[Editor's Note: This post by Harry Sit, who has been blogging for years as The Finance Buff, came in response to my Invitation to Contribute a few months ago. As you might imagine, he's a very talented financial writer. What a pleasure to hardly have to edit or format at all! We are co-authors (along with many others) of The Bogleheads Guide to Retirement Planning. We have no financial relationship.]
I'm answering Dr. Dahle's invitation for guest posts after someone suggested that his blog should feature more diversity in lifestyles. I chose the topic “How to be successful financially despite living in a high-cost of living (HCOL) area” because I have experience with it.
VHCOL Meaning…Think San Francisco
My wife and I have worked and lived in San Francisco Bay Area for nearly 20 years now. These years form the bulk of our working life. The cost of living in the San Francisco Bay Area ranks among the highest in the country. In spite of it, we are financially successful by our own standard. Now in our mid-40's, we are close to what Dr. Dahle wrote in The Concept of “Being Done” Saving. We are reducing our savings rate toward breaking-even between what we make and what we spend, with the eventual goal of spending more than we make. Yes, even in a HCOL area you can still be financially successful.
VHCOL? Here's How to Still Be Successful
Our financial success comes in part because of the HCOL.
Good Paying Jobs in VHCOL Cities
Except in say Hawaii where nearly everything has to be shipped in, high cost of living isn't created in a vacuum. The cost of living is high because many people want to live there. Many people want to live there because many good paying jobs are there. Salaries in the San Francisco Bay Area rank among the highest in the country.
Going by the nifty chart from NPR — How Far Your Paycheck Goes, In 356 U.S. Cities — the $42,802 median income in San Jose metro area, where we live, feels like $33,309 after adjusting for cost of living. The $29,331 median income in Salt Lake City metro area, where Dr. Dahle lives, feels like $28,095 after adjusting for cost of living. If a job pays the same multiple of the median income in San Francisco Bay Area versus in Salt Lake City, I'm still better off doing it in the San Francisco Bay area after adjusting for the higher cost-of-living.
Doctors may be different. The income doctors make may not differ as much by where they live (is it really true?), but we are not doctors. The jobs we do in San Francisco Bay Area pay more than the same jobs elsewhere. [One other possible minor criticism on this point is perhaps Harry should have used net income, which decreases the apparent difference between salaries in high cost/low cost areas. At the low end of the spectrum, the lower salary is eligible for more credits. At the high end, the marginal tax rate may be quite substantial. Nevertheless, his point stands for the vast majority-ed]
A high income provides the raw material for financial success. It'll be difficult if you don't have much to work with. For us W-2 employees, it means getting high-paying jobs.
Even if the pay is less after adjusting for cost-of-living, you can still save more in absolute dollars with a higher pay. Using doctor-scale numbers, suppose you make $300k in San Francisco Bay Area and you save 30%, versus you make 250k in Salt Lake City and you save 30%, you save more in absolute dollars in the higher cost-of-living area — $90k vs $75k — even though your $300k in San Francisco Bay Area feels more like $230k in Salt Lake City.
Remember that you don't have to spend your retirement savings in the high cost-of-living area! If you take your $90k/year savings plus your investment earnings over the years to Salt Lake City, you will have more than if you stayed in Salt Lake City all along.
The key is to maintain your savings rate in spite of high cost of living, which leads to our next topic.
Lower Living Standard in HCOL City
Economics says when something costs more, you consume less of it. A major part of cost-of-living is housing. The average home size in our area is more like 1,600 square feet versus the national average 2,600 square feet. You maintain your savings rate by consuming less housing. If you insist on a 2,600 sq. ft. home, you will have to spend a lot more.
Dr. Dahle has a boat [which he will be using to transport 8 friends to some Lake Powell canyoneering adventures as you read this-ed.] We don't. Dr. Dahle has an $11,000 table set. We don't. In this high cost of living area, our living standard is lower. That's the price you pay for living in the high cost area.
Let the high cost of living squeeze discretionary spending, not the savings rate.
When you are conditioned to a lower living standard, your high-dollar savings will go even farther when you eventually retire to a low cost-of-living area.
A 1,600 sq. ft. home still costs a lot in our area. After you buy it though, the higher price also leads to more dollars leveraged. You don't buy a home as an investment but sometimes it becomes an investment whether you intended it to be an investment or not. If by luck you run into a good real estate market, more dollars leveraged means more appreciation.
You don't seek out high leverage on purpose; leverage also cuts both ways. Sometimes you just get lucky and it contributes to your financial success. [It seems to do that a lot in the Bay Area, doesn't it?-ed]
VHCOL Drives Extra Motivation for Tax Efficiency
California is notorious for high taxes. When you are in AMT phaseout, even qualified dividends and long-term capital gains can be taxed at 40% between federal and state. It creates extra motivation for maxing out all available tax-advantaged accounts: two 401k's, two backdoor Roth IRAs, solo 401k for self-employment income, mega backdoor Roth, HSA, and 529 accounts. You also have to keep your taxable accounts extra tax-efficient, such as putting stock funds in tax-advantaged accounts and muni bonds in taxable.
You can still be successful financially when you work and live in a high cost-of-living area. You have to work extra hard in some aspects. In others, high cost of living actually helps.
I'm sure many other WCI readers also live in a high cost-of-living area. Let us know what you think in the comments section. What did you have to do to compensate for high cost of living? Do you think living in your high cost of living area is net positive or net negative for financial success? Comment below!