Yes, you can potentially install to an external drive, although the problem you will face there is older versions of Windows may not detect the USB drive without extra drivers.
There could be an easier way. Why do you need the older Windows version?
Virtualisation could be an option. Install Virtual Machine software natively in your Vista O/S and then build a VM (which can be on an external drive) with the older Windows version.
Examples of free (for non-commercial use) VM software:
Oracle Virtual Box
VMware Player
Windows Virtual PC (Microsoft).