Update 20180202: I didn't realise this was still coming up in search results, but it's been brought to my attention from a couple of sources that TrueCrypt seems to now be defunct and a lot of the Firefox add-ons now won't work with the most recent versions of Firefox. So please keep this in mind if you're reading this now.
For good results do levels 1 and 2. I highly recommend level 3. 4 is optional extra and 5 if you're extra paranoid. In a section after level 5 I also include some slight modifications to the installation guide for Ubuntu because I believe making the switch to Linux is really worthwhile if you don't need a program (or suite of programs) that doesn't have a Linux version. If you find any of "free", "secure" and "probably ethical" (I think) desirable in an operating system (all at once even!) hit up the Got Linux? section first and then come back to top. It's at the bottom because I was building up from pretty-easy-to-do to requires-a-bit-of-effort.
Note: most of the instructions are MacOSX Lion and Firefox-centric as that's what I use. Firefox is the same across all operating systems. The only difference is the location of their preferences panel; in OSX it's in the Application menu (it's right next to the Apple menu in the top left hand corner and will say "Firefox" when Firefox is in focus) and in Win7 and Ubuntu it's in Edit -> Preferences. Other browsers should have similar settings about the place but you're on your own there :)
Note 2: this is a GUIDE not an instruction set. You do not have to do everything laid out here exactly as stated. You can skip things or modify them to suit your requirements.
Note 3: the guide focuses on privacy and security, NOT anonymity. Privacy in this case means giving information to people you want to give it to and not having anyone else snoop in on it and use it for whatever they want. It may make your browser stand out a bit, which is only a concern if someone is targeting you specifically. The stuff outlined in here will help you avoid trackers and keep some control over where your data is going, but it will not magically make you safe and/or anonymous. You still need to be conscious of what you're doing and why, and you still need to monitor your kids while they're online.
Disclaimer: I'm a hack not an expert, and I'm using/plugging stuff I'm familiar with. You can do your own research. You do not have to trust me. Even if you do trust me, read up a little bit on some of this stuff anyway. Just don't bubble ;)
Update 0000F14x | 2013-05-23: made a collection called Fortifox with most of the extensions used in this guide.