As I mentioned in previous articles, I have moved from Texas to California. With this move came a significant increase in both salary and cost of living. This has led to my savings rate decreasing but my overall dollar savings level staying relatively the same. I wanted to explore the pros and cons of working in a high vs. a low cost of living area (so called geographic arbitrage) and its impact on savings rate as well as retirement savings.
Expenses Scale Differently Than Income
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 scale. 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 I would need to spend eight time what I previously had in Texas. If I could only negotiate an 8x increase in salary to move, then this would not be a problem but many will find that the differences in salaries do not entirely close the gap. Other things become more expensive too besides housing. Groceries, gasoline, entertainment venues all scale with most cost of living adjustments in area and this is not easily made up in salary.
Why The Previous Paragraph Doesn’t Matter for Savers
For those who have a savings rate (or, ideally, a very high savings rate) the fact that income scales less than expenses is actually not that big of a problem. Let me illustrate with an example (fictional numbers):
Low cost of living:
- Salary $50,000
- Expenses $25,000
- Savings $25,000
- Savings Rate 50%
High cost of living:
- 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 (although your savings rate will go down). This has been the scenario that I have found myself in: my expenses have scaled much higher than my income scaled yet my overall dollars saved has stayed relatively constant or even increased.
Savings Percentage vs. Volume Saved
Over much of the blogosphere, savings rate is the most important metric. This is because it gives a sense for how much you are spending in relation to how much you are saving for retirement. If a person wishes to stay fixed in location in retirement, then this should be the most important metric to determine when and how you will be able to retire. I, however, see all the dollars in my retirement account as fungible and look more towards dollars saved, since I will be flexible in where I choose to retire.
For example, you can save a smaller portion of your salary with a higher dollar tag in a high COL area and then move to a low COL area immediately on retirement, thus bringing your expenses way down.
Geographic Arbitrage Conclusion
If you are not specifically tied down to an area, there are often other metrics that you can look at to determine your financial health in retirement. 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, however, may depend on more than just your savings rate.