Before I update my phone to a new android version, what should I backup? Do I just copy everything from my SD card to my computer?
That will only backup things on your sd card, and not apps, contacts etc. You can backup your contacts by hitting menu-export in the contacts app. SMS can be backed up with the app SMS Backup and Restore. Apps cannot be backed up unless you are rooted.


Leeeroy Jennnkinnns!
Take a look at MyBackup in the market. It backs up all your apps, settings, call logs, etc.

SD card won't be touched when you update the Android OS. But it's a good idea to back up the SD card periodically; and yes, you can just copy the contents of the SD card onto your hard drive. Later if you ever need to restore, just copy it all back.