Differences Between Cost of Living vs. Inflation

Inflation and cost of living both describe changes that can affect your budget, but they measure different things. Inflation measures how prices change over time across a basket of goods and services. Meanwhile, cost of living describes how much it costs to maintain a particular standard of living. Inflation can increase your cost of living. However, your actual expenses may rise faster or slower depending on where you live and what you spend money on.

A financial advisor can help you account for inflation and changing expenses when planning for your financial goals.

What Is Inflation?

Inflation measures how prices change for similarly situated goods and services over a period of time. It does not measure price changes based on how new products perform or based on price expectations. When a broad measure of prices increase, it’s known as inflation. When a broad measure prices go down, it’s known as deflation.

For example, if the price of a gallon of whole milk increases from $1 to $1.10, this would be considered 10$ inflation, with $0.10 being 10% of the original cost of $1. However, say that instead, the supermarket began stocking organic milk that cost $1.10 per gallon. Even though prices had gone up, this wouldn’t be considered inflation because the price change, at least theoretically, reflects a different product and perceived higher quality.

Economists measure inflation in many different ways, ranging from the price of individual products to the average prices across an entire economy. When news outlets report on inflation overall, they’re referring to average inflation across the entire economy as measured by the Bureau of Labor Statistics.

Every month the BLS publishes its inflation report. Again, this report measures inflation in a number of different ways because inflation varies by factors such as region, industry, product, etc. However, the two most important factors are:

CPI. The CPI, or the “Consumer Price Index,” measures how national prices change over time for some of the products and services that consumers buy most often. The CPI is built to reflect actual consumer experiences. When it goes up, it typically means that your trip to the market has gotten more expensive.
Core Inflation. Core inflation measures how national prices change over time for some of the products and services that consumers buy most often – except for food and energy prices. Core inflation is built to reflect the productive capacity of the economy. When it goes up, it means that your trip to the market has gotten more expensive because demand for products currently outstrips the country’s ability to supply those goods.

What Is Cost of Living?

A wallet, a piggy bank, and a house, representing the cost of living vs inflation.

The cost of living is how much someone spends on their day-to-day life. This is also described as the costs involved with maintaining a given lifestyle. A household’s costs of living generally include all of their major costs, measured on a monthly basis. This includes rent, food, transportation, utilities and bills, healthcare and other frequent expenses. For example, say you spend $1,200 per month on your apartment and another $250 per month on groceries. Your cost of living will include at least $1,450 per month.

A cost-of-living calculation focuses on individuals and households, although like inflation you can measure it in many different ways. For example, an individual can determine their own personal costs of living. Or you can measure the average costs of living by lifestyle. For example, looking at the average cost of living for someone with a one-bedroom apartment or the average cost of living for a family with two parents and two children. You can also measure costs of living by area. Such as considering the average cost of living in Boston or New York.

This makes costs of living far more difficult to pin down. Unlike inflation, this is a very subjective measure and results can vary widely based on factors such as:

Region. Perhaps the biggest variable of all, since costs range widely based on where you choose to live. Someone’s costs of living are going to be far higher in San Francisco than in the Upper Peninsula.
Household. Someone living on their own will have far fewer expenses than two spouses or a family with children.
Lifestyle. How you choose to live will determine your cost of living, whether that means buying a downtown brownstone or living in a studio apartment.

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Difference Between Inflation vs. Cost of Living

The most important difference between the cost of living and inflation is this: Cost of living is subjective and can be individual. While you can measure the average cost of living among groups of people, especially in the same geographic area, it’s ultimately a personal finance concept that measures how much an individual’s living costs are. Inflation is universal and tied to specific economies. It’s a macroeconomic concept that measures how the price of goods and services changes for everyone.

Inflation can cause costs of living to rise, although this isn’t a one-to-one relationship. When prices rise for necessities, such as medication and rent, inflation almost always pushes up someone’s costs of living. When prices rise for discretionary spending, people will often balance their lifestyle choices with cost-cutting. Put another way, they will adjust to a rising cost of living by reducing their standard of living.

Why Can Your Cost of Living Rise Faster Than Inflation?

Your cost of living can rise faster than the overall inflation rate because broad inflation measures don’t necessarily reflect your individual spending patterns. The Consumer Price Index, for example, measures average price changes for a basket of goods and services purchased by consumers. Your household may spend much more or less on individual categories than the weights reflected in the index.

Housing provides a simple example. Suppose your rent increases from $1,500 to $1,650 per month, a 10% increase. If rent represents a large portion of your budget, that increase could have a much greater effect on your personal expenses than an overall inflation rate of 3%.

The same principle can apply to other major expenses, including:

Healthcare. Households with significant medical expenses may be affected more when healthcare costs increase.
Food. Families that spend a larger share of their budget on groceries may feel food price increases more strongly.
Transportation. Changes in gasoline, vehicle and public transportation costs can affect households differently depending on how they travel.
Housing. Rent, utilities and other housing expenses can represent a substantial portion of a household’s budget, so changes in these costs can have an outsized effect.
Childcare. Families that pay for daycare or other childcare can face changes in expenses that aren’t relevant to households without children.

Location can also make a difference. National inflation figures represent broad averages, while prices and price changes can vary among regions and metropolitan areas. As a result, someone living in an area experiencing large increases in housing or other expenses could see their cost of living rise differently from the national inflation rate.

The opposite is also possible. Your cost of living could rise more slowly than overall inflation if the categories experiencing the largest price increases make up a relatively small portion of your budget. Changes in your spending habits can also affect how much you ultimately spend.

For this reason, the inflation rate shouldn’t be interpreted as the percentage by which every household’s expenses have increased. Comparing changes in your own major spending categories over time can provide a more personalized picture of how rising prices are affecting your cost of living.

Bottom Line

Inflation and cost of living are closely related, but they aren’t the same. Inflation measures changes in prices over time. Meanwhile, cost of living describes how much it costs to maintain a particular standard of living. Higher inflation can push up household expenses. However, your personal cost of living may increase faster or slower than a broad inflation measure depending on your location, spending patterns and which prices are changing. Comparing changes in your own budget with broader inflation measures can provide a clearer picture of how rising prices are affecting your finances.

A financial advisor can help you take into account how inflation and changes in your living expenses may affect your savings, investments and retirement plan.

Tips for Managing Personal Finances

Figuring out how to manage your finances and what to do when the cost of living or inflation increases can be a lot. Working with a financial advisor can help ease the burden and give you peace of mind in protecting your wealth. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors who serve your area. You can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
What does it cost to live in your area? More importantly, what will it cost to live in your area? Whether you’re thinking about moving somewhere new or getting a bigger place, run the numbers through our calculator to see what you’ll need for your lifestyle.