I am a very big Disney fan and a week down at the World in March will be our third trip down since Sept 2003. By the end of this coming trip we will have spent a month at the World this year. But I don't belive in "magic." Disney has some very nice resorts (and some fairly average ones) and we've stayed on-site a number of times-- at the Polynesian, the Dolphin, Disney Villas (back when there was such a place), Dixie Landings (Now Riverside), Caribbean Beach, and All Stars. I think what people actually mean by "magic" has to do with the overall experience of staying at a Disney Resort-- the employees generally are helpful, friendly, accomodating, and pleasant, the resort is "themed" (landscaping makes sense with decor, employees wear costumes which relate to the theme, restaurants fit to the theme and so on), the place is extremely neat and tidy, rooms are well decorated and well maintained, transportation is convienent, and there are typically (with the higher-end resorts, anyway) some resort amenties such as boat rentals, spa services and so forth. The overall experience is designed to be visually and asthetically pleasing (except for, in my personal opinion, the All Stars!) and Disney does a pretty good job at giving you as much or more than you expect in a pretty hassle-free envirnoment. They are not always perfect, and individuals can have bad experiences, but on average, Disney does a great job.
There are plently of nice hotels that can be as good as Disney in regards to amenities, service, and to a lesser extent, theming, but of course, you will have to deal with transporting yourself around and you will not be immersed in the Disney ambience during your transit times (you'll have to pass gas stations and fast food joints just like you have at home). And of course, there are plently of not-so-nice hotels which will provide you with poor service, a shabby room, and plenty of hassle.
We stopped staying at Disney resorts for a number of reasons. First, costs are big issue for us-- we'd rather spend a $4000 for a month at the World over 4 trips than $4000 for a week at (say) Animal Kingdom Lodge in a room with a great view. (However, if money were no object, we'd pick a deluxe resort hands-down.) Second, we have been down enough times (and intend to keep going frequently enough) that we don't feel like every trip has to be the be-all and end-all. If we don't do something we want to on this trip, we'll catch it next time. Third, we are very impatient people and can't stand waiting around for Disney transport. We will always be driving ourslves to the parks, so this major benefit (the transportation system) of staying at a Disney resort is meaningless to us.
Overall, I'd say staying on-site vs. off-site is a pretty personal choice. For some folks, vacation time is more scarce than money and they want things to be as perfect and relaxing as they possibly can be-- these tend to be the folks who insist on staying on-site and that seems to meet their needs well. For others (like me), money is more scarce than vacation time and the expense cannot be justified. Decide what's important to you and don't worry that you may be missing out. You can get a pretty good idea of what is meant by "magic" by visiting a resort. If it appeals to you, then try a stay on-site. You will likely have a great time no matter what.
Beatnik