Government Shutdown Looks Increasingly Likely. Here's How It Could Impact Your Investments

As an investor, it sometimes seems as if every week brings new warnings of a potential crisis that might topple the economy or somehow hurt your portfolio. Whether it's a looming recession, energy crisis, war, or the debt ceiling, there've been no shortages of ways the sky could fall. Right now, the concern is that if politicians can't pass various bills before Sept. 30, there will be a government shutdown.

It's the second time this year that we've seen this kind of brinkmanship in Washington. First came the wrangling over raising the debt ceiling. If politicians hadn't reached a last-minute deal, the government would have been unable to meet its obligations. Not having enough money to pay the bills would have had bigger ramifications than the government shutdown that is now looming.

What is a government shutdown?

Without getting too far into the weeds, a government shutdown happens when Congress doesn't approve the funding that federal agencies need to operate. There are 12 annual appropriation bills that need to pass. If only some pass, those agencies would be able to operate and we'd only see a partial shutdown.

Even if there's a full shutdown, essential services will continue to operate. However, it will mean delays, limits, or closures to various non-essential federal services. That runs the gamut of the toilets in national parks to processing passport applications or small business loans. Agencies have contingency plans in place, which might involve operating a skeleton staff or tapping other sources of funding.

How a shutdown could impact your investments

Unlike the debt ceiling situation, which would have been unprecedented, there have been previous shutdowns. According to Brookings, there have been four serious government shutdowns in the past 30 years, the longest of which was in 2018 when the government shut down for 35 days.

The data from past shutdowns makes it easier to model how another one might impact investments. Even so, every economic situation is different. Here are four factors to consider in terms of a shutdown and your investment portfolio.

1. It could tip us into a recession

We've been doing a will-we, won't-we recession dance for quite some time now, and every potentially negative economic event triggers a new round of warnings. As such, there's concern a shutdown could be the straw that breaks the camel's back, recession-wise. Indeed, Treasury Secretary Janet Yellen told CNBC that a shutdown could cause a loss of momentum and create an unnecessary risk for what she says is a "strong economy."

2. A shutdown could slightly lower growth

A recent note from Goldman Sachs said, "Markets have not reacted strongly to past shutdowns." It estimated that each week of a government-wide shutdown would likely reduce growth by around 0.15%. Its economists point out that a shutdown would not impact spending on things like Medicare and Social Security. Plus, many federal employees provide essential services and would continue to work.

The U.S. Chamber of Commerce argues that this macroeconomic perspective is only one part of the picture. It says, "This approach fundamentally misses the microeconomic impacts for the private sector and Americans and communities across the country." It details the impact of, say, delays in approving permissions or loan applications can have on small businesses. It argues that the knock-on effect of a government shutdown goes beyond the direct impact on federal employees.

3. The length of the shutdown matters

Unfortunately, the U.S. Chamber of Commerce is concerned the political situation could cause any upcoming shutdown to drag on. And a longer shutdown means more time without fully functioning government departments. "If a government shutdown does occur, it is likely to be significant in duration with no clear path for reopening the government," it says.

Federal workers might consider boosting their savings account balances to cushion them against a lengthy shutdown. On an economic level, a longer shutdown would have a much bigger impact. It is one thing to weather a few days with limited federal services, but when those days stretch into weeks, it can be a different story.

4. It could dent confidence

More broadly, there's a question of confidence in the government's ability to get things done. In August, Fitch downgraded the U.S. credit rating from AAA to AA+. One of the reasons for the downgrade was "repeated debt-limit political standoffs and last-minute resolutions."

A country's credit rating is a bit like your personal credit score. On the face of it, what's essentially a move from excellent to a slightly-below-excellent doesn't make that much difference. All the same, when the biggest economy in the world loses its triple-A status, it's a reason to pay attention.

Keeping a long-term perspective

The widely forecasted recession may not have materialized, but economic uncertainty persists. Some analysts are optimistic we can avoid a prolonged downturn. Others believe it's only a question of time before a recession hits. With so much that is unknown, there is a risk that any additional stress points -- such as a government shutdown -- could upset the balance.

Recession risks aside, it looks like a government shutdown would have at least a short-term impact on markets. That said, it is unlikely to be catastrophic. Importantly, in the past, most of the GDP lost in recessions has been recovered.

If you're a long-term investor, a shutdown would likely be one of many short-term blips that cause a temporary drop in your brokerage account investments. The trick is to not panic and to keep focused on your wider investment goals and strategies.