Here is some information I found in pursuing the same issue
Both the XP Resource guide and the product docs have
good info -- do lots of reading FIRST (there are many
trap doors you can drop through if you are not careful)

One of the most important things to do is

  ====>>>>>  BACK UP YOUR KEYS  <<<<<====

Many people have gotten bitten with having their files in
the EFS (Encrypted File System) on a different drive and
for whatever reason, (crash, virus etc) re-installed windows.
If you did not back up your keys, those files are probably
gone -- the SID etc is different if you do a clean install and
the new key for the same user will NOT work with the
files that were encrypted with the key from the previous
install.  You have been warned !!!!

In light of the recent theft of the Boeing information that hit
the news, more information on file encryption ...

http://www.iopus.com/guides/efs.htm
http://www.microsoft.com/technet/prodtechnol/winxppro/support/dataprot.mspx
http://ls.berkeley.edu/mail/micronet/2005/0301.html
http://www.microsoft.com/technet/community/columns/secmgmt/sm0205.mspx
http://support.microsoft.com/default.aspx?scid=kb;en-us;241201&sd=tech
http://support.microsoft.com/default.aspx?scid=kb;en-us;223316&sd=tech
http://www.microsoft.com/technet/prodtechnol/winxppro/deploy/cryptfs.mspx
http://www.microsoft.com/technet/prodtechnol/winxppro/maintain/sharefilesefs.mspx
http://support.microsoft.com/default.aspx?scid=kb;en-us;259732
http://support.microsoft.com/default.aspx?scid=kb;en-us;290260

Mike is correct in that using EFS to encrypt files or folders is one built
in solution though you can not use EFS to secure the whole system drive. I
also want to repeat the importance of backing up your EFS
certificate/private key to a password protected .pfx file on external media
for safe keeping. Also keep in mind that if you leave your EFS
certificate/private key on your computer that the EFS encryption is only as
strong as your password. If you use a pass phrase that includes upper case,
lower case, numeric, and special character such as those above the number
keys on the keyboard AND your pass phrase is at least 15 characters long
your password will be next to impossible to crack. Pass phrases should be
easy for you to remember and leave the spaces in the pass phrase. A pass
phrase such as "I always forget my 1 password!"  is an extremely strong
password.   --- Steve

Hi,

I would not have used the builtin encryption that comes with
Windows (EFS), to many things can go wrong with it.

For a free 3rd party solution:

TrueCrypt
http://www.truecrypt.org/

<quote>
Free open-source disk encryption for Windows XP/2000/2003

Main Features:
     * It can create a virtual encrypted disk within a file and mount it
       as a real disk.
     * It can encrypt an entire hard disk partition or a device, such as
       USB memory stick, floppy disk, etc.

</quote>

We use Encryption Hard Disk Plus from PC Guardian.  
http://www.guardianedge.com/Encryption_Plus_Hard_Disk/index.html

It is easy to use and is very secure.  It does encrypt the whole hdd though,
which in my opinion is better as you don't run the risk of putting sensitive
data on a non encrpted partition.