Before I even begin, know that there are limits to what the hardware can do, and those are hard limits.
So, first off, it's a total myth that free disk space impacts computer performance. As long as there's enough disk space for swap use, there's not a single bit of difference if it's 10% to or from capacity.
Second, you don't need a more expensive FireWire drive unless you want to create a bootable backup OS install on the external drive. That's a very good idea if you ask me, but also completely optional. A USB HDD will be just fine. FireWire's better, but on a system that old, the rest of the system will generally be so slow you won't notice the difference.
I'm sure Dan meant well, but he's giving you about equal parts good and bad advice. Much of it seems to be his own opinion which is he not clearly distinguishing from fact.
Defragmenting really is pointless on Mac or PC. Unless you run a large database server or do a lot of high end video editing (unlikely on a G4), you'll see minimal gains at best, and those will be limited to specific functions, as well as fleeting in nature. Defragmenting tools are like the cockroach of the computing world. They simply refuse to die no matter what kind of toxic cocktail you throw at them. Microsoft has even started burying the defrag tool deeper and deeper into the OS since XP, hoping (in vain it would appear) that people would maybe get the hint. Apple doesn't even bother bundling one, hasn't for a very long time, if ever. Take that as a sign that $30 could be put towards something that will actually be useful, like more RAM.
Formatting the system is up to you. I don't really buy into the idea that it dramatically improves anything. I figure it seems faster because you just spent the agonizingly slow period of time formatting, so of course things seem faster after that. It can be a quick and easy way to clear out some crap that's built up over time, but it's another one of those things where people tend to put a bit too much stock in the benefits to be had. IMO, they mistakenly attribute the relative difference between booting from a CD, then waiting 30-40 minutes for the OS to install, for some kind of long term benefit. Truth be told, we humans are not as clever as we like to think. We are very easily fooled about a great many things.
So, given this is a G4, figure out how much RAM the system will take, what kind, and max it out. That will give you the maximum benefit. The next option would be to get a faster HDD, but that is a very large step down from RAM. If it's a Power Mac, you could look into getting a faster G4 CPU, but the cost-benefit ratio is likely going to be tilted way in favor of cost. If this is a laptop, the CPU is soldered directly to the logic board and that's not even an option.
Also, icons on the Dock are not necessarily running. Only if you see a black triangle under them are they running. Otherwise they are just launcher icons. Now, if there are things over past the dividing line that separates the section with the Trash icon, that is a running window and closing those may help improve performance. Just make sure you're not using them for anything before closing.
OS updates generally do nothing to improve performance, only security and sometimes usability. If the system is going to be connected to the Internet, these should all be applied. Otherwise you can consider them optional.
But at the end of the day, a G4 CPU is a G4 CPU, and it was really never all that great. You're just going to have to accept that there is only so much you can do to improve the performance of this thing. It doesn't matter if we're talking about a Mac, PC, mainframe, or pretty much any other kind of computer, there are three things that will improve performance and they are constant.
1: CPU speed
2: Amount of RAM
3: Number of running programs
Increase the first two, reduce the third. Pretty much everything else is just a gimmick and quite possibly someone setting out to prove P.T. Barnum's statement about there being a sucker born every minute. Don't let it be you.