moderate long-term capital growth by tracking the performance of a benchmark index that measures the performance of publicly traded equity REITs. PRIMARY INVESTMENT STRATEGIES The Fund normally invests at least 98% of its assets in stocks issued by real estate investment trusts (known as REITs) in an attempt to parallel the investment performance of the Morgan Stanley REIT Index. The Fund invests in the stocks that make up the Index; the remaining assets are allocated to cash investments. PRIMARY RISKS An investment in the Fund could lose money over short or even long periods. You should expect the Fund's share price and total return to fluctuate within a wide range, like the fluctuations of the overall stock market. The Fund's performance could be hurt by: - Industry concentration risk, which is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Because the Fund concentrates its assets in REIT stocks, real estate industry risk is high. - Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. - Interest rate risk, which is the chance that REIT stock prices overall will decline because of rising interest rates. Interest rate risk should be high for the Fund. - Investment style risk, which is the chance that the returns from REIT stocks--which typically are small- or mid-capitalization stocks--will trail returns from the overall stock market. Historically, these stocks have been more volatile in price than the large-cap stocks that dominate the overall stock market, and they often perform quite differently. PERFORMANCE/RISK INFORMATION The following bar chart and table are intended to help you understand the risks of investing in the Fund. The bar chart shows the performance of the Fund's Admiral Shares (including operating expenses but excluding shareholder fees) in their first full calendar year. The table shows how the average annual total returns (including operating expenses and any applicable shareholder fees) compare with those of the Fund's target index and other comparative indexes. Keep in mind that the Fund's past returns does not indicate how it will perform in the future. ---------------------------------------------------- ANNUAL TOTAL RETURN--ADMIRAL SHARES [BAR CHART] 2002 3.73 ---------------------------------------------------- The year-to-date return as of the most recent calendar quarter, which ended September 30, 2003, was 24.25%. If applicable shareholder fees were reflected, returns would be less than those shown. ---------------------------------------------------- 2 During the periods shown in the bar chart, the highest return for a calendar quarter was 12.36% (quarter ended June 30, 2003), and the lowest return for a quarter was -8.46% (quarter ended September 30, 2002). -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2002 -------------------------------------------------------------------------------- SINCE 1 YEAR INCEPTION* -------------------------------------------------------------------------------- Vanguard REIT Index Fund Admiral Shares 3.73% 8.77 Wilshire 5000 Total Market Index -20.86 -15.57% Morgan Stanley REIT Index 3.64 8.82 Target REIT Composite** 3.61 8.68 -------------------------------------------------------------------------------- *Since-inception returns are from November 12, 2001--the inception date of the Admiral Shares--through December 31, 2002. **The Target REIT Composite consists of the Morgan Stanley REIT Index adjusted to include a 2% cash position (Lipper Money Market Average). ------------------------------------------------------------------------------- FEES AND EXPENSES The following table describes the fees and expenses you may pay if you buy and hold Admiral Shares of the Fund. The expenses shown under Annual Fund Operating Expenses are based on estimated amounts for the current fiscal year. SHAREHOLDER FEES (fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases: None Purchase Fee: None Sales Charge (Load) Imposed on Reinvested Dividends: None Redemption Fee: 1%* ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets) Management Expenses: 0.20% 12b-1 Distribution Fee: None Other Expenses: 0.01% TOTAL ANNUAL FUND OPERATING EXPENSES: 0.21% *The 1% fee applies to shares redeemed within one year of purchase by selling or by exchanging to another fund. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. 3 The following example is intended to help you compare the cost of investing in the Fund's Admiral Shares with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. This example assumes that the Fund provides a return of 5% a year and that operating expenses match our estimates. The results apply whether or not you redeem your investment at the end of the given period. -------------------------------------------------- 1 YEAR 3 YEARS 5 YEARS 10 YEARS -------------------------------------------------- $22 $68 $118 $268 -------------------------------------------------- THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN. -------------------------------------------------------------------------------- PLAIN TALK ABOUT FUND EXPENSES All mutual funds have operating expenses. These expenses, which are deducted from a fund's gross income, are expressed as a percentage of the net assets of the fund. We expect Vanguard REIT Index Fund Admiral Shares' expense ratio for the fiscal year to be 0.21%, or $2.10 per $1,000 of average net assets. The average real estate mutual fund had expenses in 2002 of 1.64%, or $16.40 per $1,000 of average net assets (derived from data provided by Lipper Inc., which reports on the mutual fund industry). Management expenses, which are one part of operating expenses, include investment advisory fees as well as other costs of managing a fund--such as account maintenance, reporting, accounting, legal, and other administrative expenses. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PLAIN TALK ABOUT COSTS OF INVESTING Costs are an important consideration in choosing a mutual fund. That's because you, as a shareholder, pay the costs of operating a fund, plus any transaction costs incurred when the fund buys or sells securities. These costs can erode a substantial portion of the gross income or capital appreciation a fund achieves. Even seemingly small differences in expenses can, over time, have a dramatic effect on a fund's performance. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- ADDITIONAL INFORMATION DIVIDENDS AND CAPITAL GAINS NET ASSETS (ALL SHARE CLASSES) Dividends are distributed quarterly in March, AS OF JULY 31, 2003 June, September, and December. These $2.9 billion distributions may include income, capital gains, and a return of capital. Additional capital gains may be distributed annually in December. NEWSPAPER ABBREVIATION REITAdml INVESTMENT advisor The Vanguard Group, Valley Forge, Pa., VANGUARD FUND NUMBER since inception. 5123 INCEPTION DATE CUSIP NUMBER Investor Shares--May 13, 1996 921908877 Admiral Shares--November 12, 2001 TICKER SYMBOL VGSLX -------------------------------------------------------------------------------- 4 MORE ON THE FUND This prospectus describes the primary risks you would face as a Fund shareholder. It is important to keep in mind one of the main axioms of investing: The higher the risk of losing money, the higher the potential reward. The reverse, also, is generally true: The lower the risk, the lower the potential reward. As you consider an investment in any mutual fund, you should take into account your personal tolerance for daily fluctuations in the securities markets. Look for this [FLAG] symbol throughout the prospectus. It is used to mark detailed information about the more significant risks that you would confront as a Fund shareholder. The following sections explain the primary investment strategies and policies that the Fund uses in pursuit of its objective. The Fund's board of trustees, which oversees the Fund's management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. MARKET EXPOSURE The Fund normally invests at least 98% of its assets in stocks of real estate investment trusts (REITs) and holds any remaining assets in cash investments to meet shareholder redemptions. This policy may only be changed upon 60 days' notice to shareholders. -------------------------------------------------------------------------------- PLAIN TALK ABOUT REITS Rather than owning properties directly--which can be costly and difficult to convert into cash when needed--some investors buy shares in a company that owns and manages real estate. Such a company is known as a real estate investment trust, or REIT. Unlike corporations, REITs do not have to pay income taxes if they meet certain Internal Revenue Code requirements. To qualify, a REIT must distribute at least 90% of its taxable income to its shareholders and receive at least 75% of that income from rents, mortgages, and sales of property. REITs offer investors greater liquidity and diversification than direct ownership of a handful of properties, as well as greater income potential than an investment in common stocks. As with any investment in real estate, however, a REIT's performance depends on several factors, such as its ability to find tenants for its properties, to renew leases, and to finance property purchases and renovations. That said, returns from REITs may not correspond to returns from direct property ownership. -------------------------------------------------------------------------------- [FLAG] THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE CHANCE THAT RETURNS FROM REIT STOCKS--WHICH TYPICALLY ARE SMALL- OR MID-CAP STOCKS--WILL TRAIL RETURNS FROM THE OVERALL MARKET. HISTORICALLY, THESE STOCKS HAVE BEEN MORE VOLATILE IN PRICE THAN THE LARGE-CAP STOCKS THAT DOMINATE THE OVERALL STOCK MARKET, AND THEY OFTEN PERFORM QUITE DIFFERENTLY. 5 Stocks of publicly traded companies and funds that invest in stocks are often classified according to market value, or market capitalization. These classifications typically include small-cap, mid-cap, or large-cap. It's important to understand that, for both companies and stock funds, market capitalization ranges change over time. Also, interpretations of size vary, and there are no "official" definitions of small-, mid-, and large-cap, even among Vanguard fund advisors. REIT stocks in the Morgan Stanley REIT Index tend to be small or medium-size companies. The median market capitalization of the Fund as of July 31, 2003, was $2.3 billion. Small- and mid-cap stocks tend to have greater volatility than large-cap stocks because, among other things, smaller companies often have fewer customers, financial resources, and products than larger firms. Such characteristics can make small and medium-size companies more sensitive to changing economic conditions. REIT stocks tend to have a significant amount of dividend income to soften the impact of this volatility. However, the index and, thus, the Fund, are subject to additional risk because of the concentration in the real estate sector. This single-sector focus may result in more risk than would a more diversified, multi-sector portfolio. -------------------------------------------------------------------------------- PLAIN TALK ABOUT TYPES OF REITS An equity REIT owns properties directly. Equity REITs generate income (from rental and lease payments) and offer the potential for growth (from property appreciation) as well as occasional capital gains from the sale of property. A mortgage REIT makes loans to commercial real estate developers. Mortgage REITs earn interest income and are subject to credit risk (that is, the chance that a developer will fail to repay a loan). A hybrid REIT holds both properties and mortgages. The Fund invests in equity REITs only. -------------------------------------------------------------------------------- [FLAG] THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT STOCK PRICES OVERALL WILL DECLINE. STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF FALLING PRICES. To illustrate the volatility of stock prices, the following table shows the best, worst, and average total returns for the U.S. stock market over various periods as measured by the Standard & Poor's 500 Index, a widely used barometer of market activity. (Total returns consist of dividend income plus change in market price.) Note that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. ---------------------------------------------------------- U.S. STOCK MARKET RETURNS (1926-2002) ---------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS 20 YEARS ---------------------------------------------------------- Best 54.2% 28.6% 19.9% 17.8% Worst -43.1 -12.4 -0.8 3.1 Average 12.2 10.9 11.2 11.4 ---------------------------------------------------------- The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926 through 2002. You can see, for example, that while the average return on common stocks for all of the 5-year periods was 10.9%, average returns for individual 5-year periods ranged from -12.4% (from 1928 through 1932) to 28.6% (from 1995 through 1999). These average returns reflect past performance on common stocks; you should not regard them as an indication of future returns from either the stock market as a whole or this Fund in particular. [FLAG] THE FUND IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE CHANCE THAT REIT STOCK PRICES OVERALL WILL DECLINE BECAUSE OF RISING INTEREST RATES. INTEREST RATE RISK SHOULD BE HIGH FOR THE FUND. 6 In general, during periods of high interest rates, REITs may lose some of their appeal for investors who may be able to obtain higher yields from other income-producing investments, such as long-term bonds. Higher interest rates also mean that financing for property purchases and improvements is more costly and difficult to obtain. [FLAG] THE FUND IS SUBJECT TO REAL ESTATE INDUSTRY RISK, WHICH IS THE CHANCE THAT THE STOCKS OF REITS WILL DECLINE BECAUSE OF ADVERSE DEVELOPMENTS AFFECTING THE REAL ESTATE INDUSTRY AND REAL PROPERTY VALUES. BECAUSE THE FUND CONCENTRATES ITS ASSETS IN REIT STOCKS, REAL ESTATE INDUSTRY RISK IS HIGH. Because of its emphasis on REIT stocks, the Fund's performance may at times be linked to the ups and downs of the real estate market. In general, real estate values can be affected by a variety of factors, including supply and demand for properties; the economic health of the country as well as different regions; and the strength of specific industries that rent properties. Ultimately, an individual REIT's performance depends on the types and locations of the properties it owns and on how well the REIT manages its properties. For instance, rental income could decline because of extended vacancies, increased competition from nearby properties, tenants' failure to pay rent, or incompetent management. Property values could decrease because of overbuilding in the area, environmental liabilities, uninsured damages caused by natural disasters, a general decline in the neighborhood, losses due to casualty or condemnation, increases in property taxes, or changes in zoning laws. Loss of IRS status as a qualified REIT may also affect an individual REIT's performance. The target index tracked by the Fund is broadly diversified. Similarly, the Fund is broadly diversified, holding stocks of more than 100 companies. It is possible that the Fund's target index, in the future, could become less diversified if the index's largest companies significantly increase in value relative to the index's other components. In an extreme situation, the Fund might no longer meet the legal definition of "diversified." For this reason, the Fund is classified as "nondiversified." However, the Fund, from its inception until the date of this prospectus, in actuality has been diversified, and Vanguard expects the Fund to continue to be diversified. SECURITY SELECTION The Fund employs an indexing, or passively managed, investment approach. The Fund's advisor, The Vanguard Group (Vanguard), normally invests at least 98% of the Fund's assets in REIT securities in an attempt to parallel the performance of the target benchmark, the Morgan Stanley REIT Index. The Fund holds each stock contained in the Morgan Stanley REIT Index in roughly the same proportions as in the Index itself. For example, if 5% of the Morgan Stanley REIT Index were made up of the stock of a specific REIT, the Fund would invest the same percentage of its noncash assets in that stock. The Morgan Stanley REIT Index is made up of the stocks of publicly traded equity REITs that meet certain criteria. For example, to be included initially in the Index, a REIT must have a total market capitalization of at least $100 million and have enough shares and trading volume to be considered liquid. In line with the Index, the Fund invests in equity REITs only. As of July 31, 2003, 112 equity REITs were included in the Index. The Index is rebalanced every calendar quarter, as well as each time that a REIT is removed from the Index. A REIT may be removed from the Index because the REIT's market capitalization falls below $75 million; because the REIT becomes illiquid; because of other changes in the REIT's status; or because of corporate activity such as a merger, an acquisition, a leveraged buyout, bankruptcy, IRS removal of REIT status, or a fundamental change in business. 7 Stocks in the Morgan Stanley REIT Index represent a broadly diversified range of property types. The Index's makeup, as of July 31, 2003, was as follows: --------------------------------------------- PROPERTY TYPES PERCENTAGE OF INDEX --------------------------------------------- Retail 26% Residential Apartments 19 Office 19 Industrial 13 Diversified 12 Health Care 5 Hotels 4 Cash 2 --------------------------------------------- The Fund is generally managed without regard to tax ramifications. OTHER INVESTMENT POLICIES AND RISKS Besides investing in common stocks of REITs, the Fund may make certain other kinds of investments to achieve its objective. [FLAG] THE FUND MAY INVEST, TO A LIMITED EXTENT, IN DERIVATIVES. DERIVATIVES MAY INVOLVE RISKS DIFFERENT FROM, AND POSSIBLY GREATER THAN, THOSE OF TRADITIONAL INVESTMENTS. The Fund may also invest, to a limited extent, in futures and options contracts, which are types of derivatives. The Fund will invest in futures only for purposes of matching the performance of its target index, and not for speculative purposes or as leveraged investments that magnify losses or gains. Losses (or gains) involving futures can sometimes be substantial--in part because a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for a fund. The Fund's obligation under futures contracts will not exceed 20% of its total assets. To the extent that the Fund invests in futures contracts, it will not have 98% of its assets invested in REIT stocks. The reasons for which the Fund may invest in futures include: - To keep cash on hand to meet shareholder redemptions or other needs while simulating full investment in stocks. - To reduce the Fund's transaction costs or add value when these instruments are favorably priced. 8 -------------------------------------------------------------------------------- PLAIN TALK ABOUT DERIVATIVES A derivative is a financial contract whose value is based on (or "derived" from) a traditional security (such as a stock or a bond), an asset (such as a commodity like gold), or a market index (such as the S&P 500 Index). Some forms of derivatives, such as exchange-traded futures and options on securities, commodities, or indexes, have been trading on regulated exchanges for decades. These types of derivatives are standardized contracts that can easily be bought and sold, and whose market values are determined and published daily. Nonstandardized derivatives (such as swap agreements), on the other hand, tend to be more specialized or complex, and may be harder to value. Derivatives can carry considerable risks, particularly if used for speculation or as leveraged investments. -------------------------------------------------------------------------------- REDEMPTION FEE The Fund charges a fee on shares that are redeemed before they have been held for one year. This fee also applies when shares are redeemed by exchange to another Vanguard fund. Unlike a sales charge or load paid to a broker or fund management company, the redemption fee is paid directly to the Fund to offset the costs of buying and selling securities. The fee ensures that short-term investors pay their share of the Fund's transaction costs and that long-term investors do not subsidize the activities of short-term traders. From time to time, the Fund may waive or modify redemption fees for certain categories of investors. COSTS AND MARKET-TIMING Some investors try to profit from a strategy called market-timing--switching money into mutual funds when they expect prices to rise and taking money out when they expect prices to fall. As money is shifted in and out, a fund incurs expenses for buying and selling securities. These costs are borne by all fund shareholders, including the long-term investors who do not generate the costs. This is why all Vanguard funds have adopted special policies to discourage short-term trading or to compensate the funds for the costs associated with it. Specifically: - Each Vanguard fund reserves the right to reject any purchase request--including exchanges from other Vanguard funds--that it regards as disruptive to efficient portfolio management. A purchase request could be rejected because of the timing of the investment or because of a history of excessive trading by the investor. - Each Vanguard fund (other than the money market funds) limits the number of times that an investor can exchange into and out of the fund. - Certain Vanguard funds charge purchase and/or redemption fees on transactions. See the INVESTING WITH VANGUARD section of this prospectus for further details on Vanguard's transaction policies. THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST WITH VANGUARD IF YOU ARE A MARKET-TIMER. TURNOVER RATE Although the Fund normally seeks to invest for the long term, it may sell securities regardless of how long they have been held. The FINANCIAL HIGHLIGHTS section of this prospectus shows historical turnover rates for the Fund. A turnover rate of 100%, for example, would mean that the Fund had sold and replaced securities valued at 100% of its net assets within a one-year period. 9 -------------------------------------------------------------------------------- PLAIN TALK ABOUT TURNOVER RATE Before investing in a mutual fund, you should review its turnover rate. This gives an indication of how transaction costs could affect the fund's future returns. In general, the greater the volume of buying and selling by the fund, the greater the impact that brokerage commissions and other transaction costs will have on its return. Also, funds with high turnover rates may be more likely to generate capital gains that must be distributed to shareholders as taxable income. As of July 31, 2003, the average turnover rate for all real estate funds was approximately 68%, according to Morningstar, Inc. -------------------------------------------------------------------------------- THE FUND AND VANGUARD The Fund is a member of The Vanguard Group, a family of 35 investment companies with more than 100 funds holding assets in excess of $640 billion. All of the funds that are members of The Vanguard Group share in the expenses associated with administrative services and business operations, such as personnel, office space, equipment, and advertising. Vanguard also provides marketing services to the funds. Although shareholders do not pay sales commissions or 12b-1 distribution fees, each fund pays its allocated share of The Vanguard Group's marketing costs. -------------------------------------------------------------------------------- PLAIN TALK ABOUT VANGUARD'S UNIQUE CORPORATE STRUCTURE The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by the funds it oversees and thus indirectly by the shareholders in those funds. Most other mutual funds are operated by for-profit management companies that may be owned by one person, by a group of individuals, or by investors who own the management company's stock. By contrast, Vanguard provides its services on an "at-cost" basis, and the funds' expense ratios reflect only these costs. -------------------------------------------------------------------------------- INVESTMENT ADVISOR The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482, founded in 1975, serves as advisor to the Fund through its Quantitative Equity Group. As of July 31, 2003, Vanguard served as advisor for about $450 billion in assets. Vanguard manages the Fund on an at-cost basis, subject to the supervision and oversight of the trustees and officers of the Fund. For the fiscal year ended July 31, 2003, the advisory expenses represented an effective annual rate of 0.01% of the Fund's average net assets. The advisor is authorized to choose broker-dealers to handle the purchase and sale of the Fund's securities and to seek to obtain the best available price and most favorable execution for all transactions. Also, the board of trustees may direct the advisor to use a particular broker for certain transactions in exchange for commission rebates paid to the Fund as well as for brokerage or research services provided to the advisor. 10 -------------------------------------------------------------------------------- PLAIN TALK ABOUT THE FUND'S ADVISOR The manager primarily responsible for overseeing the Fund's investments is: GEORGE U. SAUTER, Managing Director and Chief Investment Officer of Vanguard and head of Vanguard's Quantitative Equity Group. He has worked in investment management since 1985 and has had primary responsibility for Vanguard's stock indexing and active quantitative investments and strategy since joining the company in 1987. Education: A.B., Dartmouth College; M.B.A., University of Chicago. -------------------------------------------------------------------------------- DIVIDENDS, CAPITAL GAINS, AND TAXES Each March, June, September, and December, Vanguard REIT Index Fund pays out to shareholders virtually all of the distributions it receives from its REIT investments, less expenses. Distributions may include income, return of capital, and capital gains. The Fund may also realize capital gains on the sale of its REIT investments. Distributions of these gains, if any, are included in the December distribution. In addition, the Fund may occasionally be required to make supplemental distributions at some other time during the year. Your distributions will be reinvested in additional Fund shares and accumulate on a tax-deferred basis if you are investing through an employer-sponsored retirement or savings plan. You will not owe taxes on these distributions until you begin withdrawals from the plan. You should consult your plan administrator, your plan's Summary Plan Description, or your tax advisor about the tax consequences of plan withdrawals. -------------------------------------------------------------------------------- PLAIN TALK ABOUT DISTRIBUTIONS As a shareholder, you are entitled to your portion of a fund's income from interest and dividends as well as gains from the sale of investments. Income consists of both the dividends that the fund earns from any stock holdings and the interest it receives from any money market and bond investments. Capital gains are realized whenever the fund sells securities for higher prices than it paid for them. These capital gains are either short-term or long-term, depending on whether the fund held the securities for one year or less or for more than one year. You receive the fund's earnings as either a dividend or capital gains distribution. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PLAIN TALK ABOUT RETURN OF CAPITAL The Internal Revenue Code requires a REIT to distribute at least 90% of its taxable income to investors. In many cases, however, because of "noncash" expenses such as property depreciation, an equity REIT's cash flow will exceed its taxable income. The REIT may distribute this excess cash to offer a more competitive yield (in other words, provide investors with a higher distribution). This portion of the distribution is classified as a return of capital. -------------------------------------------------------------------------------- 11 SHARE PRICE The Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time. NAV per share is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. On holidays or other days when the Exchange is closed, the NAV is not calculated, and the Fund does not transact purchase or redemption requests. However, on those days the value of the Fund's assets may be affected to the extent that the Fund holds foreign securities that trade on foreign markets that are open. Stocks held by a Vanguard fund are valued at their market value when reliable market quotations are readily available. Certain short-term debt instruments used to manage a fund's cash are valued on the basis of amortized cost. The values of any foreign securities held by a fund are converted into U.S. dollars using an exchange rate obtained from an independent third party. When reliable market quotations are not readily available, securities are priced at their fair value, calculated according to procedures adopted by the board of trustees. A fund also may use fair-value pricing if the value of a security it holds has been materially affected by events occurring before the fund's pricing time but after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign securities, but may occur in other cases as well. When fair-value pricing is employed, the prices of securities used by a fund to calculate its NAV may differ from quoted or published prices for the same securities. Vanguard fund share prices can be found daily in the mutual fund listings of most major newspapers under various "Vanguard" headings. FINANCIAL HIGHLIGHTS The following financial highlights table is intended to help you understand the Admiral Shares' financial performance for the periods shown, and certain information reflects financial results for a single Admiral Share. The total returns in the table represent the rate that an investor would have earned or lost each period on an investment in the Admiral Shares (assuming reinvestment of all distributions). The information for the six-month period ended July 31, 2003, has not been audited by independent accountants. The information for all other periods in the table through January 31, 2003, has been derived from the annual financial statements audited by PricewaterhouseCoopers LLP, independent accountants, whose report--along with the Fund's annual financial statements--is included in the Fund's most recent annual report to shareholders. To receive a free copy of the latest annual or semiannual report, you may access a report online at www.vanguard.com or you may contact Vanguard by telephone or by mail. 12 -------------------------------------------------------------------------------- PLAIN TALK ABOUT HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE The Admiral Shares began the fiscal period ended July 31, 2003, with a net asset value (price) of $49.14 per share. During the period, each Admiral Share earned $1.474 from investment income (interest and dividends) and $9.55 from investments that had appreciated in value or that were sold for higher prices than the Fund paid for them. Shareholders received $1.254 per share in the form of dividend distributions. A portion of each year's distributions may come from the prior year's income or capital gains. The share price at the end of the period was $58.91, reflecting earnings of $11.924 per share and distributions of $1.254 per share. This was an increase of $9.77 per share (from $49.14 at the beginning of the period to $58.91 at the end of the period). For a shareholder who reinvested the distributions in the purchase of more shares, the total return was 22.72% for the period. As of July 31, 2003, the Admiral Shares had $526 million in net assets. For the period, the annualized expense ratio was 0.21% ($2.10 per $1,000 of net assets), and the annualized net investment income amounted to 5.57% of average net assets. The Fund sold and replaced securities valued at an annualized rate of 4% of its net assets. --------------------------------------------------------------------------------
REIT INDEX FUND ADMIRAL SHARES ======================================================================================================== YEAR NOV. 12, ENDED 2001* TO SIX MONTH ENDED JAN. 31, JAN. 31, FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD JULY 31, 2003** 2003 2002 -------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $49.14 $51.65 $50.00 -------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income 1.474 2.619 .494 Net Realized and Unrealized Gain (Loss) on Investments*** 9.550 (1.854) 2.401 -------------------------------------------------------------------------------------------------------- Total from Investment Operations 11.024 .765 2.895 -------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (1.254) (2.878) (.970) Distributions from Realized Capital Gains -- -- -- Return of Capital -- (.397) (.275) -------------------------------------------------------------------------------------------------------- Total Distributions (1.254) (3.275) (1.245) -------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $58.91 $49.14 $51.65 -------------------------------------------------------------------------------------------------------- TOTAL RETURN+ 22.72% 1.19% 5.78% -------------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $526 $320 $166 Ratio of Total Expenses to Average Net Assets 0.21%++ 0.21% 0.23%++ Ratio of Net Investment Income to Average Net Assets 5.57%++ 4.99% 5.27%++ Portfolio Turnover Rate 4%++ 12% 10% ========================================================================================================
* Unaudited. ** Inception. *** Includes increases from redemption fees of $0.00, $0.03 and $0.01. + Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. ++ Annualized. 13 INVESTING WITH VANGUARD The Fund is an investment option in your retirement or savings plan. Your plan administrator or your employee benefits office can provide you with detailed information on how to participate in your plan and how to elect the Fund as an investment option. - If you have any questions about the Fund or Vanguard, including those about the Fund's investment objective, strategies, or risks, contact Vanguard's Participant Access Center, toll-free, at 1-800-523-1188. - If you have questions about your account, contact your plan administrator or the organization that provides recordkeeping services for your plan. INVESTMENT OPTIONS AND ALLOCATIONS Your plan's specific provisions may allow you to change your investment selections, the amount of your contributions, or how your contributions are allocated among the investment choices available to you. Contact your plan administrator or employee benefits office for more details. TRANSACTIONS Contributions, exchanges, or redemptions of the Fund's shares are processed as soon as they have been received by Vanguard in good order. Good order means that your request includes complete information on your contribution, exchange, or redemption, and that Vanguard has received the appropriate assets. In all cases, your transaction will be based on the Fund's next-determined net asset value (NAV) after Vanguard receives your request (or, in the case of new contributions, the next-determined NAV after Vanguard receives the order from your plan administrator). As long as this request is received before the close of trading on the New York Stock Exchange, generally 4 p.m., Eastern time, you will receive that day's NAV. This is known as your TRADE DATE. EXCHANGES The exchange privilege (your ability to redeem shares from one fund to purchase shares of another fund) may be available to you through your plan. Although we make every effort to maintain the exchange privilege, Vanguard reserves the right to revise or terminate this privilege, limit the amount of an exchange, or reject any exchange, at any time, without notice. Because excessive exchanges can potentially disrupt the management of the Vanguard/(R)/ funds and increase their transaction costs, Vanguard places certain limits on the exchange privilege. If you are exchanging out of the International Growth Fund, International Value Fund, International Explorer(tm) Fund, European Stock Index Fund, Pacific Stock Index Fund, Emerging Markets Stock Index Fund, Total International Stock Index Fund, Developed Markets Index Fund, or Institutional Developed Markets Index Fund, regardless of the dollar amount, the following policies generally apply: - You must wait 90 days before exchanging back into the fund from any source. - The 90-day clock restarts after every exchange our of the fund. - Exchanges out of the fund will not prevent you from making your usual periodic contributions to the fund through your employer plan. 14 For ALL OTHER VANGUARD FUNDS, the following policies generally apply: - Participant exchange activity is limited to no more than FOUR SUBSTANTIVE "ROUND TRIPS" THROUGH NON-MONEY-MARKET FUNDS (at least 90 days apart) during any 12-month period. - A "round trip" is a redemption from a fund followed by a purchase back into the fund. - "Substantive" means a dollar amount that Vanguard determines, in its sole discretion, could adversely affect the management of a fund. Please note that Vanguard reserves the right to revise the exchange privilege, limit the amount of any exchange, or reject an exchange, at any time, for any reason. Also, in the event of a conflict between the exchange-privilege limitations of two funds, the stricter policy will apply to the transaction. Before making an exchange to or from another fund available in your plan, consider the following: - Certain investment options, particularly funds made up of company stock or investment contracts, may be subject to unique restrictions. - Be sure to read that fund's prospectus. Contact Vanguard's Participant Access Center, toll-free, at 1-800-523-1188 for a copy. - Vanguard can accept exchanges only as permitted by your plan. Contact your plan administrator for details on the exchange policies that apply to your plan. ACCESSING FUND INFORMATION BY COMPUTER VANGUARD ON THE WORLD WIDE WEB WWW.VANGUARD.COM Use your personal computer to visit Vanguard's education-oriented website, which provides timely news and information about Vanguard funds and services; the online Education Center that offers a variety of mutual fund classes; and easy-to-use, interactive tools to help you create your own investment and retirement strategies. The Vanguard Group, Vanguard, Plain Talk, Explorer, Admiral, and the ship logo are trademarks of The Vanguard Group, Inc. All other marks are the exclusive property of their respective owners. (THIS PAGE INTENTIONALLY LEFT BLANK.) GLOSSARY OF INVESTMENT TERMS ACTIVE MANAGEMENT An investment approach that seeks to exceed the average returns of the financial markets. Active managers rely on research, market forecasts, and their own judgment and experience in selecting securities to buy and sell. CAPITAL GAINS DISTRIBUTION Payment to mutual fund shareholders of gains realized on securities that a fund has sold at a profit, minus any realized losses. CASH INVESTMENTS Cash deposits, short-term bank deposits, and money market instruments that include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase agreements, commercial paper, and banker's acceptances. COST BASIS The adjusted cost of an investment, used to determine a capital gain or loss for tax purposes. DISTRIBUTIONS Payments to shareholders of dividend income, capital gains, and return of capital generated by the fund's investment activities and distribution policies, after expenses. DIVIDEND DISTRIBUTION Payment to mutual fund shareholders of income from interest or dividends generated by a fund's investments. EXPENSE RATIO The percentage of a fund's average net assets used to pay its expenses during a fiscal year. The expense ratio includes management fees, administrative fees, and any 12b-1 distribution fees. INDEX An unmanaged group of securities whose overall performance is used as a standard to measure investment performance. INDUSTRY CONCENTRATION Focusing on the securities of a specific industry (such as energy, precious metals, health care, or real estate). INVESTMENT advisor An organization that makes the day-to-day decisions regarding a fund's investments. LIQUIDITY The degree of a security's marketability (that is, how quickly the security can be sold at a fair price and converted to cash). MUTUAL FUND An investment company that pools the money of many people and invests it in a variety of securities in an effort to achieve a specific objective over time. PASSIVE MANAGEMENT A low-cost investment strategy in which a mutual fund attempts to match--rather than outperform--a particular stock or bond market index; also known as indexing. PRINCIPAL The amount of money you put into an investment. REAL ESTATE INVESTMENT TRUST (REIT) A company that owns and manages real estate. RETURN OF CAPITAL A nontaxable portion of distributions. In general, the cost basis of an investment is reduced when a return of capital is distributed, deferring taxes until the investment is sold. TOTAL RETURN A percentage change, over a specified time period, in a mutual fund's net asset value, assuming the reinvestment of all distributions of dividends and capital gains. VOLATILITY The fluctuations in value of a mutual fund or other security. The greater a fund's volatility, the wider the fluctuations in its returns. YIELD Income (interest or dividends) earned by an investment, expressed as a percentage of the investment's price. [SHIP LOGO] THE VANGUARD GROUP(R) Institutional Division Post Office Box 2900 Valley Forge, PA 19482-2900 FOR MORE INFORMATION If you'd like more information about Vanguard REIT Index Fund, the following documents are available free upon request: ANNUAL/SEMIANNUAL REPORTS TO SHAREHOLDERS Additional information about the Fund's investments is available in the Fund's annual and semiannual reports to shareholders. In the Fund's annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Fund's performance during its last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI provides more detailed information about the Fund. The current annual and semiannual reports and the SAI are incorporated by reference into (and are thus legally a part of) this prospectus. To receive a free copy of the latest annual or semiannual report or the SAI, or to request additional information about the Fund or other Vanguard funds, please contact us as follows: THE VANGUARD GROUP PARTICIPANT ACCESS CENTER P.O. BOX 2900 VALLEY FORGE, PA 19482-2900 TELEPHONE: 1-800-523-1188 TEXT TELEPHONE: 1-800-523-8004 WORLD WIDE WEB: WWW.VANGUARD.COM INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC) You can review and copy information about the Fund (including the SAI) at the SEC's Public Reference Room in Washington, DC. To find out more about this public service, call the SEC at 1-202-942-8090. Reports and other information about the Fund are also available on the SEC's Internet site at http://www.sec.gov, or you can receive copies of this information, for a fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the Public Reference Section, Securities and Exchange Commission, Washington, DC 20549-0102. Fund's Investment Company Act file number: 811-3916 (C) 2003 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. I5123 112003 PART B VANGUARD(R) SPECIALIZED FUNDS (THE TRUST) STATEMENT OF ADDITIONAL INFORMATION NOVEMBER 25, 2003 This Statement is not a prospectus but should be read in conjunction with the Trust's current Prospectuses (dated November 25, 2003 for the REIT Index Fund, and dated May 27, 2003 for all other Funds). To obtain, without charge, the Prospectus or the most recent Annual Report to Shareholders, which contains the Funds' financial statements as hereby incorporated by reference, please call: INVESTOR INFORMATION DEPARTMENT: 1-800-662-7447 TABLE OF CONTENTS PAGE DESCRIPTION OF THE TRUST..............................................B-1 INVESTMENT POLICIES...................................................B-3 INVESTMENT LIMITATIONS................................................B-17 SHARE PRICE...........................................................B-18 PURCHASE OF SHARES....................................................B-18 REDEMPTION OF SHARES..................................................B-19 MANAGEMENT OF THE FUNDS...............................................B-20 INVESTMENT ADVISORY SERVICES..........................................B-25 PORTFOLIO TRANSACTIONS................................................B-31 YIELD AND TOTAL RETURNS...............................................B-32 FINANCIAL STATEMENTS..................................................B-33 DESCRIPTION OF THE TRUST ORGANIZATION The Trust was organized as a Pennsylvania business trust in 1983, was reorganized as a Maryland corporation in 1986 and then was reorganized as a Delaware statutory trust in June 1998. Prior to its reorganization as a Delaware statutory trust, the Trust was known as Vanguard Specialized Portfolios, Inc. The Trust is registered with the United States Securities and Exchange Commission (the Commission) under the Investment Company Act of 1940 (the 1940 Act). Each Fund, other than the Precious Metals and REIT Index Funds, is registered as a diversified open-end management investment company. The Precious Metals and REIT Index Funds are registered as nondiversified open-end management investment companies. As the market values of the Precious Metals and REIT Index Funds' largest holdings rise and fall, there may be times when the Funds are diversified under SEC standards and other times when they are not. The Trust currently offers the following funds with the following share class or classes: SHARE CLASSES ------------- FUND INVESTOR ADMIRAL INSTITUTIONAL ---- -------- ------- -------------- Vanguard(R) Dividend Yes No No Growth Fund* Vanguard(R) Energy Yes Yes No Fund Vanguard(R) Health Yes Yes No Care Fund Vanguard(R) Precious Yes No No Metals Fund Vanguard(R) REIT Index Yes Yes Yes Fund (individually, a Fund; collectively, the Funds) *Prior to December 6, 2002, Vanguard Dividend Growth Fund was known as Vanguard Utilities Income Fund. B-1 SERVICE PROVIDERS CUSTODIANS. JPMorgan Chase Bank, 270 Park Avenue, New York, NY 10017-2070 (for the Health Care and Precious Metals Funds), Citibank, N.A., 111 Wall Street, New York, NY 10005 (for the Energy and Dividend Growth Funds), and Wachovia Bank, N.A., 123 S. Broad Street, PA4942, Philadelphia, PA 19109 (for the REIT Index Fund), serve as the Funds' custodians. The custodians are responsible for maintaining the Funds' assets, keeping all necessary accounts and records of Fund assets, and appointing any foreign sub-custodians or foreign securities depositories. INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, Two Commerce Square, Suite 1700, 2001 Market Street, Philadelphia, PA, 19103-7042, serves as the Funds' independent accountants. The accountants audit the Funds' annual financial statements and provide other related services. TRANSFER AND DIVIDEND-PAYING AGENT. The Funds' transfer agent and dividend-paying agent is The Vanguard Group, Inc., 100 Vanguard Boulevard, Malvern, PA 19355. CHARACTERISTICS OF THE FUNDS' SHARES RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions on the right of shareholders to retain or dispose of the Funds' shares, other than the possible future termination of a Fund or share class. Each Fund or class may be terminated by reorganization into another mutual fund or class or by liquidation and distribution of the assets of the fund or class. Unless terminated by reorganization or liquidation, each Fund and share class will continue indefinitely. SHAREHOLDER LIABILITY. The Trust is organized under Delaware law, which provides that shareholders of a statutory trust are entitled to the same limitations of personal liability as shareholders of a corporation organized under Delaware law. Effectively, this means that a shareholder of a Fund will not be personally liable for payment of the Fund's debts except by reason of his or her own conduct or acts. In addition, a shareholder could incur a financial loss as a result of a Fund obligation only if the Fund itself had no remaining assets with which to meet such obligation. We believe that the possibility of such a situation arising is extremely remote. DIVIDEND RIGHTS. The shareholders of a Fund are entitled to receive any dividends or other distribution declared by the Fund. No shares of a Fund have priority of preference over any other shares of the Fund with respect to distributions. Distributions will be made from the assets of the Fund and will paid ratably to all shareholders of the Fund (or class) according to the number of shares of the Fund (or class) held by shareholders on the record date. The amount of dividends per share may vary between separate share classes of the Fund based upon differences in the way that expenses are allocated between share classes pursuant to a multiple class plan. VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (i) a shareholder vote is required under the 1940 Act; (ii) the matter concerns an amendment to the Declaration of Trust that would adversely affect to a material degree the rights and preferences of the shares of a Fund or any class; or (iii) the trustees determine that it is necessary or desirable to obtain a shareholder vote. The 1940 Act requires a shareholder vote under various circumstances, including to elect or remove trustees upon the written request of shareholders representing 10% or more of a Fund's net assets and to change any fundamental policy of a Fund. Unless otherwise required by applicable law, shareholders of a Fund receive one vote for each dollar of net asset value owned on the record date, and a fractional vote for each fractional dollar of net asset value owned on the record date. However, only the shares of the fund or class affected by a particular matter are entitled to vote on that matter. In addition, each class has exclusive voting rights on any matter submitted to shareholders that relates solely to that class, and each class has separate voting rights on any matter submitted to shareholders in which the interests of one class differ from the interests of another. Voting rights are noncumulative and cannot be modified without a majority vote. LIQUIDATION RIGHTS. In the event that a Fund is liquidated, shareholders will be entitled to receive a pro rata share of the Fund's net assets. In the event that a class of shares is liquidated, shareholders of that class will be entitled to receive a pro rata share of the Fund's net assets that are allocated to that class. Shareholders may receive cash, securities, or a combination of the two. PREEMPTIVE RIGHTS. There are no preemptive rights associated with the Funds' shares. CONVERSION RIGHTS. Shareholders of each Fund (except the Precious Metals and Dividend Growth Funds) may convert their shares into another class of shares of the same Fund upon satisfaction of any then applicable eligibility requirements. There are no conversion rights associated with the Precious Metals and Dividend Growth Funds. B-2 REDEMPTION PROVISIONS. Each Fund's redemption provisions are described in their current prospectus and elsewhere in this Statement of Additional Information. SINKING FUND PROVISIONS. The Funds' have no sinking fund provisions. CALLS OR ASSESSMENT. The Funds' shares, when issued, are fully paid and non-assessable. TAX STATUS OF THE FUNDS Each Fund intends to continue to qualify as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended. This special tax status means that the Funds will not be liable for federal tax on income and capital gains distributed to shareholders. In order to preserve its tax status, each Fund must comply with certain requirements. If a Fund fails to meet these requirements in any taxable year, it will be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, will be taxable to shareholders as ordinary income. In addition, a Fund could be required to recognize unrealized gains, pay substantial taxes and interest, and make substantial distributions before regaining its tax status as a regulated investment company. Dividends received and distributed by each Fund on shares of stock of domestic corporations may be eligible for the dividends-received deduction applicable to corporate shareholders. Corporations must satisfy certain requirements in order to claim the deduction. Capital gains distributed by the Funds are not eligible for the dividends-received deduction. Each Fund may invest in passive foreign investment companies (PFICs). A PFIC is a foreign corporation whose majority of income (75% or more) is passive or whose assets (50% or more) produce passive income. Capital gains on the sale of a PFIC will be deemed ordinary income regardless of how long the Fund held it. Also, the Fund may be subject to corporate income tax and an interest charge on certain dividends and capital gains earned from PFICs, whether or not they are distributed to shareholders. To avoid such tax and interest, the Fund may elect to treat PFICs as sold on the last day of the Fund's fiscal year and mark to market the gains (or losses, to the extent of previously recognized gains) and recognize ordinary income each year. Distributions from the Fund that are attributable to PFICs are characterized as ordinary income. INVESTMENT POLICIES Some of the investment policies described below and in each Funds' Prospectus set forth percentage limitations on a Fund's investment in, or holdings of, certain securities or other assets. Unless otherwise required by law, compliance with these policies will be determined immediately after the acquisition of such securities or assets. Subsequent changes in values, net assets, or other circumstances will not be considered when determining whether the investment complies with a Fund's investment policies and limitations. The following policies supplement each Fund's investment objective and policies set forth in each Prospectus. 80% POLICY. Each Fund (except the Dividend Growth and REIT Index Funds) will invest at least 80% of its assets in stocks of a particular industry. In applying this 80% requirement, each Fund's assets will include its net assets and any borrowings for investment purposes. BORROWING. A fund's ability to borrow money is limited by its investment policies and limitations, by the 1940 Act, and by applicable exemptive orders, no-action letters, interpretations, and other pronouncements by the Securities and Exchange Commission and its staff (SEC), and any other regulatory authority having jurisdiction, from time to time. Under the 1940 Act, a fund is required to maintain continuous asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the amount borrowed, with an exception for borrowings not in excess of 5% of the fund's total assets made for temporary or emergency purposes. Any borrowings for temporary purposes in excess of 5% of the fund's total assets must maintain continuous asset coverage. If the 300% asset coverage should decline as a result of market fluctuations or for other reasons, a fund may be required to sell some of its portfolio holdings within three days (excluding Sundays and holidays) to reduce the debt and restore the 300% asset coverage, even though it may be disadvantageous from an investment standpoint to sell securities at that time. Borrowing will tend to exaggerate the effect on net asset value of any increase or decrease in the market value of a fund's portfolio. Money borrowed will be subject to interest costs which may or may not be recovered by earnings on the securities purchased. A fund also may be required to maintain minimum average balances in connection with a B-3 borrowing or to pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate. The SEC takes the position that other transactions that have a leveraging effect on the capital structure of a fund or are economically equivalent to borrowing can be viewed as constituting a form of borrowing by the fund for purposes of the 1940 Act. These transactions can include entering into reverse repurchase agreements, engaging in mortgage dollar roll transactions, selling securities short (other than short sales "against-the-box"), buying and selling certain derivatives (such as futures contracts), selling (or writing) put and call options, engaging in sale-buybacks, entering into firm-commitment and standby-commitment agreements, engaging in when-issued, delayed-delivery, or forward-commitment transactions, and other trading practices that have a leveraging effect on the capital structure of a fund or are economically equivalent to borrowing (additional discussion about a number of these transactions can be found below). A borrowing transaction will not be considered to constitute the issuance of a "senior security" by a fund, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund (1) "covers" the borrowing transaction by maintaining an offsetting financial position or (2) segregates liquid assets (with such liquidity determined by the adviser in accordance with procedures established by the board of trustees) equal (as determined on a daily mark-to-market basis) in value to the fund's potential economic exposure under the borrowing transaction. A fund may have to buy or sell a security at a disadvantageous time or price in order to cover a borrowing transaction or segregate sufficient liquid assets. In addition, assets so segregated may not be available to satisfy redemptions or for other purposes. COMMON STOCK. Common stock represents an equity or ownership interest in an issuer. Common stock typically entitles the owner to vote on the election of directors and other important matters as well as to receive dividends on such stock. In the event an issuer is liquidated or declares bankruptcy, the claims of owners of bonds, other debt holders, and owners of preferred stock take precedence over the claims of those who own common stock. CONVERTIBLE SECURITIES. Convertible securities are hybrid securities that combine the investment characteristics of bonds and common stocks. Convertible securities typically consist of debt securities or preferred stock that may be converted (on a voluntary or mandatory basis) within a specified period of time (normally for the entire life of the security) into a certain amount of common stock or other equity security of the same or a different issuer at a predetermined price. Convertible securities also include debt securities with warrants or common stock attached and derivatives combining the features of debt securities and equity securities. Other convertible securities with features and risks not specifically referred to herein may become available in the future. Convertible securities involve risks similar to those of both fixed income and equity securities. The market value of a convertible security is a function of its "investment value" and its "conversion value." A security's "investment value" represents the value of the security without its conversion feature (i.e., a nonconvertible fixed income security). The investment value may be determined by reference to its credit quality and the current value of its yield to maturity or probable call date. At any given time, investment value is dependent upon such factors as the general level of interest rates, the yield of similar nonconvertible securities, the financial strength of the issuer, and the seniority of the security in the issuer's capital structure. A security's "conversion value" is determined by multiplying the number of shares the holder is entitled to receive upon conversion or exchange by the current price of the underlying security. If the conversion value of a convertible security is significantly below its investment value, the convertible security will trade like nonconvertible debt or preferred stock and its market value will not be influenced greatly by fluctuations in the market price of the underlying security. In that circumstance, the convertible security takes on the characteristics of a bond, and its price moves in the opposite direction from interest rates. Conversely, if the conversion value of a convertible security is near or above its investment value, the market value of the convertible security will be more heavily influenced by fluctuations in the market price of the underlying security. In that case, the convertible security's price may be as volatile as that of common stock. Because both interest rate and market movements can influence its value, a convertible security generally is not as sensitive to interest rates as a similar fixed income security, nor is it as sensitive to changes in share price as its underlying equity security. Convertible securities are often rated below investment-grade or are not rated, and are generally subject to a high degree of credit risk. While all markets are prone to change over time, the generally high rate at which convertible securities are retired (through mandatory or scheduled conversions by issuers or voluntary redemptions by holders) and replaced with newly issued convertibles may cause the convertible securities market to change more rapidly than other markets. For example, a concentration of available convertible securities in a few economic sectors could elevate the sensitivity of the convertible securities market to the volatility of the equity markets and to the specific risks of those sectors. Moreover, B-4 convertible securities with innovative structures, such as mandatory conversion securities and equity-linked securities, have increased the sensitivity of the convertible securities market to the volatility of the equity markets and to the special risks of those innovations, which may include risks different from, and possible greater than, those associated with traditional convertible securities. DEBT SECURITIEs. A debt security is a security consisting of a certificate or other evidence of a debt (secured or unsecured) on which the issuing company or governmental body promises to pay the holder thereof a fixed, variable, or floating rate of interest for a specified length of time, and to repay the debt on the specified maturity date. Some debt securities, such as zero coupon bonds, do not make regular interest payments but are issued at a discount to their principal or maturity value. Debt securities include a variety of fixed income obligations, including, but not limited to, corporate bonds, government securities, municipal securities, convertible securities, mortgage-backed securities and asset-backed securities. Debt securities include investment grade securities, non-investment grade securities, and unrated securities. Debt securities are subject to a variety of risks, such as interest rate risk, income risk, call/ prepayment risk, inflation risk, credit risk, and (in the case of foreign securities) country risk and currency risk. DEBT SECURITIES -- NON-INVESTMENT-GRADE SECURITIES. Non-investment-grade securities, also referred to as "high yield securities" or "junk bonds," are debt securities that are rated lower than the four highest rating categories by an nationally recognized statistical rating organization (for example, lower than Baa3 by Moody's Investors Service, Inc. or lower than BBB- by Standard & Poor's) or are determined to be of comparable quality by the fund's adviser. These securities are generally considered to be, on balance, predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation and will generally involve more credit risk than securities in the investment-grade categories. Investment in these securities generally provides greater income and increased opportunity for capital appreciation than investments in higher quality securities, but they also typically entail greater price volatility and principal and income risk. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of investment-grade securities. Thus, reliance on credit ratings in making investment decisions entails greater risks for high-yield securities than for investment-grade debt securities. The success of a fund's adviser in managing high-yield securities is more dependent upon its own credit analysis than is the case with investment-grade securities. Some high-yield securities are issued by smaller, less-seasoned companies, while others are issued as part of a corporate restructuring, such as an acquisition, merger, or leveraged buyout. Companies that issue high-yield securities are often highly leveraged and may not have available to them more traditional methods of financing. Therefore, the risk associated with acquiring the securities of such issuers generally is greater than is the case with investment-grade securities. Some high-yield securities were once rated as investment-grade but have been downgraded to junk bond status because of financial difficulties experienced by their issuers. The market values of high-yield securities tend to reflect individual issuer developments to a greater extent than do investment-grade securities, which in general react to fluctuations in the general level of interest rates. High-yield securities also tend to be more sensitive to economic conditions than are investment-grade securities. A projection of an economic downturn, for example, could cause a decline in junk bond prices because the advent of a recession could lessen the ability of a highly leveraged company to make principal and interest payments on its debt securities. If an issuer of high-yield securities defaults, in addition to risking payment of all or a portion of interest and principal, a fund investing in such securities may incur additional expenses to seek recovery. The secondary market on which high-yield securities are traded may be less liquid than the market for investment- grade securities. Less liquidity in the secondary trading market could adversely affect the ability of a fund to sell a high- yield security or the price at which a fund could sell a high-yield security, and could adversely affect the daily net asset value of fund shares. When secondary markets for high-yield securities are less liquid than the market for investment-grade securities, it may be more difficult to value the securities because such valuation may require more research, and elements of judgment may play a greater role in the valuation because there is less reliable, objective data available. Except as otherwise provided in a fund's prospectus, if a credit-rating agency changes the rating of a portfolio security held by a fund, the fund may retain the portfolio security if the adviser deems it in the best interest of shareholders. DEPOSITARY RECEIPTS. Depositary receipts are securities that evidence ownership interests in a security or a pool of securities that have been deposited with a "depository." Depositary receipts may be sponsored or unsponsored and include American Depositary Receipts (ADRs), European Depositary Receipts (EDRs), and Global Depositary Receipts (GDRs). In ADRs, the depository is typically a U.S. financial institution and the underlying securities are issued by a B-5 foreign issuer. In other depositary receipts, the depository may be a foreign or a U.S. entity, and the underlying securities may have a foreign or a U.S. issuer. Depositary receipts will not necessarily be denominated in the same currency as their underlying securities. Generally, ADRs are issued in registered form, denominated in U.S. dollars, and designed for use in the U.S. securities markets. Other Depositary receipts, such as GDRs and EDRs, may be issued in bearer form and denominated in other currencies, and are generally designed for use in securities markets outside the U.S. While the two types of depositary receipt facilities (unsponsored or sponsored) are similar, there are differences regarding a holder's rights and obligations and the practices of market participants. A depository may establish an unsponsored facility without participation by (or acquiescence of) the underlying issuer; typically, however, the depository requests a letter of non-objection from the underlying issuer prior to establishing the facility. Holders of unsponsored depositary receipts generally bear all the costs of the facility. The depository usually charges fees upon the deposit and withdrawal of the underlying securities, the conversion of dividends into U.S. dollars or other currency, the disposition of non-cash distributions, and the performance of other services. The depository of an unsponsored facility frequently is under no obligation to distribute shareholder communications received from the underlying issuer or to pass through voting rights to depositary receipt holders with respect to the underlying securities. Sponsored depositary receipt facilities are created in generally the same manner as unsponsored facilities, except that sponsored depositary receipts are established jointly by a depository and the underlying issuer through a deposit agreement. The deposit agreement sets out the rights and responsibilities of the underlying issuer, the depository, and the depositary receipt holders. With sponsored facilities, the underlying issuer typically bears some of the costs of the depositary receipts (such as dividend payment fees of the depository), although most sponsored depositary receipts holders may bear costs such as deposit and withdrawal fees. Depositories of most sponsored depositary receipts agree to distribute notices of shareholder meetings, voting instructions, and other shareholder communications and information to the depositary receipt holders at the underlying issuer's request. The depositary of an unsponsored facility frequently is under no obligation to distribute shareholder communications received from the issuer of the deposited security or to pass through, to the holders of the receipts, voting rights with respect to the deposited securities. For purposes of a fund's investment policies, investments in depositary receipts will be deemed to be investments in the underlying securities. Thus, a depositary receipt representing ownership of common stock will be treated as common stock. Depository receipts do not eliminate all of the risks associated with directly investing in the securities of foreign issuers. DERIVATIVES. A derivative is a financial instrument which has a value that is based on--or "derived from"--the values of other assets, reference rates, or indexes. Derivatives may relate to a wide variety of underlying references, such as commodities, stocks, bonds, interest rates, currency exchange rates and related indexes. Derivatives include futures contracts and options on futures contracts (see additional discussion below), forward commitment transactions (see additional discussion below), options on securities (see additional discussion below), caps, floors, collars, swap agreements (see additional discussion below) and other financial instruments. Some derivatives, such as futures contracts and certain options, are traded on U.S. commodity and securities exchanges, while other derivatives, such as swap agreements, are privately negotiated and entered into in the over-the-counter (OTC) market. The risks associated with the use of derivatives are different from, or possibly greater than, the risks associated with investing directly in securities and other traditional investments. Derivatives are used by some investors for speculative purposes. Derivatives also may be used for a variety of purposes that do not constitute speculation, such as hedging, risk management, seeking to stay fully invested, seeking to reduce transaction costs, seeking to simulate an investment in equity or debt securities or other investments, seeking to add value by using derivatives to more efficiently implement portfolio positions when derivatives are favorably priced relative to equity or debt securities or other investments, and for other purposes. A fund will not use derivatives for speculative purposes or as leveraged investments that magnify the gains or losses of an investment. There is no assurance that any derivatives strategy used by a fund's adviser will succeed. Derivative products are highly specialized instruments that require investment techniques and risk analyses different from those associated with stocks, bonds, and other traditional investments. The use of a derivative requires an understanding not only of the underlying instrument but also of the derivative itself, without the benefit of observing the performance of the derivative under all possible market conditions. The use of a derivative involves the risk that a loss may be sustained as a result of the insolvency or bankruptcy of the other party to the derivative contract (usually referred to as a "counterparty") or the failure of the counterparty to make required payments or otherwise comply with the terms of the contract. Additionally, the use of credit derivatives can B-6 result in losses if a fund's adviser does not correctly evaluate the creditworthiness of the issuer on which the credit derivative is based. Derivatives may be subject to liquidity risk, which exists when a particular derivative is difficult to purchase or sell. If a derivative transaction is particularly large or if the relevant market is illiquid (as is the case with many OTC derivatives), it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price. Derivatives may be subject to pricing or "basis" risk, which exists when a particular derivative becomes extraordinarily expensive relative to historical prices or the prices of corresponding cash market instruments. Under certain market conditions, it may not be economically feasible to initiate a transaction or liquidate a position in time to avoid a loss or take advantage of an opportunity. Because many derivatives have a leverage or borrowing component, adverse changes in the value or level of the underlying asset, reference rate, or index can result in a loss substantially greater than the amount invested in the derivative itself. Certain derivatives have the potential for unlimited loss, regardless of the size of the initial investment. Accordingly, certain derivative transactions may be considered to constitute borrowing transactions for purposes of the 1940 Act. Such a derivative transaction will not be considered to constitute the issuance of a "senior security" by a fund, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Like most other investments, derivative instruments are subject to the risk that the market value of the instrument will change in a way detrimental to a fund's interest. A fund bears the risk that its adviser will incorrectly forecast future market trends or the values of assets, reference rates, indices or other financial or economic factors in establishing derivative positions for the fund. If the adviser attempts to use a derivative as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the derivative will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving derivative instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many derivatives, in particular OTC derivatives, are complex and often valued subjectively. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. EXCHANGE-TRADED FUNDS. A fund may purchase shares of exchange-traded funds (ETFs), including ETF shares issued by other Vanguard funds. Typically, a fund would purchase ETF shares for the same reason it would purchase (and as an alternative to purchasing) futures contracts: to obtain exposure to all or a portion of the stock market while maintaining flexibility to meet the liquidity needs of the fund. ETF shares enjoy several advantages over futures. Depending on the market, the holding period, and other factors, ETF shares can be less costly and more tax-efficient than futures. In addition, ETF shares can be purchased for smaller sums, offer exposure to market sectors and styles for which there is no suitable or liquid futures contract, and do not involve leverage. Most ETFs are investment companies. Therefore, a fund's purchases of ETF shares generally are subject to the limitations on, and the risks of, a fund's investments in other investment companies, which are described below under the heading "Other Investment Companies." An investment in an ETF generally presents the same primary risks as an investment in a conventional fund (i.e., one that is not exchange traded) that has the same investment objectives, strategies, and policies. The price of an ETF can fluctuate within a wide range, and a fund could lose money investing in an ETF if the prices of the stocks owned by the ETF go down. In addition, ETFs are subject to the following risks that do not apply to conventional funds: (1) the market price of the ETF's shares may trade at a discount to their net asset value; (2) an active trading market for an ETF's shares may not develop or be maintained; or (3) trading of an ETF's shares may be halted if the listing exchange's officials deem such action appropriate, the shares are de-listed from the exchange, or the activation of market-wide "circuit breakers" (which are tied to large decreases in stock prices) halts stock trading generally. FOREIGN SECURITIES. Foreign securities are equity or debt securities issued by entities organized, domiciled, or with a principal place of business outside the United States, such as foreign corporations and governments. Foreign securities may trade in U.S. or foreign securities markets. A fund may make foreign investments either directly by purchasing foreign securities or indirectly by purchasing depositary receipts or depositary shares of similar instruments (depositary receipts) for foreign securities (see discussion above). Depositary receipts are securities that are listed on exchanges or quoted in OTC markets in one country but represent shares of issuers domiciled in another country. Direct investments B-7 in foreign securities may be made either on foreign securities exchanges or in the OTC markets. Investing in foreign securities involves certain special risk considerations that are not typically associated with investing in U.S. companies or governments. Because foreign issuers are not generally subject to uniform accounting, auditing, and financial reporting standards and practices comparable to those applicable to U.S. issuers, there may be less publicly available information about certain foreign issuers than about U.S. issuers. Evidence of securities ownership may be uncertain in many foreign countries. As a result, there is a risk that a fund's trade details could be incorrectly or fraudulently entered at the time of the transaction, resulting in a loss to the fund. Securities of foreign issuers are generally less liquid and more volatile than securities of comparable U.S. issuers. There is generally less government supervision and regulation of stock exchanges, brokers, and listed companies than in the U.S. In addition, with respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, war, terrorism, nationalization, limitations on the removal of funds or other assets, or diplomatic developments which could affect U.S. investments in those countries. Although an adviser will endeavor to achieve most favorable execution costs for a fund's portfolio transactions in foreign securities under the circumstances, commissions (and other transaction costs) are generally higher than those on U.S. securities. In addition, it is expected that the expenses for custodian arrangements of a funds' foreign securities will be somewhat greater than the expenses for a fund that invests primarily in domestic securities. Certain foreign governments levy withholding taxes against dividend and interest income from foreign securities. Although in some countries a portion of these taxes is recoverable by the fund, the non-recovered portion of foreign withholding taxes will reduce the income received from the companies making up a fund. The value of the foreign securities held by a fund that are not U.S. dollar-denominated may be significantly affected by changes in currency exchange rates. The U.S. dollar value of a foreign security generally decreases when the value of the U.S. dollar rises against the foreign currency in which the security is denominated and tends to increase when the value of the U.S. dollar falls against such currency (as discussed below, a fund may attempt to hedge its currency risks). In addition, the value of fund assets may be affected by losses and other expenses incurred in converting between various currencies in order to purchase and sell foreign securities, and by currency restrictions, exchange control regulation, currency devaluations, and political and economic developments. FOREIGN SECURITIES -- EMERGING MARKET RISK. Investing in emerging market countries involves certain risks not typically associated with investing in the United States, and imposes risks greater than, or in addition to, risks of investing in more developed foreign countries. These risks include, but are not limited to, the following: greater risks of nationalization or expropriation of assets or confiscatory taxation; currency devaluations and other currency exchange rate fluctuations; greater social, economic, and political uncertainty and instability (including amplified risk of war and terrorism) more substantial government involvement in the economy; less government supervision and regulation of the securities markets and participants in those markets; controls on foreign investment and limitations on repatriation of invested capital and on the fund's ability to exchange local currencies for U.S. dollars; unavailability of currency hedging techniques in certain emerging market countries; the fact that companies in emerging market countries may be smaller, less seasoned, and newly organized companies; the difference in, or lack of, auditing and financial reporting standards, which may result in unavailability of material information about issuers; the risk that it may be more difficult to obtain and/or enforce a judgment in a court outside the United States; and greater price volatility, substantially less liquidity, and significantly smaller market capitalization of securities markets. Also, any change in the leadership or politics of emerging market countries, or the countries that exercise a significant influence over those countries, may halt the expansion of or reverse the liberalization of foreign investment policies now occurring and adversely affect existing investment opportunities. Furthermore, high rates of inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of certain emerging market countries. FOREIGN SECURITIES -- FOREIGN CURRENCY TRANSACTIONS. For foreign securities that are not U.S. dollar-denominated, the value of a fund's foreign securities as measured in United States dollars may be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations, and the fund may incur costs in connection with conversions between various currencies. To seek to minimize the impact of such factors on net asset values, a fund may engage in foreign currency transactions in connection with its investments in foreign securities. A fund will not speculate in foreign currency exchange and will enter into foreign currency transactions only to attempt to "hedge" the currency risk associated with investing in foreign securities. Although such transactions tend to minimize the risk of loss because of a decline in the value of the hedged currency, they also may limit any potential gain which might result should the value of such currency increase. B-8 A fund may conduct its currency exchange transactions either on a spot (i.e., cash) basis at the rate prevailing in the currency exchange market, or through forward contracts to purchase or sell foreign currencies. A forward currency contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts are entered into with large commercial banks or other currency traders who are participants in the interbank market. Currency exchange transactions also may be effected through the use of swap agreements or other derivatives. Currency exchange transactions may be considered borrowings. A currency exchange transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." By entering into a forward contract for the purchase or sale of foreign currency involved in underlying security transactions, a fund may be able to protect itself against possible loss between trade and settlement dates for that purchase or sale resulting from an adverse change in the relationship between the U.S. dollar and such foreign currency. This practice is sometimes referred to as "transaction hedging." In addition, when the adviser reasonably believes that a particular foreign currency may suffer a substantial decline against the U.S. dollar, a fund may enter into a forward contract to sell an amount of foreign currency approximating the value of some or all of its portfolio securities denominated in such foreign currency. This practice is sometimes referred to as "portfolio hedging." Similarly, when the adviser reasonably believes that the U.S. dollar may suffer a substantial decline against a foreign currency, a fund may enter into a forward contract to buy that foreign currency for a fixed dollar amount. A fund may also attempt to hedge its foreign currency exchange rate risk by engaging in currency futures, options and "cross-hedge" transactions. In "cross-hedge" transactions, a fund holding securities denominated in one foreign currency will enter into a forward currency contract to buy or sell a different foreign currency (one that the adviser reasonably believes generally tracks the currency being hedged with regard to price movements). The adviser may select the tracking (or substitute) currency rather than the currency in which the security is denominated for various reasons, including in order to take advantage of pricing or other opportunities presented by the tracking currency or because the market for the tracking currency is more liquid or more efficient. Such cross-hedges are expected to help protect a fund against an increase or decrease in the value of the U.S. dollar against certain foreign currencies. A fund may hold a portion of its assets in bank deposits denominated in foreign currencies, so as to facilitate investment in foreign securities as well as protect against currency fluctuations and the need to convert such assets into U.S. dollars (thereby also reducing transaction costs). To the extent these monies are converted back into U.S. dollars, the value of the assets so maintained will be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations. The forecasting of short-term currency market movement is extremely difficult, and whether any hedging strategy will be successful is highly uncertain. Moreover, it is impossible to forecast with absolute precision the market value of portfolio securities at the expiration of a foreign currency forward contract. Accordingly, a fund may be required to buy or sell additional currency on the spot market (and bear the expense of such transaction) if its adviser's predictions regarding the movement of foreign currency or securities markets prove inaccurate. In addition, the use of cross-hedging transactions may involve special risks, and may leave a fund in a less advantageous position than if such a hedge had not been established. Because foreign currency forward contracts are privately negotiated transactions, there can be no assurance that a fund will have flexibility to roll-over the foreign currency forward contract upon its expiration if it desires to do so. Additionally, there can be no assurance that the other party to the contract will perform its services thereunder. FOREIGN SECURITIES -- FOREIGN INVESTMENT COMPANIES. Some of the countries in which a fund may invest may not permit, or may place economic restrictions on, direct investment by outside investors. Fund investments in such countries may be permitted only through foreign government-approved or authorized investment vehicles, which may include other investment companies. Such investments may be made through registered or unregistered closed-end investment companies that invest in foreign securities. Investing through such vehicles may involve frequent or layered fees or expenses and may also be subject to the limitations on, and the risks of, a fund's investments in other investment companies, which are described below under the heading "Other Investment Companies." FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. Futures contracts and options on futures contracts are derivatives (see additional discussion above). A futures contract is a standardized agreement between two parties to buy B-9 or sell at a specific time in the future a specific quantity of a commodity at a specific price. The commodity may consist of an asset, a reference rate, or an index. A security futures contract relates to the sale of a specific quantity of shares of a single equity security or a narrow-based securities index. The value of a futures contract tends to increase and decrease in tandem with the value of the underlying commodity. The buyer of a futures contract enters into an agreement to purchase the underlying commodity on the settlement date and is said to be "long" the contract. The seller of a futures contract enters into an agreement to sell the underlying commodity on the settlement date and is said to be "short" the contract. The price at which a futures contract is entered into is established by open outcry on the floor of an exchange between exchange members acting as traders or brokers. Open futures contracts can be liquidated or closed out by physical delivery of the underlying commodity or payment of the cash settlement amount on the settlement date, depending on the terms of the particular contract. Some financial futures contracts (such as security futures) provide for physical settlement at maturity. Other financial futures contracts (such as those relating to interest rates, foreign currencies and broad-based securities indexes) generally provide for cash settlement at maturity. In the case of cash settled futures contracts, the cash settlement amount is equal to the difference between the final settlement price on the last trading day of the contract and the price at which the contract was entered into. Most futures contracts, however, are not held until maturity but instead are "offset" before the settlement date through the establishment of an opposite and equal futures position. The purchaser or seller of a futures contract is not required to deliver or pay for the underlying commodity unless the contract is held until the settlement date. However, both the purchaser and seller are required to deposit "initial margin" with a futures commission merchant (FCM) when the futures contract is entered into. Initial margin deposits are typically calculated as a percentage of the contract's market value. If the value of either party's position declines, that party will be required to make additional "variation margin" payments to settle the change in value on a daily basis. This process is known as "marking-to-market." Because the exchange of initial and variation margin payments prior to the settlement date will not represent payment in full for a futures contract, a fund's futures transactions can be considered borrowing transactions. A futures transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." An option on a futures contract (or "futures option") conveys the right, but not the obligation, to purchase (in the case of a call option) or sell (in the case of a put option) a specific futures contract at a specific price (called the "exercise" or "strike" price) any time before the option expires. The buyer of a call option is said to go "long" a futures contract, while the buyer of a put option is said to go "short" a futures contract. The seller of an option is called an option writer. The purchase price of an option is called the "premium." Although the potential loss to an option buyer is limited to the amount of the premium plus transaction costs, that person can lose the entire amount of the premium. This will be the case, for example, if the option is held and not exercised prior to its expiration date. Generally, an option writer sells options with the goal of obtaining the premium paid by the option buyer. If an option sold by an option writer expires without being exercised, the writer retains the full amount of the premium. The option writer, however, has unlimited economic risk because its potential loss, except to the extent offset by the premium received when the option was written, is equal to the amount the option is "in-the-money" at the expiration date. A call option is in-the-money if the value of the underlying futures contract exceeds the exercise price of the option. A put option is in-the-money if the exercise price of the option exceeds the value of the underlying futures contract. Generally, any profit realized by an option buyer represents a loss for the option writer. A fund that takes the position of a writer of a futures option is required to deposit and maintain initial and variation margin with respect to the option, as described above in the case of futures contracts. Because the exchange of initial and variation margin payments prior to the expiration date of the option will not represent payment in full for a futures option, a fund's put and call option transactions can be considered borrowing transactions. A futures option transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Each fund intends to comply with Rule 4.5 of the Commodity Futures Trading Commission (CFTC), under which a mutual fund avoids being deemed a "commodity pool" or a "commodity pool operator" by limiting its use of futures contracts and futures options to "bona fide hedging" transactions (as defined by the CFTC) and by limiting the maximum B-10 amount or value of those futures and options transactions that do not constitute bona fide hedging transactions. A fund will only enter into futures contracts and futures options which are standardized and traded on a U.S. or foreign exchange, board of trade, or similar entity, or quoted on an automated quotation system. FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS -- RISKS. The risk of loss in trading futures contracts and in writing futures options can be substantial, because of the low margin deposits required, the extremely high degree of leverage involved in futures and options pricing, and the potential high volatility of the futures markets. As a result, a relatively small price movement in a futures position may result in immediate and substantial loss (as well as gain) to the investor. For example, if at the time of purchase, 10% of the value of the futures contract is deposited as margin, a subsequent 10% decrease in the value of the futures contract would result in a total loss of the margin deposit, before any deduction for the transaction costs, if the account were then closed out. A 15% decrease would result in a loss equal to 150% of the original margin deposit if the contract were closed out. Thus, a purchase or sale of a futures contract, and the writing of a futures option, may result in losses in excess of the amount invested in the position. In the event of adverse price movements, a fund would continue to be required to make daily cash payments to maintain its required margin. In such situations, if the fund has insufficient cash, it may have to sell portfolio securities to meet daily margin requirements (and segregation requirements, if applicable) at a time when it may be disadvantageous to do so. In addition, on the settlement date, a fund may be required to make delivery of the instruments underlying the futures positions it holds. A fund could suffer losses if it is unable to close out a futures contract or a futures option because of an illiquid secondary market. Futures contracts and futures options may be closed out only on an exchange which provides a secondary market for such products. However, there can be no assurance that a liquid secondary market will exist for any particular futures product at any specific time. Thus, it may not be possible to close a futures or option position. Moreover, most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of a trading session. Once the daily limit has been reached in a particular type of contract, no trades may be made on that day at a price beyond that limit. The daily limit governs only price movement during a particular trading day and therefore does not limit potential losses, because the limit may prevent the liquidation of unfavorable positions. Futures contract prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of future positions and subjecting some futures traders to substantial losses. The inability to close futures and options positions also could have an adverse impact on the ability to hedge a portfolio investment or to establish a substitute for a portfolio investment. A fund bears the risk that its adviser will incorrectly predict future market trends. If the adviser attempts to use a futures contract or a futures option as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the futures position will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving futures products can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. A fund could lose margin payments it has deposited with its FCM, if, for example, the FCM breaches its agreement with the fund or becomes insolvent or goes into bankruptcy. In that event, the fund may be entitled to return of margin owed to it only in proportion to the amount received by the FCM's other customers, potentially resulting in losses to the fund. INTERFUND BORROWING AND LENDING. The SEC has issued an exemptive order permitting the Vanguard funds to participate in Vanguard's interfund lending program. This program allows the Vanguard funds to borrow money from and lend money to each other for temporary or emergency purposes. The program is subject to a number of conditions, including the requirement that no fund may borrow or lend money through the program unless it receives a more favorable interest rate than is available from a typical bank for a comparable transaction. In addition, a Vanguard fund may participate in the program only if and to the extent that such participation is consistent with the fund's investment objective and other investment policies. The boards of trustees of the Vanguard funds are responsible for overseeing the interfund lending program. OPTIONS. An option is a derivative (see additional discussion above). An option on a security (or index) is a contract that gives the holder of the option, in return for the payment of a "premium," the right, but not the obligation, to buy from (in the case of a call option) or sell to (in the case of a put option) the writer of the option the security underlying the option (or the cash value of the index) at a specified exercise price at any time during the term of the option. The writer of an B-11 option on a security has the obligation upon exercise of the option (1) to deliver the underlying security upon payment of the exercise price (in the case of a call option) or (2) to pay the exercise price upon delivery of the underlying security (in the case of a put option). The writer of an option on an index has the obligation upon exercise of the option to pay an amount equal to the cash value of the index minus the exercise price, multiplied by the specified multiplier for the index option. The multiplier for an index option determines the size of the investment position the option represents. Unlike exchange-traded options, which are standardized with respect to the underlying instrument, expiration date, contract size, and strike price, the terms of OTC options (options not traded on exchanges) generally are established through negotiation with the other party to the option contract. While this type of arrangement allows the purchaser or writer greater flexibility to tailor an option to its needs, OTC options generally involve greater credit risk than exchange-traded options, which are guaranteed by the clearing organization of the exchanges where they are traded. The buyer of a call option is said to go "long" on the underlying position, while the buyer of a put option is said to go "short" the underlying position. The seller of an option is called an option writer. The purchase price of an option is called the "premium." Although the potential loss to an option buyer is limited to the amount of the premium plus transaction costs, that person can lose the entire amount of the premium. This will be the case if the option is held and not exercised prior to its expiration date. Generally, an option writer sells options with the goal of obtaining the premium paid by the option buyer, but that person could also seek to profit from an anticipated rise or decline in option prices. If an option sold by an option writer expires without being exercised, the writer retains the full amount of the premium. The option writer, however, has unlimited economic risk because its potential loss, except to the extent offset by the premium received when the option was written, is equal to the amount the option is "in-the-money" at the expiration date. A call option is in-the-money if the value of the underlying position exceeds the exercise price of the option. A put option is in-the-money if the exercise price of the option exceeds the value of the underlying position. Generally, any profit realized by an option buyer represents a loss for the option writer. The writing of an option will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." If a trading market in particular options were to become unavailable, investors in those options (such as the funds) would be unable to close out their positions until trading resumes, and they may be faced with substantial losses if the value of the underlying interest moves adversely during that time. Even if the market were to remain available, there may be times when options prices will not maintain their customary or anticipated relationships to the prices of the underlying interests and related interests. Lack of investor interest, changes in volatility, or other factors or conditions might adversely affect the liquidity, efficiency, continuity, or even the orderliness of the market for particular options. A fund bears the risk that its adviser will not accurately predict future market trends. If the adviser attempts to use an option as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the option will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving options can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many options, in particular OTC options, are complex and often valued based on subjective factors. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. OTHER INVESTMENT COMPANIES. A fund may invest in other investment companies to the extent permitted by applicable law or SEC order. Under the 1940 Act, a fund generally may invest up to 10% of its assets in shares of investment companies and up to 5% of its assets in any one investment company as long as the investment does not represent more than 3% of the voting stock of the acquired investment company. If a fund invests in investment companies, shareholders will bear not only their proportionate share of the fund's expenses (including operating expenses and the fees of the adviser), but also, indirectly, similar expenses of the underlying investment companies. Shareholders would also be exposed to the risks associated not only to the investments of the fund but also to the portfolio investments of the underlying investment companies. Certain types of investment companies, such as closed-end investment companies, issue a fixed number of shares that typically trade on a stock exchange or over-the-counter at a premium or discount to their net asset value. Others are continuously offered at net asset value but also may be traded in the secondary market. PREFERRED STOCK. Preferred stock represents an equity or ownership interest in an issuer. Preferred stock normally pays dividends at a specified rate and has precedence over common stock in the event the issuer is liquidated or declares B-12 bankruptcy. However, in the event an issuer is liquidated or declares bankruptcy, the claims of owners of bonds take precedence over the claims of those who own preferred and common stock. Preferred stock, unlike common stock, often has a stated dividend rate payable from the corporation's earnings. Preferred stock dividends may be cumulative or non-cumulative, participating, or auction rate. "Cumulative" dividend provisions require all or a portion of prior unpaid dividends to be paid before dividends can be paid to the issuer's common stock. "Participating" preferred stock may be entitled to a dividend exceeding the stated dividend in certain cases. If interest rates rise, the fixed dividend on preferred stocks may be less attractive, causing the price of such stocks to decline. Preferred stock may have mandatory sinking fund provisions, as well as provisions allowing the stock to be called or redeemed, which can limit the benefit of a decline in interest rates. Preferred stock is subject to many of the risks to which common stock and debt securities are subject. REPURCHASE AGREEMENTS. A repurchase agreement is an agreement under which a fund acquires a fixed income security (generally a security issued by the U.S. Government or an agency thereof, a banker's acceptance, or a certificate of deposit) from a commercial bank, broker, or dealer, and simultaneously agrees to resell such security to the seller at an agreed upon price and date (normally, the next business day). Because the security purchased constitutes collateral for the repurchase obligation, a repurchase agreement may be considered a loan that is collateralized by the security purchased for purposes of the 1940 Act. The resale price reflects an agreed upon interest rate effective for the period the instrument is held by a fund and is unrelated to the interest rate on the underlying instrument. In these transactions, the securities acquired by a fund (including accrued interest earned thereon) must have a total value in excess of the value of the repurchase agreement and are held by a custodian bank until repurchased. In addition, the board of trustees will monitor a fund's repurchase agreement transactions generally and will establish guidelines and standards for review by the investment adviser of the creditworthiness of any bank, broker, or dealer party to a repurchase agreement relating to a fund. The use of repurchase agreements involves certain risks. One risk is the seller's ability to pay the agreed-upon repurchase price on the repurchase date. If the seller defaults, the fund may incur costs in disposing of the collateral, which would reduce the amount realized thereon. If the seller seeks relief under the bankruptcy laws, the disposition of the collateral may be delayed or limited. For example, if the other party to the agreement becomes insolvent and subject to liquidation or reorganization under the bankruptcy or other laws, a court may determine that the underlying security is collateral for a loan by the fund not within its control and therefore the realization by the fund on such collateral may be automatically stayed. Finally, it is possible that the fund may not be able to substantiate its interest in the underlying security and may be deemed an unsecured creditor of the other party to the agreement. RESTRICTED AND ILLIQUID SECURITIES. Illiquid securities are securities that can not be sold or disposed of in the ordinary course of business within seven business days at approximately the value at which they are being carried on a fund's books. Illiquid securities may include a wide variety of investments, such as repurchase agreements maturing in more than seven days, OTC options contracts, and certain other derivatives (including certain swap agreements), fixed time deposits that are not subject to prepayment or do not provide for withdrawal penalties upon prepayment (other than overnight deposits), participation interests in loans, commercial paper issued pursuant to Section 4(2) of the Securities Act of 1933, as amended (1933 Act), and securities whose disposition is restricted under the federal securities laws. Illiquid securities include restricted, privately placed securities that, under the federal securities laws, generally may be resold only to qualified institutional buyers. Because these securities can be resold only to qualified institutional buyers, they may be considered illiquid securities--meaning that they could be difficult for a fund to convert to cash if needed. If a substantial market develops for a restricted security (or other illiquid investment) held by a fund, it may be treated as a liquid security, in accordance with procedures and guidelines approved by the board of trustees. This generally includes securities that are unregistered that can be sold to qualified institutional buyers in accordance with Rule 144A under the 1933 Act or securities that are exempt from registration under the 1933 Act, such as commercial paper. While a fund's adviser monitors the liquidity of restricted securities on a daily basis, the board of trustees oversees and retains ultimate responsibility for the adviser's decisions. Several factors that the trustees consider in monitoring these decisions include the valuation of a security, the availability of qualified institutional buyers, brokers and dealers that trade in the security, and the availability of information about the security's issuer. REVERSE REPURCHASE AGREEMENTS. In a reverse repurchase agreement, a fund sells a security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase that security at an agreed-upon price and time. Under a reverse repurchase agreement, the fund continues to receive any principal and interest payments on the underlying security during the term of the agreement. Reverse repurchase agreements involve the risk that the market value of securities retained by the fund may decline below the repurchase price of the securities sold by the fund which it is obligated to repurchase. A reverse repurchase agreement may be considered a borrowing transaction for purposes of the 1940 Act. A reverse repurchase agreement transaction will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable B-13 to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." A fund will enter into reverse repurchase agreements only with parties whose creditworthiness has been reviewed and found satisfactory by the adviser. SECURITIES LENDING. A fund may lend its investment securities to qualified institutional investors (typically brokers, dealers, banks, or other financial institutions) who need to borrow securities in order to complete certain transactions, such as covering short sales, avoiding failures to deliver securities, or completing arbitrage operations. By lending its investment securities, a fund attempts to increase its net investment income through the receipt of interest on the loan. Any gain or loss in the market price of the securities loaned that might occur during the term of the loan would be for the account of the fund. If the borrower defaults on its obligation to return the securities loaned because of insolvency or other reasons, a fund could experience delays and costs in recovering the securities loaned or in gaining access to the collateral. These delays and costs could be greater for foreign securities. If a fund is not able to recover the securities loaned, a fund may sell the collateral and purchase a replacement investment in the market. The value of the collateral could decrease below the value of the replacement investment by the time the replacement investment is purchased. Cash received as collateral through loan transactions may be invested in other eligible securities. Investing this cash subjects that investment, as well as the securities loaned, to market appreciation or depreciation. The terms and the structure and the aggregate amount of securities loans must be consistent with the 1940 Act and the rules or interpretations of the SEC thereunder. These provisions limit the amount of securities a fund may lend to 33 1/3% of the fund's total assets, and require that (1) the borrower pledge and maintain with the fund collateral consisting of cash, an irrevocable letter of credit or securities issued or guaranteed by the U.S. Government having at all times not less than 100% of the value of the securities loaned, (2) the borrower add to such collateral whenever the price of the securities loaned rises (i.e., the borrower "marks-to-market" on a daily basis), (3) the loan be made subject to termination by the fund at any time, and (4) the fund receive reasonable interest on the loan (which may include the fund's investing any cash collateral in interest bearing short-term investments), any distribution on the loaned securities, and any increase in their market value. Loan arrangements made by each fund will comply with all other applicable regulatory requirements, including the rules of the New York Stock Exchange, which presently require the borrower, after notice, to redeliver the securities within the normal settlement time of three business days. The adviser will consider the creditworthiness of the borrower, among other things, in making decisions with respect to the lending of securities, subject to oversight by the board of trustees, and a fund may pay such fees. At the present time, the SEC does not object if an investment company pays reasonable negotiated fees in connection with loaned securities, so long as such fees are set forth in a written contract and approved by the investment company's trustees, and a fund may pay such fees. In addition, voting rights pass with the loaned securities, but if a material event occurs affecting an investment on loan, the loan must be called and the securities voted. SWAP AGREEMENTS. A swap agreement is a derivative (see additional discussion above). A swap agreement is an agreement between two parties (counterparties) to exchange payments at specified dates (periodic payment dates) on the basis of a specified amount (notional amount) with the payments calculated with reference to a specified asset, reference rate, or index. Examples of swap agreements include, but are not limited to, interest rate swaps, credit default swaps, equity swaps, commodity swaps, foreign currency swaps, index swaps, and total return swaps. Most swap agreements provide that when the periodic payment dates for both parties are the same, payments are netted, and only the net amount is paid to the counterparty entitled to receive the net payment. Consequently, a fund's current obligations (or rights) under a swap agreement will generally be equal only to the net amount to be paid or received under the agreement, based on the relative values of the positions held by each counterparty. Swap agreements allow for a wide variety of transactions. For example, fixed rate payments may be exchanged for floating rate payments; U.S. dollar-denominated payments may be exchanged for payments denominated in a different currency; and payments tied to the price of one asset, reference rate, or index may be exchanged for payments tied to the price of another asset, reference rate, or index. An option on a swap agreement, also called a "swaption," is an option that gives the buyer the right, but not the obligation, to enter into a swap on a future date in exchange for paying a market-based "premium." A receiver swaption gives the owner the right to receive the total return of a specified asset, reference rate, or index. A payer swaption gives the owner the right to pay the total return of a specified asset, reference rate, or index. Swaptions also include options that allow an existing swap to be terminated or extended by one of the counterparties. B-14 The use of swap agreements by a fund entails certain risks, which may be different from, or possibly greater than, the risks associated with investing directly in the securities and other traditional investments that are the referenced asset for the swap agreement. Swaps are highly specialized instruments that require investment techniques and risk analyses different from those associated with stocks, bonds, and other traditional investments. The use of a swap requires an understanding not only of the referenced asset, reference rate, or index but also of the swap itself, without the benefit of observing the performance of the swap under all possible market conditions. Swap agreements may be subject to liquidity risk, which exists when a particular swap is difficult to purchase or sell. If a swap transaction is particularly large or if the relevant market is illiquid (as is the case with many OTC swaps), it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price, which may result in significant losses. In addition, a swap transaction may be subject to a fund's limitation on investments in illiquid securities. Swap agreements may be subject to pricing risk, which exists when a particular swap becomes extraordinarily expensive (or cheap) relative to historical prices or the prices of corresponding cash market instruments. Under certain market conditions, it may not be economically feasible to initiate a transaction or liquidate a position in time to avoid a loss or take advantage of an opportunity or to realize the intrinsic value of the swap agreement. Because some swap agreements have a leverage or borrowing component, adverse changes in the value or level of the underlying asset, reference rate or index can result in a loss substantially greater than the amount invested in the swap itself. Certain swaps have the potential for unlimited loss, regardless of the size of the initial investment. Certain swap transactions may be considered to constitute borrowing transactions for purposes of the 1940 Act. Such a swap transaction will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Like most other investments, swap agreements are subject to the risk that the market value of the instrument will change in a way detrimental to a fund's interest. A fund bears the risk that its adviser will not accurately forecast future market trends or the values of assets, reference rates, indices or other economic factors in establishing swap positions for the fund. If the adviser attempts to use a swap as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the swap will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving swap instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many swaps, in particular OTC swaps, are complex and often valued subjectively. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. The use of a swap agreement also involves the risk that a loss may be sustained as a result of the insolvency or bankruptcy of the counterparty or the failure of the counterparty to make required payments or otherwise comply with the terms of the agreement. Additionally, the use of credit default swaps can result in losses if a fund's adviser does not correctly evaluate the creditworthiness of the issuer on which the credit swap is based. The swaps market is a relatively new market and is largely unregulated. It is possible that developments in the swaps market, including potential government regulation, could adversely affect a fund's ability to terminate existing swap agreements or to realize amounts to be received under such agreements. TAX MATTERS -- FEDERAL TAX TREATMENT OF FUTURES CONTRACTS. A fund is required for federal income tax purposes to recognize as income for each taxable year its net unrealized gains and losses on certain futures contracts as of the end of the year as well as those actually realized during the year. In these cases, any gain or loss recognized with respect to a futures contract is considered to be 60% long-term capital gain or loss and 40% short-term capital gain or loss, without regard to the holding period of the contract. Gains and losses on certain other futures contracts (primarily non-U.S. futures contracts) are not recognized until the contracts are closed and are treated as long-term or short-term, depending on the holding period of the contract. Sales of futures contracts that are intended to hedge against a change in the value of securities held by a fund may affect the holding period of such securities and, consequently, the nature of the gain or loss on such securities upon disposition. A fund may be required to defer the recognition of losses on one position, such as futures contracts, to the extent of any unrecognized gains on a related offsetting position held by the fund. In order for a fund to continue to qualify for federal income tax treatment as a regulated investment company, at least 90% of its gross income for a taxable year must be derived from qualifying income; i.e., dividends, interest, income derived from loans of securities, gains from the sale of securities or of foreign currencies, or other income derived with B-15 respect to the fund's business of investing in securities or currencies. It is anticipated that any net gain recognized on futures contracts will be considered qualifying income for purposes of the 90% requirement. A fund will distribute to shareholders annually any net capital gains which have been recognized for federal income tax purposes on futures transactions. Such distributions will be combined with distributions of capital gains realized on the fund's other investments and shareholders will be advised on the nature of the distributions. TAX MATTERS -- FEDERAL TAX TREATMENT OF NON-U.S. TRANSACTIONS. Special rules govern the Federal income tax treatment of certain transactions denominated in terms of a currency other than the U.S. dollar or determined by reference to the value of one or more currencies other than the U.S. dollar. The types of transactions covered by the special rules include the following: (1) the acquisition of, or becoming the obligor under, a bond or other debt instrument (including, to the extent provided in Treasury regulations, preferred stock); (2) the accruing of certain trade receivables and payables; and (3) the entering into or acquisition of any forward contract, futures contract, option, or similar financial instrument if such instrument is not marked to market. The disposition of a currency other than the U.S. dollar by a taxpayer whose functional currency is the U.S. dollar is also treated as a transaction subject to the special currency rules. However, foreign currency-related regulated futures contracts and non-equity options are generally not subject to the special currency rules if they are or would be treated as sold for their fair market value at year-end under the marking-to-market rules applicable to other futures contracts unless an election is made to have such currency rules apply. With respect to transactions covered by the special rules, foreign currency gain or loss is calculated separately from any gain or loss on the underlying transaction and is normally taxable as ordinary income or loss. A taxpayer may elect to treat as capital gain or loss foreign currency gain or loss arising from certain identified forward contracts, futures contracts, and options that are capital assets in the hands of the taxpayer and which are not part of a straddle. The Treasury Department issued regulations under which certain transactions subject to the special currency rules that are part of a "section 988 hedging transaction" (as defined in the Code and the Treasury regulations) will be integrated and treated as a single transaction or otherwise treated consistently for purposes of the Code. Any gain or loss attributable to the foreign currency component of a transaction engaged in by a fund which is not subject to the special currency rules (such as foreign equity investments other than certain preferred stocks) will be treated as capital gain or loss and will not be segregated from the gain or loss on the underlying transaction. It is anticipated that some of the non-U.S. dollar-denominated investments and foreign currency contracts a fund may make or enter into will be subject to the special currency rules described above. TAX MATTERS -- FOREIGN TAX CREDIT. Foreign governments may withhold taxes on dividends and interest paid with respect to foreign securities held by a fund. Foreign governments may also impose taxes on other payments or gains with respect to foreign securities. If, at the close of its fiscal year, more than 50% of a fund's total assets are invested in securities of foreign issuers, the fund may elect to pass through foreign taxes paid, and thereby allow shareholders to take a deduction or, if they meet certain holding period requirements, a tax credit on their tax returns. If shareholders do not meet the holding period requirements, they may still be entitled to a deduction for certain gains than were actually distributed by the fund, but will also show the amount of the available offsetting credit or deduction. TEMPORARY INVESTMENTS. A fund may take temporary defensive measures that are inconsistent with the fund's normal fundamental or non fundamental investment policies and strategies in response to adverse market, economic, political, or other conditions as determined by the adviser. Such measures could include, but are not limited to, investments in (1) highly liquid short-term fixed income securities issued by or on behalf of municipal or corporate issuers, obligations of the U.S. Government and its agencies, commercial paper, and bank certificates of deposit; (2) shares of other investment companies which have investment objectives consistent with those of the fund; (3) repurchase agreements involving any such securities; and (4) other money market instruments. There is no limit on the extent to which the fund may take temporary defensive measures. In taking such measures, the fund may fail to achieve its investment objective. VIPER SHARES. VIPER Shares are exchange-traded shares that represent an interest in a portfolio of stocks held by Vanguard index funds. "VIPER" stands for Vanguard Index Participation Equity Receipts. Any fund that issues VIPER Shares may repurchase those shares on the open market at the current market price if doing so would be advantageous for the fund. A repurchase might be advantageous, for example, because the VIPER Shares are more cost-effective than alternative investments, are selling at a discount to net asset value, will cause the fund to more closely track its index than alternative investments, or some combination of the three. A fund that repurchases its VIPER Shares also may lend those shares to qualified institutional borrowers as part of the fund's securities lending activities. A fund's investments in B-16 VIPER Shares are also subject to the descriptions, limitations and risks described above under the headings "Exchange-Traded Funds" and "Other Investment Companies." WARRANTS. Warrants are instruments which give the holder the right, but not the obligation, to buy an equity security at a specific price for a specific period of time. Changes in the value of a warrant do not necessarily correspond to changes in the value of its underlying security. The price of a warrant may be more volatile than the price of its underlying security, and a warrant may offer greater potential for capital appreciation as well as capital loss. Warrants do not entitle a holder to dividends or voting rights with respect to the underlying security and do not represent any rights in the assets of the issuing company. A warrant ceases to have value if it is not exercised prior to its expiration date. These factors can make warrants more speculative than other types of investments. WHEN-ISSUED, DELAYED-DELIVERY, AND FORWARD-COMMITMENT TRANSACTIONS. When-issued, delayed-delivery, and forward-commitment transactions involve a commitment to purchase or sell specific securities at a predetermined price or yield in which payment and delivery take place after the customary settlement period for that type of security. Typically, no interest accrues to the purchaser until the security is delivered. When purchasing securities pursuant to one of these transactions, the purchaser assumes the rights and risks of ownership, including the risks of price and yield fluctuations and the risk that the security will not be issued as anticipated. Because payment for the securities is not required until the delivery date, these risks are in addition to the risks associated with a fund's investments. When a fund has sold a security pursuant to one of these transactions, the fund does not participate in further gains or losses with respect to the security. If the other party to a delayed-delivery transaction fails to deliver or pay for the securities, a fund could miss a favorable price or yield opportunity or suffer a loss. A fund may renegotiate a when-issued or forward-commitment transaction and may sell the underlying securities before delivery, which may result in capital gains or losses for the fund. When-issued, delayed-delivery, and forward-commitment transactions may be considered to constitute borrowing transactions for purposes of the 1940 Act. When-issued, delayed-delivery, and forward-commitment transactions will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction or segregates sufficient liquid assets in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." INVESTMENT LIMITATIONS Each Fund is subject to the following fundamental investment limitations, which cannot be changed in any material way without the approval of the holders of a majority of the Fund's shares. For these purposes, a "majority" of shares means the lesser of: (1) shares representing 67% or more of the Fund's net assets voted, so long as shares representing more than 50% of the Fund's net assets are present or represented by proxy; or (2) shares representing more than 50% of the Fund's net assets. BORROWING. Each Fund may borrow money for temporary or emergency purposes only in an amount not to exceed 15% of the Fund's net assets. The Fund may borrow money through banks, reverse repurchase agreements, or Vanguard's interfund lending program only, and must comply with all applicable regulatory conditions. The Fund may not make any additional investments whenever its outstanding borrowings exceed 5% of net assets. COMMODITIES. Each Fund may not invest in commodities or commodity contracts, except that it may invest in forward foreign currency exchange transaction, and each Fund may invest in futures contracts and options on futures and securities. No more than 5% of each Fund's total assets may be used as initial margin deposit for futures contracts, and no more than 20% of each Fund's total assets may be obligated under stock futures contracts or options at any time. The Precious Metals Fund may also invest in bullion as described in the prospectus. DIVERSIFICATION. With respect to 75% of its total assets, each Fund (except for the Precious Metals and REIT Index Funds) may not: (1) purchase more than 10% of the outstanding voting securities of any one issuer; or (2) purchase securities of any issuer if, as a result, more than 5% of the Fund's total assets would be invested in that issuer's securities. This limitation does not apply to obligations of the U.S. Government, its agencies, or instrumentalities. For the Precious Metals and REIT Index Funds, each Fund will limit the aggregate value of all holdings (except U.S. Government and cash items, as defined under subchapter M of the Internal Revenue Code (the Code)), each of which exceeds 5% of the Fund's total assets, to an aggregate of 50% of such assets. Additionally, each Fund will limit the aggregate value of holdings of a single issuer (except U.S. Government and cash items, a defined in the Code) to a maximum of 25% of the Fund's total assets. B-17 ILLIQUID SECURITIES. Each Fund may not acquire any security if, as a result, more than 15% of its net assets would be invested in securities that are illiquid. INDUSTRY CONCENTRATION. Each Fund (with the exception of the Dividend Growth Fund) will concentrate its assets in securities of issuers in a particular industry or group of industries denoted by the Fund's name. That is, Vanguard Energy Fund will concentrate in energy-industry securities, Vanguard Health Care Fund will concentrate in health care-industry securities, Vanguard Precious Metals Fund will concentrate in precious metals-industry securities, and Vanguard REIT Index Fund will concentrate in REIT securities. The Dividend Growth Fund will concentrate no more than 25% of its assets in any single industry. INVESTING FOR CONTROL. Each Fund may not invest in a company for the purpose of controlling its management. LOANS. Each Fund may not lend money to any person except by purchasing fixed income securities that are publicly distributed or customarily purchased by institutional investors, by lending its portfolio securities, or through Vanguard's interfund lending program. MARGIN. Each Fund may not purchase securities on margin or sell securities short (unless by virtue of its ownership of other securities it has a right to obtain, at no added cost, securities equivalent in kind and amount to the securities sold), except as permitted by the Funds' investment policies relating to commodities. PLEDGING ASSETS. Each Fund may not pledge, mortgage, or hypothecate more than 15% of its net assets. PUTS AND CALLS. Each Fund may not invest in puts or calls or combinations thereof, except as permitted by the Fund's investment policies relating to commodities. REAL ESTATE. Each Fund (with the exception of the REIT Index Fund, which may invest 100% of its assets in real estate investment trusts) may not invest directly in real estate, although it may invest in securities of companies that deal in real estate, or interests therein. SENIOR SECURITIES. Each Fund may not issue senior securities, except in compliance with the 1940 Act. UNDERWRITING. Each Fund may not engage in the business of underwriting securities issued by other persons. The Fund will not be considered an underwriter when disposing of its investment securities. Compliance with the investment limitations set forth above is measured at the time the securities are purchased. If a percentage restriction is adhered to at the time the investment is made, a later change in percentage resulting from a change in the market value of assets will not constitute a violation of such restriction. None of these limitations prevents a Fund from participating in The Vanguard Group. As a member of The Vanguard Group, each Fund may own securities issued by Vanguard, make loans to Vanguard, and contribute to Vanguard's costs or other financial requirements. See "Management of the Funds" for more information. SHARE PRICE Each Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange (the Exchange), generally 4 p.m., Eastern time. NAV per share for the Energy, Health Care, and REIT Index Funds is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. NAV per share for the Dividend Growth and Precious Metals Funds is computed by dividing the net assets of the Fund by the number of Fund shares outstanding. The Exchange typically observes the following holidays: New Year's Day, Martin Luther King Jr. Day, President's Day, Good Friday, Memorial day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. Although each Fund expects the same holidays to be observed in the future, the Exchange may modify its holiday schedule or hours of operation at any time. PURCHASE OF SHARES The purchase price of shares of each Fund is the NAV per share next determined after the purchase request is received in good order, as defined in the Fund's prospectuses. The NAV per share is calculated as of the close of regular trading on the Exchange on each day the Exchange is open for business. An order received before the close of regular trading on the Exchange will be executed at the price computed on the date of receipt; an order received after the close of regular trading on the Exchange will be executed at the price computed on the next day the Exchange is open. B-18 Each Fund reserves the right in its sole discretion (1) to suspend the offering of its shares, (2) to reject purchase orders, including a purchase by exchange from another Vanguard fund, if management determines such rejection is in the best interest of the Fund, (3) to increase or decrease the minimum amount required to open and maintain an account, without prior notice, (4) to impose a transaction fee on a purchase of the Fund's shares if the purchase, in the opinion of the adviser, would disrupt the efficient management of the Fund, and (5) to reduce or waive the minimum investment for, or any other restrictions on, initial and subsequent investments for certain categories of investors or under circumstances where certain economies can be achieved in sales of the Fund's shares. REDEMPTION OF SHARES Each Fund may suspend redemption privileges or postpone the date of payment for redeemed shares (1) during any period that the Exchange is closed or trading on the Exchange is restricted as determined by the Commission, (2) during any period when an emergency exists, as defined by the Commission, as a result of which it is not reasonable practicable for the Fund to dispose of securities it owns or to fairly determine the value of its assets, and (3) for such other periods as the Commission may permit. Shares redeemed may be worth more or less than what was paid for them, depending on the market value of the securities held by the Fund. Each Fund has made an election with the Commission to pay in cash all redemptions requested by any shareholder of record limited in amount during any 90-day period to the lesser of $250,000 or 1% of the net assets of the Fund at the beginning of such period. If Vanguard determines that it would be detrimental to the best interests of the remaining shareholders of each Fund to make payment wholly or partly in cash, the Fund may pay the redemption price in whole or in part by a distribution in kind of readily marketable securities held by the Fund in lieu of cash in conformity with applicable rules of the Commission. Investors may incur brokerage charges on the sale of such securities received in payment of redemptions. The Dividend Growth Fund does not charge a redemption fee. The Energy, Precious Metals, and REIT Index Funds charge a redemption fee of 1% of the value of shares that were held for less than one year. For the Health Care Fund, shares purchase on or after April 19, 1999, are subject to a 1% fee if redeemed within five years of purchase. Shares purchased before April 19, 1999, are subject to a 1% fee if redeemed within one year of purchase. The fee is withheld from redemption proceeds and retained by the Funds. In the event of an early redemption due to a shareholder's death, all redemption fees will be waived. In order to substantiate the death, a certified copy of the death certificate must be provided. We will always redeem your oldest shares first. In addition, in the event that you transfer your Energy, Health Care, Precious Metals, and REIT Index Funds shares to a different account registration, or convert them to a different share class, the shares will retain their redemption fee status. If you transfer or convert less than 100% of these shares, the redemption fee status of your shares will be carried over on a proportionate basis. For example, assume that John and Mary Doe hold 200 shares in a jointly registered account, with 150 shares (75% of the total shares) currently subject to a redemption fee, and 50 shares (25% of the total shares) currently exempt from the redemption fee. If the Does transfer 50 of their 200 shares to an account registered in one of their individual names, 25% of the transferred shares (or 12.5 shares) will be exempt from the redemption fee, and 75% of the transferred shares (or 37.5 shares) will continue to be subject to the redemption fee. Following the share transfer, the jointly registered account will hold 150 shares, with 25% of the shares (or 37.5 shares) exempt from the redemption fee, and 75% of the shares (or 112.5 shares) still subject to the redemption fee. This same procedure would apply if, rather than transferring shares to a different account registration, the Does were to convert a portion of their shares to a different share class. All fund shares become exempt from the redemption fee based on their initial purchase date, regardless of whether such shares are subsequently transferred to a different account registration or converted to a different share class. The redemption fee may be waived, in Vanguard's sole discretion, for certain categories of redemptions that do not raise short-term trading concerns. These categories include, but are not limited to, the following: 1. Redemptions due to the death of a shareholder; 2. Redemptions within certain institutional retirement or benefit plans for which Vanguard provides specialized recordkeeping or support services; B-19 3. Redemptions due to required minimum distributions from an IRA or other retirement plan for which Vanguard serves as the trustee or custodian; 4. Redemptions within certain Vanguard advisory programs; 5. Redemptions as part of a payment stream within certain annuity programs for which Vanguard provides specialized marketing or support services; and 6. Redemptions within certain pension plans as required by law or regulatory authorities. INVESTING WITH VANGUARD THROUGH OTHER FIRMS The Funds have authorized certain agents to accept on their behalf purchase and redemption orders, and those agents are authorized to designate other intermediaries to accept purchase and redemption orders on the Funds' behalf (collectively, Authorized Agents). A Fund will be deemed to have received a purchase or redemption order when an Authorized Agent accepts the order in accordance with the Fund's instructions. A customer order that is properly transmitted to a Fund by an Authorized Agent will be priced at the Fund's net asset value next determined after the order is received by the agent. MANAGEMENT OF THE FUNDS THE VANGUARD GROUP Each Fund is a member of The Vanguard Group of Investment Companies, which consists of more than 100 funds. Through their jointly-owned subsidiary, The Vanguard Group, Inc., the funds obtain at cost virtually all of their corporate management, administrative, and distribution services. Vanguard also provides investment advisory services on an at-cost basis to several of the Vanguard funds. Vanguard employs a supporting staff of management and administrative personnel needed to provide the requisite services to the funds and also furnishes the funds with necessary office space, furnishings, and equipment. Each fund pays its share of Vanguard's total expenses, which are allocated among the funds under methods approved by the board of trustees of each fund. In addition, each fund bears its own direct expenses, such as legal, auditing, and custodian fees. The funds' officers are also officers and employees of Vanguard. No officer or employee owns, or is permitted to own, any securities of any external adviser for the funds. Vanguard, Vanguard Marketing Corporation, the funds' advisers, and the funds have adopted Codes of Ethics designed to prevent employees who may have access to nonpublic information about the trading activities of the funds (access persons) from profiting from that information. The Codes permit access persons to invest in securities for their own accounts, including securities that may be held by a fund, but place substantive and procedural restrictions on the trading activities of access persons. For example, the Codes require that access persons receive advance approval for every securities trade to ensure that there is no conflict with the trading activities of the funds. Vanguard was established and operates under an Amended and Restated Funds' Service Agreement, which was approved by the shareholders of each of the funds. The Amended and Restated Funds' Service Agreement provides as follows: (1) each Vanguard fund may be called upon to invest up to 0.40% of its current net assets in Vanguard, and (2) there is no other limitation on the dollar amount that each Vanguard fund may contribute to Vanguard's capitalization. The amounts that each of the funds has invested are adjusted from time to time in order to maintain the proportionate relationship between each fund's relative net assets and its contribution to Vanguard's capital. As of January 31, 2003, each Fund had contributed capital to Vanguard, representing 0.02% of each Fund's net assets. The total amount contributed by the Funds was $3,797,000, which represented 3.79% of Vanguard's capitalization. MANAGEMENT. Corporate management and administrative services include: (1) executive staff; (2) accounting and financial; (3) legal and regulatory; (4) shareholder account maintenance; (5) monitoring and control of custodian relationships; (6) shareholder reporting; and (7) review and evaluation of advisory and other services provided to the funds by third parties. DISTRIBUTION. Vanguard Marketing Corporation, a wholly-owned subsidiary of Vanguard, provides all distribution and marketing activities for the funds. The principal distribution expenses are for advertising, promotional materials, and marketing personnel. Distribution services may also include organizing and offering to the public, from time to time, one or more new investment companies that will become members of Vanguard. The funds' trustees review and approve B-20 the amount to be spent annually on distribution activities, as well as the manner and amount to be spent on each fund. The trustees also determine whether to organize new investment companies. One half of the distribution expenses of a marketing and promotional nature is allocated among the funds based upon their relative net assets. The remaining half of those expenses is allocated among the funds based upon each fund's sales for the preceding 24 months relative to the total sales of the funds as a group, provided, however, that no fund's aggregate quarterly rate of contribution for distribution expenses of a marketing and promotional nature shall exceed 125% of the average distribution expense rate for Vanguard, and that no fund shall incur annual distribution expenses in excess of 0.20 of 1% of its average month-end net assets. During the fiscal years ended January 31, 2001, 2002, and 2003, and the six-month period ended July 31, 2003, the Funds paid the following approximate amounts of Vanguard's management and administrative (including transfer agency), distribution, and marketing expenses:
SIX-MONTH PERIOD ENDED FUND 2001 2002 2003 JULY 31, 2003 ---- ---- ---- ---- ------------- Vanguard Dividend Growth Fund $ 3,105,000 $ 2,547,000 $ 1,651,000 $895,000 Vanguard Energy Fund 3,926,000 3,822,000 4,708,000 2,669,000 Vanguard Health Care Fund 34,004,000 38,775,000 35,546,000 17,884,000 Vanguard Precious Metals Fund 1,731,000 1,220,000 2,014,000 766,000 Vanguard REIT Index Fund 2,909,000 3,125,000 4,612,000 2,949,000
INVESTMENT ADVISORY SERVICES Vanguard provides investment advisory services to the Funds and several other Vanguard funds. These services are provided on an at-cost basis from an experienced investment management staff employed directly by Vanguard. OFFICERS AND TRUSTEES The officers of the Funds' manage the day-to-day operations of the Funds' under the direction of the Funds' board of trustees. The trustees set broad policies for the Funds' and choose the Funds' officers. Each trustee serves a Fund until its termination; until the trustee's retirement, resignation, death; or as otherwise specified in the Trust's organizational documents. Any trustee may be removed at a meeting of shareholders by a vote representing two-thirds of the total net asset value of all shares of the Funds'. Each trustee also serves as a director of The Vanguard Group, Inc. The following chart shows information for each trustee and executive officer of the Funds'. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.
VANGUARD POSITION(S) FUNDS' TRUSTEE/ PRINCIPAL OCCUPATION(S) NUMBER OF VANGUARD FUNDS NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS OVERSEEN BY TRUSTEE/OFFICER ------------------- --------------- -------------- -------------------------- --------------------------- INTERESTED TRUSTEE John J. Brennan* Chairman of the May 1987 Chairman of the Board, Chief Executive 112 (1954) Board, Chief Officer, and Director (Trustee) of The Executive Officer, Vanguard Group, Inc. and each of the and Trustee investment companies served by The Vanguard Group, Inc. ------------------------------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES Charles D. Ellis Trustee January 2001 The Partners of '63 (pro bono ventures in 112 (1937) education); Senior Advisor to Greenwich Associates (international business strategy consulting); Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. *Officers of the Funds are "Interested Persons" as defined in the 1940 Act.
B-21
VANGUARD POSITION(S) FUNDS' TRUSTEE/ PRINCIPAL OCCUPATION(S) NUMBER OF VANGUARD FUNDS NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS OVERSEEN BY TRUSTEE/OFFICER ------------------- --------------- -------------- -------------------------- --------------------------- Rajiv L. Gupta Trustee December 2001 Chairman and Chief Executive Officer (since 112 (1945) October 1999), Vice Chairman (January- September 1999), and Vice President (prior to September 1999) of Rohm and Haas Co. (chemicals); Director of Technitrol, Inc. (electronic components) and Agere Systems (communication components); Board Member of American Chemistry Council; Trustee of Drexel University. JoAnn Heffernan Heisen Trustee July 1998 Vice President, Chief Information Officer, and 112 (1950) Member 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 Trustee May 1977 Chemical Bank Chairman's Professor of 110 (1932) Economics, Princeton University; Director of Vanguard Investment Series plc (Irish investment fund) since November 2001, Vanguard Group (Ireland) Limited (investment management) since November 2001, Prudential Insurance Co. of America, BKF Capital (investment management), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). Alfred M. Rankin, Jr. Trustee January 1993 Chairman, President, Chief Executive Officer, 112 (1941) and Director of NACCO Industries, Inc.(forklift trucks/housewares/lignite); Director of Goodrich Corporation (industrial products/ aircraft systems and services). Director of the Standard Products Company (supplier for automotive industry) until 1998. J. Lawrence Wilson Trustee April 1985 Retired Chairman and Chief Executive Officer 112 (1936) of Rohm and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), MeadWestvaco Corp. (paper products), and Amerisource Bergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. ------------------------------------------------------------------------------------------------------------------------------------ EXECUTIVE OFFICERS R. Gregory Barton* Secretary June 2001 Managing Director and General Counsel of 112 (1951) The Vanguard Group, Inc. (since September 1997); Secretary of The Vanguard Group, Inc. and of each of the investment companies served by The Vanguard Group, Inc. (since June 2001); Principal of The Vanguard Group, Inc. (prior to September 1997). Thomas J. Higgins* Treasurer July 1998 Principal of The Vanguard Group, Inc.; 112 (1957) Treasurer of each of the investment companies served by The Vanguard Group, Inc. (since July 1998). *Officers of the Funds are "Interested Persons" as defined in the 1940 Act.
Mr. Ellis is a Senior Advisor to Greenwich Associates, a firm that consults on business strategy to professional financial services organizations in markets around the world. A large number of financial service providers, including Vanguard, subscribe to programs of research-based consulting. During 2001 and 2002, Vanguard paid Greenwich subscription fees amounting to less than $275,000. Vanguard's subscription rates are similar to those of other subscribers. B-22 Board Committees: Each Fund's board has the following committees: - Audit Committee: This committee oversees the accounting and financial reporting policies, the systems of internal controls, and the independent audits of each Fund and Vanguard. All independent trustees serve as members of the committee. The committee held six meetings during each Fund's last fiscal year. - Compensation Committee: This committee oversees the compensation programs established by each Fund and Vanguard for the benefit of their employees, officers, and trustees/directors. All independent trustees serve as members of the committee. The committee held three meetings during each Fund's last fiscal year. - Nominating Committee: This committee nominates candidates for election to Vanguard's board of directors and the board of trustees of each Fund (collectively, the Vanguard boards). The committee also has the authority to recommend the removal of any director or trustee from the Vanguard boards. All independent trustees serve as members of the committee. The committee held three meetings during each Fund's last fiscal year. The Nominating Committee will consider shareholder recommendations for trustee nominees. Shareholders may send recommendations to Mr. Wilson, Chairman of the Committee. TRUSTEES' OWNERSHIP OF FUND SHARES All trustees allocate their investments among the various Vanguard funds based on their own investment needs. The following table shows each trustee's ownership of shares of each Fund and of all Vanguard funds served by the trustee as of December 31, 2002. As a group, the funds trustees and officers own less than 1% of the outstanding shares of each Fund. VANGUARD SPECIALIZED FUNDS
AGGREGATE DOLLAR RANGE OF VANGUARD DOLLAR RANGE OF FUND SHARES FUND SHARES OWNED FUND TRUSTEE OWNED BY TRUSTEE BY TRUSTEE ---- ------- ---------------- ---------- VANGUARD DIVIDEND GROWTH FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel None Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 J. Lawrence Wilson None Over $100,000 VANGUARD ENERGY FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel None Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 J. Lawrence Wilson Over $100,000 Over $100,000 VANGUARD HEALTH CARE FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen $10,001-$50,000 Over $100,000 Burton G. Malkiel None Over $100,000 Alfred M. Rankin, Jr. $50,001-$100,000 Over $100,000 J. Lawrence Wilson Over $100,000 Over $100,000 B-23 VANGUARD PRECIOUS METALS FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel None Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 J. Lawrence Wilson None Over $100,000 VANGUARD REIT INDEX FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel None Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 J. Lawrence Wilson None Over $100,000
TRUSTEE COMPENSATION The same individuals serve as trustees of all Vanguard funds (with one exception, which is noted in the table on page B-22), and each fund pays a proportionate share of the trustees' compensation. The funds also employ their officers on a shared basis; however, officers are compensated by Vanguard, not the funds. INDEPENDENT TRUSTEES. The funds compensate their independent trustees (i.e., the ones who are not also officers of the funds) in three ways: - The independent trustees receive an annual fee for their service to the funds, which is subject to reduction based on absences from scheduled board meetings. - The independent trustees are reimbursed for the travel and other expenses that they incur in attending board meetings. - Upon retirement (after attaining age 65 and completing five years of service), the independent trustees who began their service prior to January 1, 2001, receive a retirement benefit under a separate account arrangement. As of January 1, 2001, the opening balance of each eligible trustee's separate account was generally equal to the net present value of the benefits he or she had accrued under the trustees' former retirement plan. Each eligible trustee's separate account will be credited annually with interest at a rate of 7.5% until the trustee receives his or her final distribution. Those independent trustees who began their service on or after January 1, 2001, are not eligible to participate in the plan. "INTERESTED" TRUSTEE. Mr. Brennan serves as a trustee, but is not paid in this capacity. He is, however, paid in his role as officer of The Vanguard Group, Inc. B-24 COMPENSATION TABLE. The following table provides compensation details for each of the trustees. We list the amounts paid as compensation and accrued as retirement benefits by the Funds for each trustee. In addition, the table shows the total amount of benefits that we expect each trustee to receive from all Vanguard funds upon retirement, and the total amount of compensation paid to each trustee by all Vanguard funds. VANGUARD SPECIALIZED FUNDS TRUSTEES' COMPENSATION TABLE
PENSION OR RETIREMENT ACCRUED ANNUAL TOTAL COMPENSATION AGGREGATE BENEFITS ACCRUED RETIREMENT FROM ALL VANGUARD COMPENSATION AS PART OF THESE BENEFIT AT FUNDS PAID TRUSTEE FROM THESE FUNDS(1) FUNDS' EXPENSES(1) JANUARY 1, 2002(2) TO TRUSTEES(3) ------- ------------------- ------------------ ------------------ -------------- John J. Brennan None None None None Charles D. Ellis $4,405 N/A N/A $108,000 Rajiv L. Gupta 4,405 N/A N/A 108,000 JoAnn Heffernan Heisen 4,405 $87 $2,992 108,000 Burton G. Malkiel 4,425 333 9,799 108,000 Alfred M. Rankin, Jr. 4,405 170 5,000 108,000 J. Lawrence Wilson 5,015 247 7,266 123,000
--------- (1) The amounts shown in this column are based on the Funds' fiscal year ended January 31, 2003. (2) Each trustee is eligible to receive retirement benefits only after completing at least 5 years (60 consecutive months) of service as a trustee for the Vanguard funds. The annual retirement benefit will be paid in monthly installments, beginning with the month following the trustee's retirement from service, and will cease after 10 years of payments (120 monthly installments). Trustees who began their service on or after January 1, 2001, are not eligible to participate in the retirement benefit plan. (3) The amounts reported in this column reflect the total compensation paid to each trustee for his or her service as trustee of 112 Vanguard funds (110 in the case of Mr. Malkiel and 90 in the case of Mr. Gupta) for the 2002 calendar year. INVESTMENT ADVISORY SERVICES VANGUARD ENERGY AND HEALTH CARE FUNDS The Energy and Health Care Funds employ Wellington Management Company, LLP (Wellington Management), 75 State Street, Boston, MA 02109, under an investment advisory agreement to manage the investment and reinvestment of the assets of the Energy and Health Care Funds and to continuously review, supervise, and administer each Fund's investment program. Wellington Management discharges its responsibilities subject to the supervision and oversight of the officers and trustees of the Funds. Under the investment advisory agreement, the two Funds are required to pay the adviser an aggregate fee at the end of each fiscal quarter, calculated by applying a quarterly rate, based on the following annual percentage rates, to the aggregate average month-end net assets of the Funds for the quarter: NET ASSETS RATE ---------- ---- First $500 million .150% Next $500 million .125% Next $1 billion .100% Next $1 billion .075% Over $3 billion .050% The advisory fee is based on the total assets of the Funds and is allocated to each Fund based on the relative net assets of each. B-25 During the fiscal years ended January 31, 2001, 2002, and 2003, and the six-month period ended July 31, 2003, the Funds paid the following amounts in advisory fees to Wellington Management. (Note that prior to June 1, 2003, Wellington Management had a single investment advisory agreement with the Energy, Health Care, and Dividend Growth Funds. Wellington Management now has a separate investment advisory agreement with the Dividend Growth Fund.) SIX-MONTH PERIOD ENDED FUND 2001 2002 2003 JULY 31, 2003 ---- ---- ---- ---- ------------- Energy $ 646,000 $ 697,000 $ 837,000 $473,000 Health Care 6,662,000 8,801,000 9,585,000 4,782,000 Description of Wellington Management. Wellington Management is a Massachusetts limited liability partnership, of which the following persons are managing partners: Laurie A. Gabriel, Duncan M. McFarland, and John R. Ryan. VANGUARD DIVIDEND GROWTH FUND The Dividend Growth Fund employs Wellington Management under an investment advisory agreement to manage the investment and reinvestment of a portion of the assets of the Fund that the Fund's board of trustees determines in its sole discretion to assign to the adviser from time to time (currently the entire Fund), and to continuously review, supervise, and administer the Fund's investment program. Wellington Management discharges its responsibilities subject to the supervision and oversight of the officers and trustees of the Fund. (A) TOTAL QUARTERLY FEE PAYABLE. For services rendered by Wellington Management, the Fund will pay to Wellington Management at the end of each fiscal quarter an amount (the Adjusted Fee) equal to a basic fee (the Basic Fee) plus a performance adjustment amount (the Adjustment Amount), which may be negative, reflecting the investment performance of the Fund relative to the total return of the Russell 1000 Index. The Russell 1000 Index is prepared by the Frank Russell Company (which is not affiliated with the Fund or any of the Fund's affiliates). The Russell 1000 Index is composed of the 1,000 largest U.S. companies (as measured by market capitalization). For purposes of the calculations, both the Basic Fee and the Adjustment Amount will incorporate an asset-based fee (the Asset Fee) that is determined by applying a quarterly rate, calculated based on the following annual percentage rate schedule (shown in (b) below), to the average month-end net assets of the Fund over the applicable time period. (B) BASIC FEE FOR THE QUARTER. The Basic Fee for each quarter is calculated by applying a quarterly rate based on the following annual percentage rates to the average month-end net assets of the Wellington Management Portfolio for the quarter. NET ASSETS RATE ---------- ---- First $1 billion .125% Next $4 billion .100% Over $5 billion .080% (C) PERFORMANCE ADJUSTMENT. The Adjustment Amount is based on the cumulative investment performance of the Wellington Management Portfolio over a trailing 36-month period relative to that of the Russell 1000 Index over the same period. Subject to the transition rules described below, the Adjustment Amount is equal to the product of an adjustment percentage (the Adjustment Percentage) and the Asset Fee as computed over the 36-month period ending with the Relevant Fiscal Quarter (the Relevant 36-Month Period). The Adjustment Percentage will vary based on the investment performance of the Wellington Management Portfolio relative to the investment performance of the Russell 1000 Index as determined for the Relevant 36-Month Period. B-26 The Adjustment Percentage applies as follows: CUMULATIVE PERFORMANCE OF THE WELLINGTON MANAGEMENT PORTFOLIO VS. THE INDEX ADJUSTMENT OVER RELEVANT 36-MONTH PERIOD PERCENTAGE* ----------------------------- ---------- Less than -6% -0.50 X Basic Fee From -6% up to and including -3% -0.25 X Basic Fee Between -3% and +3% 0 X Basic Fee From +3% up to and including +6% +0.25 X Basic Fee More than +6% +0.50 X Basic Fee --------- *For purposes of applying the Adjustment, the Basic Fee will be calculated based on average month-end net assets over the same time period for which performance is measured. (D) PERFORMANCE ADJUSTMENT TRANSITION RULES. The Adjustment Amount will not be fully incorporated into the determination of the Adjusted Fee until the close of the quarter ending July 31, 2006. Until that date, the following transition rules will apply: 1. MAY 31, 2003 THROUGH JANUARY 31, 2004. Wellington Management's compensation will be the Basic Fee. No Adjustment Amount will apply during this period. 2. FEBRUARY 1, 2004 THROUGH JULY 31, 2006. Beginning February 1, 2004, the Adjustment Amount will take effect on a progressive basis with regards to the number of months elapsed between May 31, 2003, and the end of the quarter for which the adviser's fee is being computed. During the period, the Adjustment Amount will be calculated using cumulative performance of the Wellington Management Portfolio and the Index from May 31, 2003, through the end of the applicable quarter. For these purposes, the endpoints and size of the range over which a positive or negative Adjustment Amount applies and the corresponding Adjustment Amount will be multiplied by a fractional time-elapsed adjustment. The fraction will equal the number of months elapsed since May 31, 2003, divided by thirty-six. Example: Assume that the adviser's compensation is being calculated for the quarter ended July 31, 2005, and that the cumulative performance of the Wellington Management Portfolio versus the Index for the applicable period is +5.0%. In this case, an Adjustment Percentage of +36.11% would apply. The following demonstrates the calculation: Calculate the fractional time-elapsed adjustment by dividing 26 months by 36 months (equals 72.22%), then multiply by the endpoints for the range over which the positive or negative Adjustment Amount applies [(26/36) x 3.0% to (26/36) x 6.0% = 2.16% to 4.33%]. Given the Portfolio's cumulative performance of +5.0% is greater than the time-elapsed adjusted range of +2.16% to +4.33%, multiply the fractional time-elapsed adjustment of 72.22% by the corresponding maximum adjustment for the time-elapsed adjusted range of greater than +4.33% or (72.22%)(50.0%) = +36.11%. 3. ON AND AFTER AUGUST 1, 2006. The Adjustment Amount will be fully operable. Under a prior investment advisory agreement among Wellington Management, and the Dividend Growth (which was the Vanguard Utilities Income prior to December 6, 2002), Energy, and Health Care Funds, during the fiscal years ended January 31, 2001, 2002, and 2003, the Dividend Growth Fund paid advisory fees of $522,000, $456,000, and $361,000, respectively, to Wellington Management. VANGUARD PRECIOUS METALS FUND The Precious Metals Fund has entered into an investment advisory agreement with M&G Investment Management Limited (M&G) to manage its assets. Under this agreement M&G manages the investment and reinvestment of the assets of the Precious Metals Fund and continuously reviews, supervises, and administers the Fund's investment program. M&G discharges its responsibilities subject to the supervision and oversight of the officers and trustees of the Fund. The Precious Metals Fund pays M&G a fee at the end of each fiscal quarter, calculated by applying a quarterly rate, based on the following annual percentage rates, to the aggregate average month-end net assets of the Fund for the quarter: NET ASSETS RATE ---------- ---- First $100 million .30% Next $150 million .20% Next $250 million .15% Next $500 million .10% B-27 During the fiscal years ended January 31, 2001, 2002, and 2003, and the six-month period ended July 31, 2003, the Precious Metals Fund paid advisory fees of $668,000, $733,000, and $1,003,000, and $471,000, respectively, to M&G. Description of M&G. M&G is a wholly-owned subsidiary of Prudential plc (an English insurance company not related to The Prudential Insurance Company of America). VANGUARD REIT INDEX FUND An experienced investment management staff employed directly by The Vanguard Group provides investment advisory services to Vanguard REIT Index Fund on an at-cost basis. During the fiscal years ended January 31, 2001, 2002, and 2003, and the six-month period ended July 31, 2003, the Fund incurred expenses for investment advisory services of approximately $15,000, $19,000, and $104,000, and $63,000, respectively. DURATION AND TERMINATION OF INVESTMENT ADVISORY AGREEMENTS Each Fund's current agreement with each adviser is renewable for successive one-year periods, only if (1) each renewal is specifically approved by a vote of the Fund's board of trustees, including the affirmative votes of a majority of the trustees who are not parties to the agreement or "interested persons" (as defined in the 1940 Act) of any such party cast in person at a meeting called for the purpose of considering such approval, or (2) each renewal is specifically approved by a vote of a majority of the Fund's outstanding voting securities. An agreement is automatically terminated if assigned, and may be terminated by the Fund without penalty, at any time, (1) either by vote of the board of trustees on sixty (60) days' written notice to the adviser, (2) by a vote of a majority of the Fund's outstanding voting securities, or (3) by the adviser upon ninety (90) days' written notice to the Fund. BOARD REVIEW OF INVESTMENT ADVISORY ARRANGEMENTS Each Fund's board of trustees oversees the Fund's management and performance on a regular basis. For Vanguard Dividend Growth, Energy, Health Care, and Precious Metals Funds, the board determines annually whether to approve and renew the Fund's investment advisory arrangements. For Vanguard REIT Index Fund, the board considers annually whether the Fund and its shareholders continue to benefit from the internalized management structure whereby the Fund receives investment management services at cost from Vanguard's Quantitative Equity Group. Vanguard provides the board with monthly, quarterly, and annual analysis of each adviser's performance. In addition, the investment advisers provide the board with quarterly self-evaluations and certain other information the board deems important to evaluate the short- and long-term performance of the adviser of Vanguard Dividend Growth, Energy, Health Care, and Precious Metals Funds, and the internalized management of Vanguard REIT Index Fund. Each Fund's portfolio managers meets with the board periodically to discuss the management and performance of the Fund. When considering whether to renew an investment advisory contract (in the case of Vanguard Dividend Growth, Energy, Health Care, and Precious Metals Funds), or continue the internalized management structure of Vanguard REIT Index Fund, the board examines several factors, but does not identify any particular factor as controlling their decision. Some of the factors considered by the board include: the nature, extent, and quality of the advisory services provided as well as other material facts, such as the investment performance of the Fund's assets managed by the adviser and the fair market value of the services provided. The board reviews and considers the extent to which the adviser has realized or will realize economies of scale as the Fund grows. Additional information is provided to the board detailing other sources of revenue to the adviser or its affiliates from its relationship with the Fund; intangible or "fall-out" benefits that accrue to the adviser and its affiliates, if relevant, and the adviser's control of the investment expenses of each Fund, such as transaction costs, including ways in which portfolio transactions for the Funds are conducted and brokers are selected. For Vanguard Dividend Growth, Energy, Health Care, and Precious Metals Funds, the board also takes into account the nature of the fee arrangements, which include breakpoints that will adjust the fee downward as the size of a Fund increases and any performance adjustment that is designed to benefit shareholders by aligning the adviser's fee with the investment returns delivered to shareholders. The board also reviews the investment performance of each Fund compared with a peer group of funds and an appropriate index or combination of indexes, in addition to a comparative analysis of expense ratios of, and advisory fees paid by, similar funds. The following table reflects a sample of the most recent data for each Fund: B-28
AVERAGE ANNUAL RETURN (BEFORE TAXES) ------------------------------------ ADVISORY FEES EXPRESSED AS AN ANNUAL EFFECTIVE 1 YEAR ENDED 5 YEARS ENDED 10 YEARS ENDED RATE OF THE FUNDS' 7/31/2003 7/31/2003 7/31/2003 EXPENSE RATIO AVERAGE NET ASSETS --------- --------- --------- ------------- ------------------ VANGUARD DIVIDEND GROWTH FUND 4.59% -1.44% 4.62% 0.43% 0.10% Dividend Growth Spliced Index* 6.36 -2.57 4.64 N/A N/A Average Large-Cap Core Fund** 8.19 -1.44 8.60 1.41 0.63 Russell 1000 Index 11.19 -0.62 10.19 N/A N/A VANGUARD ENERGY FUND INVESTOR SHARES+ 12.95% 9.30% 9.78% 0.42% 0.06% Average Natural Resources Fund** 10.05 6.01 5.01 1.83 0.70 S&P Energy Sector Index 2.76 3.98 9.83 N/A N/A S&P 500 Index 10.64 -1.06 10.28 N/A N/A VANGUARD HEALTH CARE FUND INVESTOR SHARES+ 11.29% 13.43% 20.86% 0.30% 0.06% Average Health/Biotechnology Fund** 19.44 8.81 14.64 1.84 0.71 S&P Health Sector Index 9.16 2.12 17.43 N/A N/A S&P 500 Index 10.64 -1.06 10.28 N/A N/A VANGUARD PRECIOUS METALS FUND 33.03% 16.91% 1.29% 0.60% 0.20% Average Gold-Oriented Fund** 40.22 13.10 -1.01 1.93 0.71 Citigroup World Equity Gold Index# 33.80 15.16 0.46 N/A N/A S&P 500 Index 10.64 -1.06 10.28 N/A N/A VANGUARD REIT INDEX FUND INVESTOR SHARES+ 15.36% 9.70% 11.41%++ 0.27% 0.01% Average Real Estate Fund** 15.87 9.19 11.02++ 1.63 0.74 Morgan Stanley REIT Index 15.93 9.82 11.50++ N/A N/A Target REIT Composite Index## 15.62 9.72 11.35++ N/A N/A Wilshire 5000 Index *The Dividend Growth Spliced Index is based on the Fund's current and former benchmark indexes. Effective December 6, 2002, the Vanguard Utilities Income Fund changed its investment objective and its name to the Vanguard Dividend Growth Fund. The Dividend Growth Spliced Index consists of the former benchmark, a composite of utilities indexes (from the Fund's inception through December 5, 2002) and the Russell 1000 Index (beginning December 6, 2002). **Derived from data provided by Lipper Inc. +Information about the Fund's Admiral Shares may be found elsewhere in this Statement of Additional Information. #MSCI Gold Mines Index through December 31, 1994, Citigroup World Equity Gold Index thereafter (prior to April 7, 2003, this Index was known as the Salomon Smith Barney World Equity Gold Index). ++Since inception--May 13, 1996--of the REIT Index Fund's Investor Shares. ##The Target REIT Composite Index consists of the Morgan Stanley REIT Index adjusted to include a 2% cash position (Lipper Money Market Average).
Based upon its most recent evaluation of each Fund's investment staff, the portfolio management process, the short- and long-term performance results, the current advisory arrangements for Vanguard Energy, Health Care, Precious Metals, and Dividend Growth Funds, and the at-cost internalized management arrangement for Vanguard REIT Index Fund, the board determined that it would be in the best interests of each Fund's shareholders to renew the investment advisory agreements for Vanguard Dividend Growth, Energy, Health Care, and Precious Metals Funds, and continue the internalized management arrangement for Vanguard REIT Index Fund. The primary factors underlying the board's determination to renew each Fund's advisory arrangements were as follows: DIVIDEND GROWTH FUND (WELLINGTON MANAGEMENT COMPANY, LLP) The board determined that the performance results for the Fund were reasonable as compared with relevant performance standards, including the performance results of: (a) the Utilities Index (the Fund's prior benchmark index) for the same periods; (b) the average utility fund (derived from data provided by Lipper Inc.); and (c) other appropriate market indexes. - The board assessed that the advisory fee paid by the Fund was reasonable based on the average advisory fee for the Fund's Lipper peer group. The board also took into account the nature of the fee arrangements which include breakpoints that will adjust the fee downward as the size of the adviser's portfolio increases and, more recently, a performance adjustment that is designed to benefit shareholders by aligning the adviser's fee with the investment returns delivered to shareholders. B-29 - The board evaluated the adviser's investment staff and portfolio management process, and reviewed the composition and overall performance of the adviser's portfolio on both a short- and long-term basis. The board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interest of the Fund's shareholders was to renew the agreement with Wellington Management. ENERGY FUND (WELLINGTON MANAGEMENT COMPANY, LLP) The board determined that the performance results for the Fund were reasonable as compared with relevant performance standards, including the performance results of: (a) the S&P Energy Sector Index for the same periods; (b) the average natural resources fund (derived from data provided by Lipper Inc.); and (c) other appropriate market indexes. - The board assessed that the advisory fee paid by the Fund was reasonable based on the average advisory fee for the Fund's Lipper peer group. The board also took into account the nature of the fee arrangements which include breakpoints that will adjust the fee downward as the size of the adviser's portfolio increases. - The board evaluated the adviser's investment staff and portfolio management process, and reviewed the composition and overall performance of the adviser's portfolio on both a short- and long-term basis. The board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interest of the Fund's shareholders was to renew the agreement with Wellington Management. HEALTH CARE FUND (WELLINGTON MANAGEMENT COMPANY, LLP) The board determined that the performance results for the Fund were reasonable as compared with relevant performance standards, including the performance results of: (a) the S&P Health Sector Index for the same periods; (b) the average health/biotechnology fund (derived from data provided by Lipper Inc.); and (c) other appropriate market indexes. - The board assessed that the advisory fee paid by the Fund was reasonable based on the average advisory fee for the Fund's Lipper peer group. The board also took into account the nature of the fee arrangements which include breakpoints that will adjust the fee downward as the size of the adviser's portfolio increases. - The board evaluated the adviser's investment staff and portfolio management process, and reviewed the composition and overall performance of the adviser's portfolio on both a short- and long-term basis. The board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interest of the Fund's shareholders was to renew the agreement with Wellington Management. PRECIOUS METALS FUND (M&G INVESTMENT MANAGEMENT LIMITED) The board determined that the performance results for the Fund were reasonable as compared with relevant performance standards, including the performance results of: (a) the Citigroup World Equity Gold Index for the same periods; (b) the average gold-oriented fund (derived from data provided by Lipper Inc.); and (c) other appropriate market indexes. - The board assessed that the advisory fee paid by the Fund was reasonable based on the average advisory fee for the Fund's Lipper peer group. The board also took into account the nature of the fee arrangements which include breakpoints that will adjust the fee downward as the size of the adviser's portfolio increases. - The board evaluated the adviser's investment staff and portfolio management process, and reviewed the composition and overall performance of the adviser's portfolio on both a short- and long-term basis. The board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interest of the Fund's shareholders was to renew the agreement with M&G. B-30 REIT INDEX FUND (THE VANGUARD GROUP, INC.) When the board considers whether Vanguard should continue providing internalized investment management services at cost to the Fund, the board takes into account numerous factors, including: - The nature, extent, and quality of the services provided. - The investment performance of the Fund's assets managed by Vanguard. - The fair market value of the services provided. - A comparative analysis of expense ratios of, and advisory fees paid by, similar funds. - Vanguard's control of the operating expenses of the Fund, such as transaction costs, including ways in which portfolio transactions for the Fund are conducted and brokers are selected. Based upon its most recent evaluation of the investment staff, the portfolio management process, the short- and long-term performance, and the at-cost, internalized management arrangements for the Fund, the board determined that it would be in the best interests of the Fund's shareholders to continue its internalized management arrangement. Vanguard has adopted specific policies regarding the advisers' selection of brokers. For additional information, please see the Portfolio Transactions section of this Statement of Additional Information. PORTFOLIO TRANSACTIONS The advisers, pursuant to their agreements with the Funds, are authorized (with the approval of the Funds' board of trustees) to select the brokers or dealers that will execute the purchases and sales of securities for the Funds and are directed to use their best efforts to obtain the best available price and most favorable execution with respect to all transactions for the Funds. Each adviser has undertaken to execute each investment transaction at a price and commission which provides the most favorable total cost or proceeds reasonably obtainable under the circumstances. During the fiscal years ended January 31, 2001, 2002, and 2003, the Fundss paid the following amounts in brokerage commissions: FUND 2001 2002 2003 ---- ---- ---- ---- Vanguard Dividend Growth Fund $ 911,000 $ 625,000 $ 2,120,000 Vanguard Energy Fund 725,000 994,000 680,000 Vanguard Precious Metals Fund 328,000 1,033,000 1,161,000 Vanguard Health Care Fund 6,080,000 6,084,000 10,803,000 Vanguard REIT Index Fund 237,000 229,000 591,000 Some securities that are considered for investment by a Fund may also be appropriate for other Vanguard funds or for other clients served by the advisers. If such securities are compatible with the investment policies of a Fund and one or more of an adviser's other clients, and are considered for purchase or sale at or about the same time, then transactions in such securities will be aggregated by the adviser and the purchased securities or sale proceeds will be allocated among the participating Vanguard funds and the other participating clients of the adviser in a manner deemed equitable by the adviser. Although there may be no specified formula for allocating such transactions, the allocation methods used, and the results of such allocations, will be subject to periodic review by the Funds' board of trustees. The agreements also incorporate the concepts of Section 28(e) of the Securities Exchange Act of 1934 by providing that, subject to the approval of the Funds' board of trustees, the advisers may cause the Funds to pay a broker-dealer which furnishes brokerage and research services a higher commission than that which might be charged by another broker-dealer for effecting the same transaction, provided that such commission is deemed reasonable in terms of either that particular transaction or the overall responsibilities of the advisers to the Funds. Currently, it is each Fund's policy that each adviser may at times pay higher commissions in recognition of brokerage services felt necessary for the achievement of better execution of certain securities transactions that otherwise might not be available. an adviser will only pay such higher commissions if it believes this to be in the best interest of the Fund. Some brokers or dealers who may receive such higher commissions in recognition of brokerage services related to execution of securities transactions are also providers of research information to the adviser and/or a Fund. However, the B-31 Funds have informed the advisers not to pay higher commission rates specifically for the purpose of obtaining research services. YIELD AND TOTAL RETURNS The annualized yields of each Fund for the 30-day period ended July 31, 2003, are set forth below: SHARE CLASSES ------------- FUND INVESTOR ADMIRAL ---- -------- ------- Vanguard Dividend Growth Fund 1.80% N/A Vanguard Energy Fund 1.61 1.67% Vanguard Health Care Fund 0.93 0.99 Vanguard Precious Metals Fund N/A N/A Vanguard REIT Index Fund* 6.22 6.28 *This yield includes some payments that represent a return of capital by the underlying REITs. The amount of the return of capital is determined by each REIT only after its fiscal year ends. The average annual total returns (both before and after taxes) of each Fund for the one-, five-, and ten-year periods (or since inception) ended July 31, 2003, are set forth below:
5 YEARS ENDED 10 YEARS ENDED 1 YEAR ENDED 7/31/2003* 7/31/2003* 7/31/2003 (or since inception) (or since inception) --------- -------------------- -------------------- VANGUARD DIVIDEND GROWTH FUND Return Before Taxes 4.59% -1.44% 4.62% Return After Taxes on Distributions 3.44 -3.56 2.32 Return After Taxes on Distributions and Sale of Fund Shares 2.86 -2.07 2.77 VANGUARD ENERGY FUND INVESTOR SHARES** Return Before Taxes 12.95% 9.30% 9.78% Return After Taxes on Distributions 11.19 7.92 8.09 Return After Taxes on Distributions and Sale of Fund Shares 9.11 7.45 7.64 VANGUARD ENERGY FUND ADMIRAL SHARES** Return Before Taxes 13.03% 6.77%* -- VANGUARD HEALTH CARE FUND INVESTOR SHARES** Return Before Taxes 11.29% 13.43% 20.86% Return After Taxes on Distributions 8.77 11.44 18.80 Return After Taxes on Distributions and Sale of Fund Shares 7.62 10.84 17.83 VANGUARD HEALTH CARE FUND ADMIRAL SHARES** Return Before Taxes 11.38% 1.98%* -- VANGUARD PRECIOUS METALS FUND** Return Before Taxes 33.03% 16.91% 1.29% Return After Taxes on Distributions 31.07 15.63 0.41 Return After Taxes on Distributions and Sale of Fund Shares 21.17 14.00 0.53
B-32
5 YEARS ENDED 10 YEARS ENDED 1 YEAR ENDED 7/31/2003* 7/31/2003* 7/31/2003 (or since inception) (or since inception) --------- -------------------- -------------------- VANGUARD REIT INDEX FUND INVESTOR SHARES** Return Before Taxes 15.36% 9.70% 11.41%* Return After Taxes on Distributions 12.91 7.28 9.11* Return After Taxes on Distributions and Sale of Fund Shares 9.64 6.72 8.42* VANGUARD REIT INDEX FUND ADMIRAL SHARES** Return Before Taxes 15.49% 17.24% * -- *Since Inception: the inception date for the REIT Index Fund Investor Shares was May 13, 1996, and the inception date for the Energy, HealthCare, and REIT Index Funds Admiral Shares was November 12, 2001. **Total return figures reflective of the 1% fee assessed on redemptions of shares held for less than one year for the Energy, Precious Metals, and REIT Index Funds, and less than one year (for shares purchased before April 19, 1999) or five years (for shares purchased after April 19, 1999) for the Health Care Fund).
B-32 FINANCIAL STATEMENTS Each Fund's Financial Statements for the year ended January 31, 2003, appearing in the Funds' 2003 Annual Reports to Shareholders, and the reports thereon of PricewaterhouseCoopers LLP, independent accountants, also appearing therein, are incorporated by reference in this Statement of Additional Information. For a more complete discussion of each Fund's performance, please see the Fund's Annual or Semiannual Report to Shareholders, which may be obtained without charge. B-33 SAI051 112003 PART C VANGUARD SPECIALIZED FUNDS OTHER INFORMATION ITEM 23. EXHIBITS (a) Declaration of Trust, filed on October 7, 2002, Post-Effective Amendment No. 37, is hereby incorporated by reference. (b) By-Laws, filed on June 30, 1998, Post-Effective Amendment No. 25, are hereby incorporated by reference. (c) Reference is made to Articles III and V of the Registrant's Declaration of Trust (d) Investment Advisory Contracts, for M&G Investment Management Limited filed on December 2, 2002, Post-Effective Amendment No. 39, is hereby incorporated by reference; for Wellington Management Company, LLP, are filed herewith. (e) Not applicable (f) Reference is made to the section entitled "Management of the Funds" in the Registrant's Statement of Additional Information. (g) Custodian Agreements, filed on October 7, 2002, Post-Effective Amendment No. 34, for JP Morgan Chase Bank; filed on December 2, 2002, Post-Effective Amendment No. 39 for Citibank, N.A.; filed on March 28, 2003, Post-Effective amendment No. 40, for Wachovia Bank, N.A.; are herby incorporated by reference. (h) Amended and Restated Funds' Service Agreement, filed on October 7, 2002, Post-Effective Amendment No. 37, is hereby incorporated by reference. (i) Not Applicable (j) Consent of Independent Accountants, filed herewith. (k) Not Applicable (l) Not Applicable (m) Not Applicable (n) Rule 18f-3 Plan, filed on October 7, 2002, Post-Effective Amendment No. 37, is hereby incorporated by reference. (o) Not Applicable (p) Code of Ethics, filed herewith for The Vanguard Group, Inc.; filed on May 23, 2000, Post-Effective Amendment No. 28, for M&G Investment Management Limited; and filed on March 28, 2003, Post-Effective amendment No. 40, for Wellington Management Company, LLP, are hereby incorporated by reference. ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT Registrant is not controlled by or under common control with any person. ITEM 25. INDEMNIFICATION The Registrant's organizational documents contain provisions indemnifying Trustees and officers against liability incurred in their official capacity. Article VII, Section 2 of the Declaration of Trust provides that the Registrant may indemnify and hold harmless each and every Trustee and officer from and against any and all claims, demands, costs, losses, expenses, and damages whatsoever arising out of or related to the performance of his or her duties as a Trustee or officer. However, this provision does not cover any liability to which a Trustee or officer would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his or her office. Article VI of the By-Laws generally provides that the Registrant shall indemnify its Trustees and officers from any liability arising out of their past or present service in that capacity. Among other things, this provision excludes any liability arising by C-1 reason of willful misfeasance, bad faith, gross negligence, or the reckless disregard of the duties involved in the conduct of the Trustee's or officer's office with the Registrant. ITEM 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER Wellington Management Company, LLP (Wellington Management) is an investment adviser registered under the Investment Advisers Act of 1940, as amended (the Advisers Act). The list required by this Item 26 of officers and partners of Wellington Management, together with any information as to any business, profession, vocation or employment of a substantial nature engaged in by such officers and partners during the past two years, is incorporated herein by reference from Schedules B and D of form ADV filed by Wellington Management pursuant to the Advisers Act (SEC File No. 801-15908). M&G Investment Management Limited ( new M&G) is an investment adviser registered under the Advisers Act. The list required by this Item 26 of officers and directors of M&G, together with any information as to any business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated herein by reference from Schedules B and D of Form ADV filed by M&G pursuant to the Advisers Act (SEC File No. 801-21981). The Vanguard Group, Inc. (Vanguard) is an investment adviser registered under the Advisers Act. The list required by this Item 26 of officers and directors of Vanguard, together with any information as to any business profession, vocation, or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated herein by reference from Schedules B and D of Form ADV filed by Vanguard pursuant to the Advisers Act (SEC File No. 801-11953). ITEM 27. PRINCIPAL UNDERWRITERS (a) Not Applicable (b) Not Applicable (c) Not Applicable ITEM 28. LOCATION OF ACCOUNTS AND RECORDS The books, accounts, and other documents required to be maintained by Section 31 (a) of the Investment Company Act and the rules promulgated thereunder will be maintained at the offices of Registrant; Registrant's Transfer Agent, The Vanguard Group, Inc., 100 Vanguard Boulevard, Malvern, Pennsylvania 19355; and the Registrant's Custodians, Wachovia Bank,N.A., PA4942, 123 S. Broad Street, Philadelphia, Pennsylvania 19109, Citibank, N.A., 111 Wall Street, New York, NY 11245, and The Chase Manhattan Bank, N.A., 4 Chase MetroTech Center, Brooklyn, New York 11245. ITEM 29. MANAGEMENT SERVICES Other than as set forth under the description of The Vanguard Group in Part B of this Registration Statement, the Registrant is not a party to any management-related service contract. ITEM 30. UNDERTAKINGS Not Applicable C-2 SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant hereby certifies that it has duly caused this Post-Effective Amendment to this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the Town of Valley Forge and the Commonwealth of Pennsylvania, on the 21st day of November, 2003. VANGUARD SPECIALIZED FUNDS BY:_____________(signature)________________ ----------- (HEIDI STAM) JOHN J. BRENNAN* CHAIRMAN AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Act of 1933, this Post-Effective Amendment to the Registration Statement has been signed below by the following persons in the capacities and on the date indicated:
------------------------------------------------------------------------------------------------ SIGNATURES TITLE DATE ------------------------------------------------------------------------------------------------ By: ---------------------------- President, Chairman, Chief November 21, 2003 /S/ JOHN J. BRENNAN Executive Officer, and Trustee (Heidi Stam) John J. Brennan* By: ---------------------------- Trustee November 21, 2003 /S/ CHARLES D. ELLIS (Heidi Stam) Charles D. Ellis* By: ---------------------------- Trustee November 21, 2003 /S/ RAJIV L. GUPTA (Heidi Stam) RAJIV L. GUPTA* By: ---------------------------- Trustee November 21, 2003 /S/ JOANN HEFFERNAN HEISEN (Heidi Stam) JoAnn Heffernan Heisen* By: ---------------------------- Trustee November 21, 2003 /S/ BURTON G. MALKIEL (Heidi Stam) Burton G. Malkiel* By: ---------------------------- Trustee November 21, 2003 /S/ ALFRED M. RANKIN, JR. (Heidi Stam) Alfred M. Rankin, Jr.* By: ---------------------------- Trustee November 21, 2003 /S/ J. LAWRENCE WILSON (Heidi Stam) J. Lawrence Wilson* By: ---------------------------- Treasurer, Principal Financial November 21, 2003 /S/ THOMAS J. HIGGINS Officer, and Principal (Heidi Stam) Accounting Officer Thomas J. Higgins*
*By Power of Attorney. For Charles D. Ellis, see File Number 33-19446, filed on January 31, 2003; for all other trustees and officers, see File number 2-57689, filed on December 26, 2002. Incorporated by Reference.