Celebrim
Legend
Ah ah ah. Right there, the bolded part, that's where you are wrong by the rules.
From the SRD:
If you ready an action, you cannot move.
Hmmm... I can see that as a valid interpretation of the SRD. You'll have to ask an expert in 3.5 whether the interpretation you make is born out by the explanatory text.
However, I have the 3.0 PH open before me, and page 134 below the heading 'Ready' I read:
"The ready action lets you prepare to take an action later, after your turn is over but before your next one is begun. Readying is a standard action, so you can move as well."
In any event, how far you can move while taking a ready action is even less central to my point than whether you can take a readied action at all. If the bandits and the PC's move toward each other at but 5' per round, it doesn't substantially change the point of the example.
There is, of course, other huge problems with playing in "combat mode" all the time. For one, 5 people can't fit in a 10x10 room.
I have squeezing rules (granted, house rules rather than RAW) that let 5 people fight in a 10x10 room, if necessary. In fact, you can have 8 people fight in a 10x10 room (more than that if you limit yourself to grappling), but the results aren't pretty and I wouldn't recommend it. However, it would make an interesting tactical scenario to force a party to fight in such a small space.
Personally, I should hate to play in a game world that was hidebound to the RAW. Once again, my guiding philosophy of play is, "If it's reasonabe, then figure out a way to say, "Yes."
But, anyway, Celebrim, your example is flawed. You cannot ready an action and then move along, "holding" the readied action. A readied action precludes movement.
I don't claim to know all the rules perfectly and I'm only familiar enough with 3.5 to know that beyond fixing a couple of broken spells, it's a significantly less well thought out game than 3.0, but I'm pretty sure of what I'm reading here.