Geographic arbitrage turbocharges your net worth

How geographic arbitrage can help you reach Financial Independence Retire Early

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Geographic arbitrage (in short: geoarbitrage) is a powerful concept because you can take advantage of price differences between two locations. It might result in a gigantic increase in your cash flows. You can redeploy these streams of income to repay debt faster, or to invest in assets that yield you even more wealth. Geographic arbitrage is one of the most effective strategies to reach Financial Independence Retire Early (FIRE).

Geoarbitrage is a composite word that consists of “geo” and “arbitrage”.

  • Geo stands for a geographical location;
  • Arbitrage is a concept derived from economics. It means you can benefit from price differences.

Geographic arbitrage is not new. The concept gained a lot of popularity thanks to the book “The 4-Hour Work Week” written by Tim Ferris. Tim questions the traditional patterns surrounding career and life. He is a vigorous advocate of lifestyle design: he challenges traditional norms and expectations, and promotes new values, such as financial independence, mini-retirements, remote work, passive streams of income, and fanatic outsourcing. He argues that by removing the shackles that modern society places on us, we can join the New Rich.

Geographical arbitrage is also gaining momentum thanks to technological advancements and Covid-19. Our technological capabilities make it easier than ever before to work remotely. One thing that Covid-19 has taught us is that a lot of the work that we considered location-dependent can perfectly be done from somewhere else. Remote work also became more socially accepted and is no longer a taboo.

There is another important megatrend that provides support for geoarbitrage. While the total population in the world is on the rise, many parts of the world face the opposite problem. They face aging populations and low birth rates. Many countries have no choice but to welcome immigrants into their societies to keep their labor force healthy. These countries will be in competition with neighboring countries and the rest of the world. In a bid to attract skilled and/or wealthy individuals, highly appealing visa types are designed that offer significant tax benefits to those that will relocate. The war for talent is no longer a problem on the corporate level, it became a pressing and strategic priority for many countries.

My first exposure to geoarbitrage was an unintended consequence of a career move from my home country Belgium to Bahrain, an archipelago in the Middle East. My income streams increased a lot because there was no withholding tax and personal income tax in Bahrain. On the flip side, I was no longer eligible for pension benefits, a 13th-month salary, etc. My monthly expenses also changed radically. For example, a liter of fuel cost less than a bottle of water. In short, the two systems were radically different.

Initially, my move abroad didn’t have a big impact in terms of total income from employment because I was still too junior level. However, it unlocked significant cash flows that I could manage myself instead of having them managed by the government. Essentially, when a government withholds social security taxes, they might partially allocate these funds to pay your future pension benefits. In my case, I became responsible to take care of this important financial topic myself. This increased responsibility is a curse for some but a blessing for others.

Domestic geoarbitrage versus international geoarbitrage

There are two forms of geographical arbitrage: domestic and international. If the locations are in the same country, it is called domestic geoarbitrage. When it involves locations in different countries, it is international geoarbitrage. For example, the cost of living in developed countries is much higher relative to developing countries. By moving to a low-cost-of-living country, you can reduce your living expenses significantly.

Geographical arbitrage can also be applied within the borders of your country. Price differences exist between different neighborhoods. For example, the cost of living in a trendy, central neighborhood is higher relative to a suburban area. There are also differences between cities and provinces. They all have their own local and regional economies that determine the cost of living in that area. People usually have to pay a substantial premium to live in a capital city, economic center, or tourist hot spot.

While you can achieve pretty, solid cost savings with domestic geoarbitrage, international geoarbitrage might multiply the results. This is explained by the leverage that is created by lowering your costs and simultaneously maintaining or increasing your income streams. The cost of living in developed countries is very different from emerging countries and frontier markets in Asia, Europe, Latin America, and Africa.

International geoarbitrage unlocks significant cash flows

Geoarbitrage is often used by:

  • Retirees who receive their pension in their home country but live for several months a year abroad.
  • Remote workers, freelancers, and digital nomads that live in a country with a low cost of living but still earn money from a place with a high cost of living.
  • Entrepreneurs that manage their online businesses remotely.

Geographic arbitrage is similar to companies outsourcing part of their operations to countries with a low cost of living. The companies take advantage of existing price differences to purchase a similar product or service at a lower cost. This is a popular corporate strategy to increase profit margins.

While this article is mainly about international geoarbitrage, the ideas can be extrapolated to domestic geoarbitrage. In fact, international geoarbitrage is a much more complex form of geoarbitrage because of cultural differences, language barriers, family constraints, health limitations, et cetera.

Geoarbitrage helps you to achieve financial independence & retire early

Financial Independence Retire Early (in short: FIRE) and geoarbitrage are closely linked. The FIRE movement originates in the US, but its insights are also valuable for others. FIRE is traditionally split into 3 subcategories (Plain vanilla FIRE, leanFIRE, and fatFIRE). The terms are nowhere clearly defined but roughly mean:

  • Plain vanilla FIRE: The amount an average US household spends annually.
  • leanFIRE: The expenses amount to maximum half of a typical US household. It stands for a frugal, cost-conscious lifestyle.
  • fatFIRE: The household expenses are double compared to the average US household. It is synonym for a burgeoned lifestyle.

Dr. Leif Dahleen and Marco Sison, both authorities in the field of FIRE, believe geoarbitrage is one of the most effective ways to achieve FIRE. The central topic of their blogs is geoarbitrage, but both approach the topic from a different angle: Dr. Leif Dahleen’s focus is on domestic geoarbitrage and fatFIRE while Marco Sison’s blog focuses on international geoarbitrage and leanFIRE. They retired at 43, respectively 41.

I believe there is another important FIRE subcategory. I label them “FIRE sparks”. Instead of moving from a high-cost country to a low-cost country, some individuals and families move from a low-cost country to a high-cost country in search of a better financial future.

The US has historically attracted adventurers and brilliant minds that were looking to fulfill their dreams. These days most developed countries have a large, skilled amount of white-collar workers, but there is a chronic shortage of other profiles, such as electricians, plumbers, carpenters, and nurses. These profiles might emigrate to high-cost countries because their skills are valued higher there relative to their home countries.

FIRE sparks benefit from geographical arbitrage because their income levels sharply increase, albeit some benefits are lost because of an increase in their costs. Nevertheless, if FIRE sparks can control their expenses effectively, they can accumulate enough savings to support their families back home and perhaps even afford a house or finance a business venture.

Geoarbitrage benefits can be achieved by (1) reducing your expenses, or (2) increasing your income streams

Geoarbitrage is about balancing income and expenses

Unlocking the benefits of geographical arbitrage can be achieved in 2 ways. Either by reducing your living expenses or by taking advantage of price differences for the skills that you possess. It is the interaction between the expenses and the income streams that determine whether geographic arbitrage will work in your situation. Before we dig into the income streams, we will first look at the expenses.

Geographical arbitrage allows you to aggressively reduce your living expenses

Geoarbitrage is not about being frugal since you do not have to give up your current lifestyle. You actually can maintain or even improve your lifestyle at a lower cost by moving to a lower cost of living country.

7 expenses account for most of the average household budget. The exact composition of these expenses will depend on your family composition, lifestyle, income streams, income level, and location. Expense numbers 1-4 are likely to have the biggest impact on your personal circumstances.

1. Housing expenses

Housing-related expenses often are a significant chunk of everyone’s household budget. They comprise either rental expenses or mortgage repayments and maintenance expenses.

! Pro tip: As a young professional, I have lived together with other people or sub-lent a spare room to reduce my overall rental expenses. This allowed me to increase my saving rate by 100’s of USD per month.

2. Taxes

Taxable income and tax rates differ everywhere across the world. Even moving your residence to another city in your country can affect your tax position. Tax optimization is a very complex topic, but it is also an area where substantial savings can be realized in case of relocation. 

3. Healthcare

Healthcare expenses differ because of differences in cost of living, and differences in the healthcare’s architecture. For example, the US healthcare system is notoriously expensive. In other parts of the world, taxes are much higher because the government subsidizes healthcare and education.

4. Education

Education expenses rarely affect you when you move abroad as a young professional. However, if you want to send your children to a school that follows a specific curriculum, it can cost you a huge amount of money.

5. Transportation

The cost of car ownership, taxi rides, public transportation, or bike-sharing can also impact your overall budget.

6. Everyday goods

The cost of groceries, telecommunication, clothes, utilities, etc. For example, the cost of fuel and having a full-time maid are very cheap in the Middle East while fresh fruits and vegetables, alcohol, and tobacco products are very expensive.

7. Leisure & entertainment

Leisure and entertainment expenses, such as restaurant expenses, and tickets for entertainment parks and concerts.

When you move countries, you need to accept that you become part of a very different society. The systems might not be comparable at all. You might gain purchasing power in some areas while losing some in others. However, if you moved to a lower cost of living area, you will have gained purchasing power from lowering your expenses.

Stable and recurring income streams further unlock the benefits of geographical arbitrage

Having a stable and recurring income stream goes a long way to achieve FIRE. Geoarbitrage relies on the idea that you can maintain or increase your income. However, your income in absolute terms is not that important as long as you can increase your savings.

To illustrate the point, we compared the cost of living in Austin, United States with Chiang Mai, Thailand based on data from The Earth Awaits and ZipRecruiter

The average monthly salary can decrease by 42% to generate identical savings. The remaining $1,809 allows you to afford a much more comfortable and luxurious lifestyle. This is explained by the difference in the cost of living between the US and Thailand. There are small variances between the above images and the below tables because the images are constantly being updated.  

Geoarbitrage allows income levels to decrease sharply while still maintaining the same savings rate

The real impact of geoarbitrage becomes visible when the drop in income levels is less severe. When we assume a decrease from $5,555 to $4,000 or a decrease by 28%, savings actually increased by a staggering 44%!

If income streams don't decrease as much, the savings rate significantly outperforms the savings rate compared to high cost of living countries

When you only receive income from your employer, there is always a possibility that one day the contract will be terminated. This risk also exists when you work in an office setting, but the risk is probably lower because of the regular face-to-face interactions. Thus, there is a concentration risk towards a single client, your employer.

Freelancers usually diversify their client base out of necessity and to mitigate the risks of losing a client. Don’t put all your eggs in one basket and work on diversifying your income streams. If you have multiple income streams, your financial position is much less risky.

It does not matter whether your income streams stem from remote work, pension benefits, rental income, or investment income. But you need to ensure that your streams of income are diversified and sufficient to support your financial goals.

It is also important to distinguish between active and passive income streams. Active income requires effort, such as trading your time for your monthly paycheck or being actively involved in managing your rental apartments. Passive income streams on the contrary are money that does not require a lot of effort if any. Examples of passive income streams are a stable, increasing dividend stream, or income from an online course that you developed in the past.

Tim Ferris famously wrote, “Fun things happen when you earn dollars, live on pesos, and compensate in rupees.” Geoarbitrage is truly a super powerful tool that you can use to your benefit. However, there is also a major underlying risk since your income is in one currency while your expenses are in another currency. The outcome of the strategy becomes very dependent on the movements in the exchange rates because of the currency mismatch. The exchange rate volatility has the potential to further turbocharge your earnings, but it could also seriously backfire and consume part or all of the realized savings.

For example, if you earn USD, but your expenses are in local currency, obviously you would benefit when the USD is strong compared to the local currency. But the opposite is also true: a weak USD and a strong local currency would be bad news. In the past 1 year, the USD has weakened relative to many other currencies. For example, the USD lost 16.8% in value relative to the Australian Dollar (see screenshot below from Financial Times website). Hence, individuals with income streams in USD are sad, while individuals with income streams in Australian Dollars are happy.

Exchange rate volatility

Large swings in the exchange rates of more than 5% annually are relatively rare. But they do occur! It is also very hard to predict how 2 currencies will trade relative to each other over a longer period of time.

Savings should be used to create more wealth

From the above, it should be clear that geoarbitrage can unlock enormous cash flows. These cash flows should be redeployed in productive ways to further enhance your net worth and achieve FIRE. If geographical arbitrage provides short-term windfall, productive redeployment of your savings offers lasting effects. You can use these cash flows (1) to reduce your outstanding high-interest debt, (2) to invest in financial instruments, real estate, or your business ideas, and/or (3) to acquire business tools that increase your productivity or realize cost-savings.

Method 1: Reduce high-interest debt

You could reduce or eliminate interest expenses by repaying your loans. Since we live in a low-interest environment, the interest rates on many types of loans are quite low. Having some debt is not necessarily a bad thing. However, credit card debt and consumer loans can still have monstrous interest rates connected to them.

High interest rates on credit card debt

Method 2: Invest in productive assets

Financial instruments cover a wide range of instruments, such as saving accounts, shares, government and corporate debt, mutual funds, and REITs (Real Estate Investment Trusts). They are considered as productive assets because they generate income. They yield either interest, dividend, or rent.

Geographical arbitrage provides you with the income streams that allow you to comfortably invest in financial instruments. By investing in more risky assets, you can really get meaningful results towards FIRE. The price of financial instruments fluctuates almost daily and the direction is not always clear in the short run. It is called noise. In the long run, trends are more predictable that is why you should only invest with funds that you do not need in the foreseeable future. Patience is of paramount importance for investing!

Some of your investments might not yield a positive outcome, but geographic arbitrage provides you with room for error until you hit a home run. On average, your winners will more than make up for your losers.

Financial independence home run

In the summer of 2008, I started investing in the stock markets. A lot of my savings evaporated almost overnight because of the financial crisis that started in September 2008. My savings declined by a horrendous 40% in 1 day because of the total loss of trust in the financial system despite the companies I invested in were financially healthy. So, I had to choose between staying invested in the markets or accept defeat. Thanks to patience and persistence, I could gradually turn my losses into profits.

One key driver was the large income streams that were unlocked when I moved from Belgium to Bahrain. Geographical arbitrage allowed me to repatriate significant amounts of labor income back home. These funds were primarily used to invest in the stock markets and crowdfunding campaigns.

Method 3: Acquire business tools

Critical investments in business tools also have the potential to reduce your expenses or increase your income sustainably. For example, investments in automation projects, IT equipment with increased processing power, a second monitor, etc. The idea behind it is that these investments repay themselves.

Compound return: The 8th Wonder of the World

Albert Einstein considered compound interest the 8th Wonder of the World. Compound interest is a form of compound return. Investopedia defines compound return as the annualized rate at which capital has compounded over time. Your compound return can consist of interest, dividends, and/or capital gains.

While geoarbitrage provides you with the cash flows, the compound return puts your wealth generation on autopilot. In simple terms, compound return means that your net worth will grow each year by a certain percentage. Net worth is the total value an individual, household, or corporation owns after subtracting all the liabilities they owe. In subsequent periods, your increased net worth will also start to produce wealth. It is like a snowball that keeps accelerating and increasing in size.

Instead of keeping all savings in a low-interest savings account, people should consider investing in more risky assets, such as mutual funds, stocks, debt instruments, commodities, real estate, et cetera. Risky assets make your investment portfolio more sensitive to price changes. However, they generate much more income relative to low-risk, low-yield assets.

The below graph illustrates the strength of the annual compound growth rate. If you invested $100,000 as of 01/01/2021 at a rate of 0.50%, the amount would have grown to $122,079 by 01/01/2061. The rate of 0.50% is quite high in the current low-interest environment. In other words, over a period of 40 years, you would have earned an interest of $22,079. Not very inspiring, right? 

Compound rate of return

However, if you would invest the same $100,000 at a rate of 4%, the amount would have grown to $480,102. At an average rate of 8%, the sum would amount to $2,172,452. The below graph shows that by accepting some risk, your overall wealth growth can be turbocharged.

The benefits and disadvantages of geographic arbitrage

The disadvantages

Geoarbitrage is not for the faint-hearted. Moving countries can be very stressful and complex. There are several important considerations to make before you move, such as:

1. Job mobility

Not every job is suitable for remote work. A study by McKinsey found that the potential for remote work is concentrated among highly-educated workers in specific industries, occupations, and geographies. However, many jobs have little to no opportunity for remote work.

2. Family situation

The further away you live from your home country, the more important family considerations become. Some considerations are:

  • Do you have children? What is their age? Will they come with you?
  • Are you able to leave behind your friend’s circle and rebuild your circle from scratch?
  • Do you have a pet? Will you bring it with you?

3. Existing Liabilities

The presence of financial liabilities might prevent you from moving abroad. If you have an existing mortgage, you will have to decide what to do with your home. Are you planning to rent it out and manage it from abroad? Or, perhaps you don’t want the hassle of managing your property from abroad and prefer to sell it.

4. Plan for the worst

A lot of things can go wrong when living abroad. For example, when I moved to China in August 2019, I needed to exchange USD for Chinese Yuan. The bank counter staff made a mistake against the spelling of my name. This error prevented me from opening a bank account and transfer money into it. Without these funds, I could not sign a lease agreement and pay for my rent. It got rectified, but I ended up spending the entire day in the bank’s branch. 

5. Language barriers

Are you proficient in the language of your new host country? If not, would you be comfortable signing a rental agreement and other legal documents that are not in English or your mother tongue?

6. Health limitations

When you move countries, you need to take into account that the quality and costs of medical treatments are hugely different across the world. Moreover, some medicines might not be available in your new host country.

7. Currency mismatch

Receiving your income in one currency and paying your expenses in another currency exposes you to foreign exchange volatility risks. The currency mismatch is an opportunity, but also a risk factor.

The advantages

But Geographical arbitrage also offers some attractive benefits. For me, the benefits far outweigh the disadvantages.

1. Fast-track to financial independence

The most significant advantage of geographical arbitrage is that it can be your fast-track ticket to financial independence and early retirement, especially in combination with the power of compound returns. By moving to another geography, you might enhance your savings and reduce the amount of money that you require for financial independence & early retirement. So, it is a double win.

2. Better quality of living

The increase in savings also leads to an improvement in your quality of living. Living abroad can be a wonderful, life-changing, and adventurous experience.

3. Enhanced flexibility

Another benefit that is often cited by freelancers and digital nomads is that they enjoy more flexibility. The increased flexibility allows them to work with whom, when, and where they want.

Conclusion: Geographic arbitrage is an effective strategy to achieve FIRE

Geographic arbitrage is a powerful tool with the potential to turbocharge your net worth. By taking advantage of price differences between different locations, significant cash flows can be unlocked. The benefits of geoarbitrage can be achieved by reducing your expenses and/or increasing your income streams.

While geoarbitrage provides you with the cash flows, the compound return puts your wealth generation on autopilot. Geographical arbitrage and compound returns are a magic combination to achieve Financial Independence Retire Early (FIRE).

There are benefits and disadvantages to geoarbitrage. Living abroad is a wonderful, life-changing experience, but it can sometimes also become complex and stressful. Whether geographical arbitrage is something for you largely depends on your personality and what aspects you value the most in life.