Groups and categories may be confusing at first. This video explains the concepts in more detail.
A category is a collection of groups. An example would be a category of Location and groups within it would be Durban and Cape Town
A group can be a standalone group. It is not associated to any category. An example would be a volunteers group.
Finally a group could be a virtual group. This special group does not directly contain any contacts but draws it contacts from other groups. An example would be a Cape Town golfers virtual group, which has all contacts from the golf group in it as long as they are also in the Cape Town group.
Groups are used for reporting on as well as targeted messaging.
More on contact data: