Using External HD as well as local drive for iTunes?

So, I just got my brand spanking new 160GB Classic today. I have an external HD I have never set up but am thinking now is the time so I can load all of the music there and sync the iPod accordingly (as well as have a back up if I need to reset the iPod - I dont relish the idea of redoing 1600+ CDs). But, I also want to be able to use my local drive for when I make CD mixes. Am I going to foul something up setting up this way? IE, can I have the HD be the destination while loading up for the iPod, and then just change my iTunes preferences for when I want to use the local drive?
First thing I did, thanks to the forum, was upload the firmware update. I am hoping to keep moving forward with minimum complication, though I am sure I will have more questions before I am done.
TIA!

I use my iPod classic auto-synching with an iTunes library split between my Macbook Pro and an external HDD, so perhaps I can help.
*First, you should know the limitations of this setup*: When using your computer without the external HDD attached, you will not be able to create new playlists in iTunes using songs that are located on the external drive. As soon as you click a song entry in iTunes, it will put an exclamation mark icon next to the song, and iTunes will refuse to let you do anything with it (such as putting in a playlist, or modifying any song metadata). Once you reattach the external drive, you'll be good to go, and can modify any song metadata or add those songs to new playlists.
The good news comes to use of the iPod. If you add songs to an On-The-Go playlist on your iPod, or change the rating of a song on the iPod, those changes will sync back to iTunes for the song file on your computer +*even if the the song is for a file located on the external HDD, and the external HDD is not currently attached.*+ Play counts will also synchronize back, and Smart Playlists affected by changes will update as well.
In short, from iTunes you can only modify song metadata or add those songs to fixed playlists if the file is currently accessible by iTunes (so the external HDD must be attached). However, if you create an On-The-Go playlist on the iPod using external HDD songs, that playlist will be created in iTunes the next time you synch. Also, song ratings and play counts altered during iPod playback will be updated in iTunes on the next sync even if the song file is on the external HDD, and the external HDD is not currently attached. I hope that makes sense.
*Setting up a split library:*
1. Make sure the files you want stored on the external hard drive aren't currently in your iTunes library. If the files are not yet moved over to the external drive, do that now.
2. Open up iTunes preferences, click on "Advanced," and under the "General" tab, make sure that "Copy Files to iTunes Music Folder" is not checked. Click the "OK" button to save the setting.
3. Time to add the songs on the external hard drive to your iTunes library. Choose File -> Add To Library... (or just press Command+O), navigate to the folder on your external hard drive where your music files are stored, select that folder, then click "Choose". Entries for the songs will appear in your iTunes library, but the song files themselves will remain on the external drive.
4. Keeping your external drive mounted, now is the time to add any songs to playlists that you'd like, or modify song metadata (fix spelling errors in artist names, etc.).
5. Once everything is to how you currently want it, mount your iPod to your computer and let it synchronize (NOTE: your external drive must be mounted during this first sync to your iPod in order to transfer the files from it.)
6. Once the iPod synchronization is complete, you can unmount your external drive. You can also re-enable the "Copy Files to iTunes Music Folder" preference setting at this time, if that's how you normally keep things (the files put on the external drive will not move over to your internal drive unless you use the "Consolidate Library" feature at some point in the future). Obviously, though, if you add files from an external HDD in the future - and want them to stay there - you'll need to temporarily disable this setting again.
At this point, clicking on any song file in iTunes which is stored on the external drive will generate the aforementioned exclamation point icon, but the icon will disappear the next time the external drive is attached and iTunes is launched. Also, any iPod synchronizations in the future will generate a warning in iTunes that the song file could not be found on your computer (if the external HDD isn't attached). However, the file will remain on your iPod, and the placeholder entry in iTunes will remain as well (even if you are using automatic synchronization). If you don't wish to see the "can't find the file warning," there's a box you can check on the warning dialog to hide it in the future (to bring them back, control-click your iPod in the iTunes sidebar, and choose "Reset Warnings" from the menu that appears).
So that's how it works. I've been using the split library system without a hitch for quite some time (with older iPods, and now my iPod classic). This way I'm able to keep massive video files and Apple Lossless files off the internal drive of my Macbook Pro, and yet I'm still able to keep those files on my IPod and do basic synchronization with the computer even when I'm away from the external hard drive. If I ever want to create new Playlists using those external HDD files, I either create On-The-Go playlists on the iPod, or just wait until I can have the external HDD attached to the computer.
It works well for me, and perhaps it might for you, too.

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