... and should you fix the interest rate?

ONE OF the most important decisions for anyone investing in this year's crop of Tessas is whether to choose one with a variable interest rate or one with a fixed rate.

Interest on a variable-rate Tessa moves up and down in line with the building society's or bank's other interest rates. A fixed rate pays a guaranteed rate of interest for a set period of time. Some Tessas will pay one fixed rate throughout their five-year life; others will guarantee savers rising interest rates by fixing rates for each of the five years at outset - say 5 per cent in year one, 6 per cent in year two,7 in year three, and so on. Tessas that start with fixed rates but change to variable rates are also available.

If you believe that interest rates will rise during the next five years, you will opt for a variable-rate product. But if you think rates will fall, you will choose a fixed-rate account.

Over the past five years, the few investors who put money into fixed- rate Tessas have fared much better than the vast majority who chose variable- rate accounts. Anyone who invested the maximum pounds 9,000 in Bristol & West's 13 per cent fixed-rate Tessa will have seen it grow to pounds 14,000-plus at maturity. This compares with an average return of less than pounds 12,000 from variable-rate Tessas. Even the top-performing variable-rate Tessa, from Kent Reliance Building Society, is set to pay its savers a maximum maturity value of only pounds 12,400.

But it was hard to believe five years ago that interest rates would reach today's low levels. When Tessas were first launched, building society and bank base rates were a staggering 15 per cent.

It is equally as difficult to predict what the next five years will hold in terms of interest rates. Gary Marsh, an economist at the Halifax Building Society, believes that the UK is entering a period of long-term interest- rate stability. He says: "I think interest rates will hover around the 6-8 per cent mark, or could fall further."

He thinks that even if a Labour government were elected, interest rates would remain around 6-8 per cent, although other commentators are not so sure . You may, for example, take a more cyclical view of interest rates. They are at their second lowest level for 20 years. The only way for them to move could be upwards.

A fixed-rate Tessa could suit your purposes, because you know exactly what you get at maturity. You may need a precise sum to pay school fees or pay off part of your mortgage.

Abbey National's fixed-rate Tessa has an interest rate of 7 per cent and offers some protection against possible interest-rate rises. If the base rates rise by more than 1 per cent in one year, you will get a 1 per cent bonus on maturity. This fixed-rate product is only available for those who are willing to reinvest the maximum pounds 9,000 from their maturing Tessa.

Barclays, on the other hand, is offering a fixed-rate product for those with at least pounds 7,500 to invest, paying 7.5 per cent.

Two of the highest variable rates currently on offer are from the Northern Rock and Cheltenham & Gloucester building societies, 8 per cent and 7.75 per cent respectively. Birmingham Midshires Building Society offers what it claims is an "election-beating" Tessa, which has a rate fixed at 6.75 per cent to December 1997. After that, the interest rate is variable. The idea is to protect savers from the possibility of interest rates falling in the run-up to the election, and then rising after it.

As well as offering the possibility of gambling on interest-rate movements, some of the new Tessas will allow you to take a bet on the future movements of the UK stock market. HSBC Asset Management, for instance, is offering a Tessa that guarantees to pay 5 per cent interest a year, plus a percentage of the average return of the FT-SE 100 index over the five-year period. The maximum amount of tax-free interest that could be earned by saving through this Tessa is 9.16 per cent a year.

This type of product is aimed at more sophisticated investors, and HSBC advises savers to obtain independent financial advice before taking the plunge.