To start putting in new switches/buttons in a solid body, must they all be put in the tiny cavity that the other POTs are in, or is there another way to make a cavity without destroying the beauty of the guitar?

Plus, what is a suggested way to drill a hole in a guitar without the paint, etc fraying?
Learn how to use a router or keep them in the stock cavity.

For drilling holes, drill from the top down. Start with small drill bits and work up to the proper size.