What Is the Cost of Living?

What Is the Cost of Living?

At a basic level, the cost of living includes expenses that are necessary to get by, such as housing, food, clothing, transportation, utilities, health care and taxes.

Due to various factors, the cost of living can vary greatly depending on where you live. In particular, it's typically more expensive to live in an urban area than in the suburbs, and rural areas tend to have an even lower cost of living.

The cost of living in the U.S. also tends to increase over time due to inflation.

What Is the Cost of Living Index?

A cost of living index (COLI) is a method of measuring how expensive it is to live in a certain area, as well as how the cost of living changes over time.

A COLI typically tracks the average cost of a predetermined set of consumer goods and services that are necessary for a basic standard of living in an area. While this basket of goods may not be specific to your household's financial needs, it is intended to provide a general idea of what to expect.

You can use a COLI to evaluate how the cost of living where you live compares to the national average. If you're thinking about moving, it's also a useful way to compare how expensive it is to live in the areas you're considering.

The consumer price index (CPI), which is administered by the U.S. Bureau of Labor Statistics, is a type of national COLI that offers a look into how the cost of living in the U.S. changes over time. The CPI is the most commonly used way to gauge how economic inflation is affecting U.S. consumers.

How Do Cost of Living Adjustments Work?

A cost of living adjustment (COLA) is an increase in pay that allows people to maintain their standard of living as the cost of living changes over time.

For example, the U.S. Social Security Administration uses the CPI report each October to determine the COLA for Social Security benefit recipients in the upcoming year.

Private employers may also institute a COLA policy that provides annual raises to employees across the board in addition to performance-based raises. If an employer has locations in multiple states, it may even factor the local cost of living, including annual adjustments, into its compensation decisions.

Finally, the IRS typically uses annual COLAs in various areas of the federal tax code, such as retirement plan contribution limits, tax brackets and income limits for certain tax credits and deductions.

How to Calculate Cost of Living

The cost of living for a given area is a complex calculation, so if you're looking for the general cost of living for your city or another area, your best bet is to use an online cost of living index.

Depending on your lifestyle, however, your personal cost of living may be higher or lower than the average based on where you live. To calculate your personal cost of living, start by tallying up the cost of basic necessities you need to survive. This may include the following:

• Rent or mortgage payment
• Debt payments
• Utility bills
• Groceries
• Clothing
• Transportation (car payment, fuel, registration and other costs)
• Health care premiums and out-of-pocket costs
• Other insurance premiums
• Educational expenses
• Child care
• Federal and state taxes

Once you've determined your basic cost of living, you can compare it to your income to evaluate your overall financial situation. If you have some income left over, you can create a budget and add other expenses that can help you meet your desired standard of living, such as:

• Entertainment
• Dining out
• Retirement contributions
• Other savings goals
• Travel expenses

You can also go back to your necessary expenses and consider areas where you want to spend more, such as higher quality groceries or clothing or a nicer car or home.

How to Manage Increases in Cost of Living

While the cost of living and wages both tend to increase over time, it's not always even. Here are some steps you can take to manage your cost of living as even your most basic needs get more expensive:

• Get on a budget. If you don't already have a budget, research budget plans to determine the best option for you. Even a bare-bones budget can help you keep your spending in line with your income.
• Cut back on discretionary spending. Take a look at your nonessential spending to determine where you can reasonably cut back without impacting your lifestyle too much. For example, you could share a streaming subscription instead of paying on your own or dine out less often.
• Evaluate your basic expenses. Take a look at your necessary costs to determine where you can save. Options may include trading your car in for a cheaper one, downsizing your home, shopping around for cheaper car insurance and changing the thermostat to save on utilities.
• Build an emergency fund. If possible, work on building a rainy day fund that you can use in the event of a financial emergency. A rising cost of living can make unexpected expenses even more devastating if you don't have any cash reserves.

Which States Have the Highest and Lowest Cost of Living?

Regardless of your personal lifestyle, where you live has a significant impact on your cost of living. Here are the states with the highest cost of living as a percentage of the national average, according to 2023 data from the Council for Community & Economic Research:

Source: Council for Community & Economic Research

On the flip side, here are the five states with the lowest cost of living compared to the national average:

Source: Council for Community & Economic Research

The Bottom Line

The cost of living in your area has a direct impact on your lifestyle, but even in times of high inflation, there are steps you can take to minimize the impact of higher costs on your financial well-being.

If you're struggling financially, look for opportunities to adjust your expenses to give yourself some more breathing room. If necessary, you can also research government assistance programs, as well as community programs that can provide financial assistance as you take steps to get back on your feet.