I was surfing today and saw this question which has been asked of me by hundreds of my Windows clients around the world. Here is my best suggestion.
Two internal HDD. One for backing up the system, My Documents (XP) and Owner Files (Vista and 7). Throughput speed is much faster with two internal HDD. You can buy a new one or format your old one(s). Use NTFS and make the drive Logical or Primary. In either case, it is independent of the C: Drive. Never install Programs to the second HDD. Simply use it for Backup and Storage. Partition it as much as you like, but keep all system and program installations on your C: Drive. You will never go wrong by creating a complete system image using any type of highly praised Disk Manager or Backup Software. (My choice is Paragon Hard Disk Manager 2010 - I go back to 2006 with this software).
I am a Freelance Computer Tutor/Troubleshooter since 2002. I know my stuff inside out. However. No expert has the perfect answer when using two HDD in a computer. I am explaining a very practical way to use two internal HDD.
I've read the other suggestions here and they are all very good. But I like to keep life simple with my computers. Two HDD, C: Drive (System and Programs Z: Drive (System and My Documents or Owner Files).
Very important documents, movies, music, etc, should be backed up on DVD or CD. These are the most durable and long lasting media.
Hope that helps...
Use Manage by right clicking on Computer or My Computer to assign Drive Letters and to shrink your HDD if you do not have special software.