Letterspacing (also known as tracking) is the adjustment of the spacing between letters in a line or block of text. Whereas kerning affects only pairs of letters, letterspacing affects every letter.
Generally you should not add letterspacing to lowercase letters, but always add a little to all-caps text and small caps. In the samples below, you can see how the letterspacing makes the letters more distinct. This is particularly important at small sizes (e.g. the footer of a court filing).
Why use letterspacing for capital letterforms and not lowercase? Usually, capital letters appear at the beginning of a word or sentence, so they’re designed to fit next to lowercase letters. When you use capital letters together, that default spacing is too tight.
To set letterspacing:
In Word: go to the Font dialog box, select the Character Spacing tab, and on the line that says Spacing: Normal, enter the amount. Letterspacing in Word is measured in points. For all-caps text, use between 0.7 and 1 pt of letterspacing for every 12 pts of font size; for small caps, use 0.5 to 0.7 pts for every 12 pts.
In WP: go to the Format menu, select Typesetting, select Word / Letter Spacing and enter the amount under Letterspacing: Percent of optimal. Letterspacing in WP is measured as a percentage of normal. Use about 110-115% for caps, 105-110% for small caps.
Since you strongly recommend an actual small caps font (not squished by a word processor), would that font not already be properly designed and therfore not need letterspacing?
In the example above, I prefer the letterspaced HIP, but the non-letterspaced THIEF. HIP is tall enough to need it, but THIEF looks like it is already nicely proportioned.
You are correct that small caps fonts need less letterspacing than text set in all caps (as I indicate in the inset box above). However, the default spacing is usually still a little too tight for text use.
The samples above are a little misleading because they’re at large size. The need for letterspacing is more apparent at actual print sizes.