The USB drives are quick and easy to use, and scarily cheap. 500Gb will set you back less than £100.
If you're happy with opening your case and plugging things in then the internal route is for you, and it is even cheaper than the USB option as you don't have the added cost of a case and power supply.
I run the 80Gb internal HDD on the lappy as a system drive, with very little other than programmes I use regularly on it. Then I store stuff on my 500GB external drive, backed up to a network drive on our main computer. I also have an 80GB passport drive that I use for portability as it runs entirely off USB power, so no need to carry a separate power supply. Most of that is filled with music, about 60Gb!
Important photo's I post to my Picasa online storage, one click uploading, as well as on my network drive.
Anything that is of any real importance is backed up in 3 different places. The external drive, the network drive and on a CDRW that I keep in a lockbox in the garage, separate from the house, though there's not much that warrants that.
You can go as simple or complicated as you like. I personally don't trust online backups for sensitive information, never quite sure how secure they are, but for pics and the like they're ok.