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With Time Machine, the information is stored onto another hard drive. That can be internal or external.

 

Time Machine can be set to backup for I think a maximum of a year, but correct me if I'm wrong. Time Machine will alert you when your backup drive is full and it will let you delete certain periods of time to make room for the new backup.

It first makes a complete backup and then only records the changes relative to that backup. So the incremental saves are relatively small. It uses the same mechanism as Spotlight to keep track of what changes, in the same way that Spotlight doesn't have to keep scanning your drive once the original scan has been completed.

 

More than you want to know is here: http://arstechnica.com/staff/fatbits.ars/2006/8/15/4995

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