Published: September 29, 2009

A year ago the sky was falling.

At least, that's what some people thought.

When pandemonium was at its height in September of last year, Warren Buffett encouraged investors to buy U.S. stocks in an op-ed for The New York Times. Berkshire Hathaway (NYSE: BRK-A), Buffett's holding company, arranged multibillion-dollar deals with companies in need of financing during the credit crisis.

Many wondered if the world's most successful investor had lost his edge.

Looking back, it's clear that the herd was wrong and Buffett was right.

Again.

He put Berkshire's substantial cash hoard to work, investing in debt issued by Goldman Sachs (NYSE: GS), General Electric (NYSE: GE), the insurance company Swiss Re, Wrigley and Vulcan Materials (NYSE: VMC), Harley Davidson (NYSE: HOG) and Tiffany & Co. (NYSE: TIF).

Buffett lent $5 billion to Goldman and another $3 billion with GE by buying special preferred stock with a 10% perpetual dividend.

Preferred shares act like bonds. They are senior to common stock, which means dividend payments are guaranteed before the common shareholder. Like common stock, they are traded on exchanges and can appreciate in price, but with less volatility.

The Goldman and GE preferred stock deals included another feature: Warrants.

Warrants give the holder the right to purchase stock at a specified price within a certain period. Experienced investors will see a parallel to a call option.

The Goldman deal allows Berkshire to buy 43.5 million shares of Goldman common stock at $115 a share. This is a +60% gain -- $3 billion from Goldman's recent $184 price. The GE deal allows Berkshire to buy 135 million shares of common stock at $22.25 a share. GE shares are at about $17, but the warrants don't expire for another four years, and it's safe to assume the shares will be well above $22 by then.

So Buffett gets $800 million a year in preferred dividends for as long as he wants and is already $3 billion in the black on his Goldman warrants alone.

In total, the fixed-income deals Buffett inked during the worst days of the downturn will generate $1.8 billion a year for Berkshire.

Not bad for a couple months work.

Generating safe, secure income from preferred stocks is smart, but adding an extra element of safety by buying funds that own a basket of preferred stocks is even smarter.

Not everyone can make sweetheart deals like Warren Buffett, but individual investors can come close, if on a somewhat smaller scale.

These funds are worth considering:

The list includes closed-end funds trading at discounts in the table above. A closed-end fund is a publicly traded mutual fund that issues a fixed number of shares on the market. These funds sometimes tend to trade at discounts to their Net Asset Value (NAV), or the value of their assets.

These discounts offer a distinct advantage over holding individual preferred stocks. Not only do investors own a basket of safe, income-producing securities -- they can buy them for less than what other investors are paying when they buy the stocks individually.

Investors should pay attention to these funds because I think we may be headed for a pullback soon. A rally of more than +50% in the S&P 500 Index since its March lows just isn't likely to continue for long. The index is valued at slightly less than 20 times earnings -- the most expensive stocks have been in more than five years.

If a pullback happens, investors will pile into these securities seeking safety. The discounts will narrow, and the yields will shrink. Preferreds have senior status to common stock, so even if a company goes bankrupt, preferred holders still get paid after bond holders -- and it's always safer to hold many preferreds rather than one. Not only that, but the yields add to the allure of safety.

If you really want to get a Buffett-like sweetheart deal, wait to see if the pullback turns into a panic. Investors may make the same mistake twice and exit closed-end funds, leaving them trading at steep discounts to their NAVs and with sky-high yields.

Nathan Slaughter, editor of The ETF Authority, alerted subscribers to this opportunity last September. He found 636 out of 654 funds that were trading at discounts. Once investors came to their senses, they flooded back into closed-end funds. The discounts narrowed in a matter of days and share prices jumped as much as +40%. A panic selloff might not be as severe this time around, but the opportunity will be rare indeed.

It's happened before. It could happen again.

 -- Brad Briggs
Staff Writer
StreetAuthority

P.S. Nathan's favorite preferred stock investment has trounced the market so far this year. It's already up +64% and currently pays an ultra-reliable 8.3% yield. Visit this link to see how you can profit.