First, I expect them to do only one main thing: use a web browser. This alone lets them do the most important things: lookup information, do email, view multimedia (say family pictures), may play some board games, and perhaps do some minimal online financial accounting. With the advent of online games and online office apps (with Google Apps being the best known example), one can reasonably do pretty much everything in a web browser.
Advise them not to install anything else on their computer. It's simply not worth it.
Physical setup: Set the display resolution so that characters are comfortably visible on the screen. If you have the money, buy a bigger monitor. My mom was much happier with a decent used 20" LCD (1024x768) than with the piece-of-junk 17" Dell LCD (800x600) we got "free" with the computer.
If this is a laptop, get mouse! And get one to their liking in all cases. If possible teach the difference between ths mouse buttons, which maybe a stretch.
Security: This is the big problem as there are no-just-forget-about-it solutions.
First, educate them about (i) forged email identities (perhaps send email to them claiming to be someone else if you have the knowhow), (ii) forged websites, such as a website pretending to be their bank, (iii) phishing email (dig up an example from your own spam folder), and (iv) the expectation of getting constant spam. Teach them opening an email in gmail is OK, but clicking a link is dangerous, even if it is to open an image.
Beat into them the general rule "if a web page or email shows up unexpectedly, assume it is dangerous." If email seems odd as in the person you know doesn't make sense, don't trust it. The corollary is that if you expect to see something, then you can generally trust it.
Malware: All standard AV (anti-virus) and spyware security products are fairly intrusive from a CPU standpoint as they have to monitor data realtime. And they cost money and have to be updated.
Fortunately, Google came to the rescue in the last 2 years. The Google Pack contains a free AV scanner (Norton) and a spyware detector (Spyware Doctor). The great thing about them now is that they don't expire. The Norton scanner has to be run periodically to scan your disk. I suggest doing it every 3-7 days. Fiddle with the spyware software yourself and determine if you want it on continuous monitor, which uses 3-15% of your CPU, or you want this off and could do a batch scan every few days.
For a firewall, use the built in one to XP or Vista. Avoid Zonealarm, which used to be the best out there but has become a disaster. Worse still, a one-off email I used to get rebate from ZoneAlarm (owned by Broderbund at the time) started getting spam! The irony.
Web browser: Firefox 2.x has gotten very slow if you open several tabs and/or if you use various AJAX based sites, such as gmail. It's so bad that many people who used to love Firefox, now swear at it. Fortunately, the latest Firefox 3 releases (beta 5, as I type this), are much better, so much so that I love it again.
Setup a free online email account, such as gmail (or yahoo or hotmail). Note: I'm very partial to Google's gmail.
Show them how to search using a search engine such as Yahoo or say, Google.
Windows setup: Turn off all the fancy styles and UI. They use a good bit of CPU and possibly RAM. Set the UI to be"Classic" so it looks like a Windows 95 or 98 box.
If you get a retail machine, disable as much of the crapware possible. Search the web for links to remove this stuff if you want.
Lastly, tell them to relax and surf the web. They can't hurt the computer.
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