Geographic Arbitrage: Savings Rates and Amounts Saved vs. Location

June 25th, 2015 by 
Globe spun to Europe and Russia

As I've mentioned before, I once moved from Texas to California.

With this move came a significant increase in both salary... and cost of living. It led to my savings rate decreasing but my overall dollar savings level staying relatively the same.

Today let's explore the pros and cons of working in a high vs. a low cost of living area through so called geographic arbitrage. We'll examine its impact on savings rate as well as overall retirement savings.

Expenses Scale Differently Than Income: You Can't 8x a Salary Between States

One of the important distinctions that many have mentioned (and I have found to be true) is that income does not scale quite as quickly as expenses.

For example, the difference in $/sqft in a house in Texas vs. San Francisco is roughly 8-10x.

In other words, in order to purchase a similar house in California to my Texas house, I would need to spend eight times what I previously had. (If I could only negotiate an 8x increase in salary to move, then this wouldn't be a problem!)

Most of you will find that the differences in salaries do not entirely close the gap. Other things are also more expensive in California too:

  • Groceries
  • Gasoline
  • Entertainment venues
  • Taxes

All of these are higher, or generally scale with the cost of housing here. These expenses are not easily made up in salary.

Savings Rate isn't The Whole Story: When Dollars Saved Matters

We talk about savings rates here on DQYDJ often - ideal savings rates, magical savings rates, and even track our own savings rates.

For those who have a decent savings rate – or better – the fact that income scales less than expenses is actually not that big of a problem.

Let me illustrate with an example (fictional numbers, all):

Low cost of living state:

  • Salary: $50,000
  • Expenses: $25,000
  • Savings: $25,000
  • Savings Rate: 50%

High cost of living state:

  • Salary: $70,000 (40% increase)
  • Expenses: $37,500 (50% increase)
  • Savings: $32,500
  • Savings Rate: 46.4%

As you can see from the example above, your salary may increase by a lower percentage than your expenses yet your overall dollars saved can still increase. It didn't matter that your overall savings rate went down because the increased salary was such a dominant number.

This is the scenario that I found myself in: my expenses scaled at a higher percentage than my income but I saved way more absolute dollars.

Savings Percentage vs. Absolute Dollars Saved

Over much of the blogosphere, savings rate is the most important metric.

Fair enough – it gives a sense for how much you are spending in relation to how much you are saving for retirement. Well... fair enough if you plan on staying put exactly where you are in retirement.

If you wish to stay fixed in location, then savings rate should be the most important metric to determine your retirement ability.

I, however, see all the dollars in my retirement account as fungible. I'm trying to maximize the total number of dollars I can save so I can pick and choose where to go when I decide to retire.

For example, you can save a smaller portion of your salary with a higher dollar tag in a high COL area. If you then move to a low COL area immediately on retirement, your expenses will drop as well, making it even easier for you to live.

Geographic Arbitrage: Saving More Money at a Lower Savings Rate

If you are not specifically tied down to an area, the absolute maximum number of dollars you can save is the best health indicator for retirement. You need to estimate how far your stash can take you in the palce you eventually want to move.

After all the calculations, your dollar figure in your portfolio relative to your expected expenses are the numbers that matter the most to your financial health.

How quickly you get there – or how securely you can control your finances – depends on more than just your savings rate.


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