N-30D 1 0001.txt VANGUARD PREFERRED STOCK FUND REPORT VANGUARD PREFERRED STOCK FUND [PHOTO] ANNUAL REPORT October 31, 2000 [THE VANGUARD GROUP LOGO] OUR REPORTS TO THE OWNERS At Vanguard, we regard our investors not as mere customers but as owners of the enterprise. For that's exactly what a mutual fund shareholder is--part owner of an investment company. In our reports to you on how the company is doing, we have tried to convey information without hyperbole and in the context of broad market trends and relevant benchmarks. We've introduced several changes to this year's annual reports to make them even more useful. Among the changes: o Larger type and redesigned graphics to make the reports easier to read. o An at-a-glance summary of key points about fund performance and the financial markets. o A table--included for many funds--in which the investment adviser highlights significant changes in holdings. o Comparisons of fund performance and characteristics against both a broad market index and a "best fit" benchmark. We hope you'll find that these changes make the reports even more accessible and informative. SUMMARY o Vanguard Preferred Stock Fund's return was flat for the 2000 fiscal year, as preferred stock prices fell due to heightened concerns about credit quality. o Yields on high-quality, long-term bonds generally declined during the 12 months, while short-term yields climbed. o On December 3, the Preferred Stock Fund passed its first quarter-century. CONTENTS 1 Letter from the Chairman 6 Report from the Adviser 8 Fund Profile 9 Glossary of Investment Terms 10 Performance Summary 11 Financial Statements 18 Report of Independent Accountants LETTER from the Chairman Fellow Shareholders, Fixed income investors shunned riskier securities during the 12 months ended October 31, 2000, and the prices of many preferred stocks declined sharply. As a result, vanguard preferred stock fund endured a tough 2000 fiscal year and ended the period with a flat return. The adjacent table compares the fund's 12-month total return with the returns of the average fixed income fund and a broad measure of the preferred stock market. As you can see, your fund lagged both of its comparative measures. 2000 TOTAL RETURNS Fiscal Year Ended October 31 --------------------------------------------------------------- Vanguard Preferred Stock Fund 0.0% Average Fixed Income Fund* 4.4 Merrill Lynch Fixed Rate Preferred Stock Index** 0.4 --------------------------------------------------------------- *Derived from data provided by Lipper Inc. **Merrill Lynch DRD-Eligible Preferred Index through February 2000; Merrill Lynch Fixed Rate Preferred Stock Index thereafter. The fund's total return (capital change plus reinvested dividends) is based on a decline in net asset value from $9.44 per share on October 31, 1999, to $8.84 per share on October 31, 2000, and is adjusted for the reinvestment of dividends totaling $0.59 per share paid from net investment income. The fund's yield on October 31, 2000, was 6.59%, up from 6.14% a year earlier. As you may recall, Vanguard Preferred Stock Fund's board of trustees decided last year to broaden the range of securities available to the fund's investment adviser. Previously, the fund was permitted to invest only in securities that qualified for the 70% intercorporate dividends-received deduction (DRD), a special federal tax break available to corporations, but not to individual investors. The new policy took effect on March 1, 2000, but so far the fund's adviser, Wellington Management Company, LLP, has not purchased any non-DRD-eligible securities. MARKET BAROMETER Average Annual Total Returns Periods Ended October 31, 2000 -------------------------------------------------------------------------------- One Three Five Year Years Years -------------------------------------------------------------------------------- STOCKS S&P 500 INDEX (Large-caps) 6.1% 17.6% 21.7% RUSSELL 2000 INDEX (Small-caps) 17.4 5.9 12.4 WILSHIRE 5000 INDEX (Entire market) 8.1 16.0 20.1 MSCI EAFE INDEX (International) -2.7 9.7 8.9 -------------------------------------------------------------------------------- BONDS LEHMAN AGGREGATE BOND INDEX (Entire market) 7.3% 5.7% 6.3% LEHMAN 10 YEAR MUNICIPAL BOND INDEX 8.2 5.0 5.7 SALOMON SMITH BARNEY 3-MONTH U.S. TREASURY BILL INDEX 5.7 5.2 5.2 ================================================================================ CPI CONSUMER PRICE INDEX 3.4% 2.5% 2.5% -------------------------------------------------------------------------------- Because of its focus on 1 DRD-eligible securities, Vanguard Preferred Stock Fund may not be an appropriate investment for individual investors, who cannot use the special corporate tax deduction and therefore are not compensated for the interest rate and credit risks faced by the fund. FINANCIAL MARKETS IN REVIEW During the 12 months ended October 31, the economic environment was generally favorable for stocks and bonds. Early in the period, production rose rapidly, unemployment fell below 4% of the workforce, long-term interest rates declined, and inflation stayed well-behaved, aside from a rise in energy prices. But as the period progressed, evidence suggested that the economy's expansion was slowing in the wake of repeated increases in short-term interest rates engineered by the Federal Reserve Board. And despite solid increases in corporate earnings, doubts grew about the sustainability of the gains. As a result, all was not calm in the stock market or in certain segments of the fixed income markets. Extreme volatility afflicted the U.S. stock market almost daily, and although the overall bond market fared well, many higher-yielding securities took it on the chin. ---------------------- The economic back- drop was favorable, on balance, for stocks and bonds. ---------------------- Short-term interest rates rose substantially during the year, with the yield on 3-month U.S. Treasury bills increasing more than 1.3 percentage points. The rise essentially matched the 1.25-point hike in the federal funds rate engineered in four steps by the Fed, which was trying to cool the economy to stave off inflation. Yields were relatively flat, on balance, for most longer-term securities. A rising federal budget surplus shrank the supply of U.S. Treasury securities, and yields of U.S. Treasury bonds declined slightly for the fiscal year: The 30-year Treasury's yield fell from 6.16% to 5.79%. Yields on 10-year Treasuries fell by about a quarter-point. The Lehman Brothers Aggregate Bond Index, a proxy for investment-grade bonds, returned 7.3%, outpacing the Standard & Poor's 500 Index. Though interest rate movements always play a big role in the bond market, concerns about credit quality took center stage in recent months. The deceleration in economic growth prompted bond investors to shy away from speculative issues, and prices of high-yield bonds fell; the Lehman Brothers High Yield Bond Index returned -1.6% due to average price declines exceeding -10%. Mortgage-backed securities and high-quality corporate bonds performed well. --------------------- Many investors shied away from speculative issues during the fiscal year. --------------------- The U.S. stock market began the fiscal year like a skyrocket, as investors exhibited extreme enthusiasm for technology-related stocks. But beginning in early spring, investors seemed to grow wary of the 2 lofty prices of many tech and telecommunications stocks in relation to their earnings and other fundamentals. Value stocks--those characterized by relatively low prices in relation to earnings, book value, and dividends--generally benefited from the market's increased attention to current earnings. For the full 12 months, the overall stock market, as measured by the Wilshire 5000 Total Market Index, returned 8.1%--a decent result but below the double-digit gains investors have seen in recent years. For a change, small- and mid-capitalization stocks outpaced their large-cap counterparts. The small-cap Russell 2000 Index returned 17.4% for the 12 months, 11.3 percentage points ahead of the return of the large-cap S&P 500 Index, which accounts for roughly three-fourths of the market value of U.S. stocks. FISCAL 2000 PERFORMANCE OVERVIEW Although yields declined and prices rose modestly for long-term U.S. Treasury and high-quality corporate bonds during the fiscal year, prices declined and yields rose for securities with less-than-stellar credit quality--including most preferred stocks. The divergence in yields for higher- and lower-quality securities stemmed from investor concerns that a slowing economy and rising corporate debt levels would result in increased defaults. For Vanguard Preferred Stock Fund, the result was a zero return, as price decreases for our holdings offset a healthy 6.4% return from interest income. The fund returned -2.7% during the first half of the fiscal year and regained that ground--but no more--during the second half. The market's aversion to lower credit quality hit preferred stocks hard because preferreds have lower standing than bonds in a corporation's capital structure. This means that should the corporation have financial trouble, bondholders are paid before holders of its preferred stock. This distinction makes the Preferred Stock Fund riskier than the average fixed income fund, and it largely explains why we trailed our average peer during the fiscal year. We fared better in relation to our unmanaged index, which eked out a 0.4% return. The index better reflects activity in the market for preferred stocks. The Report from the Adviser on page 6 provides more details. TOTAL RETURNS Ten Years Ended October 31, 2000 Average Final Value of Annual a $10,000 Return Initial Investment -------------------------------------------------------------------------------- Vanguard Preferred Stock Fund 8.5% $22,550 Average Fixed Income Fund 7.3 20,211 Merrill Lynch Fixed Rate Preferred Stock Index* 8.6 22,845 -------------------------------------------------------------------------------- *Merrill Lynch Perpetual Preferred Index through January 1997; Merrill Lynch DRD-Eligible Preferred Index through February 2000; Merrill Lynch Fixed Rate Preferred Stock Index thereafter. LONG-TERM PERFORMANCE OVERVIEW The true measure of any investment is best taken over the long term. The adjacent table presents the 3 average annual returns of Vanguard Preferred Stock Fund and its comparative benchmarks for the past ten years. It also shows the results of hypothetical $10,000 investments made a decade ago in each. As you can see, the fund measured up well against the average fixed income fund and came up just a hair short of our benchmark index, which is a hard target to beat because its returns reflect no operating expenses or administrative costs. Both our absolute and relative results were aided by a general decline in long-term interest rates during the past decade. Our average return for the decade may suggest a smoother path than our shareholders actually experienced. There was considerable year-to-year volatility, with fiscal-year returns ranging from a low of -8.5% in 1994--a period of rapidly rising interest rates--to a high of 23.8% in fiscal 1995, when rates fell sharply. We offer this brief history lesson as a reminder that preferred stock returns are subject to considerable short-term fluctuations. To earn solid long-term returns, investors must ride out the short-term swings. For this reason, we urge investors in Vanguard Preferred Stock Fund to take the long view and be prepared for interim turbulence. --------------------- Preferred Stock Fund investors should be prepared for interim turbulence. --------------------- Our constant goal is to provide long-term returns that exceed those of our competitive measures. Our low costs are a significant aid as we pursue this objective. Your fund has an expense ratio (annual expenses as a percentage of average net assets) of 0.39%, a fraction of the 1.04% charged by the average fixed income fund. That means that for every $1,000 invested in your fund, $3.90 goes toward expenses. For every $1,000 invested in our average peer, $10.40 is consumed by expenses. Because fund operating and administrative costs directly reduce the returns investors receive, our significant cost advantage provides us with a head start versus funds that charge higher expenses. We understand that the past 24 months have been a difficult period for the preferred stock market, and we are grateful for the trust you have placed in Vanguard and the Preferred Stock Fund. We are confident that our investment approach is a sound way to capture the returns available from preferred stocks. We pledge to continue to provide an attractive level of after-tax income at a cost far lower than that of similar funds. IN SUMMARY Though some investors will always be tempted to chase the hottest-performing segment of the financial markets--whether it's technology stocks, small-caps, or long-term bonds--market movements over the past 12 months have proven just how difficult and treacherous that pursuit can be. Sectors fall in and out of favor, asset classes shift from leader to laggard, and securities rise and fall in unpredictable patterns. We suggest that rather 4 than fighting these truths of investing, you use them to your advantage by constructing a diversified, portfolio of stock funds, fixed income funds, and short-term investments that strikes a reasonable balance between the risk and rewards of the financial markets. Sincerely, /S/ JOHN J. BRENNAN [PHOTO] JOHN J. BRENNAN Chairman and Chief Executive Officer November 15, 2000 5 REPORT from the Adviser WELLINGTON MANAGEMENT COMPANY, LLP For the 6- and 12-month periods ended October 31, 2000, VANGUARD PREFERRED STOCK FUND posted total returns of 2.8% and 0.0%, respectively. Our returns reflect the decline in the prices of many preferred stocks during the fiscal year. THE INVESTMENT ENVIRONMENT The fiscal year began on November 1, 1999, with the yield of the 30-year U.S. Treasury bond at 6.16% and the yield of a representative preferred stock at 6.63%. Twelve months later, the long-term Treasury bond's yield was 37 basis points lower, while preferred stock yields were 47 basis points higher. Thus, the yield differential between riskless Treasuries and preferred stocks expanded by 84 basis points (or just under one percentage point), reflecting an unfavorable environment for preferred stocks. This unusual split in the direction of yields occurred during a time when the supplies of both preferreds and Treasuries were shrinking. The current difference between the yields of a-rated utilities' perpetual preferreds and 30-year Treasuries is 259 basis points, up from 239 basis points six months ago. The ten-year average spread is 196 basis points. The upshot is that, on a historical basis, preferreds are now inexpensive versus Treasuries. Compared with municipal bonds, preferreds today offer 90 basis points of additional after-tax yield, well above the ten-year average of 59 basis points. -------------------------------------------------------------------------------- INVESTMENT PHILOSOPHY The adviser believes that the fund can provide a relatively high and sustainable level of income by investing primarily in dividend-paying, high-quality, preferred stocks. -------------------------------------------------------------------------------- A positive factor for preferred securities during the fiscal year was the absence of discussion in Congress about lowering the corporate dividends-received deduction (DRD). Proposals to lower the DRD have surfaced in the past, but we know of no current proposals to change it from the existing level of 70%. As discussed in the last annual report, the fund's board of trustees has broadened our investment guidelines to allow us to purchase non-DRD-eligible securities when attractively priced DRD preferreds are not available. So far, we have not exercised this option. THE FISCAL YEAR IN REVIEW The fund experienced no interruptions in dividend payments, and income remained reasonably stable. The fund's investments continue to be well- diversified, with holdings from nearly 50 issuers. As yields of long-term Treasury bonds declined, yields of preferred stocks did not follow suit, as one might have expected from securities with 6 long average durations. This is because risk premiums widened across all domestic fixed income sectors, including preferreds. (Typically, longer-maturity fixed income securities such as bonds and preferred stocks benefit more from declines in interest rates, just as they suffer more when rates rise.) As the Federal Reserve Board attempted to curtail credit to slow the domestic economy, the marginal borrower--any issuer that ranked relatively low in the capital structure--had to pay a relatively steeper price to obtain credit. Preferred stock issuers were no exception, because preferred stock ranks below ordinary bonds in corporations' capital structure; that is, preferred dividends are paid only after other debt obligations are met. We believe that the Fed has accomplished its goal of slowing the domestic economy to a less-inflationary rate of growth and that, as a consequence, risk premiums should remain stable or even contract slightly. Thus, we expect to see the fund earn back some of the ground it lost due to the widening of yield spreads in fiscal 2000. THE FUND'S POSITION The investment goals and strategy of the fund are consistent with those put in place at its inception a quarter-century ago. We purchase relatively high-quality preferred stocks with the goal of providing sustainable and attractive after-tax income. We attempt to control income risk and variability by investing in securities with call protection that are issued by highly creditworthy companies. We attempt to maintain income stability through broad diversification; securities from 46 issuers were in the fund on October 31. The risk to the fund's net asset value from a reduction in the DRD is always present, as is the risk of price declines for our holdings due to rising long-term interest rates. These risks cannot be hedged over the long term. Lacking a stated maturity, preferreds perform poorly when rates are rising and well when rates are falling. We expect rates to fall slightly because the domestic economy is slowing. We also believe that the next change in short-term rates by the Federal Reserve could be to cut them. As of October 31, the fund's credit-quality breakdown (based on Moody's Investors Service ratings) was cash/Treasuries, 4%; aa-rated securities, 27%; a, 47%; and baa, 22%. The electric utility sector is the fund's largest industry exposure, representing about half of total assets. High-quality financial services companies accounted for the next-largest industry exposure. Earl E. McEvoy, Senior Vice President and Portfolio Manager November 10, 2000 7 FUND PROFILE As of October 31, 2000 for Preferred Stock Fund This Profile provides a snapshot of the fund's characteristics, compared where appropriate to both an unmanaged index that we consider a "best fit" for the fund and a broad market index. Key terms are defined on page 9. ---------------------------------------------------------- PORTFOLIO CHARACTERISTICS Lehman Fund Best Fit* Index** ---------------------------------------------------------- Number of Securities 49 152 6,044 Yield 6.6% 8.5% 7.0% Average Coupon 6.5% 8.3% 6.9% Average Quality a2 a3 Aaa Turnover Rate 6% -- -- Expense Ratio 0.39% -- -- Cash Investments 3.6% -- -- ---------------------------------------------------------- *Merrill Lynch Fixed Rate Preferred Stock Index. **Lehman Aggregate Bond Index. --------------------------------------------- TEN LARGEST HOLDINGS (% of total net assets) Federal Home Loan Mortgage Corp. 11.5% USA Education 4.7 Florida Power & Light Co. 3.9 Alabama Power Co. 3.8 PacifiCorp 3.8 Citigroup, Inc. 3.8 South Carolina Electric & Gas Co. 3.1 Indianapolis Power & Light 3.1 Virginia Electric & Power Co. 2.9 PPL Electric Utilities Corp. 2.8 --------------------------------------------- Top Ten 43.4% --------------------------------------------- ----------------------------- DISTRIBUTION BY COUPON (% of portfolio) Under 4% 2.7% 4%-5% 1.4 5%-6% 25.6 6%-7% 39.9 7%-8% 30.4 8%-9% 0.0 9%-10% 0.0 Over 10% 0.0 ----------------------------- Total 100.0% ----------------------------- ------------------------------------------------- SECTOR DIVERSIFICATION (% of preferred stocks) Auto & Transportation 0.0% Consumer Discretionary 0.0 Consumer Staples 0.3 Financial Services 43.4 Health Care 0.0 Integrated Oils 0.0 Other Energy 1.1 Materials & Processing 3.4 Producer Durables 0.0 Technology 0.8 Utilities 51.0 Other 0.0 ------------------------------------------------- ------------------------- DISTRIBUTION BY CREDIT QUALITY (% of preferred stocks) Treasury/Agency 1.5% aaa 0.0 aa 27.4 a 47.4 baa 22.1 ba 0.0 b 0.0 Not Rated 1.6 ------------------------- Total 100.0% ------------------------- 8 GLOSSARY of Investment Terms AVERAGE COUPON. The average interest rate paid on the securities held by a fund. It is expressed as a percentage of face value. -------------------------------------------------------------------------------- AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the ratings assigned to a fund's securities holdings by credit-rating agencies. The agencies make their judgment after appraising an issuer's ability to meet its obligations. Quality is graded on a scale, with aaa indicating the most creditworthy issuers of preferred stocks. -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. -------------------------------------------------------------------------------- DISTRIBUTION BY COUPON. A breakdown of the securities in a fund according to coupon rate--the interest rate that an issuer promises to pay, expressed as an annual percentage of face value. Securities with unusually high coupon rates may be subject to call risk, the possibility that they will be redeemed (or "called") early by the issuer. -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. -------------------------------------------------------------------------------- TURNOVER RATE. An indication of trading activity during the past year. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is the rate of return an investor would receive if the securities were held to their maturity dates. -------------------------------------------------------------------------------- 9 PERFORMANCE SUMMARY for Preferred Stock Fund All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. -------------------------------------------------------------------------------- TOTAL INVESTMENT RETURNS (%) October 31, 1990-October 31, 2000 -------------------------------------------------------------------------------- PREFERRED STOCK FUND MERRILL LYNCH INDEX* FISCAL CAPITAL INCOME TOTAL TOTAL YEAR RETURN RETURN RETURN RETURN -------------------------------------------------------------------------------- 1991 10.2% 10.6% 20.8% 28.8% 1992 2.9 8.4 11.3 13.5 1993 7.2 8.4 15.6 10.4 1994 -15.2 6.7 -8.5 -5.0 1995 15.1 8.7 23.8 18.0 1996 0.6 7.4 8.0 7.4 1997 5.2 7.2 12.4 8.8 1998 1.9 6.1 8.0 6.4 1999 -7.8 5.3 -2.5 1.2 2000 -6.4 6.4 0.0 0.4 -------------------------------------------------------------------------------- *Merrill Lynch Perpetual Preferred Index through January 1997; Merrill Lynch DRD-Eligible Preferred Index through February 2000; Merrill Lynch Fixed Rate Preferred Stock Index thereafter. See Financial Highlights table on page 15 for dividend and capital gains information for the past five years. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- CUMULATIVE PERFORMANCE October 31, 1990-October 31, 2000 [CHART] INITIAL INVESTMENT OF $10,000 QUARTER PREFERRED AVERAGE FIXED MERRILL LYNCH LEHMAM AGGREGATE ENDED STOCK FUND INCOME FUND FIXED RATE BOND INDEX PREFERRED STOCK 199010 $ 10000 $ 10000 $ 10000 $ 10000 199101 10575 10416 10830 10503 199104 11132 10931 11689 10781 199107 11296 11193 11917 10988 199110 12083 11789 12877 11581 199201 12673 12114 13456 11871 199204 12694 12273 13639 11966 199207 13382 12883 14258 12612 199210 13454 12958 14620 12719 199301 13903 13377 14825 13174 199304 14492 13765 15371 13553 199307 14940 14138 15739 13894 199310 15547 14440 16141 14229 199401 15617 14603 16426 14378 199404 14540 13959 15325 13668 199407 14655 14118 15563 13907 199410 14233 13979 15336 13707 199501 14670 14133 15835 14045 199504 15826 14679 16757 14667 199507 16730 15264 17454 15313 199510 17619 15721 18088 15852 199601 18066 16259 18602 16426 199604 17730 15830 18475 15935 199607 18211 16078 18772 16161 199610 19035 16640 19427 16779 199701 19430 16914 19787 16962 199704 19853 16900 20144 17064 199707 20985 17736 20692 17900 199710 21402 18040 21129 18271 199801 22228 18536 21642 18780 199804 22464 18605 21773 18926 199807 23007 18950 22310 19309 199810 23114 19099 22486 19978 199901 23486 19511 22885 20297 199904 23716 19396 23166 20113 199907 23041 19182 23004 19790 199910 22542 19364 22746 20084 200001 21722 19341 21888 19922 200004 21939 19425 22065 20366 200007 21969 19886 22799 20971 200010 22550 20211 22845 21550 AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED OCTOBER 31, 2000 FINAL VALUE -------------------------------- OF A $10,000 1 YEAR 5 YEARS 10 YEARS INVESTMENT -------------------------------------------------------------------------------- Preferred Stock Fund 0.03% 5.06% 8.47% $22,550 Average Fixed Income Fund* 4.37 5.15 7.29 20,211 Merrill Lynch Fixed Rate Preferred Stock Index** 0.44 4.78 8.61 22,845 Lehman Aggregate Bond Index 7.30 6.33 7.98 21,550 -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. **Merrill Lynch Perpetual Preferred Index through January 1997; Merrill Lynch DRD-Eligible Preferred Index through February 2000; Merrill Lynch Fixed Rate Preferred Stock Index thereafter. 11 FINANCIAL STATEMENTS October 31, 2000 STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (preferred stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets on both a dollar and per-share basis. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. -------------------------------------------------------------------------------- MARKET VALUE* PREFERRED STOCK FUND SHARES (000) -------------------------------------------------------------------------------- PREFERRED STOCKS (94.9%) -------------------------------------------------------------------------------- CONSUMER STAPLES (0.3%) Stokely-Van Camp Corp. 5.00% 45,000 $ 631 ---------- FINANCIAL SERVICES (41.1%) BANKS--NEW YORK CITY (4.0%) The Chase Manhattan Corp. 4.96% 25,000 1,128 HSBC USA, Inc. $2.858 50,000 2,038 J. P. Morgan & Co., Inc. 6.625% 100,000 5,081 BANKS--OUTSIDE NEW YORK CITY (7.4 %) (1)ABN-AMRO North America 6.59% 4,000 3,775 Comerica, Inc. 6.84% 50,000 2,487 FleetBoston Financial Corp. 6.75% 100,000 5,175 PNC Financial Services Group 6.05% 25,000 1,250 Wells Fargo & Co 6.59% 50,000 2,518 DIVERSIFIED FINANCIAL SERVICES (3.8%) Citigroup, Inc. 6.365% 170,000 7,682 FINANCE COMPANIES (5.4%) Heller Financial, Inc. 6.687% 15,000 1,328 USA Education 6.97% 200,000 9,600 FINANCIAL--MISCELLANEOUS (15.7%) Federal Home Loan Mortgage Corp. 5.00% 250,000 $ 9,938 Federal Home Loan Mortgage Corp. 5.10% 100,000 4,228 Federal Home Loan Mortgage Corp. 5.79% 198,400 9,325 Federal National Mortgage Assn. 6.45% 100,000 4,912 MBNA Corp. 7.50% 150,000 3,675 INSURANCE--PROPERTY-CASUALTY (2.3%) (1)Hillbrook Insurance Co. 5.90% 55 4,785 SECURITIES BROKERS & SERVICES (2.5%) Morgan Stanley Dean Witter Co. 7.75% 100,000 5,081 ---------- 84,006 ---------- OTHER ENERGY (1.0%) Apache Corp. 5.68% 25,000 2,074 ---------- MATERIALS & PROCESSING (3.3%) Alcoa, Inc. $3.75 77,490 4,301 E.I. du Pont de Nemours & Co. 3.50% 15,600 831 E.I. du Pont de Nemours & Co. $4.50 22,925 1,536 ---------- 6,668 ---------- 11 -------------------------------------------------------------------------------- MARKET VALUE* PREFERRED STOCK FUND SHARES (000) -------------------------------------------------------------------------------- TECHNOLOGY (0.7%) International Business Machines Corp. 7.50% 57,500 $ 1,455 ---------- UTILITIES--ELECTRICAL (48.5%) Alabama Power Co. 5.20% 400,000 7,800 Baltimore Gas & Electric Co. 7.125% 52,000 5,458 Boston Edison Co. 4.78% 2,000 136 Carolina Power & Light Co. 5.44% 4,319 332 Duke Energy Corp. 7.85% 20,544 2,160 Duquesne Light Co. 3.75% 4,200 118 Florida Power & Light Co. 6.98% 80,000 7,998 Idaho Power Co. 7.07% 25,000 2,401 Indianapolis Power & Light 5.65% 75,000 6,253 Monongahela Power Co. 7.73% 50,000 5,091 PECO Energy Co. $7.48 50,000 4,907 PPL Electric Utilities Corp. 6.75% 60,000 5,760 PSI Energy Inc. 6.875% 25,000 2,416 Pacific Gas & Electric Co. 7.04% 176,650 4,240 PacifiCorp 7.48% 75,000 7,716 Puget Sound Energy 7.45% 200,000 5,113 San Diego Gas & Electric Co. $1.70 140,000 3,525 Sierra Pacific Power Co. 7.80% 200,000 5,425 South Carolina Electric & Gas Co. 6.52% 65,000 6,320 TXU Electric Co. $7.98 45,000 4,545 Union Electric Co. $7.64 25,000 2,536 Virginia Electric & Power Co. $6.98 60,000 5,990 Wisconsin Power & Light Co. 6.20% 18,500 1,667 Wisconsin Public Service Corp. 6.88% 10,000 1,013 ---------- 98,920 ---------- -------------------------------------------------------------------------------- TOTAL PREFERRED STOCKS (Cost $209,071) 193,754 -------------------------------------------------------------------------------- FACE AMOUNT (000) -------------------------------------------------------------------------------- U.S. GOVERNMENT OBLIGATION (1.5%) -------------------------------------------------------------------------------- U.S. TREASURY NOTE 5.75%, 8/15/2010 (Cost $3,008) $3,000 2,997 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* (000) (000) -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENT (3.5%) -------------------------------------------------------------------------------- REPURCHASE AGREEMENT Collateralized by U.S. Government Obligations in a Pooled Cash Account 6.56%, 11/1/2000 (Cost $7,170) $7,170 $ 7,170 -------------------------------------------------------------------------------- TOTAL INVESTMENTS (99.9%) (Cost $219,249) 203,921 -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (0.1%) -------------------------------------------------------------------------------- Other Assets--Note C 760 Liabilities (570) ---------- 190 ---------- -------------------------------------------------------------------------------- NET ASSETS (100%) -------------------------------------------------------------------------------- Applicable to 23,093,213 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $204,111 ================================================================================ NET ASSET VALUE PER SHARE $8.84 ================================================================================ *See Note A in Notes to Financial Statements. (1)Security exempt from registration under Rule 144A of the Securities Act of 1933. These securities may be sold in transactions exempt from registration, normally to qualified institutional buyers. At October 31, 2000, the aggregate value of these securities was $8,560,000, representing 4.2% of net assets. -------------------------------------------------------------------------------- AT OCTOBER 31, 2000, NET ASSETS CONSISTED OF: -------------------------------------------------------------------------------- Amount Per (000) Share -------------------------------------------------------------------------------- Paid in Capital $ 230,304 $9.97 Undistributed Net Investment Income 966 .04 Accumulated Net Realized Loss--Note D (11,831) (.51) Unrealized Depreciation-- Note E (15,328) (.66) -------------------------------------------------------------------------------- NET ASSETS $204,111 $8.84 ================================================================================ 12 STATEMENT OF OPERATIONS This Statement shows dividend and interest income earned by the fund during the reporting period, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) on investments during the period. -------------------------------------------------------------------------------- PREFERRED STOCK FUND YEAR ENDED OCTOBER 31, 2000 (000) -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends $16,358 Interest 258 -------------------------------------------------------------------------------- Total Income 16,616 -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fee --Note B 337 The Vanguard Group--Note C Management and Administrative 515 Marketing and Distribution 43 Custodian Fees 15 Auditing Fees 9 Shareholders' Reports 18 -------------------------------------------------------------------------------- Total Expenses 937 -------------------------------------------------------------------------------- NET INVESTMENT INCOME 15,679 -------------------------------------------------------------------------------- REALIZED NET LOSS ON INVESTMENT SECURITIES SOLD (11,638) -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES (6,972) -------------------------------------------------------------------------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $(2,931) ================================================================================ 13 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the amount shareholders invested in the fund, either by purchasing shares or by reinvesting distributions, as well as the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed are shown at the end of the Statement.
------------------------------------------------------------------------------------------------- PREFERRED STOCK FUND YEAR ENDED OCTOBER 31, ----------------------------------- 2000 1999 (000) (000) ------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 15,679 $ 20,619 Realized Net Gain (11,638) (110) Change in Unrealized Appreciation (Depreciation) (6,972) (28,274) ------------------------------------------------------------------------------------------------- Net Decrease in Net Assets Resulting from Operations (2,931) (7,765) ------------------------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (15,890) (19,870) Realized Capital Gain - (4,518) ------------------------------------------------------------------------------------------------- Total Distributions (15,890) (24,388) ------------------------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 23,063 86,045 Issued in Lieu of Cash Distributions 11,381 18,858 Redeemed (126,064) (138,952) ------------------------------------------------------------------------------------------------- Net Decrease from Capital Share Transactions (91,620) (34,049) ------------------------------------------------------------------------------------------------- Total Decrease (110,441) (66,202) ------------------------------------------------------------------------------------------------- NET ASSETS Beginning of Year 314,552 380,754 ------------------------------------------------------------------------------------------------- End of Year $204,111 $314,552 ================================================================================================= 1Shares Issued (Redeemed) Issued 2,578 8,516 Issued in Lieu of Cash Distributions 1,280 1,886 Redeemed (14,085) (13,836) ------------------------------------------------------------------------------------------------- Net Decrease in Shares Outstanding (10,227) (3,434) =================================================================================================
14 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis. It also presents the fund's Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
----------------------------------------------------------------------------------------------------- PREFERRED STOCK FUND YEAR ENDED OCTOBER 31, FOR A SHARE OUTSTANDING ------------------------------------------------------- THROUGHOUT EACH PERIOD 2000 1999 1998 1997 1996 ----------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF YEAR $9.44 $10.36 $10.17 $9.67 $9.61 ----------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .59 .590 .58 .63 .69 Net Realized and Unrealized Gain (Loss) on Investments (.60) (.825) .22 .53 .04 ----------------------------------------------------------------------------------------------------- Total from Investment Operations (.01) (.235) .80 1.16 .73 ----------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.59) (.560) (.61) (.66) (.67) Distributions from Realized Capital Gains - (.125) - - - ----------------------------------------------------------------------------------------------------- Total Distributions (.59) (.685) (.61) (.66) (.67) ----------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $8.84 $9.44 $10.36 $10.17 $9.67 ===================================================================================================== TOTAL RETURN 0.03% -2.47% 8.00% 12.44% 8.04% ===================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Year (Millions) $204 $315 $381 $320 $286 Ratio of Total Expenses to Average Net Assets 0.39% 0.36% 0.36% 0.37% 0.39% Ratio of Net Investment Income to Average Net Assets 6.47% 5.76% 5.60% 6.41% 7.23% Portfolio Turnover Rate 6% 11% 39% 34% 31% =====================================================================================================
15 NOTES TO FINANCIAL STATEMENTS Vanguard Preferred Stock Fund is registered under the Investment Company Act of 1940 as a diversified open-end investment company, or mutual fund. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Bonds are valued using the lastest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Temporary cash investments are valued at cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 5. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. B. Wellington Management Company, llp, provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the year ended October 31, 2000, the advisory fee represented an effective annual rate of 0.14% of the fund's average net assets. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At October 31, 2000, the fund had contributed capital of $38,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.04% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. During the year ended October 31, 2000, the fund purchased $13,159,000 of investment securities and sold $115,331,000 of investment securities, other than U.S. government securities and temporary cash investments. 16 At October 31, 2000, the fund had available a capital loss carryforward of $11,748,000 to offset future net capital gains of $110,000 through October 31, 2007, and $11,638,000 through October 31, 2008. E. At October 31, 2000, net unrealized depreciation of investment securities for financial reporting and federal income tax purposes was $15,328,000, consisting of unrealized gains of $673,000 on securities that had risen in value since their purchase and $16,001,000 in unrealized losses on securities that had fallen in value since their purchase. 17 REPORT of Independent Accountants To the Shareholders and Trustees of Vanguard Preferred Stock Fund In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard Preferred Stock Fund (the "Fund") at October 31, 2000, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at October 31, 2000 by correspondence with the custodian, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania November 29, 2000 -------------------------------------------------------------------------------- SPECIAL 2000 TAX INFORMATION (UNAUDITED) FOR VANGUARD PREFERRED STOCK FUND This information for the fiscal year ended October 31, 2000, is included pursuant to provisions of the Internal Revenue Code. For corporate shareholders, 100% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. 18 THE VANGUARD(R) Family of Funds STOCK FUNDS 500 Index Fund Calvert Social Index(TM) Fund Capital Opportunity Fund Convertible Securities Fund Developed Markets Index Fund Emerging Markets Stock Index Fund Energy Fund Equity Income Fund European Stock Index Fund Explorer(TM) Fund Extended Market Index Fund Global Equity Fund Gold and Precious Metals Fund Growth and Income Fund Growth Equity Fund Growth Index Fund Health Care Fund Institutional Developed Markets Index Fund Institutional Index Fund International Growth Fund International Value Fund Mid-Cap Index Fund Morgan(TM) Growth Fund Pacific Stock Index Fund PRIMECAP Fund REIT Index Fund Selected Value Fund Small-Cap Growth Index Fund Small-Cap Index Fund Small-Cap Value Index Fund Strategic Equity Fund Tax-Managed Capital Appreciation Fund Tax-Managed Growth and Income Fund Tax-Managed International Fund Tax-Managed Small-Cap Fund Total International Stock Index Fund Total Stock Market Index Fund U.S. Growth Fund U.S. Value Fund Utilities Income Fund Value Index Fund Windsor(TM) Fund Windsor(TM) II Fund BALANCED FUNDS Asset Allocation Fund Balanced Index Fund Global Asset Allocation Fund LifeStrategy(R) Conservative Growth Fund LifeStrategy(R) Growth Fund LifeStrategy(R) Income Fund LifeStrategy(R) Moderate Growth Fund STAR(TM) Fund Tax-Managed Balanced Fund Wellesley(R) Income Fund Wellington(TM) Fund BOND FUNDS Admiral(TM) Intermediate-Term Treasury Fund Admiral(TM) Long-Term Treasury Fund Admiral(TM) Short-Term Treasury Fund GNMA Fund High-Yield Corporate Fund High-Yield Tax-Exempt Fund Inflation-Protected Securities Fund Insured Long-Term Tax-Exempt Fund Intermediate-Term Bond Index Fund Intermediate-Term Corporate Fund Intermediate-Term Tax-Exempt Fund Intermediate-Term Treasury Fund Limited-Term Tax-Exempt Fund Long-Term Bond Index Fund Long-Term Corporate Fund Long-Term Tax-Exempt Fund Long-Term Treasury Fund Preferred Stock Fund Short-Term Bond Index Fund Short-Term Corporate Fund Short-Term Federal Fund Short-Term Tax-Exempt Fund Short-Term Treasury Fund State Tax-Exempt Bond Funds (California, Florida, Massachusetts, New Jersey, New York, Ohio, Pennsylvania) Total Bond Market Index Fund MONEY MARKET FUNDS Admiral(TM) Treasury Money Market Fund Federal Money Market Fund Prime Money Market Fund State Tax-Exempt Money Market Funds (California, New Jersey, New York, Ohio, Pennsylvania) Tax-Exempt Money Market Fund Treasury Money Market Fund VARIABLE ANNUITY PLAN Balanced Portfolio Diversified Value Portfolio Equity Income Portfolio Equity Index Portfolio Growth Portfolio High-Grade Bond Portfolio High Yield Bond Portfolio International Portfolio Mid-Cap Index Portfolio Money Market Portfolio REIT Index Portfolio Short-Term Corporate Portfolio Small Company Growth Portfolio For information about Vanguard funds and our variable annuity plan, including charges and expenses, obtain a prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482-2600. Read it carefully before you invest or send money. 19 THE PEOPLE Who Govern Your Fund The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, which is owned by the funds and exists solely to provide services to them on an at-cost basis. Six of Vanguard's seven board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. They bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/ directors; and electing Vanguard officers. The list below provides a brief description of each trustee's professional affiliations. The year in which the trustee joined the Vanguard board is noted in parentheses. -------------------------------------------------------------------------------- TRUSTEES JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. JOANN HEFFERNAN HEISEN (1998) Vice President, Chief Information Officer, and a member of the Executive Committee of Johnson & Johnson; Director of Johnson & Johnson*Merck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and Women's Research and Education Institute. BRUCE K. MACLAURY (1990) President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL (1977) Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Banco Bilbao Argentaria, Gestion, BKF Capital, The Jeffrey Co., NeuVis, Inc., and Select Sector SPDR Trust. ALFRED M. RANKIN, JR. (1993) Chairman, President, Chief Executive Officer, and Director of NACCO Industries, Inc.; Director of The BFGoodrich Co. JAMES O. WELCH, JR. (1971) Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO Energy, Inc., and Kmart Corp. J. LAWRENCE WILSON (1985) Retired Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of AmeriSource Health Corporation, Cummins Engine Co., and The Mead Corp.; Trustee of Vanderbilt University. ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- OTHER FUND OFFICERS RAYMOND J. KLAPINSKY, Secretary; Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of each of the investment companies in The Vanguard Group. THOMAS J. HIGGINS, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies in The Vanguard Group. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- VANGUARD MANAGING DIRECTORS R. GREGORY BARTON, Legal Department. ROBERT A. DISTEFANO, Information Technology. JAMES H. GATELY, Direct Investor Services. KATHLEEN C. GUBANICH, Human Resources. IAN A. MACKINNON, Fixed Income Group. F. WILLIAM MCNABB, III, Institutional Investor Group. MICHAEL S. MILLER, Planning and Development. RALPH K. PACKARD, Chief Financial Officer. GEORGE U. SAUTER, Quantitative Equity Group. -------------------------------------------------------------------------------- JOHN C. BOGLE Founder; Chairman and Chief Executive, 1974-1996. [SHIP LOGO] [THE VANGUARD GROUP(R) LOGO] Post Office Box 2600 Valley Forge, Pennsylvania 19482-2600 About Our Cover Our cover art evokes both Vanguard's rich past and the course we've set for the future--our determination to provide superior investment performance and top-notch service. The image is based on two works: a painting titled The First Journey of 'Victory,' by the English artist W.L. Wyllie (1851-1931), and a sculpture of a compass rose on Vanguard's campus near Valley Forge, Pennsylvania. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. Standard & Poor's(R), S&P(R), S&P 500(R), Standard & Poor's 500, 500, S&P MidCap 400, and S&P SmallCap 600 are trademarks of The McGraw-Hill Companies, Inc. All other index names may contain trademarks and are the exclusive property of their respective owners. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 INDIVIDUAL ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. (C)2000 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q380 122000