It comes down to your budget; if it was my house I would put in aluminum soffit. If your budget is prohibitive to this then follow CCCs advice and cut out the damaged sections and replace.
The budget isn't really an issue, but I don't want to spend the money to redo the entire house when I only have a few problem areas. I also wouldn't like having aluminum soffit on the gables and wood soffit around the rest of the house. I want everything to be the same.
I think if I get it replaced correctly, caulk it, and paint it, the wood should be fine.