No doubt you’ve noticed the cost of everything going up, from milk and eggs to cars to rent. Thanks to today’s high inflation rate, life is getting costlier. But what does the cost of living mean, really? And how do you calculate it?
In this article we define cost of living, explain how it’s often calculated, and how it differs by location. And we’ve got tips on how to keep cost of living down so you can continue to make progress toward your financial goals—no matter where you live, and no matter what is happening in the broader economy.
Table of contents
What does “cost of living” mean?
When people talk about the cost of living, they are referring to how much money it costs to maintain an average standard of living at a certain point in time. Cost of living includes basic expenses like adequate housing, health care, transportation, and food. It’s one of the most important factors affecting your ability to build wealth. If your cost of living doesn’t leave you money to save or invest, it’s hard to plan for financial goals.
Of course, cost of living varies by location. Cities with thriving urban centers and plentiful jobs tend to have higher costs of living than areas with declining populations and weak economies. As you might imagine, $100 would buy significantly more goods and services in a rural community in the South than it might in, say, San Francisco or New York City.
Living in a location with a high cost of living means your dollars don’t go as far. Consider this: Say you live in Little Rock, Arkansas, earn a salary of $60,000, and are considering moving to Palo Alto, California. In Palo Alto, you’d need to earn $109,994 to maintain the same standard of living, according to Salary.com. That’s more than an 80% increase in cost of living. Unfortunately, the site also estimates that employers in Palo Alto typically pay just 35% more than employers in Little Rock for the same job. Bottom line? It is significantly more expensive to live in Palo Alto and you could end up with less disposable income after basic expenses are paid.
Cost of living versus standard of living
Strictly speaking, cost of living measures the basics of life: shelter, food, transportation, and medicine. Obviously, there’s more to your life than just the basics. Even the type of basics you choose will vary in price.
Some people may eat out daily, travel to luxury destinations, and dress in designer clothes. Others choose to make everything from scratch, borrow movies from the library, and take long walks in the woods for entertainment. Even in the same location, people may make different financial choices based on their interests and priorities, causing them to have very different standards of living.
Understanding cost of living is a starting point for comparing how much it will cost you to live in one location versus another. And knowing the standard of living you aspire to can be helpful, too. You will want to pay attention to both if you move to a new area. If you are moving somewhere with a high cost of living, you may need to learn ways to manage your budget to make the numbers work.
How is cost of living calculated?
To calculate the cost of living, government agencies tally up the prices for a representative sample of goods and services, like health care, food, and housing. These costs are based on what people actually spend, broken down by location.
Housing makes up the biggest share of cost of living because it takes up such a big part of most people’s budgets. According to the Bureau of Labor Statistics, housing accounted for about a third of the typical American’s expenses in 2021. Other big-ticket budget items include transportation and food.
During periods of high inflation, the categories in which people already spend a large portion of their income may rise faster than usual, pushing cost of living up. For instance, if housing costs increased at a higher rate than clothing or entertainment, you would feel the impact of that in your budget more.
You can calculate your own personal cost of living by adding up how much you spend in these common categories:
• Food
• Housing
• Childcare
• Clothing
• Transportation
• Health care
• Entertainment
• Education
• Taxes
How does cost of living vary by location?
The cost of living isn’t the same state to state or city to city. Hawaii has the highest cost of living in the United States, while Mississippi has the lowest.1 Generally, states on the coasts have higher cost of living than states in the Midwest and the South.
What accounts for the difference?
When employment opportunities are plentiful, it attracts more people to move to the area. If housing supply doesn’t keep up with the demand, home prices and rents rise. And with more people, the demand for basic goods and services also skyrockets, further increasing prices. In addition, taxes might be higher in these locations as well.
If you were to move from Mississippi to Hawaii, you would need a salary that’s more than twice as high to afford the same lifestyle. Otherwise, you would need to trim expenses, perhaps opting for a smaller home, and not eating out as often. Making changes like these could change your standard of living in a significant way.
Before you move, use a cost of living calculator like this one from Forbes Advisor to compare the cost of living of your current city or town to your new location. This will give you an idea of how much you will need to earn to maintain the standard of living you are used to.
How does cost of living change over time?
Like inflation, the cost of living fluctuates from year to year. To understand how prices move up and down, the government publishes several indexes. Among the most closely followed is the Bureau of Labor Statistics’ Consumer Price Index (CPI), which is the average of how much the prices of goods and services have risen. The CPI is often used to measure inflation.
For much of this century, the rate of inflation has hovered between 2% and 3%.2 But in early 20213 it began to rise more quickly, reaching a record high in June 2022.4 Recently, inflation has started to slow down, with a reading of 6.5% at the end of 2022.5
It’s important to understand that costs do not rise equally across the board. The CPI weighs some types of spending more than others based on what people actually spend more of their money on.
How to reduce your cost of living
When deciding whether to move to another state or city, cost of living probably isn’t your only consideration. Your social life and future career opportunities are also important factors.
In some cases, you might be willing to accept a higher cost of living if it means landing your dream job or living close to family. If so, you will need to get proactive about managing your budget and adopting better money habits to continue hitting important financial milestones.
You can reduce your cost of living by:
- Living in a smaller home or apartment
- Eating at home
- Riding your bike or taking public transportation
- Canceling unused subscriptions
- Getting a part-time job
- Paying off debt
You might also consider consolidating higher-interest debts with a personal loan, which could save you money on interest and give you some breathing room in your budget. That way, you could lower your cost of living and simplify your finances at the same time.
The bottom line
Knowing how to calculate and limit your personal cost of living is key to reaching your financial goals. It can help you make smart decisions about where to live, what to spend your money on, and how to plan for the future.
Want to learn how sticking to a simple budget can set you up for financial success wherever you live?Read About the 50/30/20 Rule