From Jo Querrien

Managing your inventory keeps your contribution to the load on inventory servers down, and also speeds up your teleporting and decreases the lag spike (for everyone in the region including you) caused when you enter a new region.  Also, it makes FINDING what you want much easier.  Everyone's inventory  will look a little different, because your inventory should be set up the way that makes it easiest for YOU to use, not someone else.

1) Start NOW.  The bigger your inventory is when you get started, the more work it will take to get it under control.

2) ORGANIZE FIRST.  Sort things in a way that makes sense to YOU, and sort EVERYTHING. (tips for this later)

3) Get rid of low hanging fruit (duplicate landmarks, unnecessary notecards, copies of things, anything named "Primitive", or stuff you'll never use).  Just delete them.

4) Once you have everything sorted so you can FIND things, packing things into boxes helps a LOT in lowering your inventory.

5) The Outfits folder - useful tool or useless load on the inventory server?

Details:

1) The easiest way to tackle an intimidating job like organizing an already huge inventory is in little pieces.  Set aside ten minutes to an hour per day (you decide what your schedule can handle) to work on it.  Set a timer.  When the time is up, STOP.  Do something else.  Making yourself stop when the time is up will help prevent burnout and make it possible to actually focus on what you're doing while you're working.  Trust me, it speeds things up in the long run.
 - You can open a second inventory window!  Normally you wouldn't want to do that, but when you're sorting a lot of stuff, it's really handy.  You can drag things from one window to the other, making it possible to sort things without waiting for scrolling.  Note that this temporarily doubles your inventory load (because the system loads it twice), so choose a low lag area to do it.
 - Your inventory can be sorted or filtered to make it easier to find what you want.  How to do so is viewer specific, but if you know that "Sort" and "Filter" are in there somewhere, you can find them!  Sort allows you to say "put the newest things on top", or "put things in alphabetical order".  Filter allows you to only show landmarks (useful if you want to delete duplicates) or to show only clothing and body parts.
 - The bar that looks like you could type in it is a search bar.  If you are looking for something specific that you know what it is called, you can type that in, and your inventory will find it for you.  If you know part of the name, type that in (you will get more results, but it may still be faster ...at least until you have your inventory organized).
 - In your preferences, there should be an option to not show empty system folders.  Turning that on can reduce the visual clutter on your screen, but will not prevent you from creating an item that would go in that folder (for instance, if you have no notecards, and your Notecards system folder is not showing, you can still Create --> New Notecard, and it will go into your Notecards folder, making it visible.

2)  Organizing is the key to making this work!  There are a number of techniques.  Consider these, then decide how YOU will be most likely to use your inventory.  Organize for yourself, not for anyone else who thinks they know how to organize.
 - Many people like to empty out the system folders entirely and recreate them, then choose not to display empty system folders.  If you do that, new things that you just acquired will pop into the system folder and cause it to appear, making it very obvious that something un-sorted is there.  If you do a lot of shopping, you might want to consider that.
 - Subfolders are your friends!!  And you can have as many as you need (in system folders, too!).  If you have a lot of clothing, for instance, you might well end up with a structure like this: Clothing --> Womens --> Tops --> Nice shirts --> Button up shirts.  Five folders deep, you can have a box with nothing in it but button up women's shirts suitable for a meeting, which you can instantly find for a new outfit.  This is an example of a way to organize things, and should not be considered THE way to do it - make it make sense to YOU, and work with YOUR inventory.  If you only have two women's tops, you obviously don't need that much organization for women's tops.  If you do not have clothing for both male and female avatars, you clearly don't need a folder to separate them.  Also, at this point, it is okay to make copies of things.  If you have an item that really ought to be in both this folder and that folder (say, a texture for gold that you would like to have in both your jewelry making folder and your metals folder), copy it and put it in both!  This will temporarily increase your inventory, but once you have it organized, those last subfolders will have everything packed into boxes.
 - KEEP any pictures included.  If no picture is included, make one.  These pictures will make it possible to tell the difference between these blue men's jeans and those blue men's jeans.
 - Where a bunch of things are part of a set (sixteen women's halter tops with the same design, but in different colors, or a men's suit that includes a jacket, tie attachment, pants, etc, or a bunch of textures with the same theme), pack them in a box with a name that will tell you what is in the suit (preferably the name that they came with, so you can tell in the store that you already have that item), and move that box into the appropriate subfolder with the picture (I like to keep the picture both inside the box and outside the box, but that's up to you).
 - If at any time you realize that you need to subdivide your folders some more, DO IT!  Yes, that means dragging things around again, but if it makes it easier for you to find what you need, it's a good thing.  If at any time you realize that you really don't need a subfolder for furniture in Living Room Sets, delete it!  Just because someone else (including the you who made up folder names in the beginning) thinks something is useful does not mean it is actually useful to you.
 - If you are using the system folders to hold your subfolders, don't be afraid to add more (for example, a folder called "Quick Access" for things you are likely to suddenly need to grab, or a folder called "To Sort" might be useful).  If you are recreating the system folders to keep the system folders from appearing unless you get something new in them, don't think you are limited to the names that were used for them.
 - Folders can be organized!  If you have them sorted in alphabetical order (which is the default), numbers come before letters, and ! comes before anything else.  So if you want, say, your Quick Access folder to always be up near the top where it's easy to find and quick to access, name it !Quick Access, and it will go just under the trash can.
 - Once you have your inventory organized to your satisfaction, you can resize your inventory window so that it is just full, but with no scroll bar on the right.  That way, if a new folder appears, so will the scroll bar, letting you know that something needs sorting.
 - Keep on top of things.  It took me months to organize my SL inventory.  I would HATE to get lazy for a bit and then find that I have months of work to do all over again.  Just a few minutes a day is enough to keep things tidy once things are organized.

3) There are probably things in your inventory that you don't need. Things that you acquired twice (because you couldn't tell if you already had that thing or not), things that you don't need (the hideous shoes you picked up for free on your first day and now hate and will never use), and things that you needed at one time, but not any more (a note from a friend detailing their travel plans to your area when they came to visit).  Delete them!  If for sentimental reasons you want to keep them as souveniers, there's no rule that says you can't have a box called Souveniers to hold them.
 - Texture organizers are AWESOME!  They allow you to take hundreds of items (textures) out of your inventory and store them in one object , while being even more useful than keeping them loose in your inventory.  If you do a lot of building, you will probably want more than one texture organizer (just make copies of the one you like with nothing in it, and rename the copies appropriately).  If you like to make houses, you might need an organizer for roofs and siding.  Or a whole organizer for interior walls.  Think about how you use textures and organize accordingly.  Most texture organizers can have user defined categories, so that your roofs and siding organizer might have a category for shingled roofs, and one for ceramic roofs, etc.  Hundreds of textures available to you at the touch of a button, all for the cost of one inventory item.  If you are concerned about accidentally deleting your texture organizer (it can happen), make a box to store the textures in.  So for example, in your Textures folder, you might have a subfolder called "Leather and Suede", containing an organizer (called "Leather and Suede") and a box (called Leather and Suede backup).  Having that backup box is also useful in answering the question "do I already have that set of textures?".  You can rez the box (or wear it on your hand), edit, and look inside to see if there is a box of textures already in there by the appropriate name.
 - A note about notecards:  You CAN put anything that is full permission on a notecard (sounds, textures, Calling Cards, even objects and assemblies of objects - as long as it's full permission, it can be put on a notecard).  That seems like a great idea (you can organize your photographs with descriptions, etc), but there is a major caveat.  Notecards turn out not to be reliable for long term storage.  Sometimes, some or all of the things on a notecard will refuse to return to your inventory, making them effectively lost forever.  Even though boxes cannot contain organizational tools, you are better off using them.  Or, if you must use notecards, use a box as a backup.

4) You do not have to delete anything in order to reduce your inventory!  Once everything is sorted into subfolders and you can find what you want easily, pack those subfolders into boxes!
 - Whenever possible, pack objects that go together into a box that is named the same as their creator named it, so that you can tell you already have those items later.  Pack these boxes, with pictures where appropriate, in a box with the same name as the subfolder.  So that the subfolder "Dress Slacks" would contain a box called "Dress Slacks", which in turn contains boxes with names like "Linda Kellie's slacks" (with a picture named Linda Kellie's slacks so they stay together) or Marshall's Dress Slacks Set 4 (with a picture named Marshall's Dress Slacks Set 4).  That way, when you are in a shop and you can't remember if you own those slacks, you can look in the box and see.
 - There is, in most viewers, an option to copy things as links.  DO NOT USE LINKS.  A link has exactly the same weight in your inventory as a regular copy, but if you use a link, the original must remain loose in your inventory and cannot be packed in a box to save inventory load.  If you already have links in your inventory, replace them with regular copies before packing things up.  Also, links can break (sometimes moving the original to another folder is enough to break them), which renders them useless until you can make another copy.  Lastly, a linked (rather than copied) item can only be fitted to one avatar.  Changing the fit of the linked item changes the fit of the original also.  The only time you are forced to use links is if you have a no-copy item.  No-copy items must NEVER be packed in boxes (because they can cause the entire contents of the box to vanish forever in a bad rez situation - I lost my entire collection of full-permission sit animations to a bad rez once because someone thought it would be a good idea to pack their full permission sit animations in a no-copy box, and I was too naive to know I needed to re-pack that box before packing up the animations).  Most creators will trade no-copy/transfer items for copy/no-transfer versions of those items.  If the creator will not do that, and you absolutely cannot live without that item, you must use links if you want it in more than one place in your inventory.
 - Calling cards also add inventory load.  If you use Firestorm's Contact Sets (a very nifty feature that allows you to organize your contacts and even not hear about it every time a business associate logs in, but hear about it when your best friend logs in), a duplicate of each contact that you put in a set is created.  You can delete the leftovers!  Opening the Calling Cards folder will display the subfolders for each contact set you created.  Any Calling Card that is in one or more of those sets can be deleted from the main list, making it easier to see when you have unsorted new contacts. Don't delete the contact set folders.

5) The Outfits folder seems like a great convenience - you can save what you're wearing as an outfit, and simply right click that Outfits folder and choose "Replace Current Outfit" from the menu, and change clothing.  However, there are several down sides to that.
 - The Outfits folder uses links.  These do not reduce inventory at all, and also require that you not pack the relevant items in boxes to reduce inventory load, thus overall, using the Outfits folder INCREASES your total inventory load.
 - The Outfits folder cannot be organized.  You cannot create subfolders in the Outfits folder to sort formalwear from beachwear from Halloween costumes, etc.  This means that more than a small number of Outfits starts being very hard to remember which is which.
 - There is no actual advantage to using the Outfits folder.  ANY folder can be right clicked and "Replace Current Outfit" chosen from the menu.  Which means you can make a regular folder (perhaps in Clothing?  Perhaps at the system level like the current folder? Perhaps called "Outfits"?) with subfolders to organize your various looks, each containing COPIES (not links that can break!) of everything you were wearing when you decided you were happy with your look, and get the same utility you had before, except without the risk of randomly losing things to a bad link, and without being prevented from reducing your inventory by packing up your originals.
 - If you have an unpacker script that is unobtrusive, you can reduce your inventory significantly by packing up your outfits with that unpacker script!  You can rez the box containing an outfit on your hand and unpack it into a folder to change into automatically, and thus be able to have hundreds of outfits, organized so you can find what you want, ready to change into with a couple of mouse clicks.  As long as you are not wasting inventory server space by using the Outfits folder.  If the box is invisible (edit box, set texture to Transparent), nobody will ever know you did it.