T. Rowe Price Spectrum Income Fund NCSR Certified annual shareholder report (management investment company)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES

Investment Company Act File Number: 811-4998

T. Rowe Price Spectrum Fund, Inc.

(Exact name of registrant as specified in charter)

100 East Pratt Street, Baltimore, MD 21202

(Address of principal executive offices)

David Oestreicher

100 East Pratt Street, Baltimore, MD 21202

(Name and address of agent for service)

Registrant’s telephone number, including area code: (410) 345-2000

Date of fiscal year end: December 31

Date of reporting period: December 31, 2011

Item 1. Report to Shareholders

Spectrum Funds

December 31, 2011

The views and opinions in this report were current as of December 31, 2011. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the fund’s future investment intent. The report is certified under the Sarbanes-Oxley Act, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects.

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Manager’s Letter

Fellow Shareholders

U.S. stocks rallied in the first four months of 2011 but retraced most of their gains by year-end as concerns about Europe’s sovereign debt crisis overshadowed signs of improvement in the U.S. economy. Worries about European policymakers’ inability to contain the eurozone’s financial crisis spurred investors to retreat from stocks in favor of more conservative assets like U.S. Treasuries, pushing much of the Treasury yield curve down to historic lows. Outside the U.S., European markets fell sharply amid slowing growth, the implementation of fiscal austerity measures, and waning confidence in policymakers’ ability to fix the region’s debt problems. Emerging markets stocks lagged their developed peers as several countries tightened monetary policy to curb inflation and the turmoil in Europe led investors to shed riskier assets.

MARKET ENVIRONMENT

U.S. stocks rallied in the first four months of 2011, as encouraging economic data overcame political unrest in the Middle East and North Africa, an ensuing spike in oil prices, and a devastating earthquake and tsunami in Japan. However, a string of mixed reports starting in the spring raised doubts about the strength of the U.S. recovery, while weakening growth in emerging and developed overseas markets raised talk about another global downturn after the 2008 crisis. Rising anxiety over Europe’s inability to stem its debt crisis led investors to seek refuge in the relative safety of U.S. government debt, causing the price of Treasuries to soar across the board. Partisan U.S. politics also drained investor confidence, as a divided Congress and President Barack Obama wrangled over the ballooning deficit and fiscal policy. Lawmakers engaged in a strident debate over raising the federal debt ceiling that took the U.S. to the brink of default, which resulted in Standard & Poor’s stripping the U.S. of its AAA credit rating in August. Financial markets’ volatility soared starting in the late summer, and the S&P 500 fell to a year low in early October. Despite the political turmoil, a string of better-than-expected economic data in the fourth quarter showed that the U.S. recovery was picking up. The jobless rate declined to 8.5% in December, its lowest level in nearly three years, after hovering at roughly 9% for most of 2011. Still, high unemployment, the depressed housing market, and Europe’s long-running debt crisis threatened to undermine the recovery. Most sectors within the S&P 500 advanced for the year, but the financials sector sank roughly 17% amid worries about regulatory changes, sluggish domestic growth, and exposure to troubled European banks.

Overseas developed stock markets underperformed U.S. stocks, partly because the dollar strengthened against other currencies. European stock markets tumbled amid contracting growth across the eurozone and fallout from the debt crisis, while developed Asian markets including Japan also fell. Emerging markets stocks fared even worse than developed markets as key countries like Brazil, India, and China tightened monetary policy to curb inflation, although some reversed course and loosened policy to shore up growth in the year’s second half. All the major emerging markets regions posted double-digit declines, led by emerging Europe.

U.S. bonds produced strong returns over the last year—largely due to Treasuries—as weakening global growth and the European debt crisis spurred demand for less risky investments. In September, the Federal Reserve announced it would move $400 billion of its short-term Treasury holdings into longer-term issues in an effort to drive down long-term interest rates, a move that further supported the Treasury market. High yield bonds trailed investment-grade issues as risk aversion rose and credit spreads widened in the year’s second half, offsetting gains from earlier in the year. Outside the U.S., local currency government bonds in developed markets rose overall, though a stronger dollar limited gains. European bond markets were restrained by sharply rising yields in several peripheral countries as leaders struggled to contain the debt crisis. Dollar-denominated government bonds in emerging markets outperformed government bonds in developed markets—a testament to their lower debt levels and stronger growth outlook compared with the developed world.

SPECTRUM GROWTH FUND

The Spectrum Growth Fund returned -3.60% for the 12 months ended December 31, 2011, trailing both the Russell 3000 Index and the Lipper Multi-Cap Core Funds Index. The fund’s allocation to international stocks hurt performance as non-U.S. stocks overall lagged the Russell 3000 Index, which represents the broad U.S. equity market. Each of the fund’s underlying international funds—International Stock Fund, International Growth & Income Fund, and the Emerging Markets Stock Fund—posted negative returns for the year. Underperformance in underlying domestic equity funds, including the Growth Stock Fund, Value Fund, Equity Income Fund, and Blue Chip Growth Fund, further detracted from relative returns. However, the portfolio benefited from strong stock selection in the Small-Cap Value and the New Horizons Funds. Our underweight to small- and mid-cap stocks also boosted relative results as small- and mid-cap stocks underperformed their large-cap counterparts.

The Spectrum Growth Fund invests in a range of underlying funds that focus on domestic stocks across the capitalization scale, international stocks in developed and emerging markets, and growth and value stocks. We are neutral between U.S. and non-U.S. stock markets because we think that a slowdown in developed markets including Europe will offset stronger growth in emerging markets. We increased our overweight to emerging markets stocks, which we believe are more attractively valued and may benefit from stronger economic growth than developed markets stocks over the next several years. Growth in China, Brazil, and other key emerging markets has cooled in response to monetary tightening in recent months. However, emerging markets generally carry far less debt than developed markets, and many developing countries have implemented conservative fiscal policies that make them better equipped to withstand a global crisis than in previous years. For valuation reasons, we are underweight small-cap stocks in favor of large-caps and increased our overweight to growth stocks over value.

SPECTRUM INCOME FUND

The Spectrum Income Fund returned 4.16% for the 12 months ended December 31, 2011, trailing both the Barclays Capital U.S. Aggregate Bond Index and the Lipper General Bond Funds Average. The fund posted a positive return, but its allocations to dividend-paying stocks, high yield bonds, and non-U.S. bonds hurt performance against the Barclays index, which represents the broad U.S. investment-grade bond market. Additionally, our holdings in the High Yield Fund and Emerging Markets Bond Fund, both of which lagged their respective benchmarks, weighed on returns. An underweight to Treasuries, which benefited from their safe-haven status as risk sentiment deteriorated over the year, further detracted from performance.

Although our allocations to high yield bonds, non-U.S. bonds, and dividend-paying stocks hurt performance last year, the inclusion of these diversifying segments are a hallmark of the Spectrum Income Fund’s design and have contributed to outperformance against the Barclays index since the fund’s 1990 inception and over the past 10 years, as seen in the Growth of $10,000 chart on page 13. We continue to favor high yield over investment-grade bonds given their attractive yields. We don’t expect a recession in the U.S. but rather a low-growth environment, which should be supportive for the high yield sector as many issuers have taken advantage of low interest rates to refinance debt and extend maturities. We increased our overweight to emerging market bonds, given the stronger fiscal position of many emerging market sovereign issuers compared with major developed countries that are grappling with high debt and low growth.

SPECTRUM INTERNATIONAL FUND

The Spectrum International Fund returned -11.61% for the 12 months ended December 31, 2011. Despite the fund’s negative return for the year, it outperformed its benchmark, the MSCI All Country World Index ex-U.S.A., as well as the Lipper International Multi-Cap Growth Funds Average. The fund’s relatively large position in the UK, one of Europe’s better-performing countries in 2011, lifted relative returns, as did favorable stock selection in Japan and Germany. Conversely, our allocation to India weighed on performance. India has been struggling with soaring inflation, slowing domestic growth, corruption scandals, and a falling currency—all of which have deterred foreign investment and hurt corporate earnings.

The fund’s allocations stayed roughly unchanged over the reporting period, with the International Stock Fund, International Growth & Income Fund, and European Stock Fund continuing to account for the top three funds. Europe remains the portfolio’s largest regional exposure, followed by the Pacific ex-Japan. As we stated before, we increased our overweight to emerging markets stocks due to their stronger long-term growth potential over developed markets. While growth in China, India, and Brazil has cooled in recent months due to tighter monetary policy and slowing demand from Europe, emerging markets are unfettered by the deep-seated debt and fiscal problems facing the U.S. and Europe and have greater flexibility to respond to financial challenges that may arise. Rapid growth of the middle class, improving living standards, and rising consumption are hallmarks of emerging markets, and we believe these factors will continue to drive strong growth over time.

OUTLOOK

Global financial markets face numerous near-term risks that have intensified since the summer. These headwinds include the European debt crisis, a weak global growth outlook, and a loss of faith in policymakers to fix deep-rooted economic problems. Recent events have made it clear that the direction of global financial markets is closely tied to government actions in the U.S. and Europe, making outcomes hard to predict and risk management challenging. Until policymakers can decisively resolve Europe’s debt problems, we believe that risk aversion will remain high and financial markets volatile.

We expect U.S. interest rates to rise over the long term as the economy continues its recovery. In the near term, we believe Treasury yields and credit spreads will be range-bound and volatility will remain high. Unfortunately, much of the current risk aversion stems from issues that have no quick or easy solution. For more than two years, fiscal policymakers in the U.S. and Europe have been struggling without success to address the twin challenges of reducing debt and increasing growth. This near-term geopolitical uncertainty underscores the value of the Spectrum Funds’ diversified holdings and investment approach. More than ever, we believe that a high level of diversification, rigorous fundamental research, and thoughtful security selection can help mitigate risks while still providing opportunity to profit from market volatility. Good performance will rely increasingly on comprehensive research into individual securities, and overseas markets will continue to offer some of the best combinations of risk and return, in our view.

Respectfully submitted,

Charles M. Shriver
Portfolio manager, Spectrum Income and Spectrum Growth Funds

Chris Alderson
Portfolio manager, Spectrum International Fund

January 23, 2012

Spectrum Income Fund

GLOSSARY

Barclays Capital U.S. Aggregate Index: An unmanaged index that tracks investment-grade corporate and government bonds.

J.P. Morgan Non-U.S. Dollar Government Bond Index: An unmanaged index that tracks the performance of major non-U.S. bond markets.

Lipper indexes: Fund benchmarks that consist of a small number of the largest mutual funds in a particular category as tracked by Lipper Inc.

MSCI All Country World Index ex-U.S.A.: An index that measures equity market performance of developed and emerging countries, excluding the U.S.

MSCI EAFE Index: An unmanaged index that tracks the stocks of about 1,000 companies in Europe, Australasia, and the Far East (EAFE).

MSCI Emerging Markets Index: An unmanaged index that tracks stocks in 26 emerging market countries.

Russell 2000 Index: An unmanaged index that tracks the stocks of 2,000 small U.S. companies.

Russell 3000 Index: An index that tracks the performance of the 3,000 largest U.S. companies, representing approximately 98% of the investable U.S. equity market.

S&P 500 Index: An unmanaged index that tracks the stocks of 500 primarily large-cap U.S. companies.

Weighted average effective duration (years): A measure of a security’s price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

Weighted average maturity: A measure of a fund’s interest rate sensitivity. In general, the longer the average maturity, the greater the fund’s sensitivity to interest rate changes. The weighted average maturity may take into account interest rate readjustment dates for certain securities. Money funds must maintain a weighted average maturity of less than 60 days.

Performance and Expenses

Growth of $10,000

This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes.

Growth of $10,000

Fund Expense Example

As a mutual fund shareholder, you may incur two types of costs: (1) transaction costs, such as redemption fees or sales loads, and (2) ongoing costs, including management fees, distribution and service (12b-1) fees, and other fund expenses. The following example is intended to help you understand your ongoing costs (in dollars) of investing in the fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the most recent six-month period and held for the entire period.

Actual Expenses
The first line of the following table (“Actual”) provides information about actual account values and expenses based on the fund’s actual returns. You may use the information on this line, together with your account balance, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number on the first line under the heading “Expenses Paid During Period” to estimate the expenses you paid on your account during this period.

Hypothetical Example for Comparison Purposes
The information on the second line of the table (“Hypothetical”) is based on hypothetical account values and expenses derived from the fund’s actual expense ratio and an assumed 5% per year rate of return before expenses (not the fund’s actual return). You may compare the ongoing costs of investing in the fund with other funds by contrasting this 5% hypothetical example and the 5% hypothetical examples that appear in the shareholder reports of the other funds. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period.

Note: T. Rowe Price charges an annual account service fee of $20, generally for accounts with less than $10,000 ($1,000 for UGMA/UTMA). The fee is waived for any investor whose T. Rowe Price mutual fund accounts total $50,000 or more; accounts employing automatic investing; accounts electing to receive electronic delivery of account statements, transaction confirmations, prospectuses, and shareholder reports; accounts of an investor who is a T. Rowe Price Preferred Services, Personal Services, or Enhanced Personal Services client (enrollment in these programs generally requires T. Rowe Price assets of at least $100,000); and IRAs and other retirement plan accounts that utilize a prototype plan sponsored by T. Rowe Price (although a separate custodial or administrative fee may apply to such accounts). This fee is not included in the accompanying table. If you are subject to the fee, keep it in mind when you are estimating the ongoing expenses of investing in the fund and when comparing the expenses of this fund with other funds.

You should also be aware that the expenses shown in the table highlight only your ongoing costs and do not reflect any transaction costs, such as redemption fees or sales loads. Therefore, the second line of the table is useful in comparing ongoing costs only and will not help you determine the relative total costs of owning different funds. To the extent a fund charges transaction costs, however, the total cost of owning that fund is higher.