Two-factor authentication uses your password and another proof of identity -- which in this case is an app called Google Authenticator, which runs on your smartphone. Every time you log in, you need to run the app and input the code it generates. The code is only good for a few seconds, which makes it very secure indeed.
Of course, if you lose your phone things can be a little tricky. Don't worry, though: the setup wizard lets you add a backup phone to your account, and generates some backup codes that you can use in a pinch.
Really, if you store any kind of sensitive data on your Google account (even your search history!), you should use two-factor authentication. It makes hacking your account almost impossible -- and in a world where your login credentials are synonymous with your real identity, that can only be a good thing.
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