A BIFoCAL document by Jeff Good
In principle, Microsoft Word can both read and write files with a range of formats. In practice, its default format is proprietary---very proprietary in fact. Compatability between versions of Word for documents in its default (.doc) format is far from perfect.
Even Microsoft's closest thing to an open standard, RTF, is problematic. While it is a form of text-based markup, and therefore can be read by any text editor, its markup conventions are determined by a Microsoft-imposed standard. So, there's no guarantee of cross-program compatibility in the long run.
Therefore, the short answer to this question is: badly.
Microsoft Word is acceptable as a narrow text editor. If you use it, you should use it only with text files. You might find some of the features that Word has to make it more useful than other text editors (macros, search and replace, etc.).
Microsoft Word is only good at creating one kind of document: Attractively formatted final-production documents. It is a WYSIWIG (what you see is what you get) editor, which makes it good for creating things to go on paper but makes it bad for storing structured data.
Most linguistic data, with the possible exception of running prose in a grammatical or theoretical description, is structured. Word is therefore bad for working with such data.
The basic structure of a Word document is very open. So, it is possible to create structured data with it. However, the structure has to be maintained manually, which means that it is very difficult to be consistent in entering data with it.
As mentioned above, Word is not good for dealing with structured data. Therefore, it is not good for annotation or markup.
Newer versions of Word support Unicode. Therefore, there is good support for special characters with it. In addition, Word offers a range of ways to access special characters not found on keyboards in a user-friendly way (the most prominent being the "Insert symbol" menu feature). This is probably the only area where Word is superior to other tools.
Warning: The Word version for the Mac (Word X) lags behind seriously in Unicode support compared to the Word versions for the PC. Improvements are promised to appear soon.
Word has versions for two of the most important plantforms for academic users: PC's and Macintoshes and it works offline. So, it should be usable in most field situations.
It does not have any special networking capabilities which means that it does not, on its own, lend itself to collaborative work. Documents changes can be tracked, but it is important that only one copy of a document be the main copy so that all changes are recorded and seen by all users.
Word is, therefore, not a good collaborative tool for anything but a very small, controlled group---and even then its utility is limited. It might be good for writing a grant proposal, or a joint paper, but not at all for a dictionary.
Word is only good at creating ``end-state'' resources, either printed materials or HTML documents. Neither of these sorts of documents encodes logical structure since they make use of visually-oriented formatting.
If you're ready to create a final, printed dictionary for distribution, Word might be all right. For anything else, it is largely inadequate. Critically, Word has no capabilities for taking a logically structured document and transforming it into a visually formatted one. You'll have to find some intermediate tool to do this---typically by converting a database to a text file or to RTF format.
Except for an extremely limited search and replace function, Word offers no analytical capabilites.
Unless you are trying to produce a small well-formatted document in a hurry, with only a limited amount of data and with a short lifespan (like a handout), Word should be avoided. Its primary legitimate use for linguistic resources is to assist in the creation of a final print/HTML document.