If your server is an Apache web server, choose Virtual. (This is the default choice in Dreamweaver.) In Apache, Virtual works in all cases, while File works only in some cases.
If your server is a Microsoft Internet Information Server (IIS), find a new hosting company, (just kidding) choose File. (Virtual works with IIS only in certain specific circumstances.) Unfortunately, IIS won’t allow you to include a file in a folder above the current folder in the folder hierarchy, unless special software has been installed on the server. If you need to include a file from a folder higher in the folder hierarchy on an IIS server, ask your system administrator if the necessary software is installed. Blah blah blah headache headache headache.
For other kinds of servers, or if you don’t know what kind of server you’re using, ask your system administrator which option to use.
G