Microsoft regularly updates their software and operating systems, as do other product developers. However, there is a difference between an update and a service pack. In fact, there's more to the story with other updates including hotfixes, security updates, and critical updates.
First, updates are broadly released fixes for specific non-critical, non-security related problems and bugs. While the updates aren't critical, they do fix specific problems and annoyances and are worth installing, especially if you are experiencing periodic computer problems.
Hotfixes are specific, cumulative packages of product updates that address a specific issue or bug in a product. They are not necessarily widely distributed. For example, hotfixes may address issues a single customer, such as a computer hardware manufacturer, is experiencing in which case the related hotfix would be distributed to that manufacturer.
Like standard updates, security updates are broadly distributed. These updates correct product-specific, security vulnerabilities which are rated according to the severity of the underlying problem. These updates are either: low, moderate, important, or critical.
Critical updates are non-security related updates that are considered more important than standard updates. These aren't to be confused with security updates with a critical rating.
Service packs are released less frequently than updates and hotfixes. Instead, think of service packs as collections of previous updates, security updates, critical updates, and hotfixes released since the product's introduction. In addition to these cumulative repairs, service packs also tend to incorporate new features or design changes.
Once a service pack has been released, the operating system or related software is often referred to with the service pack edition following the original name. For example, Microsoft recently released Service Pack 3 for Windows XP. You'll hear references such as "requires Windows XP Service Pack 3" or "This computer is running Windows XP Service Pack 3." In this context, abbreviations such as SP1, SP2, and SP3 are also used.
Keeping your computer updated is important to protect your computer from security threats as well as repair known issues. You can set up automatic updates so that you don't have to worry about manually checking for updates. You can also specific what types of updates to apply. All of this is done through Automatic Updates (Windows XP) or Windows Update (Windows Vista). These tools are found in the Control Panel. In XP's Control Panel, look for Security Center > Automatic Updates. In Vista's Control Panel, go directly to Windows Update.
An updated computer is usually better protected than one left unpatched. However, updates and service packs have been known to cause a few headaches. Microsoft usually resolves these in time.