Rural livelihoods (RLs) in highland Ethiopia is critically threatened by increasing degradation of land and water resources (LWRs) and lack of sufficient livelihood assets. In response, farmers adapted diverse indigenous land and water management (LWM) technologies and livelihood strategies. This paper describes farmers’ methods of soil erosion identification and the practices of managing LWRs to enhance RLs. It presents the results of studies focusing on assessment of soil erosion indicators, farmers’ in-built sustainable land and water management practices (LWMPs) and RLs in Dangila woreda (district) in the northwestern highlands of Ethiopia. Data were gathered from May 2010 to October 2013 through participatory transect walks, field observation, formal and informal discussions with farmers, examination of office documents and from a survey of 201 rural households. Descriptive statistics and the livelihood strategy diversification index (LSDI) were used to analyze the data. Results indicated that farmers employ around 13 indicators to identify soil erosion on their farmlands. Over 79% of the farmers indicated the occurrence of soil erosion on their farm fields and some 59% reported the trend was increasing for twenty years, 1991-2011. More than 174 km soil-bunds and greater than 4 km stone-bunds were constructed on farmlands and on grazing fields through farmer participatory watershed development campaigns. Some 34 gullies were stabilized using check-dams and vegetative measures. Almost 72% of the households applied cattle manure on about of their 75 ha lands to improve soil fertility. A total of 44 diversion canals and 34 water committees were established to facilitate the irrigation practice of 33% rural households. Over 20% farmers obtained results ranging from moderate to excellent by combining manure with chemical fertilizers in the same field. Nevertheless, introduced methods such as improved seeds and fertilizers were commented for unaffordable prices and short-range services. Farmers utilized over eight livelihood strategies but the mixed crop-livestock farming was their main source of income. Sharecropping contracts were the ways of stabilizing the land demands of the studied households. It is concluded that integrated use of technologies (i.e. structural & vegetative plus indigenous & introduced measures) and participatory research & planning should be promoted to improve farmers’ LWMPs and livelihoods. Increased effort should be made by concerned agencies to help farmers own assets (e.g. farm land) and diversify their livelihoods strategies. Special focus should be also given to farmers’ inbuilt LWMPs and livelihood strategies.