From James Marshall,
Your Guide to Word Processing.
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If you share a computer with someone else or you work in a multi-user environment where it is possible for others on your network to gain access to your hard drive, you may want to assign password protection to some of your documents containing sensitive information. As in other Office programs, Word allows you to assign password protection to your documents. To assign password protection, follow these easy steps:

1. Select Options on the Tools menu
2. Click the Security tab
3. Under the File encryption options for this document section enter a password in the box labeled Password to open:
4. The Advanced… button opens a dialog box that allows you to specify more options, such as whether you wish to protect the document properties.
5. Click OK
6. When asked, confirm the password by retyping it
7. Click OK to save your password

A few notes about password protection:

As with any password, the one you choose for your document should be easy for you to remember, but difficult for others to guess. Avoid commons ones like “password” or birthdates, pet names, astrological signs, etc. Letter-number combinations tend to work well.

Also, remember that file encryption is not failsafe. There are web services that will hack into your files for you (or anyone else): While this is comforting should you forget your password, it means that others may be able to access your encrypted files.