Defragmenting an HDD is pretty vital. If you let it it get as bad as the example above, your system will crawl. You should do it about once per month, not continuously, nor with those crapware tools that defrag on the fly. Using the HDD wears it out slightly, so defragging does the same. But not defragging means alot more "thrashing" as the drive accesses the fragmented data, so not defragging is the worst option. It's also annoying to listen to a constantly active HDD.

The windows XP/2K disk defragmentation tools tends not to compact files too well. In fact you may have to run it about 10 times to get a half decent result. It's still worth doing though.

The best way to start is to uninstall as much rubbish as possible and delete as many old files as you don't need. Next thing to do is disable the windows pagefile. To do this you need to go into the performance tab from the system properties and disable the paging file altogether. Then restart the computer in safe mode (hit F8 repeatedly before windows boots, not at your BIOS screen as you'll probably end up at the boot menu), then when the startup menu appears select safe mode. Once in safe mode, run the defrag (keep rerunning it until it gets to the stage where it finishes after a few seconds) and then re-enable the page file. Reboot.