-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NCIiAw7lkTnC2YK0zVyqk1tvop+RXDAFBKCMiUdHTGUQAjup8MkCj2kIyO90K6G2 IITLmN8LcIMclGOamXB0VA== 0000932471-02-000527.txt : 20020415 0000932471-02-000527.hdr.sgml : 20020415 ACCESSION NUMBER: 0000932471-02-000527 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020131 FILED AS OF DATE: 20020326 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD SPECIALIZED FUNDS/ CENTRAL INDEX KEY: 0000734383 FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: N-30D SEC ACT: 1940 Act SEC FILE NUMBER: 811-03916 FILM NUMBER: 02586238 BUSINESS ADDRESS: STREET 1: PO BOX 2600 STREET 2: V37 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696289 MAIL ADDRESS: STREET 1: PO BOX 2600 STREET 2: V37 CITY: VALLEY FORGE STATE: PA ZIP: 19482 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD SPECIALIZED PORTFOLIOS INC DATE OF NAME CHANGE: 19920703 N-30D 1 energy.txt VANGUARD SPECIALIZED FUNDS VANGUARD(R) ENERGY FUND ANNUAL REPORT JANUARY 31, 2002 STOCK [THE VANGUARD GROUP LOGO] PERSPECTIVE Maintaining a long-term investment perspective isn't easy. Perhaps that's why it has proven to be so rewarding. With news, information, and opinion constantly bombarding us, the temptation to buy or sell--to do something--is powerful. Yet such activity is often counterproductive. Emotions can lead us to big mistakes, like jumping into a hot investment we know little about or selling a sound long-term holding when it sags for a while. The actions we recommend are quite simple. First, take the time to decide on a mix of stocks, bonds, and cash investments that makes sense for you. Take into account your investment time horizon, your goals, and your ability and willingness to ride out market fluctuations. Write this mix down--it's your investment plan. Second, use low-cost, widely diversified mutual funds to carry out your asset allocation. Third, stick with your plan, unless there's a major change in your time horizon, goals, or financial situation. Don't "play the market"--and if you feel you must, don't risk more than a tiny percentage of your assets. Finally, if market news, the opinions of "experts," or the hope of a big score tempts you to act, consult your plan. It may help you keep a long-term perspective. - -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Report from the Adviser 6 Fund Profile 9 Glossary of Investment Terms 10 Performance Summary 11 Your Fund's After-Tax Returns 13 Financial Statements 14 - -------------------------------------------------------------------------------- SUMMARY * Vanguard Energy Fund returned -0.6% during its 2002 fiscal year--a disappointing decline, but still much less than those experienced by the average competitor and the broad stock market. * Oil and natural gas prices dropped sharply during the period, driving many energy- related stocks downward. * The broad stock market's -15.3% return reflected the U.S. economy's overall weakness and a significant decline in corporate profits. - -------------------------------------------------------------------------------- LETTER FROM THE CHAIRMAN [PHOTO] JOHN J. BRENNAN FELLOW SHAREHOLDER, During a 12-month period when energy prices skidded and the stock market suffered, vanguard(R) energy fund returned -0.6%. While disappointing on an absolute basis, your fund's return was solid when compared with those of its benchmarks, as shown in the table below. The table compares the fund's total return--capital change plus reinvested dividends--with those of its average competitor and two unmanaged market indexes, the Standard & Poor's Energy Sector Index and the Wilshire 5000 Total Market Index. Details on the fund's performance, including changes in net asset values and per-share distributions through January 31, can be found in the table on page 5. ================================================================================ 2002 TOTAL RETURNS FISCAL YEAR ENDED JANUARY 31 - -------------------------------------------------------------------------------- VANGUARD ENERGY FUND INVESTOR SHARES -0.6% Average Natural Resources Fund* -9.1 S&P Energy Sector Index -9.3 Wilshire 5000 Index -15.3 - -------------------------------------------------------------------------------- Admiral Shares (since inception on November 12, 2001) - -------------------------------------------------------------------------------- Vanguard Energy Fund 0.6% - -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. If you own the Energy Fund in a taxable account, you may wish to review our report on the fund's after-tax returns on page 13. As you may know, we introduced Admiral(TM) Shares for Vanguard Energy Fund in November 2001. This is a separate share class that carries a lower expense ratio for the benefit of shareholders whose large or long-standing accounts create economies of scale. For more information on the new share class, visit VANGUARD.COM(TM). FINANCIAL MARKETS IN REVIEW The 12 months ended January 31 were a very rough stretch for stock investors. As the table on page 2 shows, the broad U.S. stock market, as measured by the Wilshire 5000 Index, lost more than 15% of its value. Several factors contributed to the decline, including: * The first recession in the U.S. economy in a decade, part of a worldwide slowdown in economic activity. * The September 11 terrorist attacks, which resulted in economic disruption and a heightened awareness of risk--both physical and financial. * A steep reduction in corporate profits: Twelve-month net earnings reported by companies in the S&P 500 Index fell nearly 50% on average from January 2001 to January 2002. 1 * Concern about the reliability of certain corporate accounting and disclosure practices, owing largely to the collapse of Enron Corporation. The downturn that began in March 2001 ended a record ten years of uninterrupted expansion in the U.S. economy. The recession was heralded by severe reductions in corporate investment spending, especially in the technology and telecommunications sectors (both plagued by overcapacity created in the 1990s boom). As the year progressed, so did the business cutbacks and the weakness in the economy. High levels of corporate and household debt cast doubt on the economy's ability to bounce back quickly. Through all the difficulties, consumer spending held up surprisingly well--especially spending for housing and for automobiles, spurred by low interest rates (and sales incentives, in the case of autos). Joblessness rose during the 12 months--the unemployment rate in January 2002 stood at 5.6%, well above the three-decade low of 3.9% last reached in October 2000. However, layoffs seemed to be tapering off late in the fiscal year, and consumer confidence regained some of the ground lost earlier. Whether such hopeful signs will blossom into a full-fledged recovery by spring or summer is uncertain, but by January the Federal Reserve Board was encouraged enough to halt its aggressive campaign of cutting interest rates to stimulate economic activity. During the fiscal year, the Fed had lowered its target for the federal funds rate--the interest rate that banks charge each other for overnight loans--nine times, for a total of 375 basis points (3.75 percentage points). Those reductions, together with cuts totaling 1 percentage point in January 2001, brought the federal funds rate to 1.75%, its lowest level in four decades. ================================================================================ MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 ONE THREE FIVE YEAR YEARS YEARS - -------------------------------------------------------------------------------- STOCKS S&P 500 Index (Large-caps) -16.1% -2.8% 9.0% Russell 2000 Index (Small-caps) -3.6 5.6 6.9 Wilshire 5000 Index (Entire market) -15.3 -2.3 8.3 MSCI EAFE Index (International) -26.1 -6.9 0.4 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index (Entire market) 7.6% 6.3% 7.5% Lehman 10 Year Municipal Bond Index 5.2 4.7 6.3 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 3.7 4.9 5.0 - -------------------------------------------------------------------------------- CPI Consumer Price Index 1.1% 2.5% 2.2% - -------------------------------------------------------------------------------- The weak economy and even weaker corporate profits made for a bad 12 months for the broad U.S. stock market. The market seemed to be heading for a second full year in bear territory. From its peak in March 2000, the Wilshire 5000 Index had plunged -28% by the end of January 2002. The market hit a three-year low in September after the terrorist attacks, but then rallied in the final weeks of 2001. Still, the returns of most stock sectors were deeply 2 in the red for the 12 months ended January 31, although value stocks in the small- and mid- capitalization ranges produced gains. Meanwhile, bonds had another good year. The Lehman Brothers Aggregate Bond Index, a proxy for the taxable investment-grade U.S. bond market, posted a 12-month return of 7.6%. Investment-grade corporate bonds had the highest return among bond sectors. High-yield ("junk") bonds were the only group to decline; the Lehman High Yield Index returned -1.4% as a result of a rise in default rates on corporate bonds. - -------------------------------------------------------------------------------- Returns of most stock sectors were deeply in the red. - -------------------------------------------------------------------------------- Yields on U.S. Treasury securities--which move in the opposite direction from their prices--fell during the 12 months. The decline was particularly pronounced at the shorter end of the maturity spectrum, where issues are most affected by Fed actions. FISCAL 2002 PERFORMANCE OVERVIEW Vanguard Energy Fund's fiscal 2002 return of -0.6% was a far cry from its impressive results in the previous two years: 35.1% in fiscal 2001 and 25.8% in fiscal 2000. However, the fund held up remarkably well in a difficult environment for energy-related companies and the stock market in general. Energy prices declined sharply during the period. The price of a barrel of oil started at about $30 and held fairly steady for several months, but began to fall as the worldwide economic slowdown--and the September 11 attacks--reduced demand. Oil prices reached about $17 a barrel in November. By January 31, prices had rebounded a bit, to roughly $20, on news of an agreement among oil producers to reduce production in 2002. Natural gas prices, which had soared during 2000, tumbled in 2001, plummeting from about $9 per thousand cubic feet in January 2001 to about $2 per thousand cubic feet in January 2002. Demand was weak and inventories soared. - -------------------------------------------------------------------------------- Your fund fared relatively well because of its emphasis on large, integrated oil companies, which accounted for about one-third of its assets. - -------------------------------------------------------------------------------- Your fund weathered this rough patch relatively well because of its emphasis on large, integrated oil companies, which on January 31 accounted for about one-third of its assets. In fact, the fund's three largest holdings as of that date were industry titans ChevronTexaco, ExxonMobil, and BP. Typically, these diversified corporations, along with refining companies, fare better when oil prices are falling than do more speculative segments of the oil industry, such as exploration, production, and energy-service concerns. (In fact, ChevronTexaco produced a gain during the fund's fiscal year.) Generally, our average peer, and our benchmark index, held smaller stakes in 3 the major oil firms and bigger stakes in drillers, equipment makers, and service companies. The fund's big margin over its average peer--more than 8 percentage points--is a significant accomplishment and testifies to the skill of Wellington Management Company, llp, which has managed the fund since its inception 18 years ago. The fund's record also shows the value of Vanguard's low costs, exemplified by our expense ratio (expenses as a percentage of average net assets). In fiscal 2002, the Energy Fund's Investor Shares had an expense ratio of 0.39%, or $3.90 per $1,000 invested, far below the 1.70%, or $17.00 per $1,000 invested, charged by our average competitor. This huge advantage has benefited our shareholders year in and year out, and has been especially telling over the long run. For further details on the energy market and your fund's performance, see the Report from the Adviser on page 6. LONG-TERM PERFORMANCE OVERVIEW Over the past decade, the fund's return has been excellent, both on an absolute basis and relative to its benchmarks (see table below). A hypothetical $10,000 investment in the fund would have grown to more than $32,000 over the past ten years. That is about $11,000 more than would have accumulated in the average natural resources fund over the same period. ================================================================================ TOTAL RETURNS TEN YEARS ENDED JANUARY 31, 2002 -------------------------------------------------- AVERAGE FINAL VALUE OF ANNUAL A $10,000 RETURN INITIAL INVESTMENT - -------------------------------------------------------------------------------- VANGUARD ENERGY FUND INVESTOR SHARES 12.6% $32,635 Average Natural Resources Fund 7.8 21,147 S&P Energy Sector Index 12.8 33,382 Wilshire 5000 Index 12.2 31,493 ================================================================================ We urge you to keep these results in perspective. When managing your port-folio and planning for the future, it's best to assume that future returns from the Energy Fund--and the broad stock market--will be somewhat lower. The past decade was an outstanding period for stocks, and it is unlikely that the returns provided during the late 1990s will be repeated. In fact, during the ten years covered in the table, the Energy Fund recorded annual returns above 25% five times. Counting on that to happen again in the decade ahead could be dangerous to your financial health! As we hope all of our shareholders realize, an investment in a "sector fund" is almost certain to be more volatile than the broad market and to require, at times, a steely nerve and considerable patience. Even during a generally excellent decade, the Energy Fund posted returns of -9.1% (in fiscal 1995) and -21.2% (in fiscal 1999). This degree of volatility is not at all unusual for a sector fund. That is why we recommend that such funds serve as a supplement to a broadly diversified portfolio. 4 IN SUMMARY During a difficult period in the stock market, the temptation to make major adjustments to your portfolio can be powerful. But we counsel investors not to change well-considered plans in reaction to market cycles. Rather, we suggest sticking with a balanced investment program that provides exposure to stocks, bonds, and short-term investments and to many types of securities within each asset class. For those who wish to complement their programs with a fund that has a specialized focus, Vanguard Energy Fund provides skillful investment management at an extremely low cost. We thank you for your trust in our approach to investing, and we pledge to continue working hard to earn your confidence. Sincerely, /s/John J. Brennan JOHN J. BRENNAN CHAIRMAN AND CHIEF EXECUTIVE OFFICER FEBRUARY 11, 2002 ================================================================================ YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2001-JANUARY 31, 2002 DISTRIBUTIONS PER SHARE ------------------------------------------------------------ STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS - -------------------------------------------------------------------------------- VANGUARD ENERGY FUND Investor Shares $26.93 $24.76 $0.400 $1.538 Admiral Shares* 50.00 46.48 0.760 2.888 - -------------------------------------------------------------------------------- *Since inception on November 12, 2001. 5 REPORT FROM THE ADVISER VANGUARD ENERGY FUND declined -0.6% in value during its 2002 fiscal year, which ended on January 31, 2002. By comparison, the average natural resources fund declined -9.1%, and the S&P Energy Sector fell -9.3%. THE INVESTMENT ENVIRONMENT During the first nine months of the fiscal year, the price of crude oil remained high, hovering between $25 and $30 per barrel. However, prices dropped after the September 11 terrorist attacks as demand plunged for oil in general, and jet fuel in particular. The Organization of Petroleum Exporting Countries reduced output several times during 2001 and ultimately managed to get the leading non-OPEC exporters to cut production too. As we write, the price of oil is around $20 per barrel, where it may remain in 2002. Natural gas prices in the United States started the fiscal year at about $9 per thousand cubic feet, but declined sharply from this inflated level to about $2 by January 31, 2002. The high price that existed early in 2001 spurred drilling activity and negatively affected demand. Now, thanks to the extremely mild winter, the level of natural gas in storage is very high. This surplus should keep gas prices moderate for some time. However, the current price is too low to provide adequate returns on exploration and development. Therefore, we expect that North American gas production will decline until the markets tighten. For U.S. production to remain stable, the price of gas must be above $3 per thousand cubic feet. In the downstream refining industry, profit margins were quite high in early 2001, but have since declined sharply. We expect these margins to improve when the economy strengthens. - -------------------------------------------------------------------------------- INVESTMENT PHILOSOPHY This fund reflects a belief that investors who seek to emphasize a given economic sector as part of a long-term, balanced investment program are best served by holding a portfolio of securities well-diversified across that sector. - -------------------------------------------------------------------------------- Merger activity in the energy industry remains brisk, as companies seek to benefit from economies of scale and merger-related cost savings. While the oil and gas industry remains volatile, the long-term outlook is positive, given the high operating rates in the industry. OUR SUCCESSES During the year, stocks of refiners provided positive returns, those of large integrated- oil companies declined moderately, and the stocks of independent producers and oil-services companies fell more sharply. We benefited from the takeover of a number of our holdings, including integrated oils Texaco and Conoco; 6 producers Anderson Exploration, Barrett Resources, and Lasmo; and refiners Tosco and Ultramar Diamond Shamrock. Our avoidance of gas transmission and trading companies, such as Enron, also helped. Our strategy of diversifying among all industry segments and allocating a sizable part of the portfolio (about one-third of fund assets) to foreign energy companies mitigated the decline. OUR SHORTFALLS Our shortfalls were mainly in the oil-services sector, which accounts for about 20% of the Energy Fund's assets. These companies are very sensitive to declines in oil and gas prices. This is because their clients, the oil producers, must generate sufficient cash if they are to sustain exploration and drilling activity. In North America, the environment for oil-services companies deteriorated as 2001 progressed. However, a declining trend in commodity prices inevitably is followed by an upward trend, and we believe that oil-services companies will start to see better days late this year or in 2003. THE FUND'S POSITIONING We expect that the world economy will improve as 2002 unfolds, with oil and gas demand increasing later in the year. In our view, we are at a low point in the energy cycle. At the bottom of the last cycle, in 1998, the industry contracted quite sharply when commodity prices weakened. But this weakness led to a dramatic upturn in 1999 and 2000. We believe that Vanguard Energy Fund is well-positioned to take advantage of this eventual recovery. We also believe that the recovery will be most pronounced in the North American natural gas industry, where capacity utilization is highest. Among our significant holdings in the gas sector are EOG Resources and Equitable Resources. In the oil-services sector, we own Noble Drilling and Weatherford International, both of which should benefit from a pickup in drilling activity next year. Among the large integrated companies, Exxon-Mobil and the French-based TotalFinaElf have a promising outlook for oil and gas production. ERNST H. VON METZSCH, Senior Vice President and Portfolio Manager Wellington Management Company, llp FEBRUARY 4, 2002 (A table showing significant portfolio changes is on the next page.) 7 ================================================================================ PORTFOLIO CHANGES FISCAL YEAR ENDED JANUARY 31, 2002 - -------------------------------------------------------------------------------- COMMENTS - -------------------------------------------------------------------------------- ADDITIONS - -------------------------------------------------------------------------------- HALLIBURTON Sold in late summer, but repurchased after concerns about asbestos litigation caused the stock to decline. - -------------------------------------------------------------------------------- SCHLUMBERGER Premier oil-services company declined to our purchase price range. - -------------------------------------------------------------------------------- PHILLIPS PETROLEUM Company is successfully repositioning itself for growth. - -------------------------------------------------------------------------------- NOBLE DRILLING Beneficiary of expected recovery in offshore drilling. - -------------------------------------------------------------------------------- PANCANADIAN ENERGY Leading Canadian producer with above- average exploration success. ================================================================================ REDUCTIONS - -------------------------------------------------------------------------------- ANDERSON Purchased by Devon Energy. EXPLORATION* - -------------------------------------------------------------------------------- DEVON ENERGY* Reached our asset value target early in 2001. - -------------------------------------------------------------------------------- TEXACO* Taken over by Chevron. - -------------------------------------------------------------------------------- NABORS INDUSTRIES Reached our price target early in 2001. (Repurchased later in fiscal year after price dropped.) - -------------------------------------------------------------------------------- *Eliminated from portfolio. See page 14 for a complete listing of the fund's holdings. 8 FUND PROFILE AS OF JANUARY 31, 2002 FOR ENERGY FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate with a broad market index. Key terms are defined on page 10. - -------------------------------------------------------------------------------- PORTFOLIO CHARACTERISTICS FUND WILSHIRE 5000 - -------------------------------------------------------------------------------- Number of Stocks 52 6,013 Median Market Cap $8.7B $33.1B Price/Earnings Ratio 16.0x 32.5X Price/Book Ratio 2.3x 3.3x Yield 1.3% Investor Shares 1.3% Admiral Shares 1.3% Return on Equity 14.8% 22.5% Earnings Growth Rate 9.3% 14.4% Foreign Holdings 34.0% 0.0% Turnover Rate 28% -- Expense Ratio Investor Shares 0.39% -- Admiral Shares 0.34%* -- Cash Investments 4.0% -- - -------------------------------------------------------------------------------- ================================================================================ TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) ChevronTexaco Corp. 3.9% ExxonMobil Corp. 3.9 BP PLC ADR 3.6 Weatherford International, Inc. 3.5 Schlumberger Ltd. 3.4 Norsk Hydro AS ADR 3.4 Suncor Energy, Inc. 3.4 Noble Drilling Corp. 3.2 Phillips Petroleum Co. 3.1 TotalFinaElf SA ADR 3.0 - -------------------------------------------------------------------------------- Top Ten 34.4% - -------------------------------------------------------------------------------- ================================================================================ INVESTMENT FOCUS MARKET CAP - MEDIUM STYLE - VALUE - -------------------------------------------------------------------------------- ================================================================================ VOLATILITY MEASURES WILSHIRE FUND 5000 - -------------------------------------------------------------------------------- R-Squared 0.16 1.00 Beta 0.60 1.00 - -------------------------------------------------------------------------------- ================================================================================ SECTOR DIVERSIFICATION (% OF COMMON STOCKS) Energy Miscellaneous 4.0% International 34.0 Machinery--Oil Well Equipment & Services 22.5 Materials & Processing 2.6 Offshore Drilling 3.3 Oil--Crude Producers 8.3 Oil--Integrated Domestic 11.9 Oil--Integrated International 9.0 Utilities--Gas Pipelines 4.4 - -------------------------------------------------------------------------------- *Annualized. Visit our website www.vanguard.com for regularly updated fund information. 9 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. - -------------------------------------------------------------------------------- 10 PERFORMANCE SUMMARY AS OF JANUARY 31, 2002 FOR ENERGY FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares.
============================================================================================================== CUMULATIVE PERFORMANCE JANUARY 31, 1992-JANUARY 31, 2002 - -------------------------------------------------------------------------------------------------------------- FUND AVERAGE NATURAL S&P ENERGY S&P500 WILSHIRE 5000 RESOURCES FUND SECTOR INDEX INDEX INDEX - -------------------------------------------------------------------------------------------------------------- 199201 10000 10000 10000 10000 10000 199204 10433 10057 10550 10224 10018 199207 10983 10393 11106 10535 10274 199210 10936 10324 10872 10477 10301 199301 11302 10448 10980 11058 11053 199304 13747 11920 12170 11169 11069 199307 14270 12393 12452 11455 11468 199310 14900 12949 12990 12042 12132 199401 14388 13233 13003 12482 12533 199404 14231 12391 12640 11763 11810 199407 14791 12451 13045 12046 11951 199410 15140 12920 13695 12508 12437 199501 13072 11665 13145 12548 12405 199504 15156 13169 14735 13817 13568 199507 15544 13259 15279 15191 15071 199510 14776 12868 15163 15815 15640 199601 16822 14771 16839 17400 17013 199604 19493 16736 18255 17992 17932 199607 18485 15450 17965 17707 17285 199610 21352 17970 20186 19625 19050 199701 23604 19327 22273 21983 21158 199704 21829 17799 22649 22514 21095 199707 25940 19786 26924 26940 25443 199710 27649 20775 27170 25928 25068 199801 24500 18131 25122 27899 26511 199804 27622 19803 28992 31759 30218 199807 23255 15089 26171 32135 29779 199810 22572 15249 26788 31629 28776 199901 19306 13667 24787 36963 33742 199904 25395 17532 32386 38690 35392 199907 26340 17540 32296 38628 35242 199910 24944 17587 31044 39748 36164 200001 24294 17937 31240 40787 38544 200004 28368 19488 32118 42608 39573 200007 28608 19022 34005 42094 39062 200010 30635 20967 36917 42170 39095 200101 32817 23251 36812 40420 37187 200104 37045 24450 39097 37081 33981 200107 33121 20728 36110 36063 33186 200110 32037 20028 33583 31668 29099 200201 32635 21147 33382 33894 31493 - --------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 FINAL VALUE ONE FIVE TEN OF A $10,000 YEAR YEARS YEARS INVESTMENT - -------------------------------------------------------------------------------- ENERGY FUND INVESTOR SHARES -0.55% 6.69% 12.56% $32,635 Average Natural Resources Fund* -9.05 1.82 7.78 21,147 S&P Energy Sector Index -9.32 8.43 12.81 33,382 S&P 500 Index -16.15 9.04 12.98 33,894 Wilshire 5000 Index -15.31 8.28 12.16 31,493 - -------------------------------------------------------------------------------- FINAL VALUE RETURN SINCE OF A $250,000 INCEPTION+ INVESTMENT - -------------------------------------------------------------------------------- ENERGY FUND ADMIRAL SHARES** -0.44% $248,912 S&P 500 Index 1.37 253,420 - -------------------------------------------------------------------------------- ================================================================================ TOTAL INVESTMENT RETURNS (%) JANUARY 31, 1992-JANUARY 31, 2002 FISCAL YEAR TOTAL RETURN S&P ENERGY SECTOR INDEX - -------------------------------------------------------------------------------- 1993 13.0 9.8 1994 27.3 18.4 1995 -9.1 1.1 1996 28.7 28.1 1997 40.3 32.3 1998 3.8 12.8 1999 -21.2 -1.3 2000 25.8 26.0 2001 35.1 17.8 2002 -0.6 -9.3 - -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. **Reflective of the 1% fee assessed on redemption of shares held less than one year. +November 12, 2001. See Financial Highlights tables on pages 18 and 19 for dividend and capital gains information. 11 PERFORMANCE SUMMARY (CONTINUED) ================================================================================ AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2001 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal year. Securities and Exchange Commission rules require that we provide this information.
- -------------------------------------------------------------------------------------------------------------------- ONE FIVE TEN YEARS INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------------------------------------------- ENERGY FUND Investor Shares 5/23/1984 -2.55% 7.99% 10.69% 1.84% 12.53% Admiral Shares 11/12/2001 2.71%** Fee-Adjusted Returns* 1.69** - --------------------------------------------------------------------------------------------------------------------
*Reflective of the 1% fee assessed on redemptions of shares held less than one year. **Since inception. 12 YOUR FUND'S AFTER-TAX RETURNS This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund's distributions, and (2) assuming that an investor paid taxes on the fund's distributions and sold all shares at the end of each period. Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. (In the example that assumes all fund shares were sold, a negative pre-tax total return translates into a higher after-tax return. This is because the calculation assumes that the investor received a tax deduction for the loss incurred on the sale.) Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes. Finally, keep in mind that a fund's performance--whether before or after taxes--does not indicate how it will perform in the future. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 ONE YEAR FIVE YEARS TEN YEARS ----------------------------------------- ENERGY FUND INVESTOR SHARES* Returns Before Taxes -0.55% 6.69% 12.56% Returns After Taxes on Distributions -1.82 5.28 10.88 Returns After Taxes on Distributions and Sale of Fund Shares 1.23 5.04 9.97 - -------------------------------------------------------------------------------- *Total return figures do not reflect the 1% fee assessed on redemptions of shares held less than one year. 13 FINANCIAL STATEMENTS JANUARY 31, 2002 STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by sector within the fund's designated industry; international securities, if significant, may be presented in a separate group. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* ENERGY FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (96.0%) - -------------------------------------------------------------------------------- UNITED STATES (63.4%) - -------------------------------------------------------------------------------- ENERGY MISCELLANEOUS (3.9%) Sunoco, Inc. 954,967 $ 36,824 Valero Energy Corp. 300,000 13,782 ------------------ 50,606 ------------------ MACHINERY--OIL WELL EQUIPMENT & Services (21.7%) * Weatherford International, Inc. 1,200,000 46,188 Schlumberger Ltd. 800,000 45,112 * Noble Drilling Corp. 1,316,400 42,085 Halliburton Co. 2,500,000 34,375 Baker Hughes, Inc. 879,300 30,951 * Nabors Industries, Inc. 691,100 21,638 * Cooper Cameron Corp. 506,200 21,529 * Rowan Cos., Inc. 1,097,100 19,781 * Smith International, Inc. 300,000 16,515 * BJ Services Co. 244,000 7,564 ------------------ 285,738 ------------------ MATERIALS & Processing (2.5%) Ashland, Inc. 700,000 32,732 ------------------ OFFSHORE DRILLING (3.2%) GlobalSantaFe Corp. 700,000 19,880 ENSCO International, Inc. 656,800 15,632 Transocean Sedco Forex Inc. 210,700 6,456 ------------------ 41,968 ------------------ OIL--CRUDE PRODUCERS (7.9%) EOG Resources, Inc. 900,000 $ 30,591 Anadarko Petroleum Corp. 500,000 24,565 Burlington Resources, Inc. 602,800 20,640 Cabot Oil & Gas Corp. Class A 861,000 17,263 Apache Corp. 230,000 11,153 ------------------ 104,212 ------------------ OIL--INTEGRATED DOMESTIC (11.4%) Phillips Petroleum Co. 700,000 40,929 Unocal Corp. 1,000,000 34,950 Occidental Petroleum Corp. 900,000 23,355 Marathon Oil Corp. 500,000 14,025 Murphy Oil Corp. 167,100 13,201 Amerada Hess Corp. 205,400 12,603 Kerr-McGee Corp. 200,000 10,590 ------------------ 149,653 ------------------ OIL--INTEGRATED INTERNATIONAL (8.6%) ChevronTexaco Corp. 609,400 51,068 ExxonMobil Corp. 1,300,000 50,765 Conoco Inc. 400,000 11,264 ------------------ 113,097 ------------------ UTILITIES--GAS PIPELINES (4.2%) Equitable Resources, Inc. 1,228,200 37,755 El Paso Corp. 300,000 11,385 Dynegy, Inc. Class A 275,100 6,561 ------------------ 55,701 ------------------ - -------------------------------------------------------------------------------- TOTAL UNITED STATES 833,707 - -------------------------------------------------------------------------------- 14 - -------------------------------------------------------------------------------- MARKET VALUE* COMMON STOCKS (96.0%) SHARES (000) - -------------------------------------------------------------------------------- INTERNATIONAL (32.6%) - -------------------------------------------------------------------------------- BRAZIL (2.0%) Petroleo Brasileiro ADR 1,264,800 $ 26,497 ------------------ CANADA (12.9%) Suncor Energy, Inc. 1,448,400 44,267 Alberta Energy Co., Ltd. 767,600 30,073 * Petro-Canada 1,000,000 22,859 Canadian Natural Resources Ltd. 800,000 20,828 Shell Canada Ltd. CLass A 644,100 18,430 PanCanadian Energy Corp. 590,000 15,861 * Paramount Resources Ltd. 1,106,300 10,088 * Western Oil Sands Inc. 500,000 6,918 ------------------ 169,324 ------------------ CHINA (1.2%) PetroChina Co. Ltd. ADR 600,000 11,178 China Petroleum and Chemical Corp. ADR 287,400 4,282 ------------------ 15,460 ------------------ FRANCE (3.0%) TotalFinaElf SA ADR 558,200 39,275 ------------------ ITALY (2.5%) ENI SpA ADR 509,400 33,315 ------------------ NETHERLANDS (1.5%) Royal Dutch Petroleum Co. ADR 400,000 19,988 ------------------ NORWAY (3.4%) Norsk Hydro AS ADR 1,062,900 44,302 ------------------ SPAIN (0.7%) Repsol YPF SA ADR 800,000 9,632 ------------------ UNITED KINGDOM (5.4%) BP PLC ADR 1,000,000 46,720 Shell Transport & Trading Co. ADR 600,000 24,642 ------------------ 71,362 ------------------ - -------------------------------------------------------------------------------- TOTAL INTERNATIONAL 429,155 - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $1,010,435) 1,262,862 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* TEMPORARY CASH INVESTMENTS (7.6%) (000) (000) - -------------------------------------------------------------------------------- REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.91%, 2/1/2002 $69,364 $69,364 1.91%, 2/1/2002--Note G 30,250 30,250 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $99,614) 99,614 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (103.6%) (Cost $1,110,049) 1,362,476 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-3.6%) - -------------------------------------------------------------------------------- Other Assets--Note C 8,821 Liabilities--Note G (55,444) ------------------ (46,623) - -------------------------------------------------------------------------------- NET ASSETS (100%) $1,315,853 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. ADR--American Depositary Receipt. - -------------------------------------------------------------------------------- AT JANUARY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- AMOUNT (000) - -------------------------------------------------------------------------------- Paid-in Capital--Note E $ 1,048,551 Overdistributed Net Investment Income--Note E (1,109) Accumulated Net Realized Gains--Note E 15,980 Unrealized Appreciation--Note F Investment Securities 252,427 Foreign Currencies 4 - -------------------------------------------------------------------------------- NET ASSETS $1,315,853 ================================================================================ Investor Shares--Net Assets Applicable to 50,818,934 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $1,258,330 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- INVESTOR SHARES $24.76 - -------------------------------------------------------------------------------- Admiral Shares--Net Assets Applicable to 1,237,581 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $57,523 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $46.48 ================================================================================ 15 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. ================================================================================ ENERGY FUND YEAR ENDED JANUARY 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 23,236 Interest 2,390 Security Lending 454 - -------------------------------------------------------------------------------- Total Income 26,080 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 786 The Vanguard Group--Note C Management and Administrative Investor Shares 4,097 Admiral Shares 27 Marketing and Distribution Investor Shares 159 Admiral Shares -- Custodian Fees 131 Auditing Fees 12 Shareholders' Reports Investor Shares 46 Admiral Shares -- Trustees' Fees and Expenses 2 - -------------------------------------------------------------------------------- Total Expenses 5,260 Expenses Paid Indirectly--Note D (208) - -------------------------------------------------------------------------------- Net Expenses 5,052 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 21,028 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities Sold 102,396 Foreign Currencies (169) - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) 102,227 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities Sold (144,906) Foreign Currencies 4 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (144,902) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ (21,647) - -------------------------------------------------------------------------------- *Dividends are net of foreign withholding taxes of $622,000. 16 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. ================================================================================ ENERGY FUND YEAR ENDED JANUARY 31, ------------------------------- 2002 2001 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 21,028 $ 17,665 Realized Net Gain (Loss) 102,227 63,805 Change in Unrealized Appreciation (Depreciation) (144,902) 241,200 - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (21,647) 322,670 - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income Investor Shares (18,854) (16,258) Admiral Shares (745) -- Realized Capital Gain* Investor Shares (72,494) (62,352) Admiral Shares (2,829) -- - -------------------------------------------------------------------------------- Total Distributions (94,922) (78,610) - -------------------------------------------------------------------------------- Capital Share Transactions--Note H Investor Shares 93,486 63,224 Admiral Shares 58,161 -- - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 151,647 63,224 - -------------------------------------------------------------------------------- Total Increase (Decrease) 35,078 307,284 - -------------------------------------------------------------------------------- Net Assets Beginning of Period 1,280,775 973,491 - -------------------------------------------------------------------------------- End of Period $1,315,853 $1,280,775 ================================================================================ *Includes fiscal 2002 and 2001 short-term gain distributions totaling $0 and $4,943,000, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 17 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
============================================================================================= ENERGY FUND INVESTOR SHARES YEAR ENDED JANUARY 31, ----------------------------------------------- FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2002 2001 2000 1999 1998 - --------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $26.93 $21.24 $17.16 $22.68 $23.44 - --------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .428 .39 .355 .33 .32 Net Realized and Unrealized Gain (Loss) on Investments (.660) 7.04 4.080 (5.08) .57 - --------------------------------------------------------------------------------------------- Total from Investment Operations (.232) 7.43 4.435 (4.75) .89 - --------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.400) (.36) (.355) (.35) (.32) Distributions from Realized Capital Gains (1.538) (1.38) -- (.42) (1.33) - --------------------------------------------------------------------------------------------- Total Distributions (1.938) (1.74) (.355) (.77) (1.65) - --------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $24.76 $26.93 $21.24 $17.16 $22.68 ============================================================================================= TOTAL RETURN* -0.55% 35.08% 25.83% -21.20% 3.80% ============================================================================================= RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $1,258 $1,281 $973 $760 $1,090 Ratio of Total Expenses to Average Net Assets 0.39% 0.41% 0.48% 0.41% 0.38% Ratio of Net Investment Income to Average Net Assets 1.57% 1.52% 1.63% 1.46% 1.36% Portfolio Turnover Rate 28% 24% 18% 22% 19% =============================================================================================
*Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. 18 ================================================================================ ENERGY FUND ADMIRAL SHARES NOV. 12, 2001* FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD TO JAN. 31, 2002 - -------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $50.00 - -------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .118 Net Realized and Unrealized Gain (Loss) on Investments .010 - -------------------------------------------------------------------------------- Total from Investment Operations .128 - -------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.760) Distributions from Realized Capital Gains (2.888) - -------------------------------------------------------------------------------- Total Distributions (3.648) - -------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $46.48 ================================================================================ TOTAL RETURN** 0.57% ================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $58 Ratio of Total Expenses to Average Net Assets 0.34%+ Ratio of Net Investment Income to Average Net Assets 0.53%+ Portfolio Turnover Rate 28% ================================================================================ *Inception. **Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. +Annualized. 19 NOTES TO FINANCIAL STATEMENTS Vanguard Energy Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on November 12, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. Security Valuation: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments 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. Foreign Currency: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates on the valuation date as employed by Morgan Stanley Capital International in the calculation of its indexes. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the asset or liability is settled in cash, when they are recorded as realized foreign currency gains (losses). 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. Fees assessed on redemptions of capital shares are credited to paid-in capital. Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets. 20 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 January 31, 2002, the investment advisory fee represented an effective annual rate of 0.06% 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 January 31, 2002, the fund had contributed capital of $246,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.25% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment adviser to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. For the year ended January 31, 2002, these arrangements reduced the fund's expenses by $208,000 (an annual rate of 0.02% of average net assets). E. During the year ended January 31, 2002, the fund purchased $451,787,000 of investment securities and sold $361,031,000 of investment securities other than temporary cash investments. During the year ended January 31, 2002, the fund realized net foreign currency losses of $169,000, which decreased distributable net income for tax purposes; accordingly, such losses have been reclassified from accumulated net realized gains to undistributed net investment income. The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from net investment income and realized capital gains. Accordingly, the fund has reclassified $1,571,000 from undistributed net investment income, and $7,338,000 from accumulated net realized gains, to paid-in capital. For tax purposes, at January 31, 2002, the fund had capital gains of $15,980,000 available for distribution, including short-term gains of $1,118,000. Short-term gain distributions are treated as ordinary income dividends for tax purposes. F. At January 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $252,427,000, consisting of unrealized gains of $289,709,000 on securities that had risen in value since their purchase and $37,282,000 in unrealized losses on securities that had fallen in value since their purchase. The fund had net unrealized foreign currency gains of $4,000 resulting from the translation of other assets and liabilities at January 31, 2002. G. The market value of securities on loan to broker/dealers at January 31, 2002, was $29,587,000, for which the fund held cash collateral of $30,250,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 21 H. Capital share transactions for each class of shares were: - -------------------------------------------------------------------------------- YEAR ENDED JANUARY 31, ------------------------------------------- 2002 2001 ------------------------------------------- AMOUNT SHARES AMOUNT SHARES (000) (000) (000) (000) - -------------------------------------------------------------------------------- INVESTOR SHARES Issued $ 329,199 11,882 $ 348,491 13,086 Issued in Lieu of Cash Distributions 86,765 3,655 74,102 2,782 Redeemed* (322,478) (12,278) (359,369) (14,151) Net Increase (Decrease)--Investor Shares 93,486 3,259 63,224 1,717 ADMIRAL SHARES Issued 55,742 1,183 -- -- Issued in Lieu of Cash Distributions 2,870 64 -- -- Redeemed* (451) (9) -- -- Net Increase (Decrease)--Admiral Shares 58,161 1,238 -- -- - -------------------------------------------------------------------------------- *Net of redemption fees of $792,000 and $716,000, respectively (fund totals). 22 REPORT OF INDEPENDENT ACCOUNTANTS TO THE SHAREHOLDERS AND TRUSTEES OF VANGUARD ENERGY 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 Energy Fund (the "Fund") at January 31, 2002, 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 January 31, 2002 by correspondence with the custodian, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania March 6, 2002 - -------------------------------------------------------------------------------- SPECIAL 2002 TAX INFORMATION (UNAUDITED) FOR VANGUARD ENERGY FUND This information for the fiscal year ended January 31, 2002, is included pursuant to provisions of the Internal Revenue Code. The fund distributed $82,562,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year, all of which is designated as a 20% rate gain distribution. For corporate shareholders, 63.2% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. - -------------------------------------------------------------------------------- 23 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides ser-vices to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the
==================================================================================================================================== NAME POSITION(S) HELD WITH FUND (DATE OF BIRTH) (NUMBER OF VANGUARD FUNDS TRUSTEE/OFFICER SINCE OVERSEEN BY TRUSTEE) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS - ------------------------------------------------------------------------------------------------------------------------------------ JOHN J. BRENNAN* Chairman of the Board, Chairman of the Board, Chief Executive Officer, and (July 29, 1954) Chief Executive Officer, Director/Trustee of The Vanguard Group, Inc., and May 1987 and Trustee of each of the investment companies (106) served by The Vanguard Group. - ------------------------------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES Charles D. Ellis Trustee The Partners of '63 (pro bono ventures in education); Senior Adviser (October 23, 1937) (106) to Greenwich Associates (international business-strategy consulting); January 2001 Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. - ------------------------------------------------------------------------------------------------------------------------------------ RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice (December 23, 1945) (84) Chairman (January-September 1999), and Vice President (prior to December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Trustee Council; and of Drexel University. - ------------------------------------------------------------------------------------------------------------------------------------ JOANN HEFFERNAN HEISEN Trustee Vice President, Chief Information Officer, and Member of the Executive (January 25, 1950) (106) Committee of Johnson & Johnson (pharmaceuticals/consumer products); July 1998 Director of the Medical Center at Princeton and Women's Research and Education Institute. - ------------------------------------------------------------------------------------------------------------------------------------ BURTON G. MALKIEL Trustee Chemical Bank Chairman's Professor of Economics, Princeton (August 28, 1932) (104) University; Director of Prudential Insurance Co. of America, BKF May 1977 Capital (investment management), The Jeffrey Co. (a holding company), and NeuVis, Inc. (a software company). - ------------------------------------------------------------------------------------------------------------------------------------ ALFRED M. RANKIN, JR. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO (October 8, 1941) (106) Industries, Inc. (forklift trucks/housewares/lignite); Director of January 1993 Goodrich Corporation (industrial products/aircraft systems and services); Director of the Standard Products Company (a supplier for the automotive industry) until 1998. - ------------------------------------------------------------------------------------------------------------------------------------ J. LAWRENCE WILSON Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co. (March 2, 1936) (106) (chemicals); Director of Cummins Inc. (diesel engines), The Mead April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - ------------------------------------------------------------------------------------------------------------------------------------
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. Each trustee serves a fund until its termination; or until the trustee's retirement, resignation, or death; or otherwise as specified in the fund's organizational documents. Any trustee may be removed at a shareholders' meeting by a vote representing two-thirds of the net asset value of all shares of the fund together with shares of other Vanguard funds organized within the same trust. The table on these two pages shows information for each trustee and executive officer of the fund. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.
==================================================================================================================================== NAME POSITION(S) HELD WITH FUND (DATE OF BIRTH) (NUMBER OF VANGUARD FUNDS TRUSTEE/OFFICER SINCE OVERSEEN BY TRUSTEE) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS - ------------------------------------------------------------------------------------------------------------------------------------ EXECUTIVE OFFICERS* R. GREGORY BARTON Secretary Managing Director and General Counsel of The Vanguard Group, Inc. (April 25, 1951) (106) (since September 1997); Secretary of The Vanguard Group, and of June 2001 each of the investment companies served by The Vanguard Group; Principal of The Vanguard Group (prior to September 1997). - ------------------------------------------------------------------------------------------------------------------------------------ THOMAS J. HIGGINS Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the (May 21, 1957) (106) investment companies served by The Vanguard Group. July 1998 - ------------------------------------------------------------------------------------------------------------------------------------
*Officers of the funds are "interested persons" as defined in the Investment Company Act of 1940. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. - -------------------------------------------------------------------------------- VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. - -------------------------------------------------------------------------------- Vanguard, The Vanguard Group, Vanguard.com, Admiral, and the ship logo are trademarks of The Vanguard Group, Inc. Standard & Poor's(R), S&P(R), and S&P 500(R) are trademarks of The McGraw-Hill Companies, Inc. All other marks are the property of their respective owners. [SHIP LOGO] THE VANGUARD GROUP(R) POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 ABOUT OUR COVER Our cover photograph was taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photograph is copyrighted by Mr. Kahn. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the fund or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through VANGUARD.COM(TM). Prospectuses may also be viewed online. FUND INFORMATION 1-800-662-7447 TEXT TELEPHONE 1-800-952-3335 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 WORLD WIDE WEB www.vanguard.com (C)2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q510 032002 Vanguard(R) REIT Index Fund Annual Report * January 31, 2002 STOCK The Vanguard Group(R) PERSPECTIVE Maintaining a long-term investment perspective isn't easy. Perhaps that's why it has proven to be so rewarding. With news, information, and opinion constantly bombarding us, the temptation to buy or sell--to do something--is powerful. Yet such activity is often counterproductive. Emotions can lead us to big mistakes, like jumping into a hot investment we know little about or selling a sound long-term holding when it sags for a while. The actions we recommend are quite simple. First, take the time to decide on a mix of stocks, bonds, and cash investments that makes sense for you. Take into account your investment time horizon, your goals, and your ability and willingness to ride out market fluctuations. Write this mix down--it's your investment plan. Second, use low-cost, widely diversified mutual funds to carry out your asset allocation. Third, stick with your plan, unless there's a major change in your time horizon, goals, or financial situation. Don't "play the market"--and if you feel you must, don't risk more than a tiny percentage of your assets. Finally, if market news, the opinions of "experts," or the hope of a big score tempts you to act, consult your plan. It may help you keep a long-term perspective. CONTENTS Letter from the Chairman 1 Fund Profile 6 Glossary of Investment Terms 7 Performance Summary 8 Your Fund's After-Tax Returns 10 Financial Statements 11 Advantages of Vanguard.com 21 SUMMARY * Vanguard REIT Index Fund returned 11.6% during the 12 months ended January 31, 2002. * Our result was very good not only in absolute terms but also on a relative basis--it was roughly 3 percentage points above the average return of competing funds and nearly 27 percentage points above the -;15.3% return of the overall stock market. * The earnings growth of real estate investment trusts slowed considerably, but the sector still looked robust in light of the profit declines and losses in many other sectors. The relatively high yields of REITs also attracted attention as short-term interest rates sank. LETTER FROM THE CHAIRMAN [PHOTO--JOHN J. BRENNAN] John J. Brennan Fellow Shareholder, Real estate stocks provided very good returns during the 12 months ended January 31, 2002, as the overall stock market continued to decline. It was the second consecutive fiscal year of terrific relative results for the sector. VANGUARD(R) REIT INDEX FUND returned 11.6%--about 3 percentage points more than the average real estate fund and nearly 27 percentage points more than the overall stock market. The table below presents the fund's total return--capital change plus reinvested dividends--as well as the results for the average real estate fund and two unmanaged market indexes: the Morgan Stanley Real Estate Investment Trust Index (your fund's target) and the Wilshire 5000 Total Market Index. We also show the return for the fund's new Admiral(TM) Shares, a lower-cost class of shares for clients with large or long-tenured accounts that create economies of scale. - ------------------------------------------------------- 2002 Total Returns Fiscal Year Ended January 31 - ------------------------------------------------------- VANGUARD REIT INDEX FUND INVESTOR SHARES 11.6% Average Real Estate Fund* 8.5 Morgan Stanley REIT Index 11.9 Wilshire 5000 Index -15.3 - ------------------------------------------------------- Admiral Shares (since inception on November 12, 2001) - ------------------------------------------------------- Vanguard REIT Index Fund 5.8% - ------------------------------------------------------- *Derived from data provided by Lipper Inc. The table on page 5 provides details about the fund's performance in the fiscal period, including the change in share price and the distributions of investment income and return of capital. The fund's distribution yield at our fiscal year-end was 6.7%. FINANCIAL MARKETS IN REVIEW The 12 months ended January 31 were very rough for most stock investors. The broad U.S. stock market, as measured by the Wilshire 5000 Index, lost -15.3% during the fiscal year. Several factors contributed to the market's decline, including: * The first recession in the U.S. economy in a decade, part of a worldwide slowdown in economic activity. * The September 11 terrorist attacks, which resulted in economic disruption and a heightened awareness of risk--both physical and financial. * A steep reduction in corporate profits--12-month net earnings reported by companies in the Standard & Poor's 500 Index fell nearly 50% on average from January 2001 to January 2002. 1 * Concern about the reliability of certain corporate accounting and disclosure practices, owing largely to the collapse of Enron Corporation. The recession that began in March 2001 ended a record ten years of uninterrupted expansion in the U.S. economy. The downturn was heralded by severe reductions in corporate investment spending, especially in the technology and telecommunications sectors (both plagued by overcapacity created in the 1990s boom). As the year progressed, so did the business cutbacks and the weakness in most economic indicators. High levels of corporate and household debt cast doubt on the economy's ability to bounce back quickly. Through all the difficulties, consumer spending held up surprisingly well--especially spending for housing and for automobiles, spurred by low interest rates (and sales incentives, in the case of autos). Joblessness rose during the 12 months--the unemployment rate in January 2002 stood at 5.6%, well above the three-decade low of 3.9% last reached in October 2000. However, layoffs seemed to be tapering off late in the fiscal year, and consumer confidence regained some ground. Whether such hopeful signs will blossom into a full-fledged recovery by summer is uncertain, but by January the Federal Reserve Board was encouraged enough to halt its aggressive campaign of cutting interest rates to stimulate economic activity. In the 2001 calendar year, the Fed lowered its target for the federal funds rate--the interest rate that banks charge each other for overnight loans--11 times, for a total of 475 basis points (4.75 percentage points). Those reductions brought the federal funds rate to 1.75%, its lowest level in four decades. The weak economy and even weaker corporate profits kept the broad U.S. stock market in bear territory during the 12 months ended January 31. The market hit a three-year low in September after the terrorist attacks, but rallied in the final weeks of 2001. Still, the returns of most stock sectors were deeply in the red for the full fiscal year. The Wilshire 5000 Index ended the period -28% below its peak in March 2000. In contrast, investment-grade bonds had another - -------------------------------------------------------------------------------- MARKET BAROMETER Average Annual Total Returns Periods Ended January 31, 2002 ------------------------------- One Three Five Year Years Years - -------------------------------------------------------------------------------- STOCKS S&P 500 Index (Large-caps) -16.1% -2.8% 9.0% Russell 2000 Index (Small-caps) -3.6 5.6 6.9 Wilshire 5000 Index (Entire market) -15.3 -2.3 8.3 MSCI EAFE Index (International) -26.1 -6.9 0.4 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index (Entire market) 7.6% 6.3% 7.5% Lehman 10 Year Municipal Bond Index 5.2 4.7 6.3 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 3.7 4.9 5.0 ================================================================================ CPI Consumer Price Index 1.1% 2.5% 2.2% - -------------------------------------------------------------------------------- 2 good year. The Lehman Brothers Aggregate Bond Index, a proxy for the taxable investment-grade U.S. bond market, posted a 12-month return of 7.6%. Yields of U.S. Treasury securities--which move in the opposite direction from their prices--fell during the 12 months. As we would expect, the yield of the 3-month Treasury bill was most affected by the Fed's actions; it fell 324 basis points to 1.75%. The 3-year Treasury note's yield declined 57 basis points to 4.13%, while the yields of 10-year and 30-year Treasuries were nearly unchanged at 5.03% and 5.43%, respectively. - -------------------------------------------------------------------------------- WITH BOND YIELDS FALLING, MANY INVESTORS WERE LURED BY YIELDS ON REITS. - -------------------------------------------------------------------------------- FISCAL 2002 PERFORMANCE OVERVIEW Your fund's 11.6% gain for the 12 months ended January 31 consisted of a 5.8% capital return and a 5.8% income return. The income return included both net investment income and some return of capital by our underlying REITs. Once again the fund met its investment objective by closely tracking the return of its target index. Real estate stocks did well during the period for a couple of reasons. First, the sector attracted some buyers who saw REITs as a haven from losses or steep profit declines in many other sectors. Second, the relatively high yields of REITs captured the attention of many investors who saw income from other investments fall as the Fed slashed short-term interest rates. - -------------------------------------------------------------------------------- THE 11.6% RETURN OF VANGUARD REIT INDEX FUND DURING THE 12 MONTHS ENDED JANUARY 31 CONSISTED OF A 5.8% CAPITAL RETURN AND A 5.8% INCOME RETURN. - -------------------------------------------------------------------------------- But while real estate stocks held up during the fiscal year, the recession and September's terrorist attacks took a toll on the real estate market. One widely used barometer is the year-over-year growth rate in funds from operations--a measure of operating earnings for REITs. The growth rate decreased in each quarter of calendar 2001, according to the National Association of Real Estate Investment Trusts. In comparison with figures from 2000, funds from operations rose 7.5% in the first quarter of 2001, 5.7% in the second quarter, and 3.8% in the third quarter. (Fourth-quarter figures were not available.) It's important to note that even though this rate was declining, it was still positive--unlike common stock earnings. The performance of an individual REIT depends on many factors, such as its ability to find tenants for its properties, to renew leases, and to finance purchases and renovations. A REIT's rental income could decline because of extended vacancies, increased competition from nearby properties, tenants' failure to pay rent, or poor management. 3 Vanguard REIT Index Fund is a sensible way to gain broad, economical exposure to the real estate market. The fund seeks to provide a high level of income and moderate long-term capital growth by tracking a benchmark index of publicly traded equity REITs. (Equity REITs own properties directly. Other types are mortgage REITs, which make loans to commercial real estate developers, and hybrid REITs, which hold both properties and mortgages.) As of January 31, your fund held 112 equity REITs, most of which specialized in apartment buildings, office space, or retail centers. For more details, see the Fund Profile on page 6. LIFETIME PERFORMANCE OVERVIEW Vanguard REIT Index Fund is intended as a long-term investment vehicle, and we believe its merits should be judged over longer periods. Since its inception on May 13, 1996, the fund has recorded an average annual return of 10.4%. This result is solid in both absolute and relative terms. The table below presents the returns during the period for the fund, its average competitor, the Morgan Stanley REIT Index, and the all-market Wilshire 5000 Index. It also shows the results of hypothetical $10,000 investments made in each at the fund's inception. We expect our funds to outperform their peers over the long term, and the REIT Index Fund has succeeded thus far. - -------------------------------------------------------------------- TOTAL RETURNS May 13, 1996, to January 31, 2002 ------------------------------------ Average Final Value of Annual a $10,000 Return Initial Investment - -------------------------------------------------------------------- Vanguard REIT Index Fund Investor Shares 10.4% $17,573 Average Real Estate Fund 9.7 17,007 Morgan Stanley REIT Index 10.3 17,492 Wilshire 5000 Index 10.1 17,331 - -------------------------------------------------------------------- The fund is ably managed by Vanguard's Quantitative Equity Group, which runs all of our stock index funds. One sign of the group's skill is that, since inception, the REIT Index Fund has actually outpaced its target index by an average of 0.1 percentage point annually. This is remarkable because indexes exist on paper--they incur zero costs. As a real-world investment portfolio, your fund bears the burden of operating and transaction costs. Although our indexed approach helps to minimize these costs, to actually overcome them takes adroit work by the Quantitative Equity Group's professionals. Compared with its peer group of funds, the REIT Index Fund has a major cost advantage. At 0.28% of average net assets ($2.80 per $1,000 in assets), the annual expense ratio of our Investor Shares for 2001 was one-sixth of the 1.67% ratio ($16.70 per $1,000 in assets) charged by the average real estate fund. The practical meaning of our cost advantage is simple: Our average competitor must earn more than 1.4 percentage points more, on a gross basis, each year to deliver the same net result to its shareholders. That's a high hurdle to overcome. IN SUMMARY After difficult periods in the stock market--as the past two years certainly have been--it's easy to act on the temptation to concentrate one's investments in the "safest" or the "best-performing" asset class or market sector. We counsel investors to resist this impulse and to remain true to a long-term strategy of holding a well-diversified mix of stocks, bonds, and short-term investments. Because REITs have behaved very differently from the market as a whole in recent years, they may serve to further diversify a portfolio. Your portfolio's asset mix should be chosen in light of your time horizon, financial situation, and tolerance for risk, and it should not be changed substantially on the basis of transitory matters--such as which market sector did best or worst last year or what the self-appointed market experts are saying this month. "Stay the course" remains our advice. We thank you for your trust in our approach to investing, and we pledge to continue working hard to keep your confidence. Sincerely, John J. Brennan Chairman and Chief Executive Officer February 13, 2002 - -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: January 31, 2001-January 31, 2002 Distributions Per Share ------------------------------- Starting Ending Income Capital Return of Share Price Share Price Dividends Gains Capital Vanguard REIT Index Fund Investor Shares $11.61 $12.10 $0.631 $0.000 $0.179 Admiral Shares* 50.00 51.65 0.970 0.000 0.275 - -------------------------------------------------------------------------------- *Since inception on November 12, 2001. 5 FUND PROFILE As of January 31, 2002 for REIT Index Fund This Profile provides a snapshot of the fund's characteristics, compared where appropriate to a broad market index. Key terms are defined on page 7. - ------------------------------------------------ Portfolio Characteristics Wilshire Fund 5000 - ------------------------------------------------ Number of Stocks 112 6,013 Median Market Cap $2.0B $33.1B Price/Earnings Ratio 17.1x 32.5x Price/Book Ratio 1.5x 3.3x Yield 1.3% Investor Shares 6.7%* Admiral Shares 6.8%* Return on Equity 11.7% 22.5% Earnings Growth Rate 12.2% 14.4% Foreign Holdings 0.0% 0.0% Turnover Rate 10% -- Expense Ratio Investor Shares 0.28% -- Admiral Shares 0.23%** -- Cash Investments 2.0% -- - ------------------------------------------------ - --------------------------------------------- Ten Largest Holdings (% of total net assets) Equity Office Properties Trust REIT 8.8% Equity Residential Properties Trust REIT 5.3 Simon Property Group, Inc. REIT 3.9 Public Storage, Inc. REIT 3.2 Archstone-Smith Trust REIT 3.2 Vornado Realty Trust REIT 3.1 ProLogis Trust REIT 2.8 Boston Properties, Inc. REIT 2.4 Apartment Investment & Management Co. Class A REIT 2.4 Avalonbay Communities, Inc. REIT 2.3 - ---------------------------------------------- Top Ten 37.4% - ---------------------------------------------- - ---------------------- Investment Focus [Chart] Market Cap -- Small Style -- Value - ---------------------- - --------------------------------------- Volatility Measures Wilshire Fund 5000 - --------------------------------------- R-Squared -0.02 1.00 Beta 0.08 1.00 - --------------------------------------- - ----------------------------- Fund Allocation by REIT Type Apartments 23.0% Office 22.3 Retail 21.8 Industrial 14.7 Diversified 12.5 Hotels 5.7 - ----------------------------- Total 100.0% - ----------------------------- *This yield included 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. **Annualized. [COMPUTER GRAPHIC] Visit our website www.vanguard.com for regularly updated fund information. 6 GLOSSARY OF INVESTMENT TERMS Beta. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- Cash Investments. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - -------------------------------------------------------------------------------- Earnings Growth Rate. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- Expense Ratio. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- Median Market Cap. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- Price/Book Ratio. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- Price/Earnings Ratio. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-Squared. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- Return on Equity. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- Turnover Rate. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- Yield. A snapshot of a fund's income from dividends, interest, and return-of-capital distributions. The index yield is based on the current annualized rate of dividends and other distributions paid on stocks in the index. - -------------------------------------------------------------------------------- 7 Performance Summary As of January 31, 2002 for REIT Index Fund All of the data on this page and the following page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. - -------------------------------------------------------------------------------- CUMULATIVE PERFORMANCE May 13, 1996-January 31, 2002 [Mountain Chart] REIT Index Fund Average Real Morgan Stanley Wilshire 5000 Investor Shares Estate Fund REIT Index Index 5/13/1996 10000 10000 10000 10000 199607 10270 10074 10276 9448 199610 11186 10932 11201 10413 199701 13033 12618 13066 11566 199704 12637 12184 12664 11531 199707 14067 13968 14081 13908 199710 14825 14683 14842 13703 199801 15258 14981 15217 14491 199804 14873 14916 14797 16518 199807 13720 13685 13644 16278 199810 12964 12620 12913 15730 199901 12617 12554 12546 18444 199904 13544 13514 13442 19346 199907 13174 13288 13057 19264 199910 12224 12101 12131 19768 200001 12485 12270 12391 21069 200004 13583 13216 13472 21631 200007 15298 15058 15166 21352 200010 14418 14427 14301 21370 200101 15747 15670 15630 20328 200104 15957 15630 15846 18575 200107 16902 16616 16791 18140 200110 16256 15727 16172 15906 200201 17573 17007 17492 17331 Average Annual Total Returns Periods Ended January 31, 2002 ------------------------------- Final Value One Five Since of a $10,000 Year Years Inception Investment - -------------------------------------------------------------------------------- REIT Index Fund Investor Shares 11.59% 6.16% 10.36% $17,573 Average Real Estate Fund* 8.53 6.15 9.73 17,007 Morgan Stanley REIT Index 11.92 6.01 10.27 17,492 Wilshire 5000 Index -15.31 8.28 10.09 17,331 - -------------------------------------------------------------------------------- Final Value Since of a $250,000 Inception+ Investment - -------------------------------------------------------------------------------- REIT Index Fund Admiral Shares** 4.72% $261,802 Morgan Stanley REIT Index 5.84 264,594 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TOTAL INVESTMENT RETURNS (%) May 13, 1996-January 31, 2002 [Bar Chart] Fiscal REIT Index Fund Morgan Stanley Year Investor Shares REIT Index 1997 30.3 30.7 1998 17.1 16.5 1999 -17.3 -17.6 2000 -1 -1.2 2001 26.1 26.1 2002 11.6 11.9 - -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. **Reflective of the 1% fee assessed on redemptions of shares held less than one year. +November 12, 2001. Note: See Financial Highlights tables on pages 16 and 17 for information on dividends, capital gains, and return of capital. 8 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS for periods ended December 31, 2001 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal year. Securities and Exchange Commission rules require that we provide this information. Since Inception One Five ------------------------ Inception Date Year Years Capital Income Total - -------------------------------------------------------------------------------- REIT Index Fund Investor Shares 5/13/1996 12.35% 6.25% 4.76% 5.81% 10.57% Admiral Shares 11/12/2001 -- 5.78 Fee-Adjusted Returns* -- 4.72 - -------------------------------------------------------------------------------- *Reflective of the 1% fee assessed on redemptions of shares held less than one year. 9 YOUR FUND'S AFTER-TAX RETURNS This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund's distributions, and (2) assuming that an investor paid taxes on the fund's distributions and sold all shares at the end of each period. Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes. Finally, keep in mind that a fund's performance--whether before or after taxes--does not indicate how it will perform in the future. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS Periods Ended January 31, 2002 Since One Year Five Years Inception* -------------------------------------------- REIT Index Fund Investor Shares** Returns Before Taxes 11.59% 6.16% 10.36% Returns After Taxes on Distributions 9.31 3.85 8.04 Returns After Taxes on Distributions and Sale of Fund Shares 6.99 3.73 7.27 - -------------------------------------------------------------------------------- *May 13, 1996. **Total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. 10 FINANCIAL STATEMENTS January 31, 2002 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. Real Estate Investment Trusts are listed in descending market-value order. Temporary cash investments and other assets are added to, and liabilities are subtracted from, the value of Total Real Estate Investment Trusts to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- Market Value+ REIT Index Fund Shares (000) - -------------------------------------------------------------------------------- REAL ESTATE INVESTMENT TRUSTS (98.0%) - -------------------------------------------------------------------------------- Equity Office Properties Trust REIT 4,369,810 $ 125,807 Equity Residential Properties Trust REIT 2,856,034 76,485 Simon Property Group, Inc. REIT 1,850,451 56,050 Public Storage, Inc. REIT 1,273,797 46,634 Archstone-Smith Trust REIT 1,823,430 45,367 Vornado Realty Trust REIT 1,027,348 43,827 ProLogis Trust REIT 1,845,242 39,876 Boston Properties, Inc. REIT 957,267 35,074 Apartment Investment & Management Co. Class A REIT 783,436 34,158 Avalonbay Communities, Inc. REIT 734,081 32,997 Kimco Realty Corp. REIT 1,055,807 32,223 Duke Realty Corp. REIT 1,377,573 32,029 Host Marriott Corp. REIT 2,773,757 27,987 General Growth Properties Inc. REIT 640,378 25,935 Rouse Co. REIT 883,550 25,270 Liberty Property Trust REIT 774,083 22,719 AMB Property Corp. REIT 882,592 22,603 Crescent Real Estate, Inc. REIT 1,148,571 19,836 Hospitality Properties Trust REIT 659,355 19,715 CarrAmerica Realty Corp. REIT 645,770 18,999 Mack-Cali Realty Corp. REIT 601,078 18,940 New Plan Excel Realty Trust REIT 984,470 18,921 Arden Realty Group, Inc. REIT 672,838 18,052 Weingarten Realty Investors REIT 361,438 17,801 Regency Centers Corp. REIT 607,418 17,433 United Dominion Realty Trust REIT 1,088,330 15,607 Camden Property Trust REIT 430,076 14,992 Highwood Properties, Inc. REIT 559,562 14,856 BRE Properties Inc. Class A REIT 481,044 14,013 Post Properties, Inc. REIT 390,512 13,141 Cousins Properties, Inc. REIT 526,211 13,103 First Industrial Realty Trust REIT 413,422 12,659 Storage USA, Inc. REIT 290,417 12,450 Reckson Associates Realty Corp. REIT 524,206 12,099 HRPT Properties Trust REIT 1,360,049 12,023 Developers Diversified Realty Corp. REIT 627,156 11,979 CenterPoint Properties Corp. REIT 239,853 11,877 Shurgard Storage Centers, Inc. Class A REIT 342,864 11,349 Prentiss Properties Trust REIT 389,768 10,921 Realty Income Corp. REIT 345,184 10,683 Washington REIT 408,127 10,399 11 - -------------------------------------------------------------------------------- Market Value+ REIT Index Fund Shares (000) - -------------------------------------------------------------------------------- Federal Realty Investment Trust REIT 422,374 $ 10,268 Chelsea Property Group REIT 197,642 10,026 FelCor Lodging Trust, Inc. REIT 558,819 10,020 SL Green Realty Corp. REIT 316,054 10,003 The Macerich Co. REIT 357,647 9,860 Pan Pacific Retail Properties, Inc. REIT 340,912 9,777 CBL & Associates Properties, Inc. REIT 269,411 9,093 Essex Property Trust, Inc. REIT 193,873 8,984 Chateau Communities, Inc. REIT 303,375 8,913 Mills Corp. REIT 300,129 8,196 Taubman Co. REIT 529,860 8,176 Brandywine Realty Trust REIT 373,457 7,872 Home Properties of New York, Inc. REIT 233,680 7,737 Kilroy Realty Corp. REIT 289,299 7,348 Gables Residential Trust REIT 255,738 7,314 Manufactured Home Communities, Inc. REIT 226,009 7,300 Sun Communities, Inc. REIT 184,797 7,096 Colonial Properties Trust REIT 220,025 7,039 PS Business Parks, Inc. REIT 227,125 6,973 Alexandria Real Estate Equities, Inc. REIT 171,915 6,954 MeriStar Hospitality Corp. REIT 470,091 6,628 Summit Properties, Inc. REIT 284,159 6,303 Capital Automotive REIT 273,060 5,808 Glenborough Realty Trust, Inc. REIT 284,107 5,674 Glimcher Realty Trust REIT 316,038 5,657 Cornerstone Realty Income Trust, Inc. REIT 498,582 5,300 Commercial Net Lease Realty REIT 385,117 5,107 Mid-America Apartment Communities, Inc. REIT 183,749 4,724 Koger Equity, Inc. REIT 282,853 4,633 AMLI Residential Properties Trust REIT 187,947 4,601 JDN Realty Corp. REIT 346,646 4,326 Equity One, Inc. REIT 303,247 4,276 Bedford Property Investors, Inc. REIT 174,556 4,224 EastGroup Properties, Inc. REIT 167,580 4,047 Sovran Self Storage, Inc. REIT 129,633 4,030 JP Realty Inc. REIT 172,398 4,025 Getty Realty Holding Corp. REIT 206,200 4,017 Pennsylvania REIT 167,098 3,890 Innkeepers USA Trust REIT 366,732 3,796 Town & Country Trust REIT 169,710 3,620 IRT Property Co. REIT 320,613 3,578 RFS Hotel Investors, Inc. REIT 265,130 3,460 Lexington Corporate Properties Trust REIT 234,174 3,431 Saul Centers, Inc. REIT 152,936 3,215 Parkway Properties Inc. REIT 98,349 3,206 Entertainment Properties Trust REIT 156,125 3,177 Equity Inns, Inc. REIT 387,908 3,006 U.S. Restaurant Properties, Inc. REIT 196,608 2,851 Great Lakes, Inc. REIT 176,418 2,770 Corporate Office Properties Trust, Inc. REIT 217,944 2,724 Reckson Associates Realty Corp. Class B REIT 110,299 2,698 Keystone Property Trust REIT 193,300 2,639 Investors Real Estate Trust REIT 269,806 2,598 Kramont Realty Trust REIT 198,036 2,594 LaSalle Hotel Properties REIT 193,990 2,328 Mid Atlantic Realty Trust REIT 157,176 2,310 Crown American Realty Trust REIT 275,790 2,303 Mission West Properties Inc. REIT 180,310 2,171 Associated Estates Realty Corp. REIT 204,451 1,934 Tanger Factory Outlet Centers, Inc. REIT 83,452 1,883 Prime Group Realty Trust REIT 165,379 1,571 National Golf Properties, Inc. REIT 137,621 1,528 Boykin Lodging Co. REIT 180,965 1,509 Winston Hotels, Inc. REIT 178,266 1,462 Correctional Properties Trust REIT 75,300 1,393 Ramco-Gershenson Properties Trust REIT 69,900 1,195 Sizzlers Property Investors, Inc. REIT 120,600 1,108 American Land Lease, Inc. REIT 74,860 1,000 Commercial Net Lease Realty Pfd. REIT 19,948 469 Pacific Gulf Properties, Inc. REIT 245,518 245 * Five Star Quality Care, Inc. REIT 13,353 103 - -------------------------------------------------------------------------------- TOTAL REAL ESTATE INVESTMENT TRUSTS (Cost $1,314,107) 1,406,983 - -------------------------------------------------------------------------------- 12 - -------------------------------------------------------------------------------- Face Market Amount Value+ (000) (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (2.6%) - -------------------------------------------------------------------------------- REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.91%, 2/1/2002 $33,238 $ 33,238 1.91%, 2/1/2002--Note F 3,755 3,755 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $36,993) 36,993 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.6%) (Cost $1,351,100) 1,443,976 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.6%) - -------------------------------------------------------------------------------- Other Assets--Note B 7,745 Liabilities--Note F (16,068) ----------- (8,323) ----------- - -------------------------------------------------------------------------------- NET ASSETS (100%) $1,435,653 ================================================================================ + See Note A in Notes to Financial Statements. * Non-income-producing security. New issue that has not paid a dividend as of January 31, 2002. - -------------------------------------------------------------------------------- Amount (000) - -------------------------------------------------------------------------------- AT JANUARY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- Paid-in Capital $1,392,127 Overdistributed Net Investment Income (993) Accumulated Net Realized Losses--Note D (48,357) Unrealized Appreciation--Note E 92,876 - -------------------------------------------------------------------------------- NET ASSETS $1,435,653 ================================================================================ Investor Shares--Net Assets Applicable to 104,922,642 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $1,270,022 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- INVESTOR SHARES $12.10 ================================================================================ Admiral Shares--Net Assets Applicable to 3,206,607 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $165,631 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $51.65 ================================================================================ 13 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. - -------------------------------------------------------------------------------- REIT Index Fund Year Ended January 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME Income Dividends $ 66,999 Interest 804 Security Lending 34 - -------------------------------------------------------------------------------- Total Income 67,837 - -------------------------------------------------------------------------------- Expenses The Vanguard Group--Note B Investment Advisory Fees 19 Management and Administrative Investor Shares 3,052 Admiral Shares 61 Marketing and Distribution Investor Shares 154 Admiral Shares -- Custodian Fees 42 Auditing Fees 13 Shareholders' Reports Investor Shares 35 Admiral Shares -- Trustees' Fees and Expenses 2 - -------------------------------------------------------------------------------- Total Expenses 3,378 Expenses Paid Indirectly--Note C (4) - -------------------------------------------------------------------------------- Net Expenses 3,374 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 64,463 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Capital Gain Distributions Received 7,416 Investment Securities Sold (11,751) - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) (4,335) - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)OF INVESTMENT SECURITIES 69,799 - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $129,927 ================================================================================ 14 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. - -------------------------------------------------------------------------------- REIT Index Fund Year Ended January 31, ---------------------- 2002 2001 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS Operations Net Investment Income $ 64,463 $ 56,189 Realized Net Gain (Loss) (4,335) 3,956 Change in Unrealized Appreciation (Depreciation) 69,799 159,914 - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations 129,927 220,059 - -------------------------------------------------------------------------------- Distributions Net Investment Income Investor Shares (62,068) (57,697) Admiral Shares (2,640) -- Realized Capital Gain Investor Shares -- -- Admiral Shares -- -- Return of Capital Investor Shares (17,601) (15,818) Admiral Shares (751) -- - -------------------------------------------------------------------------------- Total Distributions (83,060) (73,515) - -------------------------------------------------------------------------------- Capital Share Transactions--Note G Investor Shares 131,686 57,551 Admiral Shares 165,383 -- - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 297,069 57,551 - -------------------------------------------------------------------------------- Total Increase (Decrease) 343,936 204,095 - -------------------------------------------------------------------------------- Net Assets Beginning of Period 1,091,717 887,622 - -------------------------------------------------------------------------------- End of Period $1,435,653 $1,091,717 ================================================================================ 15 Financial Highlights This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year. - -------------------------------------------------------------------------------------------------------- REIT Index Fund Investor Shares Year Ended January 31, -------------------------------------------- For a Share Outstanding Throughout Each Period 2002 2001 2000 1999 1998 - -------------------------------------------------------------------------------------------------------- Net Asset Value, Beginning of Period $11.61 $ 9.91 $10.81 $13.98 $12.64 Investment Operations Net Investment Income .631 .642 .660 .666 .590 Net Realized and Unrealized Gain (Loss) on Investments .669 1.878 (.780) (3.026) 1.520 Total from Investment Operations 1.300 2.520 (.120) (2.360) 2.110 Distributions Dividends from Net Investment Income (.631) (.644) (.670) (.666) (.590) Distributions from Realized Capital Gains -- -- -- -- (.086) Return of Capital (.179) (.176) (.110) (.144) (.094) Total Distributions (.810) (.820) (.780) (.810) (.770) Net Asset Value, End of Period $12.10 $11.61 $ 9.91 $10.81 $13.98 Total Return* 11.59% 26.13% -1.04% -17.31% 17.08% Ratios/Supplemental Data Net Assets, End of Period (Millions) $1,270 $1,092 $888 $904 $1,317 Ratio of Total Expenses to Average Net Assets 0.28% 0.33% 0.33% 0.26% 0.24% Ratio of Net Investment Income to Average Net Assets 5.35% 5.73% 5.98% 5.19% 4.66% Portfolio Turnover Rate 10% 21%** 12% 29% 2% ======================================================================================================== *Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. **The portfolio turnover rate excluding in-kind redemptions was 14%.
16 - -------------------------------------------------------------------------------- REIT Index Fund Admiral Shares Nov. 12, 2001* to For a Share Outstanding Throughout the Period Jan. 31, 2002 - -------------------------------------------------------------------------------- Net Asset Value, Beginning of Period $50.00 - -------------------------------------------------------------------------------- Investment Operations Net Investment Income .494 Net Realized and Unrealized Gain (Loss) on Investments 2.401 - -------------------------------------------------------------------------------- Total from Investment Operations 2.895 - -------------------------------------------------------------------------------- Distributions Dividends from Net Investment Income (.970) Distributions from Realized Capital Gains -- Return of Capital (.275) - -------------------------------------------------------------------------------- Total Distributions (1.245) - -------------------------------------------------------------------------------- Net Asset Value, End of Period $51.65 ================================================================================ Total Return** 5.78% ================================================================================ Ratios/Supplemental Data Net Assets, End of Period (Millions) $166 Ratio of Total Expenses to Average Net Assets 0.23%+ Ratio of Net Investment Income to Average Net Assets 5.27%+ Portfolio Turnover Rate 10% ================================================================================ *Inception. **Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. +Annualized. 17 NOTES TO FINANCIAL STATEMENTS Vanguard REIT Index Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on November 12, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. Security Valuation: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments 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. Fees assessed on redemptions of capital shares are credited to paid-in capital. Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets. B. The Vanguard Group furnishes at cost investment advisory, 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 January 31, 2002, the fund had contributed capital of $253,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.25% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. 18 C. The fund's custodian bank has agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the year ended January 31, 2002, custodian fee offset arrangements reduced expenses by $4,000. D. During the year ended January 31, 2002, the fund purchased $406,461,000 of investment securities and sold $117,059,000 of investment securities other than temporary cash investments. At January 31, 2002, the fund had available a capital loss carryforward of $48,357,000 to offset future net capital gains of $6,707,000 through January 31, 2007, $37,315,000 through January 31, 2008, and $4,335,000 through January 31, 2010. E. At January 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $92,876,000, consisting of unrealized gains of $141,015,000 on securities that had risen in value since their purchase and $48,139,000 in unrealized losses on securities that had fallen in value since their purchase. F. The market value of securities on loan to broker/dealers at January 31, 2002, was $3,656,000, for which the fund held cash collateral of $3,755,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. G. Capital share transactions for each class of shares were: - -------------------------------------------------------------------------------- Year Ended January 31, ----------------------------------------- 2002 2001 ----------------------------------------- Amount Shares Amount Shares (000) (000) (000) (000) - -------------------------------------------------------------------------------- Investor Shares Issued $ 412,985 34,364 $ 291,949 26,821 Issued in Lieu of Cash Distributions 67,098 5,714 62,084 5,632 Redeemed* (348,397) (29,184) (296,482) (27,976) -------------------------------------------- Net Increase (Decrease)-- Investor Shares 131,686 10,894 57,551 4,477 -------------------------------------------- Admiral Shares Issued 164,497 3,190 -- -- Issued in Lieu of Cash Distributions 2,437 47 -- -- Redeemed* (1,551) (30) -- -- -------------------------------------------- Net Increase (Decrease)-- Admiral Shares 165,383 3,207 -- -- - -------------------------------------------------------------------------------- *Net of redemption fees of $288,000 and $293,000, respectively (fund totals). 19 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Trustees of Vanguard REIT Index 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 REIT Index Fund (the "Fund") at January 31, 2002, 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 January 31, 2002 by correspondence with the custodian, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania March 6, 2002 20 ADVANTAGES OF VANGUARD.COM(TM) Why wait for the mail? You can get fund reports like this one sooner--and reduce the amount of mail you receive from us. Simply choose to view your fund reports online. Consider the benefits of using Vanguard.com. On our website, you can: * Choose to receive all fund reports, as well as prospectuses, online. * Request a courtesy e-mail to notify you when a new fund report or prospectus is available. When you receive fund reports and prospectuses online, you lower Vanguard's printing and postage costs--and that helps to reduce the expense ratios of your funds. You will continue to receive confirmations of purchases, redemptions, and other account activity by mail. HOW TO NOTIFY US ABOUT YOUR MAILING PREFERENCES You can easily tell us to stop mailing your fund reports and prospectuses. Just log on to Vanguard.com (or follow the easy steps to register for secure, online access to your accounts) and update your Web profile. Registered users can also view their account values; download records of recent transactions; research and track the performance of individual securities and funds; buy, exchange, and sell fund shares; and much more. If you invest directly with us, you can also elect to receive all of your account statements online or to continue the mailing of only your year-end statements, which detail every transaction you make during the year. However, if you invest with us through an employer-sponsored retirement plan or a financial intermediary, some of these options may not be available to you. All Vanguard shareholders can choose to receive our electronic newsletters: ECONOMIC WEEK IN REVIEW, a recap of each week's key economic reports and market activity; and WHAT'S NEW AT VANGUARD, a monthly update on our mutual funds, services, and online resources. YOUR ONLINE INFORMATION IS SECURE Vanguard.com uses some of the most secure forms of online communication available, including data encryption and Secure Sockets Layer (SSL) protocol. These technologies provide a high level of security and privacy when you access your account information, initiate online transactions, or send us messages. 21 The Vanguard(R) Family of Funds STOCK FUNDS 500 Index Fund Calvert Social Index(TM) Fund Capital Opportunity Fund Capital Value 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 Growth and Income Fund Growth Equity Fund Growth Index Fund Health Care Fund Institutional Developed Markets Index Fund Institutional Index Fund Institutional Total Stock Market Index Fund International Growth Fund International Value Fund Mid-Cap Index Fund Morgan(TM) Growth Fund Pacific Stock Index Fund Precious Metals 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 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 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 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 Marke 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. THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the
================================================================================================================================ Name Position(s) Held with Fund (Date of Birth) (Number of Vanguard Funds Trustee/Officer Since Overseen by Trustee) Principal Occupation(s) During the Past Five Years - -------------------------------------------------------------------------------------------------------------------------------- JOHN J. BRENNAN* Chairman of the Board, Chairman of the Board, Chief Executive Officer, and (July 29, 1954) Chief Executive Officer, Director/Trustee of The Vanguard Group, Inc., and of May 1987 and Trustee each of the investment companies served by (106) The Vanguard Group. - -------------------------------------------------------------------------------------------------------------------------------- INDEPENDENT TRUSTEES CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Adviser (October 23, 1937) (106) to Greenwich Associates (international business-strategy consulting); January 2001 Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. - -------------------------------------------------------------------------------------------------------------------------------- RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice (December 23, 1945) (84) Chairman (January-;September 1999), and Vice President (prior to December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of Technitrol, Inc.(electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. - -------------------------------------------------------------------------------------------------------------------------------- JOANN HEFFERNAN HEISEN Trustee Vice President, Chief Information Officer, and Member of the Executive (January 25, 1950) (106) Committee of Johnson & Johnson (pharmaceuticals/consumer products); July 1998 Director of the Medical Center at Princeton and Women's Research and Education Institute. - -------------------------------------------------------------------------------------------------------------------------------- BURTON G. MALKIEL Trustee Chemical Bank Chairman's Professor of Economics, Princeton (August 28, 1932) (104) University; Director of Prudential Insurance Co. of America, BKF Capital May 1977 (investment management), The Jeffrey Co. (a holding company), and NeuVis, Inc.(a software company.) - -------------------------------------------------------------------------------------------------------------------------------- ALFRED M. RANKIN, JR. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO (October 8, 1941) (106) Industries, Inc. (forklift trucks/housewares/lignite); Director of Goodrich January 1993 Corporation (industrial products/aircraft systems and services); Director of the Standard Products Company (a supplier for the automotive industry) until 1998 - -------------------------------------------------------------------------------------------------------------------------------- J. LAWRENCE WILSON Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co. (March 2, 1936) (106) (chemicals); Director of Cummins Inc. (diesel engines), The Mead April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - --------------------------------------------------------------------------------------------------------------------------------
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. Each trustee serves a fund until its termination; or until the trustee's retirement, resignation, or death; or otherwise as specified in the fund's organizational documents. Any trustee may be removed at a shareholders' meeting by a vote representing two-thirds of the net asset value of all shares of the fund together with shares of other Vanguard funds organized within the same trust. The table on these two pages shows information for each trustee and executive officer of the fund. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.
====================================================================================================================== NAME POSITION(S) HELD WITH FUND (DATE OF BIRTH) (NUMBER OF VANGUARD FUNDS TRUSTEE/OFFICER SINCE OVERSEEN BY TRUSTEE) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS - ---------------------------------------------------------------------------------------------------------------------- EXECUTIVE OFFICERS* R. GREGORY BARTON Secretary Managing Director and General Counsel of The Vanguard Group, Inc. (April 25, 1951) (106) (since September 1997); Secretary of The Vanguard Group, and of June 2001 each of the investment companies served by The Vanguard Group; Principal of The Vanguard Group (prior to September 1997). - ---------------------------------------------------------------------------------------------------------------------- THOMAS J. HIGGINS Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the (May 21, 1957) (106) investment companies served by The Vanguard Group. July 1998 - ---------------------------------------------------------------------------------------------------------------------- *Officers of the funds are "interested persons" as defined in the Investment Company Act of 1940. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - ---------------------------------------------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-;1996. - ----------------------------------------------------------------------------------------------------------------------
Vanguard, The Vanguard Group, Vanguard.com, Admiral, Explorer, Morgan, LifeStrategy, STAR, Wellesley, Wellington, Windsor, and the ship logo are trademarks of The Vanguard Group, Inc. S&P 500(R), Standard & Poor's 500, and 500 are trademarks of The McGraw-Hill Companies, Inc., and have been licensed for use by The Vanguard Group, Inc. Vanguard mutual funds are not sponsored, endorsed, sold, or promoted by Standard & Poor's, and Standard & Poor's makes no representation regarding the advisability of investing in the funds. Calvert Social Index is a trademark of Calvert Group, Ltd., and has been licensed for use by The Vanguard Group, Inc. Vanguard Calvert Social Index Fund is not sponsored, endorsed, sold, or promoted by Calvert Group, Ltd., and Calvert Group, Ltd., makes no representation regarding the advisability of investing in the fund. All other marks are the property of their respective owners. [SHIP LOGO] THE VANGUARD GROUP(R) Post Office Box 2600 Valley Forge, PA 19482-2600 ABOUT OUR COVER Our cover photograph was taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photograph is copyrighted by Mr. Kahn. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the fund or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. FUND INFORMATION 1-800-662-7447 TEXT TELEPHONE 1-800-952-3335 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR6 SERVICES 1-800-523-1036 WORLD WIDE WEB www.vanguard.com (C)2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q1230 032002 VANGUARD(R) PRECIOUS METALS FUND Annual Report * January 31, 2002 STOCK [SHIP ON THE OCEAN] [THE VANGUARD GROUP(R) LOGO] PERSPECTIVE Maintaining a long-term investment perspective isn't easy. Perhaps that's why it has proven to be so rewarding. With news, information, and opinion constantly bombarding us, the temptation to buy or sell--to do something--is powerful. Yet such activity is often counterproductive. Emotions can lead us to big mistakes, like jumping into a hot investment we know little about or selling a sound long-term holding when it sags for a while. The actions we recommend are quite simple. First, take the time to decide on a mix of stocks, bonds, and cash investments that makes sense for you. Take into account your investment time horizon, your goals, and your ability and willingness to ride out market fluctuations. Write this mix down--it's your investment plan. Second, use low-cost, widely diversified mutual funds to carry out your asset allocation. Third, stick with your plan, unless there's a major change in your time horizon, goals, or financial situation. Don't "play the market"--and if you feel you must, don't risk more than a tiny percentage of your assets. Finally, if market news, the opinions of "experts," or the hope of a big score tempts you to act, consult your plan. It may help you keep a long-term perspective. - ------------------------------------------------------------- CONTNETS Letter from the Chairman 1 Report from the Adviser 6 Fund Profile 8 Glossary of Investment Terms 9 Performance Summary 10 Your Fund's After-Tax Returns 11 Financial Statements 12 - ------------------------------------------------------------- SUMMARY * During the 12 months ended January 31, 2002, Vanguard Precious Metals Fund returned 30.1%. This stellar result-45 percentage points above the negative return of the overall stock market--was in line with the average for competing funds. * The stocks of metal-mining companies climbed amid ongoing consolidation in the industry. Although gold prices rose slightly during the year, prices for other precious metals fell sharply. * Shareholders should be aware that the Precious Metals Fund is extremely concentrated--and thus, risky. LETTER FROM THE CHAIRMAN Fellow Shareholder, VANGUARD(R) PRECIOUS METALS FUND returned 30.1% during the 12 months ended January 31, 2002, as a wave of consolidation among metal- mining companies pushed their share prices sharply higher. Your fund's return-- obviously stellar on an absolute basis--was in line with those of its peers and the relevant index. As shown in the table at left, the fund's gain outpaced the negative return of the overall stock market by more than 45 percentage points. - -------------------------------------------------------- 2002 TOTAL RETURNS FISCAL YEAR ENDED JANUARY 31 - -------------------------------------------------------- VANGUARD PRECIOUS METALS FUND 30.1% Average Gold-Oriented Fund* 32.6 Salomon Smith Barney World Gold Index 29.4 Wilshire 5000 Index -15.3 - -------------------------------------------------------- *Derived from data provided by Lipper Inc. The table presents the fund's total return--capital change plus reinvested dividends--as well as the results for its average competitor and two unmanaged market indexes: the Salomon Smith Barney World Equity Gold Index and the Wilshire 5000 Total Market Index, which is a proxy for the overall U.S. stock market. The components of the fund's total return, including the change in its net asset value and its per-share distributions during the period, are found in the table on page 5. If you own the Precious Metals Fund in a taxable account, you may wish to review our report on the fund's after-tax returns on page 11. FINANCIAL MARKETS IN REVIEW The 12 months ended January 31 were very rough for most stock investors. The broad U.S. market, as measured by the Wilshire 5000 Index, lost -15.3% during the period. Several factors contributed to the decline, including * The first recession in the U.S. economy in a decade, part of a worldwide slowdown in economic activity. * The September 11 terrorist attacks, which resulted in economic disruption and a heightened awareness of risk--both physical and financial. * A steep reduction in corporate profits: Twelve-month net earnings reported by companies in the Standard & Poor's 500 Index fell nearly 50% on average from January 2001 to January 2002. * Concern about the reliability of certain corporate accounting and disclosure practices, owing largely to the collapse of Enron Corporation. The recession that began in March 2001 ended a record ten years of uninterrupted expansion in the U.S. economy. The downturn was heralded by severe reductions in corporate investment spending, especially in the 1 technology and telecommunications sectors (both plagued by overcapacity created in the 1990s boom). As the year progressed, so did the business cutbacks and the weakness in most economic indicators. High levels of corporate and household debt cast doubt on the economy's ability to bounce back quickly. Through all the difficulties, consumer spending held up surprisingly well--especially spending for housing and for automobiles, spurred by low interest rates (and sales incentives, in the case of autos). Joblessness rose during the 12 months--the unemployment rate in January 2002 stood at 5.6%, well above the three-decade low of 3.9% last reached in October 2000. However, layoffs seemed to be tapering off late in the fiscal year, and consumer confidence regained some ground. Whether such hopeful signs will blossom into a full-fledged recovery by summer is uncertain, but by January the Federal Reserve Board was encouraged enough to halt its aggressive campaign of cutting interest rates to stimulate economic activity. In 2001, the Fed lowered its target for the federal funds rate--the interest rate that banks charge each other for overnight loans--11 times, for a total of 475 basis points (4.75 percentage points). Those reductions brought the federal funds rate to 1.75%, its lowest level in four decades. The weak economy and even weaker corporate profits held the broad U.S. stock market in bear territory during the 12 months ended January 31. The market hit a three-year low in September after the terrorist attacks, but rallied in the final weeks of 2001. Still, the returns of most stock sectors were deeply in the red for the full fiscal year. The Wilshire 5000 Index ended the period -28% below its peak in March 2000. In contrast, investment-grade bonds had another good year. The Lehman Brothers Aggregate Bond Index, a proxy for the taxable investment-grade U.S. bond market, posted a 12-month return of 7.6%. - -------------------------------------------------------------------------------- MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 ------------------------------ ONE THREE FIVE YEAR YEARS YEARS - -------------------------------------------------------------------------------- STOCKS - ------ S&P 500 Index (Large-caps) -16.1% -2.8% 9.0% Russell 2000 Index (Small-caps) -3.6 5.6 6.9 Wilshire 5000 Index (Entire market) -15.3 -2.3 8.3 MSCI EAFE Index (International) -26.1 -6.9 0.4 - -------------------------------------------------------------------------------- BONDS - ----- Lehman Aggregate Bond Index (Entire market) 7.6% 6.3% 7.5% Lehman 10 Year Municipal Bond Index 5.2 4.7 6.3 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 3.7 4.9 5.0 - -------------------------------------------------------------------------------- CPI - --- Consumer Price Index 1.1% 2.5% 2.2% - -------------------------------------------------------------------------------- Source: Bloomberg. Yields of U.S. Treasury securities--which move in the opposite direction from their prices--fell during the 12 months. As we would expect, the yield of the 3-month Treasury bill was most affected by the Fed's actions; it fell 324 basis points to 1.75%. The 3-year Treasury note's yield declined 2 57 basis points to 4.13%, while the yields of 10-year and 30-year Treasuries were nearly unchanged at 5.03% and 5.43%, respectively. FISCAL 2002 PERFORMANCE OVERVIEW The 30.1% return of Vanguard Precious Metals Fund for its 2002 fiscal year was largely a result of industry consolidation. Of the 39 companies whose stocks we owned when the period began, about one-quarter were involved in merger-and-acquisition activity. ------------------------ ROUGHLY ONE-QUARTER OF THE COMPANIES THAT WERE REPRESENTED IN THE PRECIOUS METALS FUND AT THE BEGINNING OF THE FISCAL YEAR WERE INVOLVED IN MERGER- AND-ACQUISITION ACTIVITY DURING THE PERIOD. ------------------------ The surge in takeovers--and the rise in mining-company stock prices--coincided with generally poor business conditions for mining companies. Prices for some of the most valuable metals fell sharply during the fiscal year, as shown in data from Bloomberg. For example, the price of platinum declined 25% to about $453 per ounce. Palladium plummeted 65% to roughly $370 per ounce as worries about oversupply were heightened by a drop in automakers' demand for the metal, which is used in pollution-control devices. Gold, by contrast, provided a modest boost for mining companies--its price rose about 6%, to $283 per ounce. As the mining industry has changed, so has your fund. In May 2001, shareholders overwhelmingly approved a proposal to let the fund acquire larger positions in individual companies. (The vote authorized Vanguard to change the fund's classification with the Securities and Exchange Commission from "diversified" to "nondiversified.") Our investment adviser, M&G Investment Management, has taken advantage of this flexibility. As of January 31, 2002, the fund's top ten holdings accounted for 80% of its assets, up from about 65% a year earlier. The number of stocks we own has changed more dramatically--from 39 at the beginning of fiscal 2002 to just 26 at the end. The growing concentration within the precious-metals industry underscores a truth about sector funds--that their limited focus makes them riskier than broadly diversified funds. Industry groups rotate unpredictably in and out of favor among investors and can lag the broad market for extended periods, taking sector funds along with them. In addition, the fortunes of just a few companies can sometimes have a large effect on a sector fund's returns. While longtime investors in the Precious Metals Fund certainly appreciate these risks, we want newer shareholders, too, to expect extreme price volatility from time to time. A FEW WORDS ABOUT INCOME The Precious Metals Fund has historically provided a very modest amount of dividends. In fiscal 2002, however, the fund's 30.1% total return included a 3 relatively high 6.1% income return. The spike in income was due to an increase in the dividends paid by two of the fund's largest holdings, Impala Platinum Holdings and Anglo American Platinum. The fund's objective--to provide long-term capital appreciation--has not changed, and future income dividends could be lower than those of the past year. For further discussion of the precious metals market and your fund's performance, see the Report from the Adviser on page 6. LONG-TERM PERFORMANCE OVERVIEW Most investors know that the rising tide of the bull market of the 1990s did not lift all boats. Stocks in gold-mining companies, in particular, fell along with the price of the metal, which at year-end 2001 was 21% below its level a decade earlier (see the adjacent graph). Over much of that decade, Vanguard Precious Metals Fund emphasized gold-mining stocks, a fact that contributed to disappointing absolute returns. - ------------------------------------------------ A DISMAL DECADE FOR GOLD: PRICES FOR 1991--2001 DATE PX LAST PX LAST ----------- ------------ --------- 12/31/1991 353.15 300 3/31/1992 341.70 300 6/30/1992 343.40 300 9/30/1992 350.00 300 12/31/1992 334.50 300 3/31/1993 339.00 300 6/30/1993 378.10 300 9/30/1993 355.40 300 12/31/1993 390.70 300 3/31/1994 391.00 300 6/30/1994 386.30 300 9/30/1994 394.25 300 12/30/1994 383.20 300 3/31/1995 391.40 300 6/30/1995 384.60 300 9/29/1995 384.00 300 12/29/1995 387.10 300 3/29/1996 395.45 300 6/28/1996 380.45 300 9/30/1996 378.40 300 12/31/1996 367.70 300 3/31/1997 351.25 300 6/30/1997 333.95 300 9/30/1997 334.45 300 12/31/1997 289.05 300 3/31/1998 300.95 300 6/30/1998 296.95 300 9/30/1998 296.95 300 12/31/1998 288.25 300 3/31/1999 280.05 300 6/30/1999 262.50 300 9/30/1999 298.75 300 12/31/1999 288.00 300 3/31/2000 279.075 300 6/30/2000 289.525 300 9/29/2000 274.25 300 12/29/2000 272.25 300 3/30/2001 257.95 300 6/29/2001 270.85 300 9/28/2001 293.25 300 12/31/2001 278.95 300 - ------------------------------------------------ Source: Bloomberg. The table on page 5 presents the ten-year returns of the Precious Metals Fund, its average peer, the Salomon Smith Barney World Gold Index, and the Wilshire 5000 Index. It also shows the results of hypothetical $10,000 investments made a decade ago in each. As you can see, your fund returned an average of 2.1% annually. Although this was far behind the return of the overall stock market, it was substantially better than the decline recorded by our peer group. Our investment adviser, which has managed the fund since its inception in 1984, has helped us to outpace our peers over the long haul. M&G Investment Management boosted the fund's performance in recent years by investing more heavily in platinum- and diamond-related mining stocks. This reduced the fund's exposure to companies whose stock prices were closely linked to the price of gold. In the continuing effort to deliver long-term outperformance, our adviser is aided by Vanguard's low operating and transaction costs. Although we can't match the indexes in this regard--indexes exist on paper, so they incur no costs at all--the Precious Metals Fund has a huge cost advantage over its peer group. At 0.63% of average net assets ($6.30 per $1,000 in assets), our 2002 annual expense ratio was less than one-third of the 2.11% ratio ($21.10 per $1,000 in assets) charged by our average competitor. 4 Such a gap in costs--nearly 1.5 percentage points-- provides a big head start year after year. - -------------------------------------------------------------------------------- TOTAL RETURNS TEN YEARS ENDED JANUARY 31, 2002 ------------------------------------- AVERAGE FINAL VALUE OF ANNUAL A $10,000 RETURN INITIAL INVESTMENT - -------------------------------------------------------------------------------- Vanguard Precious Metals Fund 2.1% $12,346 Average Gold-Oriented Fund -1.7 8,409 Salomon Smith Barney World Gold Index 2.4 12,649 Wilshire 5000 Index 12.2 31,493 - -------------------------------------------------------------------------------- IN SUMMARY After difficult periods in the stock market--as the past two years have certainly been--it's easy to act on the temptation to concentrate one's investments in the "safest" or the "best-performing" asset class or market sector. We counsel investors to resist this impulse and to remain true to a long-term strategy of holding a well-diversified mix of stocks, bonds, and short-term investments. Because precious metals stocks often behave very differently from the market as a whole, they can serve to further diversify a mainstream portfolio. Your portfolio's asset mix should be chosen in light of your time horizon, financial situation, and tolerance for risk, and it should not be changed substantially on the basis of transitory matters--such as which market sector did best or worst last year or what the self-appointed market experts are saying this month. "Stay the course" remains our advice. We thank you for your trust in our approach to investing, and we pledge to continue working hard to keep your confidence. Sincerely, /S/ JOHN J. BRENNAN John J. Brennan Chairman and Chief Executive Officer February 12, 2002 - -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2001-JANUARY 31, 2002 DISTRIBUTIONS PER SHARE ---------------------- STARTING ENDING INCOME CAPTIAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS - -------------------------------------------------------------------------------- Vanguard Precious Metals Fund $7.51 $9.31 $0.39 $0.00 - -------------------------------------------------------------------------------- 5 REPORT FROM THE ADVISER VANGUARD PRECIOUS METALS FUND returned 30.1% during the 12 months ended January 31, 2002. The fund outperformed the Salomon Smith Barney World Gold Index (+29.4%), but fell a bit short of the average return of its mutual fund peers (+32.6%). THE INVESTMENT ENVIRONMENT Prior to fiscal 2002, we had spent several years feeling bearish toward gold stocks and favoring more-diversified mining companies. This stance boosted our performance, as companies such as Lonmin, Anglo American Platinum, Impala Platinum, and Aber Diamond outpaced gold stocks. During the past 12 months, however, we moved back into gold shares and captured most of a resurgence in the sector. The price of gold rose modestly during the period as investors sought a haven from volatile equity markets. Gold stocks also benefited from considerable industry consolidation. Notable transactions involved Delta Gold and Goldfields, the February 2002 acquisitions of Normandy Mining and Franco-Nevada by Newmont Mining, and the merger of Barrick Gold with Homestake Mining. Your fund held significant stakes in all of these companies. The best-performing precious-metals stocks during the fiscal year were in companies producing only gold, such as Lihir Gold, Royal Gold, and Meridian Gold. But other companies also did well. The share price of Normandy Mining was boosted by the takeover bid from Newmont, and Aber Diamond benefited from strong diamond sales after September 11. Platinum stocks, which had performed extremely well in several previous fiscal years, were a drag on performance during much of the past 12 months. The price of platinum fell because of concerns about weakening demand in Japan and lower growth of retail sales globally. However, in the last three months of fiscal 2002, platinum prices recovered and the share prices of platinum producers recouped some of their earlier declines. - --------------------------- INVESTMENT PHILOSOPHY THE FUND REFLECTS THE BELIEF THAT INVESTORS WHO SEEK TO EMPHASIZE PRECIOUS METAL STOCKS AS PART OF A LONG-TERM, BALANCED INVESTMENT PROGRAM ARE BEST SERVED BY HOLDING A LOW-COST PORTFOLIO OF CAREFULLY SELECTED SECURITIES IN THE SECTOR. - --------------------------- THE FUND'S POSITIONING During the past 12 months we were focused on increasing the portfolio's exposure to gold stocks and reducing its holdings in more widely diversified resource companies. We eliminated or reduced our positions in M.I.M. Holdings, WMC, Rio Tinto, Anglo American Platinum, and Stillwater Mining, and invested the proceeds in pure gold shares, including Newmont Mining and Barrick Gold. 6 By the end of the period, the fund had become very concentrated in a handful of large holdings because of the extensive consolidation of industry players. To offset some of the risk of this increased concentration, we added to our holdings in Ashanti Goldfields, Royal Gold, and Placer Dome. OUR OUTLOOK We believe that the outlook for gold stocks is very positive for a number of reasons. Ongoing consolidation remains an encouraging factor, and the events of September 11 have reminded investors of the need for a haven. Central banks are refraining from selling more gold from their stockpiles, and the supply-and-demand situation remains generally favorable. There is evidence that some gold companies share our belief--they have stopped "selling forward" (a process that locks in prices for future gold transactions), with the expectation that the metal's price will rise. Graham E. French, Portfolio Manager M&G Investment Management Ltd. February 20, 2002 7 FUND PROFILE AS OF JANUARY 31, 2002 FOR PRECIOUS METALS FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate to a broad market index. Key terms are defined on page 9. - ---------------------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND 5000 - ---------------------------------------------------------------- Number of Stocks 26 6,013 Median Market Cap $0.9B $33.1B Price/Earnings Ratio N.M.* 32.5x Price/Book Ratio 3.2x 3.3x Return on Equity -2.6% 22.5% Earnings Growth Rate 36.8% 14.4% Foreign Holdings 83.7% 0.0% Turnover Rate 52% -- Expense Ratio 0.63% -- - ---------------------------------------------------------------- - --------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) Barrick Gold Corp. 12.6% Goldfields Ltd. 9.3 Placer Dome Inc. 8.6 Impala Platinum Holdings Ltd. ADR 8.5 Lihir Gold Ltd. 8.3 Newmont Mining Corp. 7.7 Normandy Mining Ltd. 7.3 Anglo American Platinum Corp. ADR 6.2 Aber Diamond Corp. 6.2 Meridian Gold Co. 5.4 - --------------------------------------------- Top Ten 80.1% - --------------------------------------------- - ------------------------------------- VOLATILITY MEASURES WILSHIRE FUND 5000 - ------------------------------------- R-SQUARED 0.07 1.00 BETA 0.50 1.00 - ------------------------------------- - ----------------------------------------------- COUNTRY DIVERSIFICATION (% OF TOTAL NET ASSETS) - ----------------------------------------------- Canada 32.3% Australia 26.7 United States 15.8 South Africa 15.2 United Kingdom 4.5 Ghana 2.5 - ----------------------------------------------- Subtotal 97.0% - ----------------------------------------------- Bullion 0.2% Cash Investments 2.8 - ----------------------------------------------- Total 100.0% - ----------------------------------------------- *N.M.: Not meaningful. [COMPUTER] VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. 8 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- 9 PERFORMANCE SUMMARY AS OF JANUARY 31, 2002 FOR PRECIOUS METALS FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares.
- ------------------------------------------------------------------------------------------------------------------- CUMULATIVE PERFORMANCE JANUARY 31, 1992-JANUARY 31, 2002 [MOUNTAIN CHART] YEAR/QTR PRECIOUS METALS FUND AVERAGE GOLD-ORIENTED FUND SALOMON INDEX** WILSHIRE 5000 INDEX - ------------------------------------------------------------------------------------------------------------------- 199201 $10000 $10000 $10000 $10000 199204 9118 8727 8334 10018 199207 9660 9848 9147 10274 199210 8257 8775 7788 10301 199301 7942 8400 7671 11053 199304 11145 11358 11916 11069 199307 14479 14622 16512 11468 199310 13063 13750 15726 12132 199401 15030 15123 16995 12533 199404 13908 13390 15158 11810 199407 14453 13502 15717 11951 199410 15786 14728 17362 12437 199501 12145 11463 13405 12405 199504 13495 13035 14860 13568 199507 14244 13802 15012 15071 199510 12905 12740 14205 15640 199601 16182 15853 18059 17013 199604 16170 17023 18273 17932 199607 14289 15268 16056 17285 199610 14394 15497 16283 19050 199701 12864 13638 15367 21158 199704 12098 12394 14596 21095 199707 11415 11353 14238 25443 199710 9838 10356 12051 25068 199801 9024 8689 10567 26511 199804 10129 9868 12249 30218 199807 7534 7140 8533 29779 199810 8543 8112 9505 28776 199901 8026 7204 8512 33742 199904 9352 8160 10521 35392 199907 8841 6817 9558 35242 199910 9571 7977 10719 36164 200001 9430 6876 9721 38544 200004 7669 6304 8642 39573 200007 8261 6128 8668 39062 200010 8236 5761 8355 39095 200101 9493 6342 9774 37187 200104 10052 7142 10753 33981 200107 9821 6924 10194 33186 200110 10654 7505 10815 29099 200201 12346 8409 12649 31493 - -------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 --------------------------------- FINAL VALUE ONE FIVE TEN OF A $10,000 YEAR YEARS YEARS INVESTMENT - ------------------------------------------------------------------------------------------------------------------- Precious Metals Fund* 30.05% -0.82% 2.13% $12,346 Average Gold-Oriented Fund** 32.59 -9.22 -1.72 8,409 Salomon Smith Barney World Gold Index+ 29.41 -3.82 2.38 12,649 Wilshire 5000 Index -15.31 8.28 12.16 31,493 - -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------- TOTAL INVESTMENT RETURNS (%) JANUARY 31, 1992-JANUARY 31, 2002 [BAR CHART] FISCAL YEAR TOTAL RETURN SALOMON INDEX+ 1993 -20.6 -23.3 1994 89.2 121.5 1995 -19.2 -21.1 1996 33.2 34.7 1997 -20.5 -14.9 1998 -29.8 -31.2 1999 -11.1 -19.4 2000 17.5 14.2 2001 0.7 0.5 2002 30.1 29.4 - -------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2001 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal year. Securities and Exchange Commission rules require that we provide this information.
- ------------------------------------------------------------------------------------------------------------------- ONE FIVE TEN YEARS INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL - ------------------------------------------------------------------------------------------------------------------- Precious Metals Fund* 5/23/1984 18.33% -3.68% -0.69% 2.17% 1.48% - -------------------------------------------------------------------------------------------------------------------
*Total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. **Derived from data provided by Lipper Inc. +MSCI Gold Mines Index through December 31, 1994; Salomon Smith Barney World Gold Index thereafter. Note: See Financial Highlights table on page 16 for dividend information. 10 YOUR FUND'S AFTER-TAX RETURNS This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund's distributions, and (2) assuming that an investor paid taxes on the fund's distributions and sold all shares at the end of each period. Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. (In the example that assumes all fund shares were sold, a negative pre-tax total return translates into a higher after-tax return. This is because the calculation assumes that the investor received a tax deduction for the loss incurred on the sale.) Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes. Finally, keep in mind that a fund's performance--whether before or after taxes--does not indicate how it will perform in the future. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 ONE YEAR FIVE YEARS TEN YEARS ------------------------------------ PRECIOUS METALS FUND* Returns Before Taxes 30.05% -0.82% 2.13% Returns After Taxes on Distributions 27.66 -1.72 1.37 Returns After Taxes on Distributions and Sale of Fund Shares 18.09 -1.14 1.39 - -------------------------------------------------------------------------------- *Total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. 11 FINANCIAL STATEMENTS JANUARY 31, 2002 STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by country. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* PRECIOUS METALS FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (97.0%) - -------------------------------------------------------------------------------- AUSTRALIA (26.7%) Goldfields Ltd. 28,018,941 $ 38,333 * Lihir Gold Ltd. 49,000,000 34,263 Normandy Mining Ltd. 28,000,000 29,936 Rio Tinto Ltd. 296,000 5,746 * Aurora Gold Ltd. 9,950,000 781 * Tanami Gold NL 5,600,000 261 * Bougainville Copper Ltd. 2,000,000 137 * Star Mining Corp. NL 5,000,000 10 * Cape Tel Ltd. 127,230 1 * Cape Tel Ltd. Newco Shares 12,723 1 * Australian Resources Ltd. 16,250,000 -- -------- 109,469 -------- CANADA (32.3%) Barrick Gold Corp. 3,018,500 51,822 Placer Dome Inc. 2,850,000 35,128 * Aber Diamond Corp. 1,675,000 25,280 Franco-Nevada Mining Corp., Ltd. 1,150,000 20,069 * Geomaque Explorations Ltd. 3,000,000 170 * Princess Resources Ltd. 6,000,000 -- -------- 132,469 -------- GHANA (2.5%) * Ashanti Goldfields Co., Ltd. GDR 2,550,000 10,378 SOUTH AFRICA (15.2%) Impala Platinum Holdings Ltd. ADR 775,000 35,076 Anglo American Platinum Corp. ADR 653,400 25,292 Anglogold Ltd. ADR 100,000 2,064 ------- 62,432 ------- UNITED KINGDOM (4.5%) Lonmin PLC 1,300,000 18,557 UNITED STATES (15.8%) Newmont Mining Corp. 1,450,000 31,668 * Meridian Gold Co. 1,830,000 22,143 Royal Gold, Inc. 1,300,000 7,436 Freeport-McMoRan Copper & Gold, Inc. Gold Denomination Shares Pfd. 150,000 3,674 * Crown Resources Corp. 400,000 44 * Atlas Minerals Inc. 33,333 4 ------- 64,969 ------- - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $352,965) 398,274 - -------------------------------------------------------------------------------- 12 - -------------------------------------------------------------------------------- MARKET VALUE* PRECIOUS METALS FUND (000) - -------------------------------------------------------------------------------- PRECIOUS METALS (0.2%) * Platinum Bullion (2009 Ounces) $ 889 - -------------------------------------------------------------------------------- TOTAL PRECIOUS METALS (Cost $1,212) 889 - -------------------------------------------------------------------------------- FACE AMOUNT (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (12.6%) - -------------------------------------------------------------------------------- REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.91%, 2/1/2002--Note F $38,518 38,518 1.91%, 2/1/2002 13,034 13,034 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $51,552) 51,552 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (109.8%) (Cost $405,729) 450,715 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-9.8%) - -------------------------------------------------------------------------------- Other Assets--Note C 1,222 Security Lending Collateral Payable to Brokers--Note F (38,518) Other Liabilities (2,924) -------- (40,220) -------- - -------------------------------------------------------------------------------- NET ASSETS (100%) - -------------------------------------------------------------------------------- Applicable to 44,102,551 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $410,495 ================================================================================ NET ASSET VALUE PER SHARE $9.31 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. ADR--American Depositary Receipt. GDR--Global Depositary Receipt. - -------------------------------------------------------------------------------- AMOUNT PER (000) SHARE - -------------------------------------------------------------------------------- AT JANUARY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- Paid-in Capital $492,241 $11.16 Overdistributed Net Investment Income--Note D (3,455) (.08) Accumulated Net Realized Losses--Note D (123,276) (2.79) Unrealized Appreciation (Depreciation)--Note E Investment Securities 44,986 1.02 Foreign Currencies (1) -- - -------------------------------------------------------------------------------- NET ASSETS $410,495 $ 9.31 ================================================================================ 13 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. - -------------------------------------------------------------------------------- PRECIOUS METALS FUND YEAR ENDED JANUARY 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 13,168 Interest 354 Security Lending 95 - -------------------------------------------------------------------------------- Total Income 13,617 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 733 The Vanguard Group--Note C Management and Administrative 1,230 Marketing and Distribution 39 Custodian Fees 57 Auditing Fees 13 Shareholders' Reports 27 Annual Meeting and Proxy Costs 14 - -------------------------------------------------------------------------------- Total Expenses 2,113 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 11,504 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities Sold 957 Foreign Currencies (79) - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) 878 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities 80,109 Foreign Currencies (1) - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 80,108 - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $92,490 ================================================================================ *Dividends are net of foreign withholding taxes of $79,000. 14 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. - -------------------------------------------------------------------------------- PRECIOUS METALS FUND YEAR ENDED JANUARY 31, ---------------------- 2002 2001 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 11,504 $ 8,849 Realized Net Gain (Loss) 878 (8,375) Change in Unrealized Appreciation (Depreciation) 80,108 (1,138) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations 92,490 (664) - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (16,266) (8,252) Realized Capital Gain -- -- - -------------------------------------------------------------------------------- Total Distributions (16,266) (8,252) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 103,246 60,887 Issued in Lieu of Cash Distributions 15,025 7,563 Redeemed* (91,406) (92,655) - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 26,865 (24,205) - -------------------------------------------------------------------------------- Total Increase (Decrease) 103,089 (33,121) - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 307,406 340,527 End of Period $410,495 $307,406 1Shares Issued (Redeemed) Issued 12,580 8,662 Issued in Lieu of Cash Distributions 1,870 1,060 Redeemed (11,275) (13,205) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN SHARES OUTSTANDING 3,175 (3,483) ================================================================================ *Net of redemption fees of $205,000 and $185,000, respectively. 15 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
- ---------------------------------------------------------------------------------------------------------------------- PRECIOUS METALS FUND YEAR ENDED JANUARY 31, ----------------------------------------- FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2002 2001 2000 1999 1998 - ---------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF THE PERIOD $7.51 $7.67 $6.61 $7.53 $10.94 - ---------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .28 .22 .11 .10 .14 Net Realized and Unrealized Gain (Loss) on Investments 1.91 (.18) 1.05 (.93) (3.42) - ---------------------------------------------------------------------------------------------------------------------- Total from Investment Operations 2.19 .04 1.16 (.83) (3.28) - ---------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.39) (.20) (.10) (.09) (.13) Distributions from Realized Capital Gains -- -- -- -- -- - ---------------------------------------------------------------------------------------------------------------------- Total Distributions (.39) (.20) (.10) (.09) (.13) - ---------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $9.31 $7.51 $7.67 $6.61 $ 7.53 ====================================================================================================================== TOTAL RETURN* 30.05% 0.67% 17.49% -11.06% -29.85% ====================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $410 $307 $341 $310 $327 Ratio of Total Expenses to Average Net Assets 0.63% 0.65% 0.77% 0.77% 0.62% Ratio of Net Investment Income to Average Net Assets 3.45% 2.94% 1.42% 1.33% 1.41% Portfolio Turnover Rate 52% 17% 28% 23% 26% ======================================================================================================================
*Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. 16 NOTES TO FINANCIAL STATEMENTS Vanguard Precious Metals Fund (formerly Vanguard Gold and Precious Metals Fund) is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund invests in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. 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. Precious metals are valued at the mean of the latest quoted bid and asked prices. 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. FOREIGN CURRENCY: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates on the valuation date as employed by Morgan Stanley Capital International in the calculation of its indexes. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the asset or liability is settled in cash, when they are recorded as realized foreign currency gains (losses). 3. 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. 4. 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. 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 6. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital. B. M&G Investment Management Ltd. provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the year ended January 31, 2002, the investment advisory fee represented an effective annual rate of 0.22% 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 17 Notes TO FINANCIAL STATEMENTS (CONTINUED) assets in capital contributions to Vanguard. At January 31, 2002, the fund had contributed capital of $68,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.07% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. During the year ended January 31, 2002, the fund purchased $187,825,000 of investment securities and sold $171,528,000 of investment securities other than temporary cash investments. During the year ended January 31, 2002, the fund elected to use a provision of the Taxpayer Relief Act of 1997 to mark-to-market certain appreciated securities held on January 1, 2001; such securities were treated as sold and repurchased, with unrealized gains of $46,006,000 becoming realized, for tax purposes. The mark-to-market allows future gains realized on the sale of these securities to be eligible for a lower capital gains tax rate if the securities are held for over five years. The mark-to-market had no effect on realized gains or unrealized appreciation for financial statement purposes. For tax purposes, at January 31, 2002, the fund had available a capital loss carryforward of $79,127,000 to offset future net capital gains of $64,644,000 through January 31, 2007, $13,355,000 through January 31, 2008, and $1,128,000 through January 31, 2010. During the year ended January 31, 2002, the fund realized net foreign currency losses of $79,000, which decreased distributable net income for tax purposes; accordingly, such losses have been reclassified from accumulated net realized losses to undistributed net investment income. Certain of the fund's investments are in securities considered to be "passive foreign investment companies," for which any unrealized appreciation and/or realized gains are required to be included in distributable net income for tax purposes. During the year ended January 31, 2002, the fund realized gains on the sale of passive foreign investment companies of $228,000, which are included in distributable net income for tax purposes; accordingly, such gains have been reclassified from accumulated net realized losses to undistributed net investment income. Unrealized appreciation on passive foreign investment company holdings at January 31, 2002, was $6,464,000, of which $4,428,000 has been distributed and is reflected in the balance of overdistributed net investment income; the remaining $2,036,000 will be distributed to shareholders in March 2002. E. At January 31, 2002, net unrealized depreciation of investment securities for federal income tax purposes was $7,484,000, consisting of unrealized gains of $47,919,000 on securities that had risen in value since their purchase and $55,403,000 in unrealized losses on securities that had fallen in value since their purchase. (See Note D.) The fund had net unrealized foreign currency losses of $1,000 resulting from the translation of other assets and liabilities at January 31, 2002. F. The market value of securities on loan to broker/dealers at January 31, 2002, was $38,066,000, for which the fund held cash collateral of $38,518,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 18 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Trustees of Vanguard Precious Metals 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 Precious Metals Fund, formerly Vanguard Gold and Precious Metals Fund, (the "Fund") at January 31, 2002, 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 January 31, 2002 by correspondence with the custodian, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania March 6, 2002 - -------------------------------------------------------------------------------- SPECIAL 2002 TAX INFORMATION (UNAUDITED) FOR VANGUARD PRECIOUS METALS FUND This information for the fiscal year ended January 31, 2002, is included pursuant to provisions of the Internal Revenue Code. The fund has elected to pass through to shareholders the credit for taxes paid in foreign countries. Shareholders receive detailed information on foreign income and foreign tax per share by country along with their 2001 Form 1099-DIV. - -------------------------------------------------------------------------------- 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 a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the
================================================================================================================================ Name Position(s) Held with Fund (Date of Birth) (Number of Vanguard Funds Trustee/Officer Since Overseen by Trustee) Principal Occupation(s) During the Past Five Years - -------------------------------------------------------------------------------------------------------------------------------- JOHN J. BRENNAN* Chairman of the Board, Chairman of the Board, Chief Executive Officer, and (July 29, 1954) Chief Executive Officer, Director/Trustee of The Vanguard Group, Inc., and of May 1987 and Trustee each of the investment companies served by (106) The Vanguard Group. - -------------------------------------------------------------------------------------------------------------------------------- INDEPENDENT TRUSTEES CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Adviser (October 23, 1937) (106) to Greenwich Associates (international business-strategy consulting); January 2001 Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. - -------------------------------------------------------------------------------------------------------------------------------- RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice (December 23, 1945) (84) Chairman (January-;September 1999), and Vice President (prior to December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of Technitrol, Inc.(electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. - -------------------------------------------------------------------------------------------------------------------------------- JOANN HEFFERNAN HEISEN Trustee Vice President, Chief Information Officer, and Member of the Executive (January 25, 1950) (106) Committee of Johnson & Johnson (pharmaceuticals/consumer products); July 1998 Director of the Medical Center at Princeton and Women's Research and Education Institute. - -------------------------------------------------------------------------------------------------------------------------------- BURTON G. MALKIEL Trustee Chemical Bank Chairman's Professor of Economics, Princeton (August 28, 1932) (104) University; Director of Prudential Insurance Co. of America, BKF Capital May 1977 (investment management), The Jeffrey Co. (a holding company), and NeuVis, Inc.(a software company.) - -------------------------------------------------------------------------------------------------------------------------------- ALFRED M. RANKIN, JR. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO (October 8, 1941) (106) Industries, Inc. (forklift trucks/housewares/lignite); Director of Goodrich January 1993 Corporation (industrial products/aircraft systems and services); Director of the Standard Products Company (a supplier for the automotive industry) until 1998 - -------------------------------------------------------------------------------------------------------------------------------- J. LAWRENCE WILSON Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co. (March 2, 1936) (106) (chemicals); Director of Cummins Inc. (diesel engines), The Mead April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - --------------------------------------------------------------------------------------------------------------------------------
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. Each trustee serves a fund until its termination; or until the trustee's retirement, resignation, or death; or otherwise as specified in the fund's organizational documents. Any trustee may be removed at a shareholders' meeting by a vote representing two-thirds of the net asset value of all shares of the fund together with shares of other Vanguard funds organized within the same trust. The table on these two pages shows information for each trustee and executive officer of the fund. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.
====================================================================================================================== NAME POSITION(S) HELD WITH FUND (DATE OF BIRTH) (NUMBER OF VANGUARD FUNDS TRUSTEE/OFFICER SINCE OVERSEEN BY TRUSTEE) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS - ---------------------------------------------------------------------------------------------------------------------- EXECUTIVE OFFICERS* R. GREGORY BARTON Secretary Managing Director and General Counsel of The Vanguard Group, Inc. (April 25, 1951) (106) (since September 1997); Secretary of The Vanguard Group, and of June 2001 each of the investment companies served by The Vanguard Group; Principal of The Vanguard Group (prior to September 1997). - ---------------------------------------------------------------------------------------------------------------------- THOMAS J. HIGGINS Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the (May 21, 1957) (106) investment companies served by The Vanguard Group. July 1998 - ---------------------------------------------------------------------------------------------------------------------- *Officers of the funds are "interested persons" as defined in the Investment Company Act of 1940.
More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group.
- ----------------------------------------------------------------------------------------------------------- VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. - ----------------------------------------------------------------------------------------------------------- JAMES H. GATELY, Direct Investor Services. Michael S. Miller, Planning and Development. - ----------------------------------------------------------------------------------------------------------- KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. - ----------------------------------------------------------------------------------------------------------- IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - ----------------------------------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. - -----------------------------------------------------------------------------------------------------------
VANGUARD, THE VANGUARD GROUP, VANGUARD.COM, ADMIRAL, EXPLORER, MORGAN, LIFESTRATEGY, STAR, WELLESLEY, WELLINGTON, WINDSOR, and the ship logo are trademarks of The Vanguard Group, Inc. STANDARD & Poor's(R), S&P(R), S&P 500(R), and 500 are trademarks of The McGraw-Hill Companies, Inc., and have been licensed for use by The Vanguard Group, Inc. Vanguard mutual funds are not sponsored, endorsed, sold, or promoted by Standard & Poor's, and Standard & Poor's makes no representation regarding the advisability of investing in the funds. CALVERT SOCIAL INDEX is a trademark of Calvert Group, Ltd., and has been licensed for use by The Vanguard Group, Inc. Vanguard Calvert Social Index Fund is not sponsored, endorsed, sold, or promoted by Calvert Group, Ltd., and Calvert Group, Ltd., makes no representation regarding the advisability of investing in the fund. All other marks are the property of their respective owners. [SHIP] [THE VANGUARD GROUP (R)LOGO] POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-260 ABOUT OUR COVER Our cover photograph was taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photograph is copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the fund or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. FUND INFORMATION 1-800-662-7447 TEXT TELEPHONE 1-800-952-3335 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 WORLD WIDE WEB www.vanguard.com All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. (C)2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q530 032002 VANGUARD(R)HEALTH CARE FUND ANNUAL REPORT * JANUARY 31, 2002 STOCK THE VANGUARD GROUP(R) LOGO PERSPECTIVE Maintaining a long-term investment perspective isn't easy. Perhaps that's why it has proven to be so rewarding. With news, information, and opinion constantly bombarding us, the temptation to buy or sell--to do something--is powerful. Yet such activity is often counterproductive. Emotions can lead us to big mistakes, like jumping into a hot investment we know little about or selling a sound long-term holding when it sags for a while. The actions we recommend are quite simple. First, take the time to decide on a mix of stocks, bonds, and cash investments that makes sense for you. Take into account your investment time horizon, your goals, and your ability and willingness to ride out market fluctuations. Write this mix down--it's your investment plan. Second, use low-cost, widely diversified mutual funds to carry out your asset allocation. Third, stick with your plan, unless there's a major change in your time horizon, goals, or financial situation. Don't "play the market"--and if you feel you must, don't risk more than a tiny percentage of your assets. Finally, if market news, the opinions of "experts," or the hope of a big score tempts you to act, consult your plan. It may help you keep a long-term perspective. ================================================================================ CONTENTS Letter from the Chairman 1 Report from the Adviser 7 Fund Profile 9 Glossary of Investment Terms 10 Performance Summary 11 Your Fund's After-Tax Returns 13 Financial Statements 14 Advantages of Vanguard.com 26 - -------------------------------------------------------------------------------- SUMMARY * Vanguard Health Care Fund posted a -;1.1% total return, its first fiscal-year decline in nine years. * The Health Care Fund's result beat the average return for the health/biotechnology fund category by 10.8 percentage points. * Our excellent long-term track record reflects the strength of the health care sector, our portfolio manager's expertise, and our big cost advantage. LETTER FROM THE CHAIRMAN Fellow Shareholder, VANGUARD(R) HEALTH CARE FUND declined -;1.1% during the 12 months ended January 31, 2002, a bleak period during which the U.S. stock market posted a -;15.3% loss. Although your fund posted its first fiscal-year decline in nine years, our performance was far better than the results of our comparative standards. Our total return (capital change plus reinvested dividends) was nearly 11 percentage points ahead of the average decline for health/biotechnology funds, our peer group, and was 4.1 points ahead of the return of the Standard & Poor's Health Sector Index. The table below presents the returns for your fund, its average peer, and the sector index, as well as for the Wilshire 5000 Total Market Index, a proxy for the overall U.S. stock market. We also show the return for the fund's Admiral(TM) Shares--a separate class of shares that carries a lower expense ratio for the benefit of large or long-tenured accounts that create economies of scale for the fund. We introduced the fund's Admiral Shares in November 2001. For more information on the new share class, visit VANGUARD.COM(TM). ===================================================== 2002 TOTAL RETURNS Fiscal Year Ended January 31 - ----------------------------------------------------- VANGUARD HEALTH CARE FUND INVESTOR SHARES -1.1% Average Health/Biotechnology Fund* -11.9 S&P Health Sector Index -5.2 Wilshire 5000 Index -15.3 - ----------------------------------------------------- Admiral Shares (since inception on November 12, 2001) - ----------------------------------------------------- Vanguard Health Care Fund 1.2% - ----------------------------------------------------- *Derived from data provided by Lipper Inc. The table at the end of this letter provides details about the total returns for both the Investor and Admiral share classes, including net asset values for each class of shares and distributions of income and capital gains. If you own the Health Care Fund in a taxable account, you may wish to review our report on the fund's after-tax returns on page 13. FINANCIAL MARKETS IN REVIEW The 12 months ended January 31 were a very rough stretch for stock investors. As mentioned above, the broad U.S. stock market, as measured by the Wilshire 5000 Index, lost -;15.3% during the fiscal year. Several factors contributed to the market's decline, including: * The first recession in the U.S. economy in a decade, part of a worldwide slowdown in economic activity. * The September 11 terrorist attacks, which resulted in economic disruption and a heightened awareness of risk--both physical and financial. 1 * A steep reduction in corporate profits: Twelve-month net earnings reported by companies in the S&P 500 Index fell nearly 50% on average from January 2001 to January 2002. * Concern about the reliability of certain corporate accounting and disclosure practices, owing largely to the collapse of Enron Corporation. The downturn that began in March 2001 ended a record ten years of uninterrupted expansion in the U.S. economy. The recession was heralded by severe reductions in corporate investment spending, especially in the technology and telecommunications sectors (both plagued by overcapacity created in the 1990s boom). As the year progressed, so did the business cutbacks and the weakness in the economy. High levels of corporate and household debt cast doubt on the economy's ability to bounce back quickly. ================================================================================ Market Barometer Average Annual Total Returns Periods Ended January 31, 2002 -------------------------------- One Three Five Year Years Years - -------------------------------------------------------------------------------- STOCKS S&P 500 Index (Large-caps) -16.1% -2.8% 9.0% Russell 2000 Index (Small-caps) -3.6 5.6 6.9 Wilshire 5000 Index (Entire market) -15.3 -2.3 8.3 MSCI EAFE Index (International) -26.1 -6.9 0.4 BONDS Lehman Aggregate Bond Index (Entire market) 7.6% 6.3% 7.5% Lehman 10 Year Municipal Bond Index 5.2 4.7 6.3 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 3.7 4.9 5.0 CPI Consumer Price Index 1.1% 2.5% 2.2% - -------------------------------------------------------------------------------- Through all the difficulties, consumer spending held up surprisingly well--especially spending for housing and for automobiles, spurred by low interest rates (and sales incentives, in the case of autos). Joblessness rose during the 12 months--the unemployment rate in January 2002 stood at 5.6%, well above the three-decade low of 3.9% last reached in October 2000. However, layoffs seemed to be tapering off late in the fiscal year, and consumer confidence regained some of the ground lost earlier. Whether such hopeful signs will blossom into a full-fledged recovery soon is uncertain, but by January the Federal Reserve Board was encouraged enough to halt its aggressive campaign of cutting interest rates to stimulate economic activity. During the fiscal year, the Fed had lowered its target for the federal funds rate--the interest rate that banks charge each other for overnight loans--nine times, for a total of 375 basis points (3.75 percentage points). Those reductions, following cuts totaling 1 percentage point in January 2001, brought the federal funds rate to 1.75%, its lowest level in four decades. The weak economy and even weaker corporate profits made for a bad 12 months for the broad U.S. stock market. The market seemed to be heading for a second full year in bear territory. From its peak in March 2000, the Wilshire 5000 Index had plunged -28% by the end of January 2002. The market hit 2 a three-year low in September after the terrorist attacks, but then rallied in the final weeks of 2001. Still, the returns of most stock sectors were deeply in the red for the 12 months ended January 31, although value stocks in the small- and mid-capitalization ranges produced gains. Meanwhile, bonds had another good year. The Lehman Brothers Aggregate Bond Index, a proxy for the taxable investment-grade U.S. bond market, posted a 12-month return of 7.6%. Investment-grade corporate bonds had the highest return among bond sectors. High-yield ("junk") bonds were the only group to decline; the Lehman High Yield Index returned -;1.4% as a result of a rise in default rates on corporate bonds. Yields on U.S. Treasury securities--which move in the opposite direction from their prices--fell during the 12 months. The decline was particularly pronounced at the shorter end of the maturity spectrum, where issues are most affected by Fed actions. The yield of the 3-month Treasury bill fell 324 basis points to 1.75%. The 3-year Treasury note's yield fell 57 basis points to 4.13%, and the yields on 10-year and 30-year Treasuries fell a mere 8 and 7 basis points to 5.03% and 5.43%, respectively. FISCAL 2002 PERFORMANCE OVERVIEW Your fund's -;1.1% return during the fiscal year was disappointing in that it was our first negative result for a full fiscal year since 1993. But in other respects, this small decline was actually quite an achievement. The average return for our peer funds in the health/biotechnology group was -;11.9%, while the overall stock market plunged -;15.3%. In our report to you a year ago, our portfolio manager, Edward P. Owens, of Wellington Management Company, llp, predicted that fiscal 2002 was likely to be "very tough for health care stocks" because of the high valuations for companies in the sector. Although health care stocks as a group posted returns of -;4% to - -;5% during the fiscal year, the sector turned out to be one of the market's better performers. Within the S&P 500 Index, for example, only two sectors performed better--materials & processing firms, which gained about 8.0%, and consumer staples companies, which eked out a return of 0.7%. - -------------------------------------------------------------------------------- Our effort to diversify across various parts of the health care sector helped, since returns were quite disparate within subsectors of this industry. - -------------------------------------------------------------------------------- Among the reasons that your fund outpaced its peer group was our long-standing effort to diversify across the health care sector. Returns were quite disparate within this industry: While a number of the big pharmaceutical companies that dominate the sector had significant declines, there were solid gains for stocks of insurers, equipment makers, and hospital operators. 3 Although the year was, in fact, difficult for health care stocks, the group benefited from its reputation as being somewhat "recession proof"--the demand for pharmaceuticals, health insurance, or hospital care does not tend to react as much to a slowing economy as does the demand for products of other industries. However, no industry is truly unaffected by a slowing economy. And we regard Mr. Owens's comment of a year ago about the high valuations of health care stocks as still valid. Indeed, corporate earnings have fallen even more steeply over the past year than stock prices, so the stock market as a whole seems far from cheap when measured by historical standards for such yardsticks as price/earnings ratios and dividend yields. - -------------------------------------------------------------------------------- The sustained excellence of our portfolio manager is a big part of the fund's substantial long-term advantage over its peer group. - -------------------------------------------------------------------------------- LONG-TERM PERFORMANCE OVERVIEW Vanguard Health Care Fund is intended as a long-term investment vehicle, and we believe its merits should be judged over longer periods. The fund's long-term track record is, in a word, outstanding. Our description is based not only on the fund's absolute return of 20.1% annually over the past decade but on its relative record: The fund has trounced its peer-group average during the decade. The table below presents the ten-year records of the fund and its comparative standards. It also shows what the performance advantage has meant in absolute terms, assuming that investments of $25,000 (your fund's initial investment requirement) had been made a decade ago in the Health Care Fund, its average peer, the S&P Health Sector Index, and the all-market Wilshire 5000 Index. As you can see, the margin of superiority over our peer group was equal to more than $68,000--or some 2.7 times the initial $25,000 investment. ================================================================================ Total Returns Ten Years Ended January 31, 2002 ----------------------------- Average Final Value of Annual a $25,000 Return Initial Investment - -------------------------------------------------------------------------------- VANGUARD HEALTH CARE FUND INVESTOR SHARES 20.1% $155,510 Average Health/ Biotechnology Fund 13.3 86,824 S&P Health Sector Index 14.9 100,666 Wilshire 5000 Index 12.2 78,734 - -------------------------------------------------------------------------------- We believe that several factors were responsible for the stellar record of your fund. One is that the fund and its peer group benefited from the excellent performance of health care stocks over the past decade. The sector outpaced the broad market by 2.7 percentage points--a significant "win." The sustained excellence of our portfolio manager, Ed Owens, and his team at Wellington Management is also a big part of the story, since the fund has earned substantially more than the sector index during the past decade. By 4 considering not only the growth prospects and financial health of potential investments but also their price, Mr. Owens has demonstrated a keen eye for value and has avoided some significant pitfalls. A third key factor in your fund's advantage over its peers is the fund's relatively low operating and transaction costs. Although we can't match the index in this regard--indexes exist on paper, so they incur zero costs--the Health Care Fund has a huge cost advantage over its peer group. At 0.31% of average net assets (0.23% for Admiral Shares), our annual expense ratio is a small fraction of the 1.81% ratio charged by our average competitor. The cost gap of 1.5 percentage points is a nice head start, year after year. - -------------------------------------------------------------------------------- Valuations are high for health care stocks, implying that investors have very high expectations for future earnings. - -------------------------------------------------------------------------------- A fourth major advantage for the fund is its lower portfolio turnover relative to competitors. Our adviser's patient, diversified approach to health care investing has generally resulted in turnover rates of around 25% or less--meaning that the average investment has been held about four years or more. Annual turnover rates of 100% or more are not uncommon among other funds, which incur significant transaction costs as a result. Despite our pride in the fund's results over the past decade, we caution investors not to expect such strong returns in the coming ten years. As noted earlier, valuations remain high for health care stocks, implying that investors have very high expectations for future earnings. Yet, competition is tough in the industry, and pressure from consumers, insurers, and government to limit increases in health care expenses can be expected to continue. Some investors pin their hopes for health care stocks on demographics, reasoning that the "baby boom" generation will be a huge consumer of health care products and services. However, this demographic tailwind is no secret and is, presumably, already factored into prices for stocks. We believe that investing in this sector makes sense as part of a more broadly diversified portfolio for those who are prepared to withstand considerable volatility and who understand that health care stocks will fall in and out of favor over the years. IN SUMMARY After difficult periods, such as the past two years for the overall stock market, it's easy to act on the temptation to concentrate investments in the "safest" or the "best-performing" asset class or market sector. We counsel investors to resist this impulse and to remain true to a long-term strategy of holding a well-diversified mix of stocks, bonds, and short-term investments. The mix should vary according to your personal time horizon, financial situation, and tolerance for risk, but should not change substantially due to transient events-- 5 such as which market sector did best or worst last year or what self-appointed market experts are saying this month. "Stay the course" remains our advice. We thank you for committing your hard-earned money to Vanguard, and we'll strive to continue earning your confidence. Sincerely, /S/ JOHN J. BRENNAN JOHN J. BRENNAN Chairman and Chief Executive Officer February 11, 2002 ================================================================================ YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2001-;JANUARY 31, 2002 Distributions Per Share ------------------- Starting Ending Income Capital Share Price Share Price Dividends Gains - -------------------------------------------------------------------------------- VANGUARD HEALTH CARE FUND Investor Shares $123.04 $115.01 $1.030 $5.464 Admiral Shares* 50.00 48.52 0.390 1.698 - -------------------------------------------------------------------------------- *Since inception on November 12, 2001. 6 REPORT FROM THE ADVISER VANGUARD HEALTH CARE FUND RETURNED -;1.1% FOR THE FISCAL YEAR ENDED JANUARY 31, 2002. THIS DECLINE WAS FAR LESS SEVERE THAN THE -;16.1% LOSS FOR THE S&P 500 Index, the -;5.2% LOSS FOR THE S&P Health Sector Index, and the -;11.9% LOSS FOR THE AVERAGE FUND IN THE HEALTH/BIOTECHNOLOGY CATEGORY. THE INVESTMENT ENVIRONMENT It was a difficult 12 months for stocks, and the health care sector was not spared. Major pharmaceutical companies that had significant patent expirations or shortfalls in product demand were treated harshly in the period. Many of the sector's best performers were in the health services and medical products categories, but it was really a stock-picker's market, with both opportunities and pitfalls in all areas of health care. International health care stocks were somewhat weaker than U.S. issues. OUR SUCCESSES We did well with many of our health services selections. Tenet Healthcare was the strongest contributor to the fund's return in the fiscal year. McKesson, UnitedHealth Group, Quest Diagnostics, and AmerisourceBergen were also very strong performers, as were the medical products companies Abbott Laboratories, St. Jude Medical, and Biomet. In the biotech sector, Gilead Sciences and Genzyme delivered good performance. Johnson & Johnson and American Home Products were our best investments among the major pharmaceutical companies. OUR SHORTFALLS Our Japanese holdings were weak, hurt by that nation's troubled economy and the decline in the value of the yen against the dollar. European stocks also underperformed, although to a lesser extent. The major U.S. pharmaceuticals are the core of any health care portfolio, so of course we participated in that group's weakness. However, we were well served by having less exposure to the area than we have had in the past. THE FUND'S POSITIONING For the health care sector, one slightly negative year could not correct all the overvaluation built up over many years of soaring stock prices. We believe that the coming year will be full of challenges, ================================================================================ INVESTMENT PHILOSOPHY The fund reflects the belief that investors who seek to emphasize health care stocks as part of a long-term, balanced investment program are best served by holding a portfolio of securities well diversified across the sector. ================================================================================ 7 as corporate earnings continue to weaken and investors face the end of the Federal Reserve Board's efforts to lower interest rates. But health care is traditionally a defensive sector, and that reality should stand us in good stead. We will continue to position the portfolio defensively, with broad diversification, low turnover, and a focus on stocks offering the best values. Edward P. Owens, Senior Vice President and Portfolio Manager Wellington Management Company, LLP February 13, 2002 ================================================================================ PORTFOLIO CHANGES Fiscal Year Ended January 31, 2002 Comments - -------------------------------------------------------------------------------- ADDITIONS CVS* Attractive in the wake of severe price weakness. Aventis Added to position because of strong growth. Eli Lilly Has an improving pipeline of new products. Roche Holdings Attractive owing to price weakness. ================================================================================ REDUCTIONS Bristol-Myers Squibb Halved position due to patent-expiration problems. C.R. Bard** Sold because of Tyco takeover plan. Novo Nordisk** Sold after its price appreciated. UnitedHealth Group Reduced as price appreciated. - -------------------------------------------------------------------------------- *New Holding. **Eliminated from portfolio. See page 14 for a complete listing of the fund's holdings. 8 FUND PROFILE As of January 31, 2002 for HEALTH CARE FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate with a broad market index. Key terms are defined on page 10. ================================================ PORTFOLIO CHARACTERISTICS Wilshire Fund 5000 --------------------- Number of Stocks 135 6,013 Median Market Cap $21.9B $33.1B Price/Earnings Ratio 37.6x 32.5x Price/Book Ratio 4.9x 3.3x Yield 1.3% Investor Shares 0.7% Admiral Shares 0.8% Return on Equity 17.3% 22.5% Earnings Growth Rate 5.9% 14.4% Foreign Holdings 23.7% 0.0% Turnover Rate 13% -- Expense Ratio -- Investor Shares 0.31% Admiral Shares 0.23%* Cash Investments 9.8% -- - ----------------------------------------------- ============================================= TEN LARGEST HOLDINGS (% of total net assets) Pharmacia Corp. 5.8% American Home Products Corp. 3.7 Pfizer, Inc. 3.3 Abbott Laboratories 3.1 McKesson Corp. 3.1 Merck & Co., Inc. 2.8 Johnson & Johnson 2.7 Eli Lilly & Co. 2.7 HCA Inc. 2.4 Roche Holdings AG 2.2 - --------------------------------------------- Top Ten 31.8% - --------------------------------------------- ================================== INVESTMENT FOCUS Market Cap Large Style Growth - ---------------------------------- ============================================= VOLATILITY MEASURES Wilshire Fund 5000 - ------------------------------------------- R-Squared 0.10 1.00 Beta 0.26 1.00 - --------------------------------------------- ============================================= SECTOR DIVERSIFICATION (% of common stocks) - --------------------------------------------- Biotech Research & Production 6.3% Consumer Discretionary 0.3 Consumer Staples 2.7 Drugs & Pharmaceuticals 37.9 Electronics--Medical Systems 0.6 Financial Services 0.4 Health & Personal Care 3.7 Health Care Facilities 7.7 Health Care Management Services 5.6 International 23.7 Materials & Processing 1.7 Medical & Dental Instruments & Supplies 7.3 Medical Services 0.7 Producer Durables 0.2 Technology 0.1 Other 1.1 - --------------------------------------------- *Annualized. Visit our website www.vanguard.com for regularly updated fund information. 9 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in the fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total return were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of a fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. - -------------------------------------------------------------------------------- 10 PERFORMANCE SUMMARY AS OF JANUARY 31, 2002 for HEALTH CARE FUND All of the data below and on the following page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. ================================================================================ CUMULATIVE PERFORMANCE January 31, 1992-;January 31, 2002 [MOUNTAIN CHART] HEALTH CARE AVERAGE HEALTH/ S&P HEALTH QUARTER FUND INVESTOR BIOTECHNOLOGY SECTOR S&P 500 WILSHIRE ENDED SHARES FUND** INDEX INDEX 500 INDEX - -------------------------------------------------------------------------------- 199201 $25000 $25000 $25000 $25000 $25000 199204 23666 21095 23330 25560 25046 199207 24464 21755 23657 26337 25686 199210 24238 21087 22375 26192 25753 199301 24269 21935 20760 27645 27632 199304 23562 19959 19871 27921 27673 199307 23866 20226 18151 28637 28669 199310 27186 22599 19790 30105 30331 199401 29416 24868 20790 31205 31333 199404 27072 22600 19180 29407 29524 199407 27727 21771 20086 30114 29876 199410 31158 24985 23153 31269 31092 199501 32295 25479 25149 31370 31013 199504 34416 26677 26962 34543 33921 199507 38186 29284 29972 37977 37677 199510 41002 32421 33309 39537 39099 199601 46981 37896 38779 43500 42531 199604 49768 39519 37498 44979 44830 199607 48242 34828 38087 44269 43212 199610 50895 38620 43156 49064 47625 199701 56680 42629 49676 54958 52896 199704 58105 39867 50773 56284 52737 199707 68654 46534 60196 67350 63609 199710 68219 49318 59131 64819 62671 199801 72196 49786 68834 69747 66276 199804 82296 55662 77004 79398 75546 199807 84495 51992 81474 80338 74446 199810 89380 51971 83841 79074 71940 199901 99193 58708 93252 92408 84354 199904 100136 56609 90878 96724 88481 199907 101808 57955 87160 96569 88106 199910 102195 59247 93248 99371 90410 200001 109678 75710 90590 101968 96359 200004 124055 83051 92353 106521 98932 200007 139992 94386 99124 105236 97656 200010 156837 107373 108146 105424 97737 200101 157249 98597 106240 101050 92969 200104 153568 91962 101070 92703 84951 200107 159440 90299 102443 90156 82964 200110 154436 88465 100412 79169 72747 200201 155510 86824 100666 84734 78734 - --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 -------------------------------- FINAL VALUE ONE FIVE TEN OF A $25,000 YEAR YEARS YEARS INVESTMENT - ------------------------------------------------------------------------------------------------------------------- Health Care Fund Investor Shares* -2.09% 22.37% 20.06% $155,510 Average Health/Biotechnology Fund** -11.94 15.29 13.26 86,824 S&P Health Sector Index -5.25 15.17 14.95 100,666 S&P 500 Index -16.15 9.04 12.98 84,734 Wilshire 5000 Index -15.31 8.28 12.16 78,734 - ------------------------------------------------------------------------------------------------------------------- FINAL VALUE RETURN OF A $250,000 SINCE INCEPTION^ INVESTMENT - ------------------------------------------------------------------------------------------------------------------- Health Care Fund Admiral Shares* 0.22% $250,542 S&P 500 Index 1.37 253,420 - -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- TOTAL INVESTMENT RETURNS (%) JANUARY 31, 1992-JANUARY 31, 2002 HEALTH CARE FUND S&P HEALTH CARE INVESTOR SHARES SECTOR INDEX 1993 -2.9 -17.0 1994 21.2 0.1 1995 9.8 21.0 1996 45.5 54.2 1997 20.6 28.1 1998 27.4 38.6 1999 37.4 35.5 2000 10.6 -2.9 2001 43.4 17.3 2002 -1.1 -5.2 - -------------------------------------------------------------------------------- *Reflective of the 1% fee assessed on redemptions of shares held less than five years. **Derived from data provided by Lipper Inc. ^November 12, 2001. Note: See Financial Highlights tables on pages 20 and 21 for dividend and capital gains information. 11
- ----------------------------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2001 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal year. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE ---------------------------------- INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL - ----------------------------------------------------------------------------------------------------- Health Care Fund Investor Shares 5/23/1984 -6.87% 23.71% 18.40% 1.53% 19.93% Fee-Adjusted Returns* -7.80 23.71 18.40 1.53 19.93 Admiral Shares 11/12/2001 2.84** Fee-Adjusted Returns* 1.81** - ----------------------------------------------------------------------------------------------------- *Reflective of the 1% fee assessed on redemptions of shares held less than five years. **Returns are since inception.
12 YOUR FUND'S AFTER-TAX RETURNS This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund's distributions, and (2) assuming that an investor paid taxes on the fund's distributions and sold all shares at the end of each period. Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. (In the example that assumes all fund shares were sold, a negative pre-tax total return translates into a higher after-tax return. This is because the calculation assumes that the investor received a tax deduction for the loss incurred on the sale.) Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes. Finally, keep in mind that a fund's performance--whether before or after taxes--does not indicate how it will perform in the future. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 ONE YEAR FIVE YEARS TEN YEARS ----------------------------------------- HEALTH CARE FUND INVESTOR SHARES* Returns Before Taxes -2.09% 22.37% 20.06% Returns After Taxes on Distributions -3.45 20.20 17.92 Returns After Taxes on Distributions and Sale of Fund Shares -0.56 18.29 16.57 - -------------------------------------------------------------------------------- *Reflective of the 1% fee assessed on redemptions of shares held less than five years. 13 FINANCIAL STATEMENTS January 31, 2002 STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by sector within the fund's designated industry; international securities, if significant, may be presented in a separate group. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. MARKET VALUE* HEALTH CARE FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (90.2%) - -------------------------------------------------------------------------------- UNITED STATES (68.7%) - -------------------------------------------------------------------------------- BIOTECH RESEARCH & Production (5.7%) * Immunex Corp. 11,988,700 335,084 * Genzyme Corp. 4,780,940 218,059 * (1)Quintiles Transnational Corp. 7,308,200 117,076 * Genentech, Inc. 2,000,000 98,900 * IDEC Pharmaceuticals Corp. 1,560,000 92,758 * Amgen, Inc. 1,359,800 75,469 * IDEXX Laboratories Corp. 909,300 23,114 * Cephalon, Inc. 290,000 19,018 * Cor Therapeutics, Inc. 900,000 16,911 * Celera Genomics Group-Applera Corp. 467,400 9,769 ----------- 1,006,158 ----------- CONSUMER DISCRETIONARY (0.3%) Kimberly-Clark Corp. 500,000 30,150 Eastman Kodak Co. 450,000 12,780 * Ventiv Health, Inc. 437,800 1,130 ----------- 44,060 ----------- CONSUMER STAPLES (2.4%) CVS Corp. 12,856,300 349,691 Procter & Gamble Co. 825,000 67,386 Longs Drug Stores, Inc. 637,700 14,189 ----------- 431,266 ----------- DRUGS & Pharmaceuticals (34.2%) Pharmacia Corp. 25,307,182 1,024,940 American Home Products Corp. 10,111,000 653,777 Pfizer, Inc. 13,929,836 580,456 Abbott Laboratories 9,554,500 551,295 Merck & Co., Inc. 8,390,000 496,520 Johnson & Johnson 8,382,000 482,049 Eli Lilly & Co. 6,320,000 474,632 Cardinal Health, Inc. 5,151,608 339,542 Schering-Plough Corp. 8,556,400 277,056 * Gilead Sciences, Inc. 4,024,962 263,313 Allergan, Inc. 3,044,100 203,194 AmerisourceBergen Corp. 2,684,480 173,766 Bristol-Myers Squibb Co. 2,984,500 135,407 * Forest Laboratories, Inc. 1,451,000 120,288 *(1)Vertex Pharmaceuticals, Inc. 3,755,400 74,132 *(1)Perrigo Co. 5,322,320 68,658 Mylan Laboratories, Inc. 1,945,000 65,527 Alpharma, Inc. Class A 748,313 19,269 * Scios, Inc. 491,750 11,300 * Pharmacyclics, Inc. 738,000 5,941 * Genaera Corp. 1,328,100 4,236 * Triangle Pharmaceuticals, Inc. 564,800 2,344 ----------- 6,027,642 ----------- 14 MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- ELECTRONICS--MEDICAL SYSTEMS (0.5%) *(1)Haemonetics Corp. 1,983,900 56,958 * Varian Medical Systems, Inc. 506,000 19,935 Datascope Corp. 342,100 10,910 --------------- 87,803 --------------- FINANCIAL SERVICES (0.4%) CIGNA Corp. 500,000 46,000 * American Medical Security Group, Inc. 678,000 7,811 NDCHealth Corp. 181,800 5,769 Global Payments Inc. 145,440 5,224 --------------- 64,804 --------------- Health & Personal Care (3.3%) McKesson Corp. 14,209,350 547,060 Omnicare, Inc. 1,000,000 21,950 * Anthem, Inc. 238,000 12,662 * American Retirement Corp. 637,000 1,325 --------------- 582,997 --------------- Health Care Facilities (6.9%) HCA Inc. 9,967,620 423,624 * Tenet Healthcare Corp. 5,135,000 327,562 * Quest Diagnostics, Inc. 2,720,000 188,468 * HEALTHSOUTH Corp. 7,500,000 87,750 * Laboratory Corp. of America Holdings 1,033,681 84,142 * Triad Hospitals, Inc. 1,572,666 49,854 * LifePoint Hospitals, Inc. 991,715 34,601 * Beverly Enterprises, Inc. 3,030,000 21,271 --------------- 1,217,272 --------------- HEALTH CARE MANAGEMENT SERVICES (5.1%) Aetna Inc. 5,850,200 201,130 IMS Health, Inc. 9,047,400 180,496 *(1)Humana Inc. 11,495,000 143,113 UnitedHealth Group Inc. 1,900,000 141,265 * Cerner Corp. 1,446,600 70,015 * WebMD Corp. 5,175,600 40,887 * WellPoint Health Networks Inc. 300,000 38,067 * Health Net Inc. 984,000 21,924 * Universal Health Services Class B 400,000 16,740 * Trigon Healthcare, Inc. 200,000 14,706 * Mid Atlantic Medical Services, Inc. 500,000 12,525 * Pediatrix Medical Group, Inc. 348,100 11,627 * Cobalt Corp. 678,000 3,763 --------------- 896,258 --------------- Materials & Processing (1.5%) (1) Sigma-Aldrich Corp. 4,986,300 208,527 Monsanto Co. 1,847,800 61,532 --------------- 270,059 --------------- Medical & Dental Instruments & Supplies (6.5%) Becton, Dickinson & Co. 8,951,800 324,234 * St. Jude Medical, Inc. 2,501,300 198,353 (1) Bausch & Lomb, Inc. 4,550,000 171,763 Beckman Coulter, Inc. 2,529,400 117,769 Biomet, Inc. 2,851,925 92,089 * Guidant Corp. 1,000,000 48,050 DENTSPLY International Inc. 961,800 47,561 (1) Owens & Minor, Inc. Holding Co. 2,362,100 45,943 * PSS World Medical, Inc. 3,000,000 30,180 * STERIS Corp. 1,150,000 21,160 * Zimmer Holdings, Inc. 464,450 15,109 * Ventana Medical Systems, Inc. 614,400 14,666 * Viasys Healthcare Inc. 482,130 10,968 * Varian, Inc. 253,000 8,906 *(1)Cohesion Technologies, Inc. 525,800 2,438 * E-Z-EM, Inc. Class B 304,344 2,222 * E-Z-EM, Inc. Class A 219,258 1,864 --------------- 1,153,275 --------------- Medical Services (0.6%) *(1)Coventry Health Care Inc. 3,785,000 84,973 *(1)PAREXEL International Corp. 1,570,200 21,732 --------------- 106,705 --------------- PRODUCER DURABLES (0.2%) Pall Corp. 1,554,600 35,849 * Kadant Inc. 201,960 2,857 --------------- 38,706 --------------- TECHNOLOGY (0.1%) * IDX Systems Corp. 1,109,200 13,255 * DAOU Systems, Inc. 513,500 488 -------------- 13,743 --------------- OTHER (1.0%) Tyco International Ltd. 3,000,000 105,450 * Thermo Electron Corp. 3,300,000 72,468 --------------- 177,918 --------------- - -------------------------------------------------------------------------------- TOTAL UNITED STATES 12,118,666 - -------------------------------------------------------------------------------- INTERNATIONAL (21.5%) - -------------------------------------------------------------------------------- BELGIUM (0.1%) UCB SA 483,593 19,880 --------------- CANADA (0.1%) * Axcan Pharma Inc. 1,356,900 18,346 --------------- DENMARK (0.1%) Novozymes A/S 400,000 7,580 --------------- FRANCE (2.1%) Aventis SA 2,475,168 171,862 Aventis SA ADR 2,052,615 143,663 Sanofi-Synthelabo SA 615,004 41,193 --------------- 356,718 --------------- 15 MARKET VALUE* HEALTH CARE FUND SHARES (000) - -------------------------------------------------------------------------------- GERMANY (1.7%) Bayer AG 6,243,031 199,836 Bayer AG ADR 1,921,500 61,506 Schering AG 640,410 35,750 Fresenius Medical Care Pfd. ADR 645,400 9,023 --------------- 306,115 --------------- JAPAN (5.6%) Fujisawa Pharmaceutical Co., Ltd. 13,298,000 264,925 Eisai Co., Ltd. 8,006,000 181,941 Banyu Pharmaceutical Co. 7,015,000 89,778 Chugai Pharmaceutical Co., Ltd. 7,181,000 74,564 Yamanouchi Pharmaceuticals Co., Ltd. 2,980,000 72,177 Shionogi & Co., Ltd. 5,031,000 71,458 Takeda Chemical Industries Ltd. 1,500,000 59,542 Tanabe Seiyaku Co., Ltd. 6,037,000 52,757 Daiichi Pharmaceutical Co., Ltd. 2,204,000 42,426 Olympus Optical Co., Ltd. 1,900,000 26,248 Sankyo Co., Ltd. 1,550,000 23,128 Ono Pharmaceutical Co., Ltd. 632,000 18,662 --------------- 977,606 --------------- NETHERLANDS (0.6%) Akzo Nobel NV 2,500,000 107,251 --------------- SWEDEN (0.5%) Gambro AB A Shares 7,531,120 44,240 Gambro AB B Shares 7,314,580 42,968 --------------- 87,208 --------------- SWITZERLAND (4.3%) Roche Holdings AG 5,923,977 393,651 Novartis AG (Registered) 6,769,880 231,951 Roche Holdings AG (Bearer) 825,000 66,268 Serono SA Class B 56,871 45,515 * Syngenta AG 234,247 12,631 * Syngenta AG ADR 917,843 10,095 --------------- 760,111 --------------- UNITED KINGDOM (6.4%) AstraZeneca Group PLC ADR 7,536,372 354,134 GlaxoSmithKline PLC ADR 6,748,881 325,431 AstraZeneca Group PLC 5,731,500 263,262 Amersham PLC 13,565,820 126,060 SSL International PLC 6,400,000 48,301 Boots Co. PLC 1,703,342 15,695 --------------- 1,132,883 --------------- - -------------------------------------------------------------------------------- TOTAL INTERNATIONAL 3,773,698 - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $10,831,833) 15,892,364 - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (10.2%) - -------------------------------------------------------------------------------- U.S. GOVERNMENT AND AGENCY OBLIGATIONS (3.8%) Federal Home Loan Bank 1.80%, 2/27/2002 41,000 40,947 Federal Home Loan Mortgage Corp. 1.64%, 7/18/2002 280,000 277,752 1.66%, 8/16/2002 60,000 59,389 1.82%, 3/7/2002 42,000 41,934 Federal National Mortgage Assn. 1.64%, 7/17/2002 120,000 119,042 1.66%, 7/17/2002 74,000 73,409 2.03%, 2/21/2002 49,415 49,369 --------------- 661,842 --------------- COMMERCIAL PAPER (4.8%) General Electric Capital Corp. 1.82%, 5/15/2002 300,000 298,446 1.83%, 3/26/2002 150,000 149,598 1.84%, 7/24/2002 200,000 198,251 1.84%, 7/25/2002 200,000 198,241 --------------- 844,536 --------------- REPURCHASE AGREEMENTS (1.6%) UBS Warburg LLC 1.89%, 2/1/2002 (Dated 1/31/2002, Repurchase Value $197,904,000, collateralized by U.S. Treasury Bonds 6.75-;8.00%, 11/15/2021-;8/15/2026) 197,894 197,894 Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.91%, 2/1/2002--Note G 91,913 91,913 --------------- 289,807 --------------- - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $1,796,460) 1,796,185 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.4%) (Cost $12,628,293) 17,688,549 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES(-0.4%) - -------------------------------------------------------------------------------- Other Assets--Note C 121,561 Liabilities--Note G (198,660) (77,099) --------------- NET ASSETS (100%) $17,611,450 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. (1)Considered an affiliated company as the fund owns more than 5% of the outstanding voting securities of such company. The total market value of investments in affiliated companies was $995,313,000. ADR--American Depositary Receipt. 16 ============================================================= Amount (000) - ------------------------------------------------------------- AT JANUARY 31, 2002, NET ASSETS CONSISTED OF: - ------------------------------------------------------------- Paid-in Capital--Note E $12,488,249 Overdistributed Net Investment Income--Note E (4,230) Accumulated Net Realized Gains--Note E 67,344 Unrealized Appreciation (Depreciation)--Note F Investment Securities 5,060,256 Foreign Currencies (169) - ------------------------------------------------------------- NET ASSETS $17,611,450 ============================================================= Investor Shares--Net Assets Applicable to 138,952,872 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $15,980,631 - ------------------------------------------------------------ NET ASSET VALUE PER SHARE-- INVESTOR SHARES $115.01 ============================================================= Admiral Shares--Net Assets Applicable to 33,608,827 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $1,630,819 - ------------------------------------------------------------- NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $48.52 ============================================================= 17 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. ================================================================================ HEALTH CARE FUND Year Ended January 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME Income Dividends*Y $133,943 Interest 59,061 Security Lending 1,126 - -------------------------------------------------------------------------------- Total Income 194,130 - -------------------------------------------------------------------------------- Expenses Investment Advisory Fees--Note B 10,168 The Vanguard Group--Note C Management and Administrative Investor Shares 38,265 Admiral Shares 428 Marketing and Distribution Investor Shares 1,931 Admiral Shares 4 Custodian Fees 1,203 Auditing Fees 13 Shareholders' Reports Investor Shares 288 Admiral Shares -- Trustees' Fees and Expenses 22 - -------------------------------------------------------------------------------- Total Expenses 52,322 Expenses Paid Indirectly--Note D (1,134) - -------------------------------------------------------------------------------- Net Expenses 51,188 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 142,942 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities SoldY 631,488 Foreign Currencies and Forward Currency Contracts 83,174 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) 714,662 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities (1,035,006) Foreign Currencies and Forward Currency Contracts (39,940) - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (1,074,946) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ (217,342) ================================================================================ *Dividends are net of foreign withholding taxes of $3,756,000. YDividend income and realized net gain from affiliated companies were $10,205,000 and $44,707,000, respectively. 18 Statement of Changes in Net Assets This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. ================================================================================ HEALTH CARE FUND Year Ended January 31, ------------------------------- 2002 2001 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS Operations Net Investment Income $ 142,942 $ 149,109 Realized Net Gain (Loss) 714,662 1,474,140 Change in Unrealized Appreciation (Depreciation) (1,074,946) 3,145,332 - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (217,342) 4,768,581 - -------------------------------------------------------------------------------- Distributions Net Investment Income Investor Shares (138,966) (135,390) Admiral Shares (10,721) -- Realized Capital Gain* Investor Shares (741,844) (1,913,673) Admiral Shares (46,678) -- - -------------------------------------------------------------------------------- Total Distributions (938,209) (2,049,063) - -------------------------------------------------------------------------------- Capital Share Transactions--Note H Investor Shares (181,612) 3,796,440 Admiral Shares 1,706,176 -- - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 1,524,564 3,796,440 - -------------------------------------------------------------------------------- Total Increase (Decrease) 369,013 6,515,958 - -------------------------------------------------------------------------------- Net Assets Beginning of Period 17,242,437 10,726,479 - -------------------------------------------------------------------------------- End of Period $17,611,450 $17,242,437 ================================================================================ *Includes fiscal 2002 and 2001 short-term gain distributions totaling $130,142,000 and $145,175,000, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 19 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
===================================================================================================== HEALTH CARE FUND INVESTOR SHARES Year Ended January 31, -------------------------------------------- For a Share Outstanding Throughout Each Period 2002 2001 2000 1999 1998 - ----------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $123.04 $ 98.83 $97.32 $74.02 $60.65 - ----------------------------------------------------------------------------------------------------- Investment Operations Net Investment Income .980 1.16 .92 .86 .80 Net Realized and Unrealized Gain (Loss) on Investments (2.516) 40.05 8.70 26.36 15.49 - ----------------------------------------------------------------------------------------------------- Total from Investment Operations (1.536) 41.21 9.62 27.22 16.29 - ----------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (1.030) (1.07) (.97) (.84) (.78) Distributions from Realized Capital Gains (5.464) (15.93) (7.14) (3.08) (2.14) - ----------------------------------------------------------------------------------------------------- Total Distributions (6.494) (17.00) (8.11) (3.92) (2.92) - ----------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $115.01 $123.04 $98.83 $97.32 $74.02 ===================================================================================================== TOTAL RETURN* -1.11% 43.37% 10.57% 37.39% 27.37% ===================================================================================================== Ratios/Supplemental Data Net Assets, End of Period (Millions) $15,981 $17,242 $10,726 $9,884 $4,720 Ratio of Total Expenses to Average Net Assets 0.31% 0.34% 0.41% 0.36% 0.40% Ratio of Net Investment Income to Average Net Assets 0.84% 1.03% 0.92% 1.13% 1.28% Portfolio Turnover Rate 13% 21% 27% 11% 10% ===================================================================================================== *Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than five years (or less than one year in the case of shares purchased prior to April 19, 1999).
20 ================================================================================ HEALTH CARE FUND ADMIRAL SHARES Nov. 12, 2001* to For a Share Outstanding Throughout the Period Jan. 31, 2002 - -------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $50.00 - -------------------------------------------------------------------------------- Investment Operations Net Investment Income .066 Net Realized and Unrealized Gain (Loss) on Investments .542 - -------------------------------------------------------------------------------- Total from Investment Operations .608 - -------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.390) Distributions from Realized Capital Gains (1.698) - -------------------------------------------------------------------------------- Total Distributions (2.088) - -------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $48.52 ================================================================================ TOTAL RETURN** 1.23% ================================================================================ Ratios/Supplemental Date Net Assets, End of Period (Millions) $1,631 Ratio of Total Expenses to Average Net Assets 0.23%Y Ratio of Net Investment Income to Average Net Assets 0.50%Y Portfolio Turnover Rate 13% ================================================================================ *Inception. **Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than five years. YAnnualized. 21 NOTES TO FINANCIAL STATEMENTS Vanguard Health Care Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on November 12, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. Security Valuation: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments acquired over 60 days to maturity are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. Foreign Currency: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates on the valuation date as employed by Morgan Stanley Capital International in the calculation of its indexes. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the asset or liability is settled in cash, when they are recorded as realized foreign currency gains (losses). 3. Forward Currency Contracts: The fund enters into forward currency contracts to protect the value of securities and related receivables and payables against changes in future foreign exchange rates. The fund's risks in using these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the ability of the counterparties to fulfill their obligations under the contracts. Forward currency contracts are valued at their quoted daily settlement prices. The aggregate principal amounts of the contracts are not recorded in the financial statements. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized forward currency contract gains (losses). 4. 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. The fund may also invest directly in repurchase agreements. 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. 5. Distributions: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 22 6. Other: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital. 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 January 31, 2002, the investment advisory fee represented an effective annual rate of 0.06% 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 January 31, 2002, the fund had contributed capital of $3,272,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 3.30% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment adviser to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the year ended January 31, 2002, directed brokerage and custodian fee offset arrangements reduced expenses by $1,054,000 and $80,000, respectively. The total expense reduction represented an effective annual rate of 0.01% of the fund's average net assets. E. During the year ended January 31, 2002, the fund purchased $3,031,047,000 of investment securities and sold $2,070,376,000 of investment securities other than temporary cash investments. During the year ended January 31, 2002, the fund realized net foreign currency losses of $778,000, which decreased distributable net income for tax purposes; accordingly such losses have been reclassified from accumulated net realized gains to undistributed net investment income. The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from net investment income and realized capital gains. Accordingly, the fund has reclassified $4,706,000 from undistributed net investment income, and $21,690,000 from accumulated net realized gains, to paid-in capital. For tax purposes, at January 31, 2002, the fund had capital gains of $67,344,000 available for distribution, including short-term gains of $549,000. Short-term gain distributions are treated as ordinary income dividends for tax purposes. F. At January 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $5,060,256,000, consisting of unrealized gains of $5,443,464,000 on securities that had risen in value since their purchase and $383,208,000 in unrealized losses on securities that had fallen in value since their purchase. The fund had net unrealized foreign currency losses of $169,000 resulting from the translation of other assets and liabilities at January 31, 2002. 23 NOTES TO FINANCIAL STATEMENTS (continued) G. The market value of securities on loan to broker/dealers at January 31, 2002, was $85,878,000, for which the fund held cash collateral of $91,913,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. H. Capital share transactions for each class of shares were:
Year Ended January 31, ------------------------------------------------ 2002 2001 ----------------------------------------------- Amount Shares Amount Shares (000) (000) (000) (000) - -------------------------------------------------------------------------------------------- Investor Shares Issued $ 2,209,879 18,56 $ 3,238,817 27,062 Issued in Lieu of Cash Distributions 839,983 7,423 1,949,097 16,646 Redeemed* (3,231,474) (27,177) (1,391,474) (12,103) Net Increase (Decrease)--Investor Shares (181,612) (1,185) 3,796,440 31,605 Admiral Shares Issued 1,672,978 32,914 -- -- Issued in Lieu of Cash Distributions 51,584 1,067 -- -- Redeemed* (18,386) (372) -- -- ---------------------------------------------- Net Increase (Decrease)--Admiral Shares 1,706,176 33,609 -- -- - --------------------------------------------------------------------------------------------- *Net of redemption fees of $3,883,000 and $1,838,000, respectively (fund totals).
24 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Trustees of Vanguard Health Care 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 Health Care Fund (the "Fund") at January 31, 2002, 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 January 31, 2002 by correspondence with the custodian, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania March 6, 2002 ================================================================================ SPECIAL 2001 TAX INFORMATION (unaudited) for VANGUARD HEALTH CARE FUND This information for the fiscal year ended January 31, 2002, is included pursuant to provisions of the Internal Revenue Code. The fund distributed $678,944,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year, all of which is designated as a 20% rate gain distribution. For corporate shareholders, 51.9% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. - -------------------------------------------------------------------------------- 25 ADVANTAGES OF VANGUARD.COM(TM) [Picture of a Computer] Why wait for the mail? You can get fund reports like this one sooner--and reduce the amount of mail you receive from us. Simply choose to view your fund reports online. Consider the benefits of using Vanguard.com. On our website, you can: * Choose to receive all fund reports, as well as prospectuses, online. * Request a courtesy e-mail to notify you when a new fund report or prospectus is available. When you receive fund reports and prospectuses online, you lower Vanguard's printing and postage costs--and that helps to reduce the expense ratios of your funds. You will continue to receive confirmations of purchases, redemptions, and other account activity by mail. HOW TO NOTIFY US ABOUT YOUR MAILING PREFERENCES You can easily tell us to stop mailing your fund reports and prospectuses. Just log on to Vanguard.com (or follow the easy steps to register for secure, online access to your accounts) and update your Web profile. Registered users can also view their account values; download records of recent transactions; research and track the performance of individual securities and funds; buy, exchange, and sell fund shares; and much more. If you invest directly with us, you can also elect to receive all of your account statements online or to continue the mailing of only your year-end statements, which detail every transaction you make during the year. However, if you invest with us through an employer-sponsored retirement plan or a financial intermediary, some of these options may not be available to you. All Vanguard shareholders can choose to receive our electronic newsletters: ECONOMIC WEEK IN REVIEW, a recap of each week's key economic reports and market activity; and WHAT'S NEW AT VANGUARD, a monthly update on our mutual funds, services, and online resources. YOUR ONLINE INFORMATION IS SECURE Vanguard.com uses some of the most secure forms of online communication available, including data encryption and Secure Sockets Layer (SSL) protocol. These technologies provide a high level of security and privacy when you access your account information, initiate online transactions, or send us messages. 26 THE VANGUARD(R) FAMILY OF FUNDS STOCK FUNDS 500 Index Fund Calvert Social Index(TM) Fund Capital Opportunity Fund Capital Value 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 Growth and Income Fund Growth Equity Fund Growth Index Fund Health Care Fund Institutional Developed Markets Index Fund Institutional Index Fund Institutional Total Stock Market Index Fund International Growth Fund International Value Fund Mid-Cap Index Fund Morgan(TM) Growth Fund Pacific Stock Index Fund Precious Metals 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 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 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 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, ew 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. The People Who Govern Your Fund The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the
================================================================================================================ Name Position(s) Held with Fund (Date of Birth) (Number of Vanguard Funds Trustee/Officer Since Overseen by Trustee) Principal Occupation(s) During the Past Five Years - ------------------------------------------------------------------------------------------------------------ JOHN J. BRENNAN* Chairman of the Board, Chairman of the Board, Chief Executive Officer, and (July 29, 1954) Chief Executive Officer, Director/Trustee of The Vanguard Group, Inc., and of May 1987 and Trustee each of the investment companies served by (106) The Vanguard Group. - ------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Adviser (October 23, 1937) (106) to Greenwich Associates (international business-strategy consulting); January 2001 Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. - ------------------------------------------------------------------------------------------------------------ RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice (December 23, 1945) (84) Chairman (January-;September 1999), and Vice President (prior to December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of Technitrol, Inc.(electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. - ------------------------------------------------------------------------------------------------------------ JOANN HEFFERNAN HEISEN Trustee Vice President, Chief Information Officer, and Member of the Executive (January 25, 1950) (106) Committee of Johnson & Johnson (pharmaceuticals/consumer products); July 1998 Director of the Medical Center at Princeton and Women's Research and Education Institute. - ------------------------------------------------------------------------------------------------------------ BURTON G. MALKIEL Trustee Chemical Bank Chairman's Professor of Economics, Princeton (August 28, 1932) (104) University; Director of Prudential Insurance Co. of America, BKF Capital May 1977 (investment management), The Jeffrey Co. (a holding company), and NeuVis, Inc.(a software company.) - ------------------------------------------------------------------------------------------------------------ ALFRED M. RANKIN, JR. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO (October 8, 1941) (106) Industries, Inc. (forklift trucks/housewares/lignite); Director of Goodrich January 1993 Corporation (industrial products/aircraft systems and services); Director of the Standard Products Company (a supplier for the automotive industry) until 1998 - ------------------------------------------------------------------------------------------------------------ J. LAWRENCE WILSON Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co. (March 2, 1936) (106) (chemicals); Director of Cummins Inc. (diesel engines), The Mead April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - ------------------------------------------------------------------------------------------------------------
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. Each trustee serves a fund until its termination; or until the trustee's retirement, resignation, or death; or otherwise as specified in the fund's organizational documents. Any trustee may be removed at a shareholders' meeting by a vote representing two-thirds of the net asset value of all shares of the fund together with shares of other Vanguard funds organized within the same trust. The table on these two pages shows information for each trustee and executive officer of the fund. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.
======================================================================================================================== NAME POSITION(S) HELD WITH FUND (DATE OF BIRTH) (NUMBER OF VANGUARD FUNDS TRUSTEE/OFFICER SINCE OVERSEEN BY TRUSTEE) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS - ----------------------------------------------------------------------------------------------------------------------- EXECUTIVE OFFICERS* R. GREGORY BARTON Secretary Managing Director and General Counsel of The Vanguard Group, Inc. (April 25, 1951) (106) (since September 1997); Secretary of The Vanguard Group, and of June 2001 each of the investment companies served by The Vanguard Group; Principal of The Vanguard Group (prior to September 1997). - ---------------------------------------------------------------------------------------------------------------------- THOMAS J. HIGGINS Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the (May 21, 1957) (106) investment companies served by The Vanguard Group. July 1998 - ----------------------------------------------------------------------------------------------------------------------------- *Officers of the funds are "interested persons" as defined in the Investment Company Act of 1940.
More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group.
VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. - -------------------------------------------------------------------------------------------------------------- JAMES H. GATELY, Direct Investor Services. Michael S. Miller, Planning and Development. - -------------------------------------------------------------------------------------------------------------- KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. - -------------------------------------------------------------------------------------------------------------- IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-;1996. - --------------------------------------------------------------------------------------------------------------
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[SHIP] [THE VANGUARD GROUP (R)LOGO] POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-260 ABOUT OUR COVER Our cover photograph was taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photograph is copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the fund or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. FUND INFORMATION 1-800-662-7447 TEXT TELEPHONE 1-800-952-3335 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 WORLD WIDE WEB www.vanguard.com All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. (C)2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q520 032002 VANGUARD(R)UTILITIES INCOME FUND ANNUAL REPORT * JANUARY 31, 2002 STOCK THE VANGUARD GROUP(R) LOGO PERSPECTIVE Maintaining a long-term investment perspective isn't easy. Perhaps that's why it has proven to be so rewarding. With news, information, and opinion constantly bombarding us, the temptation to buy or sell--to do something--is powerful. Yet such activity is often counterproductive. Emotions can lead us to big mistakes, like jumping into a hot investment we know little about or selling a sound long-term holding when it sags for a while. The actions we recommend are quite simple. First, take the time to decide on a mix of stocks, bonds, and cash investments that makes sense for you. Take into account your investment time horizon, your goals, and your ability and willingness to ride out market fluctuations. Write this mix down--it's your investment plan. Second, use low-cost, widely diversified mutual funds to carry out your asset allocation. Third, stick with your plan, unless there's a major change in your time horizon, goals, or financial situation. Don't "play the market"--and if you feel you must, don't risk more than a tiny percentage of your assets. Finally, if market news, the opinions of "experts," or the hope of a big score tempts you to act, consult your plan. It may help you keep a long-term perspective. ================================================================================ CONTENTS Letter from the Chairman 1 Report from the Adviser 6 Fund Profile 8 Glossary of Investment Terms 9 Performance Summary 10 Your Fund's After-Tax Returns 11 Financial Statements 12 - -------------------------------------------------------------------------------- Summary * VANGUARD UTILITIES INCOME FUND returned -17.2% during its 2002 fiscal year, a difficult period for stocks that was especially tough on some utility shares. * The fund's return, though disappointing, was significantly ahead of the average return for utility mutual funds. * The broad stock market declined by more than -;15% during the 12 months amid an economic recession and a plunge in corporate profits. Bonds provided solid results. LETTER FROM THE CHAIRMAN [Photo] [John J. Brennan] Fellow Shareholder, VANGUARD(R) UTILITIES INCOME FUND returned -17.2% during its 2002 fiscal year, a disappointing result that reflected both the decline in the broad stock market and the significant challenges that beset the utility industry during the period. As you can see in the table below, your fund's 12-month total return (capital change plus reinvested dividends) was much better than the results of its average competitor and its unmanaged composite index, but trailed the return of the Wilshire 5000 Total Market Index, a proxy for the entire U.S. stock market. At the fiscal year-end on January 31, the fund's yield was 2.6%, about double the yield of the overall stock market. Details on the fund's performance, including the change in net asset value and per-share distributions, can be found in the table on page 5. If you own the Utilities Income Fund in a taxable account, you may wish to review the fund's after-tax returns, listed on page 11. ==================================================================== 2002 TOTAL RETURNS FISCAL YEAR ENDED JANUARY 31 - -------------------------------------------------------------------- VANGUARD UTILITIES INCOME FUND -17.2% Average Utility Fund* -23.2 Utilities Composite Index** -26.1 Wilshire 5000 Index -15.3 - -------------------------------------------------------------------- *Derived from data provided by Lipper Inc. **Weighted 75% S&P Utilities Index and 25% S&P Telephone Index through December 31, 2001; 75% S&P Utilities Index and 25% S&P Integrated Telecommunication Services Index thereafter. - -------------------------------------------------------------------- The 12 months ended January 31 were a very rough stretch for stock investors, as illustrated by the -;15.3% decline of the Wilshire 5000 Index. Several factors contributed to the market's decline, including: * The first recession in the U.S. economy in a decade, part of a worldwide slowdown in economic activity. * The September 11 terrorist attacks, which resulted in economic disruption and a heightened awareness of risk--both physical and financial. * A steep reduction in corporate profits: Twelve-month net earnings reported by companies in the Standard & Poor's 500 Index fell nearly 50% on average from January 2001 to January 2002. * Concern about the reliability of certain corporate accounting and disclosure practices, owing largely to the collapse of Enron Corporation. The downturn that began in March 2001 ended a record ten years of uninterrupted expansion in the U.S. economy. The recession was heralded by severe reductions in corporate investment spending, especially in the technology and telecommunications sectors (both plagued by overcapacity created in 1 the 1990s boom). As the year progressed, so did the business cutbacks and the weakness in the economy. High levels of corporate and household debt cast doubt on the economy's ability to bounce back quickly. Through all the difficulties, consumer spending held up surprisingly well--especially spending for housing and for automobiles, spurred by low interest rates (and sales incentives, in the case of autos). Joblessness rose during the 12 months. However, layoffs seemed to be tapering off late in the fiscal year, and consumer confidence regained some of the ground lost earlier. Whether such hopeful signs will blossom into a full-fledged recovery is uncertain, but by January the Federal Reserve Board was encouraged enough to halt its campaign of cutting interest rates to stimulate economic activity. During the fiscal year, the Fed had lowered its target for the federal funds rate--the interest rate that banks charge each other for overnight loans--nine times, for a total of 3.75 percentage points. Those reductions, together with cuts totaling 1 percentage point in January 2001, brought the fed funds rate to 1.75%, its lowest level in four decades. ================================================================================ MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2002 ------------------------------- One Three Five Year Years Years STOCKS S&P 500 Index (Large-caps) -16.1% -2.8% 9.0% Russell 2000 Index (Small-caps) -3.6 5.6 6.9 Wilshire 5000 Index (Entire market) -15.3 -2.3 8.3 MSCI EAFE Index (International) -26.1 -6.9 0.4 BONDS Lehman Aggregate Bond Index (Entire market) 7.6% 6.3% 7.5% Lehman 10 Year Municipal Bond Index 5.2 4.7 6.3 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 3.7 4.9 5.0 CPI Consumer Price Index 1.1% 2.5% 2.2% - -------------------------------------------------------------------------------- The weak economy and even weaker corporate profits made for a bad 12 months for the broad U.S. stock market. Stocks seemed to be heading for a second full year in bear territory. From its peak in March 2000, the Wilshire 5000 Index had plunged -28% by the end of January 2002. The market hit a three-year low after the terrorist attacks, but then rallied in the final weeks of 2001. Still, the returns of most stock sectors were deeply in the red for the 12 months, although value stocks in the small- and mid-capitalization ranges produced gains. Meanwhile, bonds had another good year. The Lehman Brothers Aggregate Bond Index, a proxy for the taxable investment-grade U.S. bond market, posted a 12-month return of 7.6%. Yields of U.S. Treasury securities--which move in the opposite direction from their prices--fell during the 12 months. The decline was particularly pronounced at the shorter end of the maturity spectrum, where issues are most affected by Fed actions. The yield of the 3-month Treasury bill fell 324 basis 2 points (3.24 percentage points) to 1.75%. The yields of 10-year and 30-year Treasuries fell a mere 8 and 7 basis points to 5.03% and 5.43%, respectively. FISCAL 2002 PERFORMANCE OVERVIEW During the 12 months ended January 31, the utility industry faced a series of stiff challenges: * The economic slowdown reduced demand for electricity and natural gas. * Shares of telecommunications companies dropped in price because of concern about overcapacity. * California struggled through a severe energy crisis. * And Enron's fall cast a pall over power companies. Your fund's -17.2% return reflected the generally dismal environment. However, the fund achieved a strong performance relative to its competitors, topping the average peer's return by 6 percentage points. This was a result of the generally conservative positioning of the portfolio. Overall, your fund had less exposure than competitors did to the sector's more speculative fare, such as telecom stocks, networking concerns, and independent power companies. While this less-risky stance could not protect the fund from a sharp drop, it did help limit the decline. As of January 31, the fund's investment adviser, Wellington Management Company, llp, allocated about 15% of the assets to telecoms. The bulk of our assets--about 62%--were invested in electric utilities, and about 8% were in natural gas distributors. Electric companies provided mixed results during the year, though declines were more prevalent than gains. ================================================================================ Overall, your fund has less exposure to the sector's more specualtive fare, such as telecom stocks, networking concerns, and independent power companes, than did its competitors. ================================================================================ Your fund owned a small stake in Enron--about 1.4% of net assets--at the beginning of the period. The collapse of the energy-trading giant, therefore, had a negative effect on the fund, but not a serious one. However, Enron's troubles had a ripple effect on similar companies, including El Paso Corporation (-40%), Calpine (-72%), and former Enron suitor Dynegy (-51%). Together, shares of these companies accounted for about 8% of our net assets when the fiscal year began. The fund eliminated Enron from its holdings in August, but still owned shares of the other firms on January 31. For further discussion of the fund's performance and the utility industry, see the Report from the Adviser on page 6. Toward the fiscal year-end, a portion of the fund's benchmark index changed slightly. Effective January 1, 2002, Standard & Poor's Corporation eliminated the S&P Telephone Index and replaced it with the S&P Integrated Telecommunication Services Index, which includes the seven companies that 3 made up the Telephone Index along with four additional businesses. The fund's composite index was modified in accordance with S&P's shift. The change does not affect the fund's investment objective, strategy, or policies. LONG-TERM PERFORMANCE OVERVIEW Since its inception nearly ten years ago, your fund's return relative to its aver-age peer has been solid. However, the fund has fallen short of its unmanaged composite index and the broad market. This shortfall is due, in part, to the fact that indexes don't incur the expenses that real-world funds must bear. But these costs also help explain our advantage over our average peer, which charges much higher expenses than your fund. In fiscal 2002, the Utilities Income Fund had an expense ratio (annual expenses as a percentage of average net assets) of 0.37%, or $3.70 per $1,000 invested. This was substantially less than the 1.47%, or $14.70 per $1,000 invested, charged by the average utility fund, according to Lipper Inc. It's hard to overstate the role that costs play in investment performance. Costs directly reduce the return received by investors, regardless of whether the market is slumping or soaring. ================================================================================ TOTAL RETURNS MAY 15, 1992,* THROUGH JANUARY 31, 2002 -------------------------------- Average Final Value of Annual a $10,000 Return Initial Investment VANGUARD UTILITIES INCOME FUND 8.8% $22,746 Average Utility Fund 8.0 21,107 Utilities Composite Index** 9.9 24,955 Wilshire 5000 Index 12.6 31,628 *Inception. **The index was weighted 80% S&P Utilities Index and 20% Lehman Utility Bond Index through June 30, 1996; 40% S&P Utilities Index, 40% S&P Telephone Index, and 20% Lehman Utility Bond Index through April 30, 1999; 63.75% S&P Utilities Index, 21.25% S&P Telephone Index, and 15% Lehman Utility Bond Index through March 31, 2000; 75% S&P Utilities Index and 25% S&P Telephone Index through December 31, 2001; and 75% S&P Utilities Index and 25% S&P Integrated Telecommunication Services Index thereafter. - -------------------------------------------------------------------------------- The table above shows your fund's performance since inception in comparison with its benchmarks. As you review these results, keep in mind that the past decade was an excellent period for stocks, and it is unlikely that the returns provided during the late 1990s will be repeated. Counting on the broad stock market to return 12% annually in the decade ahead could be dangerous to your financial health. It's also important to understand that the utility industry has undergone significant changes since we introduced VANGUARD UTILITIES INCOME FUND in 1992. At that time, the industry was made up of a generally staid group of companies known for their generous dividends. In fact, for years utility stocks--and the mutual funds that emphasized them--were viewed as quite conservative stock investments. Since then, however, as a result of deregulation and the explosive growth of certain industries such as telecommunications, utility companies as a group have become less focused on 4 paying--or increasing--dividends. In fact, many of these companies pay lower dividends, and their share prices demonstrate much greater volatility. As we hope all of our shareholders realize, an investment in a "sector fund" is almost certain to be more volatile than the broad market. Such an investment may require, at times, a steely nerve and considerable patience. For example, in its 1995 fiscal year the UTILITIES INCOME FUND returned -;4.5%, declining about three percentage points more than the Wilshire 5000 Index. And in fiscal 1997 the fund underperformed the broad market by almost 19 percentage points (5.5% for the UTILITIES INCOME FUND versus 24.4% for the Wilshire 5000). On the positive side, in fiscal 2001 the fund was ahead by more than 10 percentage points, returning 7.1% while the overall market slid -;3.5%. Because volatility is part and parcel of investing in a sector fund, we recommend that such funds serve as a supplement to a broadly diversified portfolio. IN SUMMARY During a difficult period in the stock market, the temptation to make major adjustments to your portfolio can be powerful. But we counsel investors to avoid making big changes to their mix of stocks, bonds, and short-term investments based on market cycles. Rather, we suggest maintaining a balanced investment program that provides exposure to all asset classes and to many types of securities within each asset class. For those who wish to complement their programs with a fund that has a specialized focus, VANGUARD UTILITIES INCOME FUND provides skillful investment management at an extremely low cost. We thank you for your trust in our approach to investing, and we pledge to continue working hard to earn your confidence. Sincerely, /S/ JOHN J. BRENNAN JOHN J. BRENNAN Chairman and Chief Executive Officer February 11, 2002 ================================================================================ YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2001-;JANUARY 31, 2002 Distributions Per Share ------------------------- Starting Ending Income Capital Share Price Share Price Dividends Gains - -------------------------------------------------------------------------------- VANGUARD UTILITIES INCOME FUND $14.71 $11.47 $0.37 $0.41 - -------------------------------------------------------------------------------- 5 REPORT FROM THE ADVISER VANGUARD UTILITIES INCOME FUND returned -17.2% for the 12 months ended January 31, a decline less severe than those of both the average utility fund (-23.2%) and our composite index benchmark (-26.1%). The fund held up better because of its focus on defensive, integrated utilities with attractive yields and its smaller exposure to the telecommunications sector. THE INVESTMENT ENVIRONMENT The climate for electric and gas utilities changed dramatically over the past year. Energy trading came under pressure as Enron collapsed, and the industry's earnings outlook suffered as both gas and electricity prices plunged. Investors' appetite for risk waned, and more conservative companies--those with yields of 4% to 6% and modest annual growth--came back into favor. With Enron-related issues haunting the sector, many companies were aggressively canceling construction plans and focusing anew on ways to strengthen their balance sheets and improve cash flow. The telephone sector also performed poorly during the fiscal year, as the glut of broadband capacity led to several bankruptcies. In addition, revenue growth slowed across all business segments. We continued to focus our telecom investments on large carriers with strong balance sheets, rather than on the new competitors. On a positive note, water utilities performed well in fiscal 2002. Both domestic and international companies benefited from water-utility growth projects, which tend to entail less risk than the expansion of other utilities. MAJOR SHORTFALLS We sold our stakes in two telecommunications companies, Montana Power and Qwest Communications, that were not coping well in an environment of excess capacity and lower wholesale pricing. Our holdings in El Paso Corporation and Dynegy--dominant players in the gas pipeline and energy-trading business--declined because of the sharp decline in natural gas prices as well as concerns related to Enron. Constellation Energy and Calpine were among companies with a focus on independent power generation and deregulated growth that suffered during the period. ================================================================================ INVESTMENT PHILOSOPHY The fund reflects the belief that investors who seek to emphasize utility stocks as part of a long-term, balanced investment program are best served by holding a portfolio of securities well-diversified across the sector. ================================================================================ As for Enron, we had a relatively small position in it during the first half of the year, and we sold the last piece at slightly more than $35 a share in August. 6 MAJOR SUCCESSES Large integrated electric utilities with attractive yields--our holdings included FirstEnergy, TXU, and Progress Energy--did very well in fiscal 2002. Meeting their earnings estimates, they provided stability in a volatile sector. Overall, companies with strong fundamentals provided positive total returns during the 12 months. Several of these companies were acquired at a premium during the year, including American Water Works, Niagara Mohawk, PowerGen, and Westcoast Energy. Cinergy, CH Energy, and Vectren--medium-size electric utility companies with good competitive positions within their respective regions--also performed well. THE FUND'S POSITIONING Fiscal 2002 was a year of high volatility and increased risk across the utility sector, as investors saw the downside potential of deregulation both in Enron's demise and in sharp drops in gas and electricity prices. We reacted to the changes by continuing to emphasize yield-oriented utilities, building our electric utilities up to more than 60% of assets and letting telecommunications drop to the neighborhood of 15%. We believe energy prices will remain under pressure in the short term as investors wait for signs of a true economic recovery. In the meantime, capital spending has come to a halt in the generation sector; all projects scheduled for 2003 and beyond are being canceled; and more utilities are returning to the integrated model of safety with a high current dividend. Mark J. Beckwith, Senior Vice President and Portfolio Manager Wellington Management Company, LLP February 11, 2002 7 FUND PROFILE As of January 31, 2002 for UTILITIES INCOME FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate to a broad market index. Key terms are defined on page 9. =============================================== PORTFOLIO CHARACTERISTICS Wilshire Fund 5000 - ---------------------------------------------- Number of Stocks 58 6,013 Median Market Cap $9.4B $33.1B Price/Earnings Ratio 16.2x 32.5x Price/Book Ratio 1.8x 3.3x Yield 2.6% 1.3% Return on Equity 14.4% 22.5% Earnings Growth Rate 5.2% 14.4% Foreign Holdings 9.6% 0.0% Turnover Rate 27% -- Expense Ratio 0.37% -- Cash Investments 5.6% -- =============================================== =========================================== TEN LARGEST HOLDINGS (% of total net assets) FPL Group, Inc. 4.7% Exelon Corp. 4.7 Pinnacle West Capital Corp. 4.6 Progress Energy, Inc. 4.5 BellSouth Corp. 3.6 Dominion Resources, Inc. 3.5 FirstEnergy Corp. 3.4 El Paso Corp. 3.4 KeySpan Corp. 3.3 Cinergy Corp. 3.1 - ------------------------------------------- Top Ten 38.8% =========================================== =========================================== MARKET CAP Medium STYLE Value =========================================== =============================================== VOLATILITY MEASURES Wilshire Fund 5000 - ---------------------------------------------- R-Squared 0.06 1.00 Beta 0.22 1.00 =============================================== =============================================== SECTOR DIVERSIFICATION (% of common stocks) Electrical 62.5% Energy 7.8 Gas Distribution 7.7 Telecommunications 15.8 Water 2.8 Other 3.4 =============================================== [Picture of a Computer] Visit our website www.vanguard.com for regularly updated fund information. 8 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of an overall market index. The index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the index rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the market in general, as measured by an overall market index. If a fund's total returns were precisely synchronized with an index's returns, its R-squared would be 1.00. If the fund's returns bore no relationship to the index's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. - -------------------------------------------------------------------------------- 9 - -------------------------------------------------------------------------------- PERFORMANCE SUMMARY As of January 31, 2002 for UTILITIES INCOME FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. ================================================================================ CUMULATIVE PERFORMANCE May 15, 1992-;January 31, 2002 [Mountain Chart]
Quarter Utilities Average Utilities S&P 500 S&P Utilities Wilshire Ended Income Fund Utility Fund Composite Index Index Index 5000 Index - ---------------------------------------------------------------------------------------------------------- 5/15/1992 10000 10000 10000 10000 10000 10000 199207 10700 10430 10762 10397 10853 10122 199210 10750 10392 10688 10340 10748 10148 199301 11451 10899 11219 10913 11291 10888 199304 12220 11543 11899 11022 12065 10905 199307 12952 12103 12638 11305 12902 11297 199310 13392 12427 13158 11885 13469 11952 199401 12949 12183 12670 12319 12824 12347 199404 12143 11490 11843 11609 11983 11634 199407 12112 11345 11950 11888 12079 11773 199410 11942 11246 11693 12344 11834 12252 199501 12371 11440 12421 12384 12643 12221 199504 12924 11772 12847 13636 13008 13366 199507 13687 12486 13627 14992 13817 14847 199510 14851 13220 14908 15608 15300 15407 199601 16016 14309 16178 17172 16772 16760 199604 15540 14036 15409 17756 15955 17665 199607 15462 13913 15239 17476 15490 17028 199610 16310 14730 16002 19369 16799 18767 199701 16899 15737 16912 21696 17155 20844 199704 16477 15326 16676 22219 16219 20781 199707 17981 17043 18055 26587 17846 25065 199710 18491 17353 18624 25588 18463 24695 199801 20814 19281 21370 27534 20405 26116 199804 22101 20807 22564 31344 22025 29769 199807 21872 20721 22666 31715 21592 29336 199810 23593 21152 24785 31216 23383 28348 199901 24960 22885 26455 36480 23295 33240 199904 25431 23464 26874 38183 24071 34866 199907 25697 24414 27511 38122 24407 34718 199910 25421 25027 27080 39228 23872 35626 200001 25656 26800 27317 40254 24626 37970 200004 26017 26728 28582 42051 25938 38984 200007 25296 27051 29011 41544 27355 38482 200010 28130 28451 35179 41618 32753 38514 200101 27473 27484 33768 39891 32082 36634 200104 28646 27708 35546 36596 34967 33475 200107 25015 25484 31284 35590 29720 32692 200110 22986 22089 26977 31253 25484 28666 200201 22746 21107 24995 33450 23317 31628 -----------------------------------------------------------------------------------------------------
================================================================================ Average Annual Total Returns Periods Ended January 31, 2002 ----------------------------- Final Value One Five Since of a $10,000 Year Years Inception* investment - -------------------------------------------------------------------------------- UTILITIES INCOME FUND -17.21% 6.12% 8.83% $22,746 Average Utility Fund** -23.20 6.05 7.99 21,107 Utilities Composite IndexY -26.10 8.09 9.87 24,955 S&P 500 Index -16.15 9.04 13.24 33,450 S&P Utilities Index -27.32 6.31 9.11 23,317 Wilshire 5000 Index -15.31 8.28 12.59 31,628 - -------------------------------------------------------------------------------- =============================================================== TOTAL INVESTMENT RETURNS (%) May 15, 1992-January 31, 2002 - --------------------------------------------------------------- Utilities Fiscal Year Total Return Composite Index* - --------------------------------------------------------------- 1993 14.5% 12.2% 1994 13.1 12.9 1995 -4.5 -2 1996 29.5 30.2 1997 5.5 4.5 1998 23.2 26.4 1999 19.9 23.8 2000 2.8 3.3 2001 7.1 23.6 2002 -17.2 -26.1 =============================================================== ================================================================================ Average Annual Total Returns for periods ended December 31, 2001 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal year. Securities and Exchange Commission rules require that we provide this information. ================================================================================ Since Inception* One Five ------------------------ Inception Date Year Years Capital Income Total - -------------------------------------------------------------------------------- Utilities Income Fund 5/15/1992 -19.45% 7.19% 4.89% 4.42% 9.31% - -------------------------------------------------------------------------------- * May 15, 1992. **Derived from data provided by Lipper Inc. Y80% S&P Utilities Index, 20% Lehman Utility Bond Index through June 30, 1996; 40% S&P Utilities Index, 40% S&P Telephone Index, 20% Lehman Utility Bond Index through April 30, 1999; 63.75% S&P Utilities Index, 21.25% S&P Telephone Index, 15% Lehman Utility Bond Index through March 31, 2000; 75% S&P Utilities Index, 25% S&P Telephone Index through December 31, 2001; 75% S&P Utilities Index, 25% S&P Integrated Telecommunication Services Index thereafter. See Financial Highlights table on page 16 for dividend and capital gains information. 10 YOUR FUND'S AFTER-TAX RETURNS This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund's distributions, and (2) assuming that an investor paid taxes on the fund's distributions and sold all shares at the end of each period. Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. (In the example that assumes all fund shares were sold, a negative pre-tax total return translates into a higher after-tax return. This is because the calculation assumes that the investor received a tax deduction for the loss incurred on the sale.) Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes. Finally, keep in mind that a fund's performance--whether before or after taxes--does not indicate how it will perform in the future. ================================================================================ AVERAGE ANNUAL TOTAL RETURNS Periods Ended January 31, 2002 One Five Since Year Years Inception* -------------------------------------------- Utilities Income Fund Returns Before Taxes -17.21% 6.12% 8.83% Returns After Taxes on Distributions -18.64 3.56 6.37 Returns After Taxes on Distributions and Sale of Fund Shares -9.87 4.25 6.34 *May 15, 1992. - ------------------------------------------------------------------------------- 11 FINANCIAL STATEMENTS January 31, 2002 STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. UTILITIES INCOME FUND Market Value* Shares (000) - -------------------------------------------------------------------------------- COMMON STOCKS (94.4%) - -------------------------------------------------------------------------------- Electrical (59.0%) FPL Group, Inc. 600,000 32,166 Exelon Corp. 650,000 32,006 Pinnacle West Capital Corp. 794,300 31,661 Progress Energy, Inc. 702,900 30,717 Dominion Resources, Inc. 400,000 23,548 FirstEnergy Corp. 625,000 23,250 Cinergy Corp. 650,000 20,995 DPL Inc. 891,693 20,741 Duke Energy Corp. 554,440 19,333 Northeast Utilities 1,000,000 18,110 TXU Corp. 275,000 13,398 Endesa SA ADR 899,800 13,137 CMS Energy Corp. 500,000 11,415 PowerGen PLC ADR 254,500 10,966 CH Energy Group, Inc. 216,300 10,155 Southern Co. 350,000 8,627 Constellation Energy Group, Inc. 300,000 8,460 Energy East Corp. 400,000 7,880 Alliant Energy Corp. 250,000 7,452 Black Hills Corp. 253,000 7,302 Sierra Pacific Resources 425,000 6,796 Allete, Inc. 230,000 6,132 Allegheny Energy, Inc. 186,200 6,128 NiSource, Inc. 281,562 5,856 PNM Resources Inc. 200,000 5,402 E.On AG ADR 100,000 5,120 E.On AG 100,000 5,116 DQE Inc. 256,830 4,967 * International Power PLC ADR 60,000 1,743 Innogy Holdings PLC ADR 60,000 1,686 DTE Energy Co. 36,211 1,485 * NiSource Inc. SAILS 145,007 283 --------- 402,033 --------- Energy (7.3%) El Paso Corp. 603,650 22,909 Dynegy, Inc. Class A 540,000 12,879 * Reliant Resources, Inc. 500,000 7,025 * Calpine Corp. 400,000 4,480 Westcoast Energy Inc. 100,000 2,627 --------- 49,920 --------- Gas Distribution (7.2%) KeySpan Corp. 700,000 22,652 National Fuel Gas Co. 600,000 13,740 Sempra Energy 224,071 5,366 ONEOK, Inc. 290,800 5,016 Peoples Energy Corp. 75,000 2,752 --------- 49,526 --------- Telecommunications (15.0%) BellSouth Corp. 605,200 24,208 Verizon Communications 391,000 18,123 ALLTEL Corp. 205,000 11,373 Sprint Corp. 584,200 10,340 Vodafone Group PLC ADR 475,000 10,307 SBC Communications Inc. 267,200 10,007 12 Market Value* Shares (000) - -------------------------------------------------------------------------------- COMMON STOCKS (94.4%) - -------------------------------------------------------------------------------- National Grid Group PLC 750,000 4,759 Telecom Corp. of New Zealand Ltd. ADR 250,800 4,625 TDC A/S ADR 275,000 4,496 BCE, Inc. 80,000 1,757 TELUS Corp. 100,912 1,460 TELUS Corp. (Non-voting) 33,637 454 --------- 101,909 --------- Water (2.6%) Suez SA 625,000 17,757 Other (3.3%) MDU Resources Group, Inc. 300,000 8,394 UtiliCorp United, Inc. 285,750 6,632 Vectren Corp. 308,600 7,360 --------- 22,386 --------- - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $606,547) 643,531 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Face Amount (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (4.9%) - -------------------------------------------------------------------------------- Repurchase Agreements Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.91%, 2/1/2002 $20,146 20,146 1.91%, 2/1/2002--Note G 13,300 13,300 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $33,446) 33,446 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (99.3%) (Cost $639,993) 676,977 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (0.7%) - -------------------------------------------------------------------------------- Other Assets--Note C 20,858 Liabilities--Note G (16,439) --------- 4,419 - -------------------------------------------------------------------------------- NET ASSETS (100%) - -------------------------------------------------------------------------------- Applicable to 59,428,362 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $681,396 ================================================================================ NET ASSET VALUE PER SHARE $11.47 ================================================================================ *See Note A in Notes to Financial Statements. * Non-income-producing security. ADR--American Depositary Receipt. SAILS--Stock Appreciated Income Linked Securities. - -------------------------------------------------------------------------------- Amount Per (000) Share - -------------------------------------------------------------------------------- AT JANUARY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- Paid-in Capital $ 736,763 $12.40 Undistributed Net Investment Income 1,404 .02 Accumulated Net Realized Losses--Note E (93,755) (1.57) Unrealized Appreciation--Note F 36,984 .62 - -------------------------------------------------------------------------------- NET ASSETS $681,396 $11.47 ================================================================================ 13 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. ================================================================================ UTILITIES INCOME FUND Year Ended January 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends $ 24,192 Interest 745 Security Lending 95 - -------------------------------------------------------------------------------- Total Income 25,032 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 456 The Vanguard Group--Note C Management and Administrative 2,274 Marketing and Distribution 95 Custodian Fees 23 Auditing Fees 13 Shareholders' Reports 37 Trustees' Fees and Expenses 1 - -------------------------------------------------------------------------------- Total Expenses 2,899 Expenses Paid Indirectly--Note D (373) - -------------------------------------------------------------------------------- Net Expenses 2,526 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 22,506 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) ON INVESTMENT SECURITIES SOLD (93,439) - ------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES (76,54) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $(147,457) ================================================================================ 14 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.
================================================================================ UTILITIES INCOME FUND Year Ended January 31, -------------------------------- 2002 2001 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 22,506 $ 24,015 Realized Net Gain (Loss) (93,439) 48,325 Change in Unrealized Appreciation (Depreciation) (76,524) (15,386) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (147,457) 56,954 - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (22,165) (30,622) Realized Capital Gain* (24,496) (41,786) - -------------------------------------------------------------------------------- Total Distributions (46,661) (72,408) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 100,154 166,523 Issued in Lieu of Cash Distributions 39,598 61,722 Redeemed (152,083) (179,219) - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions (12,331) 49,026 - -------------------------------------------------------------------------------- Total Increase (Decrease) (206,449) 33,572 - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 887,845 854,273 - -------------------------------------------------------------------------------- End of Period $681,396 $887,845 ================================================================================ 1Shares Issued (Redeemed) Issued 7,738 11,023 Issued in Lieu of Cash Distributions 3,080 4,141 Redeemed (11,737) (12,019) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Shares Outstanding (919) 3,145 ================================================================================ *Fiscal 2002 and 2001 include short-term gain distributions of $0 and $3,805,000, respectively. Short-term gain distributions are treated as ordinary income for tax purposes.
15 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
- ------------------------------------------------------------------------------------------------------ UTILITIES INCOME FUND Year Ended January 31, ---------------------------------------------- For a Share Outstanding Throughout Each Period 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $14.71 $14.93 $16.27 $14.97 $12.93 - ------------------------------------------------------------------------------------------------------ INVESTMENT OPERATIONS Net Investment Income .37 .42 .49 .55 .58 Net Realized and Unrealized Gain (Loss) on Investments (2.83) .62 (.12) 2.35 2.32 - ------------------------------------------------------------------------------------------------------ Total from Investment Operations (2.46) 1.04 .37 2.90 2.90 - ------------------------------------------------------------------------------------------------------ DISTRIBUTIONS Dividends from Net Investment Income (.37) (.53) (.51) (.59) (.60) Distributions from Realized Capital Gains (.41) (.73) (1.20) (1.01) (.26) - ------------------------------------------------------------------------------------------------------ Total Distributions (.78) (1.26) (1.71) (1.60) (.86) - ------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF PERIOD $11.47 $14.71 $14.93 $16.27 $14.97 ====================================================================================================== TOTAL RETURN -17.21% 7.08% 2.79% 19.92% 23.17% ====================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $681 $888 $854 $952 $699 Ratio of Total Expenses to Average Net Assets 0.37% 0.37% 0.40% 0.38% 0.44% Ratio of Net Investment Income to Average Net Assets 2.85% 2.76% 3.13% 3.51% 4.30% Portfolio Turnover Rate 27% 48% 47% 55% 41% ======================================================================================================
16 NOTES TO FINANCIAL STATEMENTS Vanguard Utilities Income Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. Security Valuation: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments 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 January 31, 2002, the advisory fee represented an effective annual rate of 0.06% 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 January 31, 2002, the fund had contributed capital of $130,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.13% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment adviser to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the year ended 17 January 31, 2002, directed brokerage and custodian fee offset arrangements reduced expenses by $371,000 and $2,000, respectively. The total expense reduction represented an effective annual rate of 0.05% of the fund's average net assets. E. During the year ended January 31, 2002, the fund purchased $204,865,000 of investment securities and sold $253,430,000 of investment securities other than temporary cash investments. At January 31, 2002, the fund had available realized losses of $93,440,000 to offset future net capital gains of $70,259,000 through January 31, 2010, and $23,181,000 through January 31, 2011. F. At January 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $36,984,000, consisting of unrealized gains of $90,963,000 on securities that had risen in value since their purchase and $53,979,000 in unrealized losses on securities that had fallen in value since their purchase. G. The market value of securities on loan to broker/dealers at January 31, 2002, was $12,985,000, for which the fund held cash collateral of $13,300,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Trustees of Vanguard Utilities Income 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 Utilities Income Fund (the "Fund") at January 31, 2002, 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 January 31, 2002 by correspondence with the custodian, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania March 6, 2002 ================================================================================ SPECIAL 2002 TAX INFORMATION (unaudited) for VANGUARD UTILITIES INCOME FUND This information for the fiscal year ended January 31, 2002, is included pursuant to provisions of the Internal Revenue Code. The fund distributed $24,643,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year, all of which is designated as a 20% rate gain distribution. For corporate shareholders, 93.9% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. - -------------------------------------------------------------------------------- 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 a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides ser-vices to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the
================================================================================================================ Name Position(s) Held with Fund (Date of Birth) (Number of Vanguard Funds Trustee/Officer Since Overseen by Trustee) Principal Occupation(s) During the Past Five Years - ------------------------------------------------------------------------------------------------------------ JOHN J. BRENNAN* Chairman of the Board, Chairman of the Board, Chief Executive Officer, and (July 29, 1954) Chief Executive Officer, Director/Trustee of The Vanguard Group, Inc., and of May 1987 and Trustee each of the investment companies served by (106) The Vanguard Group. - ------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Adviser (October 23, 1937) (106) to Greenwich Associates (international business-strategy consulting); January 2001 Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. - ------------------------------------------------------------------------------------------------------------ RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice (December 23, 1945) (84) Chairman (January-;September 1999), and Vice President (prior to December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of Technitrol, Inc.(electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. - ------------------------------------------------------------------------------------------------------------ JOANN HEFFERNAN HEISEN Trustee Vice President, Chief Information Officer, and Member of the Executive (January 25, 1950) (106) Committee of Johnson & Johnson (pharmaceuticals/consumer products); July 1998 Director of the Medical Center at Princeton and Women's Research and Education Institute. - ------------------------------------------------------------------------------------------------------------ BURTON G. MALKIEL Trustee Chemical Bank Chairman's Professor of Economics, Princeton (August 28, 1932) (104) University; Director of Prudential Insurance Co. of America, BKF Capital May 1977 (investment management), The Jeffrey Co. (a holding company), and NeuVis, Inc.(a software company.) - ------------------------------------------------------------------------------------------------------------ ALFRED M. RANKIN, JR. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO (October 8, 1941) (106) Industries, Inc. (forklift trucks/housewares/lignite); Director of Goodrich January 1993 Corporation (industrial products/aircraft systems and services); Director of the Standard Products Company (a supplier for the automotive industry) until 1998 - ------------------------------------------------------------------------------------------------------------ J. LAWRENCE WILSON Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co. (March 2, 1936) (106) (chemicals); Director of Cummins Inc. (diesel engines), The Mead April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - ------------------------------------------------------------------------------------------------------------
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. Each trustee serves a fund until its termination; or until the trustee's retirement, resignation, or death; or otherwise as specified in the fund's organizational documents. Any trustee may be removed at a shareholders' meeting by a vote representing two-thirds of the net asset value of all shares of the fund together with shares of other Vanguard funds organized within the same trust. The table on these two pages shows information for each trustee and executive officer of the fund. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.
======================================================================================================================== NAME POSITION(S) HELD WITH FUND (DATE OF BIRTH) (NUMBER OF VANGUARD FUNDS TRUSTEE/OFFICER SINCE OVERSEEN BY TRUSTEE) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS - ----------------------------------------------------------------------------------------------------------------------- EXECUTIVE OFFICERS* R. GREGORY BARTON Secretary Managing Director and General Counsel of The Vanguard Group, Inc. (April 25, 1951) (106) (since September 1997); Secretary of The Vanguard Group, and of June 2001 each of the investment companies served by The Vanguard Group; Principal of The Vanguard Group (prior to September 1997). - -------------------------------------------------------------------------------------------------------------------- THOMAS J. HIGGINS Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the (May 21, 1957) (106) investment companies served by The Vanguard Group. July 1998 - -------------------------------------------------------------------------------------------------------------------- *Officers of the funds are "interested persons" as defined in the Investment Company Act of 1940. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-;1996. - --------------------------------------------------------------------------------------------------------------------
Vanguard, The Vanguard Group, Vanguard.com, and the ship logo are trademarks of The Vanguard Group, Inc. Standard & Poor's(R), S&P(R), S&P 500(R), and Standard & Poor's 500 are trademarks of The McGraw-Hill Companies, Inc. All other marks are the property of their respective owners. [SHIP] [THE VANGUARD GROUP (R)LOGO] Post Office Box 2600 Valley Forge, PA 19482-2600 ABOUT OUR COVER Our cover photograph was taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photograph is copyrighted by Mr. Kahn. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the fund or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. FUND INFORMATION 1-800-662-7447 TEXT TELEPHONE 1-800-952-3335 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR6 SERVICES 1-800-523-1036 WORLD WIDE WEB www.vanguard.com (C)2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q570 032002 -----END PRIVACY-ENHANCED MESSAGE-----