Final answer:
The term 'variable annuity' refers to an investment vehicle that may fluctuate based on the market performance of the insurer's separate account, which can involve diversified portfolios similar to mutual funds. The value of these annuities, like stock prices, is affected by changes in market expectations and the concept of diversification is vital for mitigation of investment risk.
Step-by-step explanation:
The variable annuity fluctuates based on the investment experience in the insurer's separate account. Essentially, a variable annuity is an investment vehicle that allows individuals to invest in diversified portfolios similar to mutual funds, with the potential to receive a stream of payments over time.
Since it is linked to various investment options, typically consisting of stocks and bonds, the value of a variable annuity can go up or down depending on market conditions, replicating the idea of private rates of return to the individual investor. Just like stock prices, the performance of these accounts and the returns they generate are influenced by changes in market expectations regarding future profits.
Investing in any single firm carries a significant risk which is why investors often diversify their portfolios, spreading their capital across a range of companies. By doing so, one can mitigate the risks associated with poor performance of any single investment. This concept is a foundational strategy in mutual funds which aggregate an assortment of stocks or bonds, wherein investors effectively become shareholders in a diverse pool of assets, and their returns are dictated by the fund's collective performance.