When planning a move to a new city or state, the cost of living is an important consideration. Here’s why: Cost of living tells you how much money it takes to maintain a basic standard of living in a given place. If you were offered your dream job in a city 1,000 miles away, you’d want to know whether the salary would allow you to live well…or whether you’d have to be on a super tight budget.
Location typically plays a major role in determining the level of income needed to finance your lifestyle. For instance, a dollar doesn’t buy as much in New York as it would in Des Moines. If the cost of living is higher because you live in a major city, you’ll likely have to allocate more of your budget toward everyday expenses, such as housing, food, and transportation.
It’s important to understand the factors that affect cost of living calculations and what a higher or lower cost of living means for your finances. Otherwise, you could wind up with an uncomfortable level of “sticker shock” if you relocate.
Here, you’ll learn:
• What does the cost of living mean?
• Which factors determine cost of living?
• What is the cost of living index?
• Where is the cost of living typically highest?
• How can you control the cost of living?
Cost of Living Definition
What does cost of living mean? In simple terms, the cost of living is the cost to maintain a certain standard of living. It refers to how far your income will go, based on where you live and your expenses.
The cost of living can vary from state to state and city to city. As you might guess, renting a 1,500-square-foot home is likely to be much more affordable in a small town in the middle of the country than doing so in a hip neighborhood in San Francisco.
That said, you can also have different costs of living within the same metro area. For example, someone who owns a home in the suburbs of a major city may have higher or lower expenses compared to someone who lives downtown.
In terms of what the cost of living is used for, it’s a gauge for determining affordability. Before moving to a new location, you might look at the cost of living in that area to help you decide if it’s realistic for your budget.
How Does the Cost of Living Work?
Cost of living calculations work by measuring how much it costs to live in a specific location, using basic living expenses as a guide. The cost of living is not static; it can go up or down over time. Looking at cost of living trends for a certain city, region, or state can give you an idea which way consumer prices are trending.
There are a number of entities that perform cost of living calculations. The Council for Community and Economic Research, for example, maintains a cost of living index for participating cities across the U.S. Other organizations calculate cost of living for locations around the world.
On a personal level, the most important question to ask is, “What does the cost of living mean for me?” The simple answer is that cost of living can determine how far your income is able to go toward funding your lifestyle.
Factors That Determine Cost of Living
When discussing cost of living and expenses, you’re talking about necessities. In other words, the things people in a given area need to spend money on to live each month. According to the Economic Policy Institute, that includes:
• Other necessities, such as clothing, household supplies, and personal care items
Cost of living calculators use prices for those types of expenditures in a particular area to determine how much it costs to live there on average. Consumer prices for goods and services are largely a product of supply and demand, and what’s happening with inflation. Inflation is a general upward trend in prices over time.
When inflation is higher, prices tend to rise across the board, which brings a higher cost of living. Even when inflation is lower, prices may still be higher in some areas than others if there’s higher demand for goods and services.
Calculating Cost of Living
Cost of living indexes collect information about various costs for different cities and locations, then use average prices to determine how much it costs to live there. If you’re comparing two cities, you can use a cost of living index to see which one is less expensive.
If you’d like to calculate your personal cost of living, you’d use your spending history to determine your average monthly expenses for these categories:
• Childcare, if applicable
• Other necessary expenses
Using those numbers can tell you how much it costs to maintain your basic standard of living each month. You can also add in your average monthly spending for debt repayment or non-essentials or discretionary expenses, like dining out, travel, or recreation, to get a sense of what your actual cost of living adds up to.
What Is the Cost of Living Index?
Generally speaking, a cost of living index is a measurement of average prices. Similar to a stock market index, a cost living index is meant to provide a benchmark for comparison. The Consumer Price Index (CPI) is often referred to as a cost of living index, though that description isn’t entirely accurate.
The CPI measures the average change in prices over time for a market basket of consumer goods and services. That’s how the U.S. Bureau of Labor Statistics (BLS) defines the Consumer Price Index. The CPI isn’t a true cost of living index but an inflation index. Changes to the CPI can be an indicator of how inflation is changing; whether it is rising, falling, or remaining flat.
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Does Cost of Living Vary State by State?
The cost of living by state is not uniform and what you might pay to live in one state could be very different from what you’d pay to live in another. That’s important to keep in mind if you’re considering moving across state lines to a new location. The more expensive a state is, the less purchasing power your money holds.
For example, the California cost of living index is much higher than the Texas cost of living index. So why do some states have a higher cost of living? Again, it depends largely on things like supply and demand, though taxes and average incomes can also play a part.
When the average income in a state is higher and job opportunities abound, that can lead to an increase in people moving to the state. That means more demand for housing, which can send home and rental prices soaring. More people can also mean more demand for everyday goods and services, such as food or utilities. As demand rises, prices can follow suit.
So, in our example above, if you were living in Texas in a two-bedroom rental apartment and were offered a job at the same salary in California, you’d face a higher cost of living. If you moved there, you might have to rent a smaller home. Your groceries would likely be more expensive as well as your other monthly necessities. You might find you couldn’t eat out or go to concerts as often since prices are higher.
Recommended: What Percentage of Income Should Go to Rent and Utilities?
Which State Has the Lowest Cost of Living?
As of 2022, Mississippi had the lowest cost of living in the U.S., with a cost of living index of 83.1. For perspective, cost of living indexes are generally based on 100 as an average. So an index of 83.1 means that the cost of living in Missouri is 16.9% less than the national average.
Housing, which is typically the biggest expense most people have, is nearly 37% cheaper in Mississippi compared to the U.S. average. The median sale price for a home there was $263,400 as of August 2022, while the national median was $427,055. Transportation, food, and utility costs are also well below the national average.
Which State Has the Highest Cost of Living?
Hawaii is the most expensive place to live in the U.S., with a cost of living index of 192.1. Housing is more expensive there than in any other state in the country, with a median list price of $848,000. A home buyer would have to shell out considerably more to live in Hawaii’s natural paradise than elsewhere in America.
But housing demand isn’t the only factor. Higher taxes and higher costs for transporting goods and materials to the state are some of the other factors that drive up the cost of living in Hawaii. Other states that rank among the most expensive include New York, California, and Alaska.
How Much Should Your Cost of Living Be?
Your cost of living should be a figure that, given your income, you can reasonably afford to pay for the area that you live in. When your expenses exceed your income, that can cause shortfalls in your budget each month. You may need to use credit cards or loans to fill the gap, which can leave you with a pile of bills, wondering how to pay off high-interest debt.
When calculating your ideal cost of living, start with your income. Then work your way backwards to determine how much you should be spending on things like housing, food, transportation, utilities, and other necessities. If your income comfortably covers those things, you can then decide how much to allocate to savings, debt repayment, or “wants” like travel and entertainment.
Also, consider your household size. The cost of living for a single person can be very different from the cost of living for a family of four. So you may need to allocate more of your budget for necessities if you have a spouse, partner, or children in your household.
Tips to Improve Cost of Living
If you’ve run the numbers and your cost of living is higher than you’d like it to be, say, when contemplating a move, you aren’t necessarily out of luck. There are some things you can do to try and bring it down. Here are some ideas for ways to reduce your cost of living:
• Eliminate unnecessary spending from your budget.
• Move your money to a different financial institution to avoid bank fees and/or pays higher interest.
• Plan meals at home, and cut down on restaurant meals.
• Consider refinancing student loans or your mortgage to lower your interest rate.
• Consolidate credit card debt using a 0% balance transfer offer.
• Shop around for better rates on auto, homeowners, or renters insurance.
• Aggressively pay off debt.
• Consider moving to a cheaper area.
• Take on a roommate to share expenses.
• Downsize into a smaller home.
• Sell a vehicle if you own more than one.
Some of these money-saving ideas are relatively easy to implement; others may seem a bit more extreme. But the more you can cut your expenses, the easier it may be to improve your cost of living.
You can also research different ways to make more money. That might mean taking a different job, getting a part-time gig, or starting a side hustle. If you’re contemplating a move for a higher-paying role, remember to factor in the cost of living in a new location to see how far a higher salary might go. A higher cost of living could eat up the salary boost you’ll receive, and so you’d want to be prepared for that.
Managing Finances With SoFi
Achieving a manageable cost of living starts with keeping a close eye on your budget and spending. Even making small changes, such as cutting out high banking fees, can free up more cash that you can use to save and fund your financial goals.
If you’re looking for a new way to bank, SoFi can help. When you open a new bank account with SoFi, you can get checking and savings in one convenient place. There are no fees, so you can hold on to more of your hard-earned money. And you can earn a competitive APY on deposits.
What is a cost of living adjustment?
The Social Security Administration (SSA) applies a cost of living adjustment to Social Security benefits, based on changes to the Consumer Price Index. That means benefits can rise as the cost of living does. In other words, these adjustments are designed to ensure that recipients’ benefit payments are able to keep pace with inflation.
How can I compare the cost of living between two cities?
The easiest way to compare the cost of living between two cities is to use a cost of living index. You can subtract the cost of living index for the city that’s lower from the one that’s higher to figure out how much cheaper it is.
Which country has the highest cost of living?
Bermuda is the world’s most expensive place to live, according to Numbeo. The island country has a cost of living index of 141.74.
Photo credit: iStock/artisteer
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