its always best to run updates, yes.
software (computer programs) sometimes have security holes in them. this is just like a bucket of water with a hole in the bottom: it leaks! but with a security hole in software, it means that your personal information can get out, or others can get in, and get access to your personal information.
when the company that writes the software finds out about a hole, they release a patch for it, that patches it up (just as with a bucket of water being fixed). this is also called an update, though an update can include several patches at once.
when there are enough updates, eventually microsoft releases a service pack, with all of this updates bundled into one download. XP currently is on service pack 2 (SP2).
so it's best to have the latest SP. but with SP2, lots of programs stopped working, for instance. one reason was that it turned on the windows firewall by default, that could block programs like outlook.
i would recommend running all possible updates, then seeing what works and what doesn't. ideally though, you run all updates on a fresh system, then install all your programs and things.