It's doable. You can buy smartcard readers and couple of cards for about $100.
Essentially, the smartcard acts as a store for a security 'certificate'. Certificates are used by software to verify your identity and to encrypt data.
E.g. Windows encrypted file system uses a certifcate to encrypt your files, so that only your login can acccess them. With a smartcard, it is possible to delete the certificate off the hard drive and install it on the smartcard. The certificate will only be available to windows while the smartcard is in the reader, and the smartcard has been activated by your password.
Similarly, certificates are used for logging into secure websites, or logging into secure networks (e.g. corporate). It is possible to configure windows to require a certificate instead of a username+password (and therefore you can use a smartcard login) - but this alone doesn't do anythign to secure your data.
Smartcards are more secure than usename/password. The smartcard is deactivated when removed from the reader, and must be reactivated with a password. The password is checked in the hardware of the card - and the card will lock-out or self-destruct after too many incorrect attempts.
The smartcard is also copy-proof. Someone can't just look over your shoulder and note down your usename/pw. They actually have to have the physical card in their hands, together with your password.
I've never actually set up a smartcard for windows, so I don't really know how easy or hard it is, but I've used several systems that use smartcard security in Windows - and they work, but are inconvenient. You can't log into 2 comps on the same network at the same time, and everytime you take the card out, you get forcibly logged out.