This is actually a pretty big and rather complex issue if you dig around a bit in it. And I will focus it on sense 4, but most of it is similar in earlier sense as well.
Type of contacts
SIM – Old of contacts that was used on older phones, this is to avoid now since it’s just so limited since you can have ONE number or information per contact and sim-card can contain x amount of contacts. I do NOT use this myself.
Phone – Contacts gets stored in phone memory ONLY.
Google – Contacts gets stored in phone memory AND online in the google contacts when the phone is synced with google. This is to recommend if you really don’t want to lose a contact or have more than one phone (like myself) since if you uses this with auto-sync on your devices you will ALWAYS have the same contacts on both (or more). This I recommend myself since it’s just the easy way. This assumes that you have added a Google account to your android phone, which is just Mandatory.
If you add a Microsoft Hotmail account under Settings > Account & Sync there will be a fourth contact type:
Microsoft Hotmail – Which the contacts you have in your windows live account, could be very handy to have this as well.
How to add a contact to Google on your phone.
Open People where you in the upper parts second from the right got: + with add under it.
if Contact type isn’t Google you simple click on that button and select Google. Add your contact details and click Save.
How to manage contacts
Under Menu > Manage contacts you have a number of tools for managing your contacts.
Copy contacts – If you’ve made all your contacts as local Phone contacts you can copy them to another account, like your google or hotmail account. This is very handy!
Import/Export contacts – Let you import/export contacts. Before you do something major with the contacts you can export them to sd/user storage and import them later on if things go bad.
De-duplicate contacts – If you have multiple contacts that contains the very same information you can use this to simple clean up your contacts a bit.
Merge contacts – Checks all linked accounts and merges these into a preferred account. Can be a little tricky to get it right.
Blocked callers – See list of blocked callers
Linked contacts – See and check linked contacts