It's usually easier if you take the base install, and work from there using the manual, but I'll see if I can explain.
The first important file is your global settings.conf file, found in the RetroFE root directory (
http://www.retrofe.nl/wiki/doku.php?id=global_settings.conf). Within that file is a setting called baseItemPath. This setting defines the root directory for all your roms. This defaults to the collections directory, so if you just comment it out (by putting a # in front of the line) it will use the default.
The second important file is the settings.conf file of the collection, in this case collections/Sega Master System/settings.conf (
http://www.retrofe.nl/wiki/doku.php?id=settings.conf). This contains the list.includeMissingItems parameter. If it's set to false, it will only show the games actually in your roms directory. If you commented out the baseItemPath in your global settings.conf, this will default to the collections/Sega Master System/roms directory, which is exactly what you want. As you can see, the default settings of RetroFE are basically what you expect them to be.
I would delete the collections/Sega Master System/include.txt file if I were you. You only need it if you don't want all your roms in your roms directory to show, and you probably prefer automatically showing them in your menu when you add them. When showing them, RetroFE will look for artwork with the same name in the subdirectories of collections/Sega Master System/medium_artwork, like collections/Sega Master System/medium_artwork/video for the video of the game. Since the setup you downloaded already contains a lot of them, you may just need to rename them to match the name of your rom for them to show up.