Unfortunately, no matter how compact you make them, only so many bookmarks can fit onto the Favorite's Menu at one time. For organizing the rest of IE favorites, you'll need to use the Bookmarks Menu and the Organize Favorites window. Internet Explorer 8 does not support tags for bookmarks like better web browsers do, so users are left to organize them via a folder structure.
You can open the Organize Favorites window by selecting Organize Favorites from the Favorites Menu, or by pressing CTR-B which is the standard hot key on other web browsers which refer to such saved webpages as "bookmarks". The window provides buttons to create a new folder, to move bookmarks or folders to another folder, and a button to delete favorites or folders of favorites. While these buttons are usable, users can also move favorites around by dragging and dropping them as well.
Also, new folders can be created as part of the bookmarking process. When a new favorite is added, the ADD a Favorite window that pops up allows the user to select which folder to put the favorite into. Alternatively, the user can click the New Folder button to create a folder here.
How to organize your favorites depends upon how you use them. You can organize them into work and personal bookmarks, for example, or by project, or subject. Basically, the structure of IE Favorites is identical to that of file folders on the hard drive, so for many users organizing them in a similar fashion is useful.