It's entirely possible, but IIRC, a FAT filesystem (such as the "Nokia N900" volume (/home/user/MyDocs)) will probably not work for most Live OS installs. If I'm not mistaken on that, then I'm guessing that was what killerjay was referring to, as formatting your microSD card as ext2 or similar is less problematic (for the average user) than reformatting the main volume.
But yeah, this should work fine. Just make sure the card you pick is decent (I wouldn't go under Class 4, and faster is better, of course). If you need to format the card as ext2, you can do that from the N900 command line (after installing the ext2 tools package, the name of which escapes me - probably e2fsprogs or something), or from a Desktop Linux install/CD, such as K/Ubuntu. It's not terribly complicated to do from the command line, but make sure you do it right, as you are messing with low-level disk commands, which can do Bad Things if you make a mistake.
Cheers, and let us know if you get it working.